This Akshaya Tritiya, you might be tempted to buy Sovereign Gold Bonds or even Gold exchange-traded funds (ETFs) considering the lucrative prices at which they usually trade in.
But before you make the purchase, check out the hidden cost and tax component on them, as well as gather any specialised knowledge that you might require in order to buy them.
What Are Sovereign Gold Bonds (SGBs)?
SGBs are central government-backed gold bonds which are denominated in grams of gold, and also bear an interest of 2.5 per cent per annum on the issue price. They are issued for a fixed term of eight years with an option to redeem them from the fifth year onwards at the RBI buyback window.
Cost: An investor doesn’t have to pay any cost or charges for buying these. He/she can hold them either in his/her demat account or by way of e-certificates (non-demat). If you were to hold them in your demat account, then depending on your broker, you will have to bear an annual maintenance charge. Conversely, if you hold them via an e-certificate mode, then you cannot sell it on the stock exchange.
Taxation: The interest received on SGBs are taxable in the hands of the investor. “The interest received from SGBs will be taxable as Income From Other Sources (IFOS), but as per Section 193 of the Income Tax Act, 1961, no Tax Deducted At Source (TDS) shall be applicable on this interest earned,” says Ankur Agarwal, a Chartered Accountant with expertise in taxation.
Specifically, there are two aspects to its taxation. “If one prematurely sells his gold bonds by selling them on the stock exchange before three years, then it will attract short-term capital gains tax (STCG) as per the investor’s slab rate. But if he sells them after a period of three years, then long-term capital gains tax (LTCG) of 20 per cent will be applicable, and the investor will also get indexation benefits. But if one were to hold the bonds till maturity, or till the RBI buyback window, then no capital gains tax will be applicable. The exemption at the time of redemption is also regardless of whether one has originally applied for the SGB or has purchased it in the open market, irrespective of the holding period,” says Balwant Jain, a tax and investment expert.
“Generally, bonds are not given indexation benefits, but in the Finance Act 2016, a special exemption was given to SGBs, wherein they were given indexation benefit. Indexation benefits help lower the final tax outgo of the investor, since it factors in the inflation cost of an investment,” adds Agarwal.
Knowledge: It is good to have a basic knowledge about bonds and where they are issued, when they will be redeemed, what forms to fill up, and how to check the interest credit in a bank account. But if you wish to trade in them by selling them on the stock exchange, then some degree of specialised trading knowledge is required, otherwise you might have to bear a loss on your investment.
What Are Gold Exchange-Traded Funds (ETF)?
Gold ETFs represent the physical gold, but in dematerialised or electronic form. Investors can trade in them just the same as with stocks through a registered broker by using a demat account. ETFs are cash settled, and hence, upon selling, investors will get cash, and not the physical gold.
Cost: Although no exit or entry load is charged on gold ETFs, but they incur some charges, including a demat account maintenance charge, which is charged by the respective brokers.
“A gold ETF incurs three main charges and one hidden cost. Those are the expense ratio, which is taken for managing the ETF, trading cost, which is the brokerage fee, and the holding cost, which is the demat account annual maintenance charge as applicable. There is also a hidden tracking difference opportunity cost component attached, especially if the product is traded at a premium. This is the difference between the actual value and the traded-value of the ETFs, which investors need to check in the respective ETF before investing,” says Rushabh Desai, founder, Rupee With Rushabh Investment Services.
Taxation: Gold ETFs are traded on the stock exchanges. Their taxation aspect is explained as, “They will attract STCG tax as per an investor’s income tax bracket if they are sold before 36 months of buying. It will be included in the ‘Capital Gains’ tax column. If they are sold after 36 months, then LTCG of 20 per cent will be applicable, and an investor will also get indexation benefits,” adds Jain.
“Indexation is a type of benefit that lets an investor adjust their original purchase price of an investment with respect to inflation. The Cost Inflation Index (CII) is announced by the Central Board of Direct Taxes (CBDT), and is used to calculate this. The Formula is Original amount*CII of the current year divided by CII of the purchasing year,” says Jain.
Knowledge: Buying an ETF requires a bit of experience and knowledge in trading, since a lot of different factors are involved. For example, on certain volatile days, these ETFs trade at a high premium, and if you place a market order instead of limit order on those days, then there is a high chance you will buy it at a higher cost. The tracking error values are also different for different ETFs. You will need to draw up a chart and compare them, before deciding on which one to buy.
A Sovereign Gold Bond (SGB) will pay you a fixed interest and allow certain tax benefits, but the money will get locked for quite a substantial time, unless you decide to sell it on the stock exchange, but that’s another aspect to them. You can read more about that here
On the other hand, Gold ETFs allow you to buy smaller quantity of gold and provide a good liquidity exit option, but they have certain mandatory expenses, and also require a little bit of trading knowledge.