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Nov 01, 2012, 12.16 PM IST
Once the DTC kicks in ELSS will lose its tax benefit. This has raised concerns among investors who are already invested or wish to invest in ELSS. While some of the concerns are genuine, others show that the product is simply misunderstood. Financial expert Manshu Verma enlightens on the effects of DTC on ELSS to help investors understand better.
ELSS (Equity Linked Savings Scheme) mutual funds are eligible for tax benefits under Section 80C of the Income Tax Act. Currently these are the only equity investments eligible under 80C, and they also happen to have the lowest lock-in period of 3 years.
When DTC (Direct Tax Code) kicks in, it will do away with the tax benefit on ELSS funds, but you still have at least this year to take advantage of these, as the soonest DTC can kick in is next year.
I have heard several questions about ELSS funds since the first draft of DTC came out and while some of these questions are genuine concerns, others show that the product is simply misunderstood.
For example, a concern that I hear quite often is that the product has a lock in period of three years but the tax benefit might be taken away as early as next year, so does that mean you won't get the full tax benefit of investing in an ELSS mutual fund?
On the face of it, this looks like a simple question to answer, and to some extent it is, but there is more to it than meets the eye.
Let's start with the simple part first, which is the tax benefit.
When you buy this fund, you are allowed to reduce your taxable salary by the amount you invest (subject to certain limits), and since your taxable salary is reduced, your tax liability is also reduced.
There are no other tax benefits of investing in this type of mutual fund. So, if you bought this fund this year and benefitted from the tax breaks, it doesn't matter if those tax benefits are withdrawn next year because you wouldn't get any deductions on your existing funds next year even if Section 80C were to remain in place.
So far, so good, but the tax structure today favors equity funds since there are no long term capital gains on them, and there are no dividend distribution taxes on them either.
There is a short-term capital gains tax of 15% if you sell an equity fund within a year but since these funds have a lock in period of 3 years, you would never incur a short-term capital gains tax on them.
Now, the zero long term capital gains, and no tax on dividends is because these funds invest in equity, and if these rules were to be changed in the future for all equity funds then such rules will be applicable on ELSS funds as well.
The difference from your perspective is that while you can get rid of the other equity funds if you don't like the new taxes, you can't get rid of ELSS funds since they have a lock in period.
So should that turn you away from investing in an ELSS fund?
I don't think this alone is a valid reason because the tax treatment on long-term capital gains could change today without DTC coming in, and you would still be stuck with your existing ELSS funds.
While the above may not be a valid reason, some people are concerned that the sole reason investors opt for ELSS funds are tax savings, and if that is withdrawn then wouldn't these funds gradually shrink in size, and what's the incentive for the fund house to focus on the performance of these funds and would they even continue with them?
I believe this is a valid concern because there is uncertainty on what will be the future of these funds. It is perhaps likely that they run as-is for some time and are then merged with other funds of the same fund house.
So of course, you won't wake up one day and find that your fund has just been discontinued and your money is gone, but you may find that it has been merged with another fund, and that is certainly something that can happen.
I call this a valid concern because at this point no one can say with certainty that this won't happen but certainly two funds merging together is nothing new, and has happened several times earlier in India. I certainly don't mean this is a big enough concern for you to turn away from ELSS funds just that this is a factor that you should think about while making a decision to invest in these funds just as you would weigh in other factors, and it's better to be aware that such a thing can happen before investing in the fund rather than learning this after your money is invested.
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