Five things to consider before you opt for premature withdrawal from sovereign gold bonds

The premature withdrawal of sovereign gold bonds (SGBs) issued in October-September 2016—Series III of SGB 2016-17—opens is due on May 17. SGBs are government securities denominated in grams of gold and are substitutes for holding physical gold. The bond is issued by the Reserve Bank of India (RBI) on behalf of the government. Although the maturity tenor of the bond is eight years, investors are allowed an early exit after the fifth year from the date of issue on coupon payment dates, but with some conditions. However, just because there is an option to exit early, should you exercise it? Let’s read more about things one should consider before opting for early withdrawal.

How to make premature withdrawal

In order to make a premature redemption, investors can approach the bank concerned, Stock Holding Corporation of India, post office or agents from between thirty days and one day before the coupon payment date. The proceeds get credited to the customer’s bank account provided at the time of applying for the bond.

Given that SGBs are listed on the stock exchanges, investors also have the option to sell their holdings on the bourses as well, but the problem is that such bonds are very thinly traded. Also, many times they trade at a discount to the fair value.

How is the redemption price calculated?

The redemption price of SGBs is calculated based on the simple average of the closing price of gold of 999 purity of the week (Monday-Friday) preceding the date of redemption as published by the India Bullion and Jewellers Association. If we take into account the redemption price for Series III of SGB 2016-17, which is due on May 17, is Rs 5,115 per unit of SGB based on the simple average of the closing price of gold for the week May 9 to 13.

Taxation on gains

According to FAQs related to SGB on the RBI website, “Interest on the Bonds will be taxable as per the provisions of the Income-tax Act, 1961 (43 of 1961). The capital gains tax arising on redemption of SGB to an individual has been exempted. The indexation benefits will be provided to long-term capital gains arising to any person on transfer of bond.” The statement related to capital gains tax is a little vague as it says that “capital gains tax arising on redemption of SGB to an individual has been exempted” but at the same time it also says indexation benefits will be provided to long-term capital gains.

However, according to tax experts, in the RBI statement, redemption should be read as exiting at the time of scheduled maturity, whereas transfer should be read as premature withdrawal any time before maturity. Accordingly, “After the maturity of eight years, the entire gains are exempted or tax free. But if the SGBs are redeemed after the lock-in period of five years and before the maturity period of eight years, the gains accumulated on the redemption of SGBs will be long-term capital gains (LTCG) and will be taxed at 20 percent with indexation benefit,” said Deepak Jain, chief executive, TaxManager.in, a tax e-filing and compliance management portal.

But if you sell these bonds before 36 months from the date of purchase, any gains in such a case will be considered as short-term capital gains and taxed at your slab rate, he added.

The benefit of indexation

Selling SGBs at a profit attracts capital gains tax. The LTCG from selling SGBs is taxed at 20 percent, with indexation, the benefit of which is provided to long-term investors. A higher indexation lifts the cost price up to factor in inflation. This brings down the taxable gains and your taxes also go down. For instance, consider that you have invested in Series III of SGB 2016-17, and now you have redeemed your investments.

As the bond was held for more than three years, it will be considered a long-term capital asset. So, you should first calculate the indexed cost of acquisition by applying CII (cost inflation index) on the cost of purchase, i.e., Rs 2,957 per unit (after considering Rs 50 as initial promotional discount) of the SGB. You can find the CII values on www.incometaxindia.gov.in. In the example, CII is 264 (2016-17) and 317 (2021-22) for the years of purchase and sale, respectively. (CII values for 2022-23 are yet to be notified, you should consider that while making the final calculation.) So, the indexed cost of acquisition per unit would be Rs 3,551 [2,957 * (317/264)]. Accordingly, your LTCG would be Rs 1,564 (5,115 – 3,551) per unit. This is the amount on which LTCG tax at the rate of 20 percent will apply.

Reinvestment risks

The other important point to consider before you decide to make a premature withdrawal is the purpose or logic behind withdrawing the funds. “Investors should first ask, ‘Is there a need for funds? What are the alternative sources for the same?’” said Lovaii Navlakhi, MD and CEO, International Money Matters. If the intention is to reinvest, why exit in the first place, he said.

Selling out the SGB just because gold prices have turned weak in the international market may not be a wise decision. Your asset allocation should be the guiding factor for this decision. If you have invested in SGBs to achieve a certain level of exposure to the yellow metal, then sell the SGB if and only if you are overinvested in gold. Otherwise it is a good investment to hold on to.

Considering the current market scenario and return from SGBs in the last few years, many experts believe it is wise to remain invested till maturity instead of making an early exit.

“SGBs are primarily bought for buying gold as a long-term asset allocation strategy which, apart from the capital appreciation, also gives 2.5 percent annual interest. SGB 2016-17 Series III bonds have given very good returns of about 13.5 percent annualised including the interest earned,” said Sanjeev Govila, CEO of financial advisory firm Hum Fauji Initiatives.

With the current uncertainty on inflation stickiness and GDP growth outlooks, it would be good to hold on to these SGBs, added Govila.

So, before you rush for the exit on SGB investments, take into consideration associated LTCG taxation disadvantages and reinvestment risks.