The tax season is approaching and naturally we all wish to save our taxes. But how? Which is the best investment instrument for saving taxes? The answer to this question is the four-lettered word ELSS. ElSS stands for Equity-Linked Saving Schemes which refer to mutual funds which qualify for a tax deduction of Rs. 1.5 lakh under Section 80C of the Income Tax Act.
Everything You Need to Know About ELSS
An ELSS is a type of open-ended equity mutual fund which comes with a lock-in period of 3 years. The minimum amount of investment in an ELSS varies across mutual fund houses, however, it generally ranges between Rs. 500 to Rs. 5,000. Being an equity-oriented scheme, it invests at least 80% of its total assets in equities and equity related instruments. Like all other mutual funds, it also allows you to invest either in a lump sum or using a Systematic Investment Plan (SIP), through which you can pool in the money periodically, either monthly, quarterly, semi-annually or annually.
For instance, Mr. A had invested Rs. 3 lakh in Axis Long Term Equity on April 4, 2018. The investment makes him eligible for claiming a deduction of Rs. 1.5 lakh from his total income under Section 80C of the Income Tax Act while filing his tax return for FY 2018-2019. However, if he makes gains in the fund, he will be liable to pay a long term capital gains tax at the rate of 10% per annum at the time of redemption (after 3 years). This will be levied on the capital gain earned in excess of Rs. 1 lakh.
Taxation of ELSS
The investment made in an ELSS qualifies for a tax deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. The returns on ELSS funds attract a long term capital gains tax (LTCG) at 10%. However, long term capital gains up to Rs. 1 lakh per year are exempt from tax.
ELSS vs Other Tax-saving Investment Instruments.
Besides ELSS, there are various other tax-saving investment instruments also, for example, 5-year Fixed Deposits, Public Provident Fund (PPF), National Savings Certificate (NSC), etc. However, ELSS emerge as the best among all the tax-saving investment instruments on the basis of the following factors:
1. Lock-in: ELSS features a lock-in period of 3 years, which is the minimum among all tax-saving investment options. The lock-in periods of other tax-saving investment options are as follow:
Tax-saving Investment Option
Lock-in Period
ELSS
3 years
Fixed Deposit
5 years
Public Provident Fund
15 years
National Savings Certificate
5 years
National Pension Scheme
Till retirement
2. Return: Being a market-sensitive investment instrument, an ELSS has the potential of generating returns greater than other tax-saving investment vehicles. An ELSS can provide you returns ranging between 15%-18%.
Tax-saving Investment Option
Return (p.a.)
Fixed Deposit
6.50%-8.25%
Public Provident Fund
8%
National Savings Certificate
8%
National Pension Scheme
10.81%*
*5-year weighted average return (with 50% in equity and 25% each in corporate bonds and government bonds) of NPS Tier-1 schemes. Returns not guaranteed
3. Taxation: Like all other tax-saving investment options, the amount invested in an ELSS is tax-deductible up to Rs. 1.5 lakh under section 80C of the Income Tax Act. However, unlike other tax-saving instruments, returns earned from an investment in an ELSS and an NPS are not fully taxable. ELSS and NPS returns are only partially taxable. Moreover, the long-term capital gains of up to Rs. 1 lakh on ELSS are tax free.
4. SIP option: In case of tax-saving instruments other than ELSS, such as tax-saver FD, only lump sum deposits can be made. Whereas, an ELSS offers two options of investing either via a lump sum deposit or using a system investment plan (SIP) through which you can invest small amounts at regular intervals which can be as low as Rs. 500 per month.
However, it is important to note that since an ELSS is a market instrument, it involves a higher degree of risk than other tax-saving investment options.
