Sold a house recently for a profit? After some joy and relief, you would be worried about paying taxes. If the gains are long-term — property was held for over two years — there are three ways to avoid paying capital gain taxes. Two of the options — investing in another property and buying 54EC bonds — are popular and they have existed for long. There is also a lesser-known option — investing in a business.
Section 54GB of the Income Tax Act allows investment of long-term property gains in eligible business by individuals and Hindu Undivided Families (HUFs). To be eligible, the company should be in the business of manufacturing articles or in an other eligible business. The company can be a start-up (as defined by the government for incorporate date, turnover) or be qualified under the MSME Act, 2006.
To claim tax exemption, you need to have an equity stake or voting rights of over 25 per cent after buying the shares. The purchase must happen within six months of selling the property. The company should invest the capital raised to buy new assets such as plant and machinery within one year from the date of investment. Assets also include computers or computer software, for technology driven start-ups. The assets must not be transferred for five years. However, as computers and software do not have a long life, their holding period restriction has been reduced from five years to three years.
The company should be a new entity. For instance, for capital gains arising in 2018-19, it must have been incorporated on or after April 1, 2017.
Doing it right
As this is a new provision (introduced in Budget 2016), there may be questions raised by the Income Tax Department. “You need to have evidence of manufacturing activity, paperwork for machinery purchase and clear source of funds,” says Venkat Krishnamurthy, chartered accountant at V Ramaratnam & Company. He notes that the company getting MSME approval is a must, whereas registration with the Department for Promotion of Industry and Internal Trade (DPIIT) is not mandatory.
He added that based on the timelines there may be one more complication. For example, say an investor sold a house in August 2018. Share purchase needs to happen by February 2019 and the company has until February 2020 to invest in plant and machinery. However, the investor needs to file income tax returns by July 31, 2019.
“If the company had made investments by the time of filing returns, there will be no issues; if not, the company has to invest in a separate bank account designated for such purposes,” he said. The amount not invested within a year becomes taxable.
Also, while you can split your gains across two houses or across bonds when reinvesting, there is no such provision to split across multiple companies. Venkat notes that if the seller is an NRI, they should make sure there are no RBI restrictions on the investment.
How do the three options compare — buying a house, investing in bonds or buying shares in a company?
If you have a requirement to buy a house, that gets precedence over other two options. The rules are reasonably flexible in allowing purchase — you can buy a house within two years after the date of sale, or construct a house within three years after the date of sale.
If you do not plan to buy a house, bonds may be the next best option. Rules allow you to invest up to Rs. 50 lakh in qualifying bonds to get the deduction. If the property was held jointly, each of the owner can invest Rs. 50 lakh individually. Section 54EC bonds are issued by National Highways Authority of India (NHAI), Rural Electrification Corporation (REC) and Power Finance Corporation (PFC).
The bonds have a low interest yield — 5.75 per cent. Plus, the interest income is taxable at the investor’s income tax bracket. There is also a lock-in of five years.
The idea of 54GB was to enable founders to sell their property to launch a company or attract early-stage investors to bet on new enterprises, with tax benefit. So, this is a good option if these thoughts are on your mind.
You cannot compare buying AAA rated bonds to investing in a new venture — it will be comparing chalk and cheese.
So, if you anyway plan to start a venture that requires capital or you wish to invest in a start-up after understanding the illiquidity, long holding period and risks, you can weigh the new provision. Else, bonds are a good bet.