Monday 4 February 2008

Want to save tax? Invest in ELSS now

For the high-income individuals, equity-linked saving schemes are a good way to save tax.

Investor: Section 80C has several instruments that qualify for the deduction of Rs 100,000 from my gross total income. Some of the important ones I know are Provident Fund, Public Provident Fund, National Saving Certificates, LIC [Get Quote] premium, ELSS of mutual funds, Pension Funds and others. Which is the best avenue?

Advisor: While it would be difficult for anyone to single out one single instrument that is best for everyone across the board, you must appreciate that the list of eligible instruments is kept wide enough to cater to different classes of investors by the income tax authorities.

For instance, someone who is risk-averse can opt for life insurance or five-year deposit with a bank. For someone keen on saving tax, even on income arising out of the instrument would prefer PF or PPF. Then, for the young and high net worth, with a good risk appetite can go for ELSS.

Investor: Tell me more about ELSS.

Advisor: ELSS is abbreviation for Equity-Linked Saving Scheme. This is one of several schemes by the mutual funds and is popular among high net worth tax payers because of their unique features

Investor: What are these unique features?

Advisor: As the name suggests, this is a scheme which predominately invests in equity shares of companies. Under the regulations, the scheme has to invest 80 per cent of its corpus in the equity shares and the balance 20 per cent can be invested in other instruments like bonds, debentures, government securities and others.

Investor: This implies that by putting my money in ELSS, I am participating in the stock markets and therefore, exposing myself to risky investment.

Advisor: Yes, you are. But the advantage here is that there is no direct participation in the stock markets or in a particular stock. So, you have a basket of stocks that have been selected by professionals.

Since these professionals or fund managers, as they are known have access to elaborate research facilities and insights into the functioning of the companies and consequently, you get the benefit of those skills which go into systematic stock selection.

Investor: Are there any other benefits?

Advisor: The other benefits come on the taxation front. If you are making an investment in of Rs 100,000 you will be entitled for a deduction equal to Rs 100,000 from your gross total income under section 80C.

In other words, someone who is in the highest income bracket of 34 per cent (30 per cent + 10 per cent +3 per cent), investing Rs 100,000 in ELSS reduces the tax liability by Rs 34,000.

Effectively, it means that you would have invested only Rs 66,000 because you are getting a benefit of Rs 34,000 on Rs 100,000. Assuming the mutual fund declares a dividend of 9 per cent, your return on Rs 66,000 would work to 13.63 per cent (9,000/66,000 � 100).

Investor: What else?

Advisor: This is not all. This dividend of Rs 9,000 on your own Rs 66,000 is totally exempt in your hands under section 10(35). In effect it is tax free return in your hands.

Investor: What are the other tax implications?

Advisor: There is yet another bonanza from ELSS awaiting you and that is: whatever capital gain that you will make on this investment after a lock in period of three years is also totally exempt from tax in your hands under section 10(38).

Investor: That is great news

Advisor: Yes. This is what makes ELSS the most attractive investment for those who have the appetite for moderate risk. However, before you rush, do select a good fund house based on its reputation and track record.