To the surprise of many investors, Finance Minister Arun Jaitley re-introduced the Long Term Capital Gains (LTCG) Tax during his Union Budget speech in February 2018. In 2004-05, then Finance Minister P. Chidambaram had done away with it. This has left many investors confused as to whether they should continue investing in ELSS fund or shift their money to alternative tax-saving options.
ELSS funds and tax benefits
ELSS funds are a type of mutual fund known primarily known for their tax-saving benefits. These funds invest in equities and qualify for a deduction under Section 80C of the Income Tax Act, 1961. Any investment up to Rs. 1.5 lakh in ELSS funds can be claimed for tax deduction during a financial year.
By investing in ELSS funds, you can enjoy the dual benefits of investment growth as well as tax savings. Until recently, dividends and long-term capital gains from the earnings were totally tax-free. As a result, it was an excellent avenue for people to invest and decrease their tax liability every year. But the story changed in 2018 with the introduction of LTCG tax.
What is LTCG tax?
Long Term Capital Gains (LTCG) is a tax levied on the profits generated by assets such as real estate, shares and equity-oriented products. This is applicable for assets that were held for a minimum period of one year.
How does it affect you?
Under the new rule, LTCG tax is levied on shares and equity-oriented funds if the profits earned on these assets exceed Rs. 1 lakh. The tax rate is fixed at 10%. Let’s assume you sell your equity-oriented mutual funds and make a profit of Rs. 1.4 lakh during a year.
As per the latest rule, you would have to pay a 10% tax on the amount exceeding Rs. 1 lakh, i.e. Rs. 40,000.
Should you stop investing in ELSS?
The change in taxation has left many investors wondering if ELSS still holds as a good investment. In reality, ELSS continues to be an excellent tax-saving investment avenue. This is because the fundamental nature of ELSS funds has not changed despite the introduction of the LTCG tax.
ELSS funds continue to provide tax benefits for investments up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. ELSS funds also offer the highest returns compared to other investment avenues in the Section 80C category. Besides, it does all this with the lowest lock-in period of just three years. Traditional tax-saving avenues such as Public Provident Fund (PPF) and National Saving Certificate (NSC) come with lock-in periods of 15 and five years respectively.
Ideally, the best option would be to have no LTCG tax on ELSS funds. But since it is a government policy, the next best thing is to find out how to maximise your tax benefits and investment returns under the current rules. And despite the new 10% tax, other benefits ensure that ELSS funds continue to remain among the best investment avenues under Section 80C.