Your Questions Answered: What are the pros and cons of investing in SGBs and how are they taxed?

Q. I am a 28-year-old businessman running my real estate business in Varanasi, Uttar Pradesh. My family has been investing in gold since ages, however, recently I came to know about the Sovereign Gold Bonds Scheme. Based on my limited understanding SGB appears to be as safe as investing in physical gold. Can you please elaborate on what are the pros and cons of investing in SGB, how they are taxed and whether investing in SGB is advantageous over investing in physical gold.

Sovereign gold bonds (SGBs) are government securities denominated in grams of gold. They are substitutes for holding physical gold. Investors have to pay the issue price in cash and the bonds will be redeemed in cash on maturity.

The bond is issued by the Reserve Bank of India on behalf of the Government of India. SGBs were introduced in 2015 to reduce the demand for physical gold and shift a part of the domestic savings into financial assets. The scheme also aims to provide a new source of funding for the government and diversify its borrowing instruments.

Physical Gold vs SGB

Here are the key differences between investing in physical gold and sovereign gold bonds:

Purity: Physical gold is available in various purities, such as 24k, 22k, 21k, and 18k. SGBs are issued in 99.5% purity.

Storage: Physical gold needs to be stored safely, which can be a hassle and involve some cost. SGBs are held in demat form, which means they are stored electronically in the investor's account.

Liquidity: Physical gold is highly liquid and can be easily sold in the market. SGBs have a lock-in period of 5 years, after which they can be redeemed or traded in the secondary market.

Risk: The price of gold can fluctuate, so there is a risk of loss if the price falls. However, the price of gold in the long term has generally increased and therefore gold has been the preferred asset class, especially in uncertain times, world over. In case of SGB redemption redemption price will be based on the simple average of the closing price of gold of 999 purity of the previous 3 business days from the date of repayment.

Return: The return on investment (ROI) on physical gold depends on the change in the gold price. Additionally, it is important to note that the SGB investors will also receive additional 2.5% interest annually.

Advantages 

SGBs have several advantages some of them are:

• The quantity of gold for which the investor pays is protected, since he receives the ongoing market price at the time of redemption/ premature redemption.
• The investor also receives a fixed interest of 2.5% per annum on the amount of initial investment, payable semi-annually.
• SGBs are free from issues like making charges and purity in the case of gold in jewellery form.
• The bonds are held in the books of the RBI or in demat form eliminating risk of loss of scrip etc.
• SGBs can be used as collateral for loans from banks, financial institutions and non-banking financial companies (NBFCs).
• SGBs are tradable on stock exchanges within a fortnight of issuance.
• SGBs are exempt from capital gains tax if held till maturity.

Disadvantages

Drawbacks associated with SGB are as follows:

• There may be a risk of capital loss if the market price of gold declines. However, the investor does not lose in terms of the units of gold which he has paid for.
• The liquidity of SGBs is lower than physical gold, as they have a lock-in period of 5 years for early redemption. The trading volume and frequency on stock exchanges may also be low.
• The interest income from SGBs is taxable as per the provision of 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.

Latest tranche of SGBs

The latest tranche of SGBs will be issued in September 2023 with a tenor of 8 years and an interest rate of 2.5% per annum. The issue price will be based on the simple average closing price published by the India Bullion and Jewellers Association Limited for gold of 999 purity for three working days before the subscription period. The minimum investment will be one gram and the maximum will be 4 kg for individuals and HUFs and 20 kg for trusts and similar entities per fiscal year.

SGB vs Physical Gold: Which is better?

The answer to this question depends on the investor's objective, risk appetite, time horizon, and preference. Both forms of gold investment have their pros and cons, and investors should weigh them carefully before making a decision. However, some general points to consider are:

• If the investor wants to earn interest income and capital appreciation from gold investment, SGBs are better than physical gold.
• If the investor wants to use gold for personal or gifting purposes, physical gold is better than SGBs.
• If the investor wants to save tax on capital gains from gold investment, SGBs are better than physical gold.
• If the investor wants to have high liquidity and flexibility from gold investment, physical gold is better than SGBs.

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Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.