What are the Tax Implications of ELSS?

Nowadays, investors have a variety of asset classes to look at as options that provide both worthwhile returns on investment and tax savings. An ELSS, or Equity Linked Savings Scheme, is one of these well-liked investment plans.

Since they are equity funds, ELSS is renowned for offering good returns over long periods of time. One of the key characteristics of an ELSS is that, out of all the tax-saving investment alternatives offered in India, its three-year lock-in period is the shortest.

ELSS or Equity Linked Savings Scheme is a type of mutual fund in India that offers tax benefits to investors under Section 80C of the Income Tax Act. Investment in ELSS is eligible for a tax deduction of up to INR 1.5 lakh per financial year.  

Many NBFCs and investment bankers propose investments into ELSS mutual funds to support savings and reduce the tax to be paid to the government during a financial year while also reaping good ELSS returns.

ELSS is suitable for investors looking to create wealth in the long term, as equity mutual funds have the potential to provide higher returns compared to other investment options, such as fixed deposits or debt funds. LIke any other investment – be it mutual funds or stocks, an ELSS fund is also subject to market risks. This includes conditions like the state of the economy, the asset management company’s performance and overall market conditions.

As a long-term ELSS investment can generate good returns, and for the fact, in case of contingency conditions, people can pledge their ELSS investments for a loan against securities to fund the margin funds for trading accounts. 

The guidelines and rules are against ELSS mutual funds being used as a loan against securities online or loans on mutual funds to use as collateral loans as cash. 

There are several reasons why people choose to invest in ELSS:

• Tax benefits: As mentioned earlier, investment in ELSS is eligible for a tax deduction of up to INR 1.5 lakh per financial year under Section 80C of the Income Tax Act. This can help reduce the investor’s tax liability. Having said so, one has to bear in mind that an ELSS can be used as a collateral for borrowing against mutual funds after the lock-in period has passed.
• Long-term wealth creation: ELSS funds invest primarily in equities, which have the potential to provide higher returns over the long term. This makes ELSS Return a suitable investment option for those looking to create wealth in the long run.
• Diversification: ELSS funds invest in a diversified portfolio of stocks, providing investors with exposure to a wide range of companies across different sectors. This helps to diversify the investor’s portfolio and manage risk.
• Flexibility: ELSS Returns has a lock-in period of 3 years, after which the investor is free to withdraw their investment. This provides investors with the flexibility to exit their investment after a certain period if they wish to do so, as other mutual funds where they can have a loan on mutual funds.

However, there are some implications too in the investments to ELSS funds. Firstly, in the case of ELSS investments, the loan against securities is not feasible. Though Abhiloans, one of India’s leading NBFC lenders, supports its customers with a loan against mutual funds, and an instant loan against securities, the ELSS funds at present has complexities for loan against securities.

In addition to the usual lock-in period conditions, the ELSS solutions have some tax implications. 

The income earned from ELSS is taxed as follows:

• Long-term capital gains (holding period greater than one year) are taxed at a rate of 10% without indexation and 20% with indexation.
• Short-term capital gains (holding period less than one year) are taxed as per the individual’s tax slab rate.
• It’s important to note that the tax treatment of ELSS may change from time to time based on government regulations. It’s advisable to consult with a financial advisor or tax professional for specific tax advice on the investment in ELSS.
• Also, the ELSS investments are not eligible for a loan on mutual funds schemes.

Long-Term TAX implications

LTCG (Long-Term Capital Gains) is the profit earned on the sale of a long-term capital asset, such as shares or mutual fund units held for more than one year. In the case of ELSS Returns, LTCG is taxed at a rate of 10% without indexation and 20% with indexation.

Indexation refers to the adjustment of the cost of an asset for inflation. When indexation is applied, the tax on LTCG is calculated by considering the effect of inflation on the cost of the asset. This results in a lower tax liability for the investor.

For example, suppose an investor buys ELSS units for INR 50,000 and sells them after 3 years for INR 1,00,000. The investor has made an ELSS return profit of INR 50,000, which is taxed as LTCG. If indexation is applied, the tax on the LTCG will be calculated by adjusting the cost of the units for inflation. This may result in a lower tax liability as the ELSS interest rate for the investor is compared to the tax liability if indexation is not applied.

Investors are obligated and must pay taxes on income distribution and capital withdrawals (IDCW), and mutual funds will subtract TDS from payments and reinvestments at a rate of 10% for resident investors and 20% (plus any relevant surcharge and cess) for non-resident investors over the ELSS interest rates into the account. 

Investors can, however, seek a tax credit for TDS deducted when completing their yearly return. For units purchased before January 31, 2018, and redeemed on or after April 1, 2018, capital gains accrued up to that date are free from LTCG tax.

Conclusion

Many financial advisors are wary of the tax implications with ELSS mutual funds as there is a definitive lock-in period, and the scope of loan against securities or loan on mutual fund options is limited. 

Despite all that challenges, when the ELSS investments are held for longer periods, the tax implications with the investments get limited, and the overall profits from the investments can be effective overall.

On a decisive note, it can be seen that ELSS mutual funds are a good choice. However, there are various other investment options available apart from ELSS mutual funds. Some of these can generate better returns for the investors and can save taxes while they are also eligible for digital loan against securities in the form of loan against equity shares or loan on mutual funds.