Learn the tax rules that apply to your ELSS investments

Hands down, ELSS is one of the best tax-saving options available to young investors, given its transparency, low-cost nature, and ease of investing.

At Finbingo, we believe that knowledge is power. As an informed investor, we want to empower you with the proper knowledge to make better decisions with your money.

In this post, you will learn about the tax rules on ELSS & also some helpful tips to maximize the benefits of investing in ELSS.

Taxation Stage #1: On making the investment:

There is no cap on the money you can invest in an ELSS scheme & also across schemes. However, under Section 80C of the Income Tax Act, the maximum tax benefit you can get from your ELSS investment per year is restricted to INR 1,50,000.

Taxation Stage #2: On receipt of dividend:

This stage is applicable ONLY if you have chosen the dividend payout mode, at the time of investing.

Earlier, before paying out the dividend to you, the mutual fund company had to pay “dividend distribution tax” to the government on the “gross” amount. Hence, the net dividend in your hands was tax-free.

However, post the changes in Finance Act, 2020, dividend income is now taxable in your hands as per your tax slab. Further, if the amount of dividend is more than INR 5,000, it will be subject to TDS which presently stands at 7.5%.

Due to the above, selecting a dividend payout mode for your ELSS investments is not a very tax-efficient option. We do not recommend it. Dividend payout also kills the benefit of compounding that is a must for wealth creation.

Hence in our view, you should always prefer to opt for a growth option at the time of investing. If you already have ELSS investments running on dividend mode, you can request your mutual fund to change it to growth mode.

Taxation Stage #3: On withdrawing the money (redemption):

The money that you invest in the ELSS scheme is subject to a lock-in period of 3 years. So, you cannot withdraw that money at all.

Once the lock-in period is over, the question of tax liability will arise only when you withdraw the money. Till you do not withdraw, there is no question of tax liability.

The profit that you earn on withdrawing the money is called, in tax language, “long-term capital gain”. This long-term capital gain (combined with any other long-term capital gain from equity mutual funds is tax-exempt up to INR 1 lac.

Practically speaking, if you are new to the investing journey, your investment corpus in the initial years will not be very high. Hence, the chances you will be taxed at the time of redeeming the ELSS are significantly less.

Even after the corpus increases down the line, you can easily plan your withdrawals so that the LTCG is below INR 1 lac & hence tax impact remains NIL.

Tips to take maximum benefit of ELSS taxation provisions
If you are clear on the tax provisions & are planning to invest in ELSS, it is a wise decision & we congratulate you for taking this first step. However, we also have some more tips for you below to help you get the best return for your ELSS investment till the last rupee:

  1. Don’t blindly invest in ELSS for tax benefit. First consider your financial goals, risk appetite, and asset allocation & then invest.
  2. Even though it comes with a brief lock-in period of 3 years, ELSS is a long-term investment. Try to stay invested and not withdraw the money for at least 5 years. The more you stay invested, the more you reduce the risk of market volatility & increase compounding, which helps you in long-term wealth creation.
  3. Since your investment is locked in for 3 years, spend a good time researching the scheme at the time of investment itself. Prefer schemes from reputed mutual fund houses with a good track record. This will help you reduce the chances of getting stuck in a lousy scheme & need to move to a different scheme after the lock-in period is over.
  4. Even if the long-term capital gain or dividend is tax-free, don’t forget to disclose the same tax return under the “exempt income” section.

Conclusion

ELSS is a super transparent investment avenue. The taxation impact on the investment is also nil if redemptions are planned well. Further, the ease of investing and the low-cost nature of investment makes it an ideal tax saving option for young investors.