Gold deposit Scheme-tax efficient way of investing in gold

In my previous articles I have discussed various avenues of investment for gold like Gold ETF, e-gold and gold funds. With this article I want to apprise readers about one more avenue - the gold deposit scheme. This will enable investors to get the benefit of investment in gold, with additional benefits of earning income on the same, saving on the cost of insurance and storage and retaining the right to receive the appreciation in the price of gold.
This scheme was introduced in 1999 by the Government of India with the objective to save on precious foreign exchange by utilising the vast gold holdings lying with Indian households and various religious trusts.This article will elaborate on various facets of the gold deposit scheme.
Basics of the scheme
Under this scheme, the owner of gold gets a certificate against delivery of the physical gold with the designated banks. Here you can tender gold in the form of gold bars, coins and even jewellery.

While making the application, you have to submit proof of your address and identity with a list of inventory of gold tendered after which the bank branch will issue a provisional receipt while accepting the gold.

The gold received from you is first tested for its purity in a non-destructive method and the provisional percentage of purity is conveyed. You have the option to withdraw the tender if you are not satisfied with the provisional purity ratio on payment of nominal charge to cover the cost of initial testing. But if you accept the results of initial testing, then the gold received is sent for melting and assayed and minted in the government mint. Based on the purity of the melted gold at this stage, the certificate of gold deposited is issued for the equivalent content of pure gold, that is, 0.999 purity. Broadly, banks can issue you a certificate or a statement of account or a passbook for the gold deposited.
Any individual, whether singly or jointly, can make an application under this scheme. Anyone can even make the deposit on behalf of a minor. In addition to individuals, the application can also be made in the name of HUF, trusts or companies. The trust making the application can be a charitable or religious one.
You can avail the benefit of nomination for these bonds, provided the deposits are made in your name. The nomination facilities are not available in case the applications are made in the name of HUF, trusts or companies as these entities have perpetual existence. For making an application under this scheme, you need to tender minimum 500 grams of gold. . However there is no upper limit upto which you can avail the benefits of this scheme.
The deposit can be made for three, four or five years. These deposit certificates can be requested in the denominations of your choice. However, the number of certificates to be issued for each tender shall not exceed five. The minimum denomination of the certificate is 500 grams. These deposit certificates are transferable by endorsement and delivery. Effectively, these are bearer in nature.
After expiry of the tenure opted by you, you have the option to renew these certificates for further periods of your choice. But in case you not want to do this, you can either take delivery of the gold of the same quantity as mentioned on the certificate or you can opt to receive the amount in Indian rupees on the basis of the rate of gold prevalent at the time.
Please note that when you exercise the option to receive the gold in physical form, you will be given gold bar only and not in the form in which you had surrendered.
Benefits of the scheme
First and foremost, the benefit is that while retaining the advantages attached with the ownership of gold like price appreciation, you do not have to incur any expenditure for the purpose of insurance, safe keeping or costs associates with holding of gold in physical form.
In addition to this, the scheme offers you a direct benefit in the form of interest which you earn on the value of your gold. The present rate of interest effective from September 1 2010 are 0.75%pa for three years and1% pa for deposit for the periods of four and five years.
The interest is calculated in gold currency and is paid in equivalent Indian currency. As far as frequency of payment of interest is concerned, you have the option to receive it either on March 31 of each year or lump sum at the time of maturity of the bonds, in which case it is compounded. In case you want to withdraw the gold prematurely, it can be done but you will have to pay a premature penalty in the range of 0.25% to 0.50%, which is adjusted against interest payable to you. Thus, these deposits can be withdrawn in order to reap the benefits of temporary and sudden spurt in the prices of the gold and you do not necessarily have to wait for the entire duration of the tenure of the certificates.
In addition to the above benefits, you can also avail loans against security of the certificates of gold deposit in Indian Rupees from any bank.
What are the tax implications of the scheme?
As per the provisions of the Income Tax Act, the interest earned on these bonds is exempt from income tax, so there is no tax liability on the interest earned by you on such bonds. In addition to the interest exemption, these bonds are exempt from payment of wealth tax as well an additional saving of 1% if your other taxable wealth exceeds Rs30 lakhs.
In addition to the exemption for interest earned and wealth tax under this scheme, these deposit certificates are not treated as capital assets for the purpose of capital gain tax.
However one very important thing to note is that though deposits certificates are not capital assets for the purpose of capital gains and any appreciation in the value of such deposits is exempt from payment of tax on capital gains,this does not hold true when you convert your physical gold into gold deposit certificate. Since the gold deposit certificate is not the same as physical gold and as both the assets are distinct and separate, conversion of your old physical gold into gold deposit certificate will amount to transfer for the purpose of income tax act. Therefore, such conversion will entail capital gains and based on the holding period of the physical gold and difference between the prices of gold as on the date of issue of the certificate and the indexed cost of the physical gold, it will attract capital gains tax @ 20%.
However, in case you feel bullish about gold and want to do some tax planning, gold deposit scheme offers you an excellent avenue for saving on tax, thus boosting your post tax returns on gold. This purpose can be achieved by purchasing the gold in bar form from the market for the purpose of converting the same into gold deposit. Since the time gap between the date of purchase of gold and deposit with the bank will be very small, there will not be any major difference in price. Hence , you do not have to pay any capital gains tax at the time of tenderinggold under gold deposit scheme unlike in case of your old holding of gold.
The scheme is operated by many banks, but State Bank of India is a major operator and can be approached for availing the benefits of this scheme.
Gold deposits scheme thus offers excellent tax effective opportunity for high net worth investors who wish to take large long-term exposure to gold.