ELSS taxation

Equity Linked Savings Schemes (ELSS) are a popular choice for investors looking to save taxes while building long-term wealth. But what makes ELSS unique is its tax efficiency and high return potential compared to traditional tax-saving instruments. This blog will guide you through everything you need to know about ELSS taxation, including how to claim deductions under Section 80C of the Income Tax Act, the taxation of long-term capital gains (LTCG) on ELSS returns, and the implications of dividend payouts under the current tax regime. We’ll also compare ELSS with other tax-saving options and explore its role under the old and new tax regimes, helping you decide how it fits into your financial plan. Dive in to unlock the full potential of ELSS as a tax-saving investment!

ELSS (Equity Linked Savings Scheme) is a type of mutual fund in India that invests primarily in equity or equity-related instruments. It is specifically designed to provide investors with both the opportunity for wealth creation and tax savings.

Features of ELSS:

1. Tax Benefits:
   Investments in ELSS are eligible for tax deductions of up to ₹1.5 lakh per year under Section 80C of the Income Tax Act. This makes it a popular choice for tax-saving purposes.

2. Lock-In Period:
   ELSS comes with a mandatory lock-in period of three years, which is the shortest among all Section 80C investment options. During this time, the funds cannot be withdrawn.

3. Equity Investment:
   ELSS funds invest at least 80% of their assets in equity and equity-related instruments. This gives investors the potential for higher returns, although it also comes with market-related risks.

4. Returns:
   Since ELSS is linked to the equity market, the returns are market-dependent and can fluctuate. Historically, ELSS funds have provided higher returns compared to traditional tax-saving options like PPF or fixed deposits.

5. Flexibility in Investment:
   ELSS allows investments through lump sums or systematic investment plans (SIPs), making it accessible to all types of investors.

Tax Benefits Offered by ELSS Funds

ELSS investments are eligible for tax deductions of up to ₹1.5 lakh per financial year under Section 80C of the Income Tax Act, 1961.This deduction helps reduce your taxable income, resulting in significant tax savings. Then maximum tax saving at 30% tax slab is Rs. 46,800

Capital Gains Tax on ELSS

ELSS investments, being equity-oriented mutual funds, are subject to capital gains taxation as per the rules defined under the Income Tax Act. Here’s a detailed breakdown of how capital gains tax applies to ELSS:

1. Nature of Capital Gains in ELSS

ELSS investments come with a mandatory lock-in period of three years. This automatically qualifies any gains as long-term capital gains (LTCG) since short-term capital gains do not apply to investments held for more than 12 months.

2. Tax on Long-Term Capital Gains (LTCG)

Till FY 23-24 –

Long-term capital gains up to ₹1 lakh in a financial year are tax-free.

Gains exceeding ₹1 lakh are taxed at a rate of 10% without the benefit of indexation.

FY 24-25 and onwards – 

Long-term capital gains up to ₹1.25 lakh in a financial year are tax-free.

Gains exceeding ₹1.25 lakh are taxed at a rate of 12.5% without the benefit of indexation.

3. How LTCG is Calculated

The capital gains from ELSS are calculated as:

LTCG = Sale Price – Purchase Price (NAV at time of investment)

For example, if you invest ₹1.5 lakh in an ELSS fund at a NAV of ₹50, and after three years, the NAV rises to ₹75, the total gain would be ₹75,000. Since this is below ₹1.25 lakh, it would be tax-free.

4. Tax Deduction vs. Tax on Gains

While ELSS provides a deduction of up to ₹1.5 lakh under Section 80C on the invested amount, the gains on redemption after three years are taxed as per the LTCG rules.

5. Key Considerations

• Dividend Taxation: If you choose a dividend payout option, dividends are taxable as per slab rates.
• Systematic Investment Plans (SIPs): In SIPs, each installment is treated as a separate investment with its own three-year lock-in period. The LTCG tax is calculated individually for each installment.

Example:

• Investment: ₹1.5 lakh in an ELSS fund
• Redemption Value After 3 Years: ₹2 lakh
• LTCG: ₹2 lakh – ₹1.5 lakh = ₹50,000
• Tax: Since ₹50,000 is below the ₹1.25 lakh exemption, no tax is payable.

Comparison of ELSS with various tax saving instruments

This table provides a concise overview to help you choose the best investment options under Section 80C based on your financial goals and tax-saving needs.