How can you save tax by investing in ELSS?

Tax season can become a stressful period for many working professionals. But it can all be worked out with a simple investment in a tax-saving fund. Yes, we are talking about ELSS Mutual Fund.

Tax Saving Mutual Funds

Equity Linked Savings Scheme, also known as an ELSS investment allows an individual or HUF a deduction from the total income up to Rs. 1.5 lacs under Sec 80C of Income Tax Act.

As the name suggests, this scheme invests in Equity, which entails that it has a potential of high returns but also carries a chance of high risk along with it. Therefore, you must stay invested for a long time for a chance of better returns. This is how ELSS offers dual benefits of tax saving and wealth creation over a long time!

You can invest in ELSS Funds through Systematic Investment Plans (SIP) as well as in lump sum. However, investing in ELSS via SIP has certain benefits, such as, it helps you time the market by mitigating risk and it also helps your investments grow exponentially with the power of compounding. If you are investing at the end of a financial year or if you have a higher risk appetite, then lump sum investments will suit you better.

ELSS Funds have a lock-in period of 3 years which means that you cannot withdraw your money for 3 years. This is the shortest lock-in period under section 80c. Therefore, choosing ELSS helps you in maximizing tax benefits under Section 80C.

However, after the re-introduction of Long-Term Capital Gains (LTCG) tax in the budget, returns from the investments in ELSS funds would be taxed. Long-term capital gains from Equity Mutual Funds above? 1 Lakh would be taxed at 10% without any indexation benefit. Now let’s have a look at the concept of tax on Mutual Funds in detail.

Mutual Funds provides earnings in two forms- Capital Gains and Dividends. While capital gains are taxable and paid by the investors, the tax on Mutual Funds dividends, which is called Dividend Distribution Tax (DDT) is paid by the fund house (Asset Management Company) on behalf of the investors.

Capital Gains

Capital gains is a tax on mutual funds. While planning your finances, remember your gains remain tax-free up to? 1 lakh. It’s paid on the profit you make while redeeming/selling our Mutual Fund holdings (units). The gain is the difference in Net Asset Value (NAV) of the scheme on the date of sale and date of purchase (Selling Price - Purchase Price).

Capital gains tax is further classified depending on the period of holding.

For equity funds (funds with equity exposure>= 65%), a holding period of one year or more is considered long-term and it is subjected to Long-Term Capital Gains (LTCG) tax. LTCG tax of 10% is applicable on equity funds if the cumulative capital gain in a financial year exceeds? 1 lakh. Profits on holdings of less than a year are subject to 15% Short-Term Capital Gains (STCG) tax in equity funds.

Long-term is defined as a holding period of 3 years or more in case of non-equity funds (debt funds) and 20% LTCG tax is applicable on such holdings with indexation i.e. purchase price is adjusted upwards for inflation while computing capital gains. Profits on holdings of less than 3 years are subject to STCG tax, which is the highest income tax slab individuals fall into.

DDT

Dividends from Mutual Fund schemes are another aspect of Mutual Fund taxation. While being tax-free in the hands of the investor, Dividend Distribution Tax (DDT) is deducted at source. It is calculated as a percentage of the scheme’s face value, and not the NAV.

So, if you are looking for a tax saving investment, ELSS is the way to go, but one must also be aware of the other taxation aspects of this Mutual Fund.

I'm 32 Years Old, Marketing Manager. I provides investment guidance in Mutual Funds & other investment options.