Why ELSS Funds Could Be Your New Tax-Saving Ally

Equity-Linked Savings Schemes (ELSS) are a type of equity fund that invests a major portion of their corpus into equity or equity-related instruments. The main purpose of ELSS funds is to enable investors avail 80C tax deductions.

Equity or equity-oriented instruments receive a minimum of 80 per cent allocation from these schemes' total assets. Since a major portion of the corpus is allocated to equities, ELLS funds are subject to market-linked risks.

"The long-term holding of these funds, however, creates possibilities for attractive return generation. Salaried taxpayers who want to save taxes and build wealth through long-term investments may consider ELSS as their investment option," says Gibin John, Senior Investment Strategist, Geojit Investments Limited.

Multiple tax-deduction options are available for taxpayers under the Old Tax Regime. Through ELSS taxpayers gain special advantages that extend past their tax deduction benefits.

All tax-saving investment options under different sections of the Income Tax Act have a mandatory lock-in period. The lock-in period of 3 years makes ELSS unique among other tax-saving investment avenues.

Investors can access their funds after three years because of this feature, which makes ELSS more liquid than other options.

Investment flexibility is a major benefit of ELSS. Investors can make investments through either lump sum payments or Systematic Investment Plans (SIPs) or a combination of both methods at any point during the financial year.

"You can benefit from ELSS by transferring your existing mutual fund investments from different categories into an ELSS scheme even when you do not have new funds available at the time of investment. The switch enables investors to claim tax deductions under Section 80C. The three-year lock-in period will begin on the switch date for ELSS funds, even if the funds were invested in the previous scheme," informs John.

How ELSS Funds Are Taxed

The Income-Tax Act of 1961 allows ELSS funds to function as widely used tax-saving investment instruments which operate under section 80C.

"The tax deduction of Rs 1.5 lakh from your taxable income applies to ELSS investments, which can generate a maximum tax saving of Rs 46,800 for individuals under the highest tax bracket of the Old Tax Regime. ELSS funds invest primarily in equity markets and come with a mandatory lock-in period of three years, the shortest among all other section 80C options," says Neeraj Agarwala, Partner, Nangia & Co LLP.

As for taxation, returns from ELSS are treated as capital gains. Since these are equity-oriented mutual funds, Long-Term Capital Gains (LTCG) tax applies when transferred after the lock-in period of three years.

"Capital gains up to Rs 1.25 lakh during a financial year remain tax-free, but any gains above this limit are taxed at 12.5% without taking indexation into account. Investors must pay tax on their dividend income according to their regular tax slab rates," adds Agarwala.

Potential To Generate Higher Returns

According to industry experts, investors primarily want to create wealth while reaching their financial targets on time. ELSS funds consist of equity-oriented investment options which have the potential to generate higher returns when compared to traditional fixed-return products.

ELSS investments, thus, help you save taxes through Section 80C while providing the chance to build wealth through equity market exposure in the long term. This makes it a convenient and disciplined way to save tax while building long-term wealth.