On May 17, the early withdrawal period for sovereign gold bonds (SGBs) issued in October-September 2016—Series III of SGB 2016-17—ends.
SGBs are government securities that are denominated in gold grammes and can be used to replace physical gold.
The Reserve Bank of India (RBI) issues the bond on behalf of the government.
Despite the bond's eight-year maturity, investors are permitted to exit early on coupon payment dates after the fifth year from the date of issue, subject to certain conditions.
Should you take advantage of the option to leave early just because it exists?
Let's look at some of the items to think about before making an early withdrawal.
How do I make an early withdrawal?
Between thirty days and one day before the coupon payment date, investors can approach the bank, Stock Holding Corporation of India, post office, or agents to make a premature redemption.
The funds are deposited into the customer's bank account, which was provided when the bond was applied for.
Due to the fact that SGBs are sold on stock exchanges, investors can sell their holdings there as well, however the difficulty is that such bonds are rarely exchanged.
Furthermore, they frequently trade at a discount to fair value.
What factors go into determining the redemption price?
The simple average of the closing price of gold of 999 purity for the week (Monday-Friday) preceding the redemption date, as announced by the India Bullion and Jewellers Association, is used to compute the redemption price of SGBs.
Based on the simple average of the closing price of gold for the week of May 9 to 13, the redemption price for Series III of SGB 2016-17, which is due on May 17, is Rs 5,115 per unit of SGB.
Gains are taxed.
"Interest on the Bonds shall be taxable as per the terms of the Income-tax Act, 1961," according to RBI FAQs on SGB (43 of 1961).
The capital gains tax on SGB redemptions to individuals has been eliminated.
Long-term capital gains deriving from the transfer of a bond will be eligible for indexation benefits."
The statement on capital gains tax is a little ambiguous because it states "capital gains tax resulting on redemption of SGB to an individual has been exempted," yet it also says long-term capital gains would receive indexation benefits.
According to tax experts, redemption should be interpreted as exiting at the time of scheduled maturity in the RBI statement, whereas transfer should be interpreted as premature withdrawal any time before maturity.
As a result, the entire gain is exempted or tax free after the maturity of eight years.
However, if the SGBs are redeemed after the five-year lock-in period and before the eight-year maturity period, the gains accumulated on the redemption of SGBs will be long-term capital gains (LTCG) and will be taxed at 20% with indexation benefit.
However, if you sell these bonds within 36 months of the purchase date, any earnings will be considered short-term capital gains and taxed at your slab rate, he warned.
Indexation's Advantage
Capital gains tax is triggered when SGBs are sold for a profit.
The long-term capital gain (LTCG) from selling SGBs is taxed at 20% with indexation, which benefits long-term investors.
Increased indexation raises the cost price to account for inflation.
As a result, your taxable gains are reduced, and your taxes are reduced as well.
Consider the case where you invested in Series III of SGB 2016-17 and have now redeemed your assets.
The bond will be classified as a long-term capital asset because it has been kept for longer than three years.
As a result, you need first compute the indexed cost of acquisition by using the CII (cost inflation index) to the SGB's purchase price, which is Rs 2,957 per unit (after subtracting Rs 50 for the initial promotional discount).
The CII values can be found at www.incometaxindia.gov.in.
For the years of purchase and sale, CII is 264 (2016-17) and 317 (2021-22), respectively.
(Because the CII figures for 2022-23 have not yet been released, you should factor it into your final calculations.)
As a result, the indexed purchase cost per unit is Rs 3,551 [2,957 * (317/264)].
As a result, your LTCG per unit would be Rs 1,564 (5,115 – 3,551).
This is the sum that will be subject to LTCG tax at a rate of 20%.
Risks of reinvestment
The goal or logic behind withdrawing the funds is another key factor to examine before making a premature withdrawal.
Selling the SGB simply because gold prices have fallen in the international market may not be a good idea.
This selection should be made based on your asset allocation.
If you bought SGBs to get a set amount of gold exposure, you should sell them only if you are overexposed to the yellow metal.
Otherwise, it's a great investment to keep.
Given the present market environment and SGB returns during the last few years, many experts say it is prudent to stay invested until maturity rather than exit early. SGBs are primarily purchased for the purpose of purchasing gold as a long-term asset allocation strategy that provides 2.5 percent yearly interest in addition to capital appreciation.
With the current uncertainties around inflation stickiness and GDP growth forecasts, Govila suggests holding on to these SGBs.
Take into account the accompanying LTCG taxation disadvantages and reinvestment risks before selling your SGB investments.
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