The Complete Guide on Sovereign Gold Bonds (SGB)

Posted by  Fintra , updated 2023-02-04

Sovereign Gold Bonds (SGB), issued by the Reserve Bank of India (RBI) in November 2015 on behalf of the Government of India, are not like any other government bonds- They are bonds backed by gold. SGB are RBI mandated certificates issued against grams of gold, enabling individuals to invest in gold without bearing the strain of safekeeping the physical asset. Having a fixed interest rate of 2.5% interest per annum that is paid semi-annually, the SGB acts as a secured investment instrument among individuals, as gold prices are less exposed to market fluctuations. Their maturity period is eight years, but one can opt for redemption with RBI after the end of five years. Sovereign Gold Bonds (SGB) are listed on the stock exchanges and can be traded on them as well. 

Being popular and having a widespread demand, gold prices over time tend to rise significantly, making it a highly prospective investment avenue. Since SGBs are issued by the RBI under Government of India stocks, they have a particular window that is pre-set for subscription, and during it, the sovereign gold bond scheme gets issued in the name of the investor in tranches. Typically, the RBI declares the issuance of the latest sovereign bonds in a press release every 2-3 months, with a one-week window during which you can subscribe to this scheme. Upon the successful purchase of a sovereign gold bond, a holding certificate gets issued in the name of the investor.

In this blog, we will highlight the following topics on Sovereign Gold Bonds (SGB):

1. Why Should You Invest or Purchase Sovereign Gold Bonds (SGB)?
2. Benefits and Features of Sovereign Gold Bonds (SGB)
3. Pros and Cons of Sovereign Gold Bonds (SGB)
4. How Do Sovereign Gold Bonds (SGB) Work?
5. How to Purchase Sovereign Gold Bonds (SGB) Online?  
6. How Sovereign Gold Bonds (SGB) are Taxed in India?

In SGB, the gold gets sold on a per-unit basis, every unit derives its value from underlying one gram of gold with 999 purity. The cost is then calculated by taking the average of the closing prices of gold for the latest three working days preceding the subscription period. The closing prices are published by the India Bullion and Jewellers Association Limited (IBJAL). Even the redemption price gets calculated on the latest base data from the same source.

Why Should You Invest or Purchase Sovereign Gold Bonds (SGB)?

Why should you invest in gold via Sovereign Gold Bonds (SGB)? The answer is that it is easier and quicker. The portion of gold the investor pays for is protected, and at the time of redemption/ premature redemption, the investor receives the ongoing market price. Since the principal in gold units and the regular payment of interest gets guaranteed by the government, there is no risk of default involved. Moreover, gold decreases the risk of bonds and equity portfolios in uncertain times because do bear in mind gold usually performs best when there is uncertainty. For these reasons, SGB offers one of the best alternatives to holding gold in physical form. In fact, these bonds are maintained in the books of the RBI or in the demat form; this eliminates the risk of loss of scrip etc.

Benefits and Features of Sovereign Gold Bonds (SGB)

Sovereign Gold Bonds (SGB) is known to be a lucrative investment option because they help in taking advantage of rising gold prices along with paying annual interest of 2.50% to investors. Hence there are various benefits and features of SGB. For example, one of the biggest benefits of these bonds is that they offer a good hedge to an investor's overall portfolio during tough times. Some other benefits and features are listed below: 

• The SGB prices are calculated by taking the average of the closing prices of 999 purity gold of the last 3 days that is set by the Indian Bullion and Jewellers Association Limited (IBJA)
• SGB bonds get issued for a period of 8 years, and the premature withdrawal permission is availed from the 5th year. Moreover, individuals may sell their securities in the secondary market at the market rate of gold
• After a mandatory holding period of 5 years, individuals can cash in their investment. The payout benefit can be availed for the 5th, 6th, and 7th year of bond tenor, and it will be processed on the interest disbursement days
• The Sovereign Gold Bond Scheme can be traded in the secondary market after 14 days from the initial subscription date, subject to a notice published by the RBI. The prices of these bonds are transacted depending on the prevailing gold prices on the stipulated date, and its corresponding demand and supply in the stock market. For transactions in the stock market, one needs a holding certificate that's digitised and stored in its Demat account

• Subscriptions have to be made as grams of gold. The minimum acceptable investment is 1 gram of gold. On the other hand, the maximum limit of subscribed is 4kg for individuals and Hindu Undivided Families (HUF). For trusts and corporations, the upper limit is set at 20kg

• The RBI issues Press Release that states the issue price of the Bond before the new Issue. The Bond's price gets fixed in Indian Rupees based on the simple average of the closing price of gold of 999 purity that's published by the India Bullion and Jewellers Association Limited (IBJA) for the last 3 business days of the week preceding the subscription period
• The payment of the Bonds gets done through cash payment, up to a maximum of Rs. 20,000, and/or demand draft, cheque, or electronic banking
• Gold Bonds are issued as Government of India Stocks under the Government Security Act, 2006
• SGB is used as collateral for loans, too. Loan-to-value (LTV) ratio is set equal to the ordinary gold loan, which is mandated by the RBI. The lien on the bond will be marked in the depository by the authorised banks. Do note that the loan against SGBs is subjected to the decision of the bank/financing agency and can't be inferred
• SGB is tradable on stock exchanges within a fortnight of the issuance on the date that's notified by the RBI

Pros and Cons of Sovereign Gold Bonds (SGB) 

There are some pros and cons of investing in SGBs, hence, we now begin browsing through the pros of investing in gold bonds:

• The procedure and process of making an investment are very simple and it can also be done offline or online via a banking or trading account. The KYC requirement is minimal, just a basic PAN Card based KYC is required.
• Since the principal and interest are in units of gold, it is guaranteed by the government, eliminating any default risk on the investment.
• When holding on to the bonds for the entire tenure of 8 years, the capital gains are entirely tax-free, which in turn substantially improves an individual's post-tax yield.
• There is substantial freedom to invest in gold bonds. One can invest a minimum of 1 gram and a maximum of 4 KGs per person. If multiple members in a family are investing, then up to 4 KGs can be invested by each person.
• The SGB price appreciates with the gold's price, thus, it feels like owning gold without the hassles of physical holding. It is cheaper to hold as SGBs than physical gold.
• Although SGBs mirror the gold's price like how gold ETFs do, they have added advantage of paying 2.5% annual interest on the principal amount.

Some of the cons of SGBs are: 

• SGBs bear the gold price risk. For example, in the past, we have observed gold prices have been in a long-term facing falling trend. Between 1981 and 1999, gold fell tremendously, approximately from $980/oz to $240/oz. Hence, in these conditions, SGBs wouldn't be profitable.
• To be free of capital gains tax, SGBs have to be held for a tenure of 8 years. Any holding below it makes the capital gain taxable. Even interest earned gets entirely taxable at peak rates.
• While SGBs are usually listed on the stock exchanges after 6 months of issue, the secondary market trading is too thin. Either, one doesn't get liquidity or the prices are too skewed.
• Unlike gold ETFs that are available at real-time gold prices along with total liquidity, SGBs are only obtainable in tranches and exit is possible only when the government opens the repurchase window after 5 years.
• At present, SGBs accept only investments in cash forms and are redeemable in cash. The scheme could have been more useful if it even had a gold monetization angle to it.
• Gold prices at times have an inverse correlation with the stock market, wherein any upturn in stock market returns is normally followed by reduced gold prices. During economic booms, investors do have an optimistic approach towards the stock markets, as expectations rise for companies to perform well in response to surging aggregate demand levels. As a result, the demand for gold bonds falls, leading to a downtrend in market prices. Hence, during the upswing of the business cycle, gold prices tend to get relatively lower.
• Any fluctuations occurring in currency values tend to have an impact on the price at which gold is to be traded. Appreciation of the US dollar, which is the benchmark currency, causes gold prices to falter because of higher inflation rates. As import expenses rise of a country, the total investment level of the country falls, hence, affecting the demand for gold and its prices.
• The returns of SGB can be classified into two types, the capital gains earned on the maturity of a bond and interest earnings that gets disbursed semi-annually. Those who have been holding a bond for the entirety of the tenure don't have to pay long-term capital gains tax. However, the periodical interest income does get taxed under ‘Income from other sources,’ and attracts tax rates as per the respective income tax slabs that are established by the central government. Investors opting for the resale of a bond in the secondary market will have to pay tax on their capital gains realised. Resale before the completion of 3 years will attract short-term capital gains on total profits, at rates as per the annual income of the investors. On the other hand, long-term capital gains are believed to attract tax at 20% of the total earnings, after adjusting the same for indexation. 

How Do Sovereign Gold Bonds (SGB) Work? 

As described earlier, RBI issues SGBs in different tranches during the financial year. SGBs are made available through brokers, banks, post offices, and online platforms. In fact, it is believed that a certain discount on per gram purchased is offered to individuals who purchase them digitally to encourage buying SGBs online. Throughout the year, RBI introduces new series of SGBs for sale in the market. Hence, if someone misses the last one announced, the investor can wait for the next issue to be announced.

An investor can purchase the bonds in digital, physical or dematerialized format. If purchased physically, investors will get the bonds credited to their demat accounts by making a specific request for it. RBI will then process the dematerialization at their end, and during this process, until it's not done, the bonds are held in RBI’s books. Dematerialization may also be done post-allotment. Those who aren't purchasing directly from the RBI can purchase the units from the secondary market such as from the stock exchanges.

How to Purchase Sovereign Gold Bonds (SGB) Online?  

SGBs are generally sold via offices or branches of the Nationalised Banks, Scheduled Private Banks, Scheduled Foreign Banks, designated Post Offices, Stock Holding Corporation of India Ltd. (SHCIL), and the authorised stock exchanges directly and/or through their agents. Hence, purchasing Sovereign Gold Bonds (SGB) online is very easy, they can be purchased online through the website of the listed scheduled commercial banks. The Gold Bond's issue price will mostly be Rs. 50 per gram less than the nominal value to the investors who're applying online. The payment against the application will be done through digital mode. Following are some of the common steps to be done while purchasing bonds online:

Step 1: Log in to the preferred bank’s internet banking account

Step 2: Click on the “e-service” option and select the “Sovereign Gold Bond” option

Step 3: Read carefully the “terms and conditions” drafted by RBI and click on “Proceed”

Step 4: After filling out the registration form, click on “Submit”

Step 5: In the purchase form, put the quantity of subscription you desire and insert the nominee details

Step 6: Finally, after verifying the details, click on the “Submit” option

How Sovereign Gold Bonds (SGB) are Taxed in India?

In India, interest on the SGBs gets taxable as per the provisions of the Income-tax Act, 1961 (43 of 1961). However, the capital gains tax occurring on the redemption of SGB to an individual is been exempted. The indexation benefits are provided to long terms capital gains arising to any individual on the transfer of a bond. Do note that tax deducted at source (TDS) isn't applicable on the bond. However, the bondholder must concede with the tax laws.

Following are some insights on how SGB are taxed: 

1. Short-term capital gain (STCG): If an investor within 3 years of purchase sells its SGBs at a profit, then it is assumed STCG, this is taxable. This gain gets added to the income of the investor for the year and it will be taxed as per the applicable tax slab to the individual. As an example, if an investor's income falls in the tax slab of 20%, then 20% STCG will be assigned on the profit amount.
2. Long-term capital gain (LTCG): When an investor books profit in SGBs after 3 years of purchase, this tax is used. This is applicable at 20%, when indexation is availed, or 10% if the indexation is not availed. Briefly describing, indexation is the method used for adjusting the purchase price of an investment to reflect the influence of inflation on it. This, increases the purchasing price of the asset, resulting in lower profits. LTCG doesn't apply to investors holding the units until maturity. The gains on units held till maturity are tax-exempt. LTCG even does not apply to Hindu Undivided Family and Trusts.
3. Tax on Interest: The SGB holders will get an interest of 2.5% per annum on the face value of their bond. This interest amount is taxable and will be added to the investor’s income and will get taxed as per the applicable tax slab. 
4. GST on stamp duty and brokerage: Do note on the purchase of SGBs from the secondary markets and/or stock exchanges brokerage is applicable. The broker charges brokerage and the rate of the brokerage may vary from broker to broker and person to person. It is assumed that a flat 18% Goods and Service charge is applicable on the brokerage amount. This tax gets paid by the investors while purchasing the SGBs.

Conclusion

Although there are several risks in a Sovereign Gold Bond (SGB), it has still successfully emerged as an authentic method of investing in gold with minimal risk and hassles. Above all, SGB is a great investment tool too to diversify the risk of the portfolio. SGB schemes, claimed to be profitable investment avenues bearing widespread benefits and low restrictions, are suitable to those who have low aptitudes for risk but desire to enjoy substantial returns on their corpus. This is so because they are one of the highest returns-bearing government-mandated schemes.

In comparison to physical gold investments and gold ETFs, an SGB is arguably more profitable, since it is backed by the highest financial authority. However, do bear in mind that while purchasing these sovereign bonds, you should consider them only after you've analysed the financial goals and time frame of the investment because considerable funds have to be kept locked in to obtain subsequent returns in the future. Interested individuals must also periodically keep themselves updated by reading through the RBI’s website to successfully invest in SGBs.