- A Bond is a debt instrument issued for the purpose of raising capital by borrowing.
- Bonds can be issued by companies, financial institutions, or the government. Bonds issued by the government are considered the safest bonds.
- Bonds can be divided into different categories based on tax status, credit rating, issuer type and maturity.
- Bonds are suitable for regular income purposes.
- Specific tax saving or tax free bonds are available that offer certain tax benefits to the investor.
What is Capital Gains Bonds (U/S 54EC)?
- In accordance with section 54 EC of the Income Tax Act, 1961, all categories of tax payers would be eligible to save tax in respect of long term capital gains by making investments in certain Bonds prescribed.
- These bonds are classified as “long-term specified asset” and are issued by NABARD, REC, NHAI, NHB and SIDBI.
- These bonds are specifically for investors who have made some long term capital gains, and would like to save capital gain taxes on this amount.
- Only long term capital gains are eligible for these bonds though, and short term gains are not covered under section 54EC.
- The interest from these bonds is fully taxable.
- Investment returns are fixed. You receive a fixed rate of interest and your principal returned when the bond matures. You know exactly how much your return will be.
- Less risky compared to stocks. Besides receiving specified investment returns, bondholders are paid first over shareholders in the event of liquidation.
- Less volatile. A bond’s value can fluctuate according to current interest and inflation rates but are generally more stable compared to stocks.
- Bonds have clear ratings. Unlike stocks, bonds are universally rated by credit rating agencies like Standard & Poor’s and Moody’s, CRISIL(Credit Rating Information Services of India Limited, ICRA Limited, Small and Medium Enterprises Rating Agency of India (SMERA), Brickwork Rating etc This gives investors more assurance when picking a bond but you probably still want to conduct your own research and due diligence before investing.
- Investment returns are fixed. While this offers higher safety for investors, it is also a disadvantage as you forgo the higher potential gains if you invested in equity.
- Larger sum of investment needed. While some bonds can be purchased for relatively low sums (10 thousand to 1 Lakh rupees), some bonds may require larger amounts which may put them out of reach for individual investors.
- Less liquid compared to stocks. Some bonds may be highly liquid like those issued from the Government Treasuries and major corporations, but bonds issued by a smaller; less financially stable company may be less liquid as there are fewer people willing to buy them. Bonds with very high face values will also be less liquid as the pool of potential buyers is smaller.
- Direct exposure to interest rate risk. Interest rates (Bank Rates changes by Reserve bank of India) affect the value of bonds more directly compared to stocks. If you plan on just receiving interest payments and holding the bond to maturity, this might not concern you. But otherwise, bondholders are more exposed to interest rate risk.