Tax Benefits of Investing in Equity-Linked Savings Schemes (ELSS)

Whether you’re a beginner, an advanced trader, or an investor in the mutual fund market, understanding taxation and regulatory aspects of mutual funds can significantly influence your investment decisions and ultimate financial returns. This discussion will revolve specifically around the tax benefits of investing in Equity-Linked Savings Schemes (ELSS).

What is ELSS?

ELSS stands for Equity-Linked Savings Scheme. It’s an open-ended, diversified equity mutual fund that benefits investors from two perspectives. Firstly, it offers to create wealth over the long term due to the inherent equity exposure. Secondly, it provides tax benefits to investors under the Indian Income Tax Act.

Tax benefits of ELSS investments

ELSS and Section 80C of the Indian Income Tax Act

The primary tax advantage of ELSS mutual funds comes from Section 80C of the Indian Income Tax Act. An investor can claim a deduction of up to INR 1.5 lakh in a financial year from their total income under this section. This effectively reduces the taxable income and, consequently, the tax liability.

ELSS investments are eligible for this deduction, which is a significant advantage over many other mutual fund schemes. The very nature of the ELSS to lock-in your investments for three years ensures you hold them long enough to possibly see significant growth, thus making it attractive not just from a taxation perspective but also as an equity investment.

Dividend Distribution Tax in ELSS

In the past, ELSS investments provided tax-free dividends, but this has changed as per the amendments in the 2020 budget. Starting from April 2020, dividends from mutual funds, including ELSS, are taxable in the hands of investors. However, this tax imposition will be as per your respective income tax slab.

Despite this change, ELSS remains an attractive investment option due to its potential for higher returns when compared to other tax-saving investments.

Long-Term Capital Gains Tax (LTCG)

In the context of mutual funds, when an investor sells their investment after one year, the gains are considered Long Term Capital Gains. ELSS funds, being equity funds, also come under this category.

A flat rate of 10% is levied as LTCG on the gains above INR 1 lakh in a financial year from all equity investments. Even with this, the effective tax rate is considerably lower than most investors’ tax slabs, making it a tax-efficient investment option.

Tax-saving ELSS vs other tax-saving investment

When compared to other tax-saving investment avenues, such as National Savings Certificate (NSC), Public Provident Fund (PPF), or 5-year fixed deposits, ELSS has the shortest mandatory lock-in period of three years. This provides comparatively higher liquidity.

Further, while the returns on most tax-saving avenues are fixed, ELSS, being market-linked, has the potential to deliver higher returns. Experienced fund managers who systematically invest in a diversified portfolio of equity and equity-related securities manage these funds.

Understanding the Risks

It is crucial to note that ELSS schemes are subject to market risks since they predominantly invest in equity and related securities. Thus, while the potential for returns is high, the volatility can also be substantial, especially in the short term.

Summing Up

ELSS funds offer significant tax benefits under Section 80C of the Income Tax Act, a short lock-in period, and the potential for high returns. Therefore, these are worthy of consideration while planning tax savings or looking for long-term investment options. Always consult with a financial advisor or conduct thorough research before plunging into ELSS or any mutual fund investments.

Note: The provisions of the tax benefits are subject to change as per the amendments in the respective laws. Always refer to the current legal stipulations before making any investment decisions.