Introduction

Equity Linked Saving Scheme (ELSS) is the only category of mutual funds that qualify for tax saving under Section 80C of the Income Tax Act. However, the returns are taxable according to the existing rules. Scripbox helps investors to invest in the top tax saving mutual funds after taking into consideration their income and other tax deductions.

Taxes levied on mutual funds

Returns from mutual funds are subject to Capital Gains Tax. On the basis of the holding period, capital gains are categorized as Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG). Also, the capital gains taxation varies depending on the type of mutual funds.

Dividend income is taxable as per the applicable income tax slab rate of the shareholder. Also, the dividend is subject to TDS. The rate has been cut from 10% to 7.5%, due to the pandemic outbreak and the new rate is until March 2021.

Short Term Capital Gains Tax (STCG)

For Equity Mutual Funds

Redemptions from investment in equity mutual funds within 12 months will attract short term capital gains tax. These short term gains from equity mutual funds are subject to STCG tax of 15%.

For Debt Mutual Funds

Redemptions from investment in debt mutual funds within three years will attract short term capital gains tax. Gains from investment in debt mutual funds are added to the taxable income of the investor. Therefore, the gains are subject to tax as per the investor’s income tax slab rate.

Long Term Capital Gains Tax (LTCG)

For Equity Mutual Funds

Redemptions from investment in equity mutual funds after one year will attract long term capital gains tax. However, gains up to INR 1 lakh in a financial year will not attract LTCG tax. Gains above INR 1 lakh in a year are subject to LTCG tax of 10%.

For Debt Mutual Funds

Redemptions from investment in debt mutual funds after three years will attract long term capital gains tax. The profits are subject to 20% tax with indexation benefit or 10% tax without indexation.

Claim deduction and save tax

Investors can declare their investments while filing income tax returns. Certain investments like Public Provident Fund (PPF), National Savings Certificate (NSC), Equity Linked Savings Scheme (ELSS), etc., qualify for income tax deductions under Section 80C of the Income Tax Act.

However, to claim these deductions, investors have to declare their investments while filing Income Tax Returns.

These tax savings instruments help investors in reducing their tax outflow. Various sections qualify for tax deductions. For example, 80C, 80D, 80G, 80TTA, etc.

Invest in tax saving mutual funds

A good tax saving investment that also qualifies under Section 80C of the Income Tax Act is the Equity Linked Savings Scheme (ELSS). ELSS mutual funds invest in equity and equity-related instruments. ELSS has a lock-in period of three years. Individuals can invest either through lump sum or SIP in these funds. Since the funds have an exposure to equity markets, the investments may earn significant returns. However, ELSS funds are highly volatile, and investors should be mindful of it.

All about ELSS

Equity Linked Saving Scheme (ELSS) are a type of open-ended mutual funds that invest 80% of their total assets in equity and equity-related instruments. ELSS funds have a statutory lock-in period of three years. These also provide tax benefits. They qualify for tax exemption up to INR 1,50,000 under Section 80C of the Income Tax Act.

These tax saver funds invest in equities across market capitalization, sectors and themes. One can start investing in these funds with an amount as low as INR 500 through a Systematic Investment Plan (SIP). There is no cap on the maximum amount of investment, however, only up to INR 1,50,000. One can also invest in these tax saver funds through a lump sum route.

ELSS funds best suit investors who want equity exposure in their portfolio but at the same time enjoy tax benefits. Since these tax saver funds invest in equity, the ideal investment horizon is around seven years. Investors who want to just save tax and redeem the money after the lock-in period should consider other alternatives. This is because the fund invests in equity and equities have significant growth in the long term. Hence these funds cannot be an alternative for short term investments.

When compared to other tax saving investments like tax-saving FDs, National Saving Certificate (NSC) and National Pension Scheme, ELSS funds have the shortest lock-in and have the potential to give significant returns. There is no minimum investment to be made to keep the fund active, and investors can redeem them with no restrictions or penalties once the lock-in period ends.

ELSS funds are taxed similar to equity funds. Since there is no question of short-term capital gains, one need not worry about them. However, long term capital gains are taxable at 10% if the gains are above INR 1 lakh.