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With gains from the BSE Sensex at eight per cent this year, close to all-time highs, this may be a good time to look at equities from a tax-saving perspective. Also, with the Direct Taxes Code (DTC) likely to be implemented soon, these will affect your investment in a tax-saving fund, too.
Under Section 80C of the Income Tax Act, tax-saving mutual funds, better known as equity-linked savings schemes (ELSS), and a few other investments are tax-exempt. An investment in these funds (with an overall ceiling of Rs 1 lakh) will reduce your tax by 20 per cent of the amount invested. Future returns (capital gains, dividends) from tax-saving equity funds are tax-free in your hands.
However, in the final draft of the new tax code, no tax breaks have been provided in case you invest; only retirement-oriented investments are eligible, ELSS are not. Sanjay Sinha, chief executive, Citrus Advisors, says, "ELSS will lose tax-saving advantage in the current form of the DTC, if passed. But there's a clear need for retail investors to participate in equity markets. So, you have to give them a financial incentive through tax savings." However, DTC provides tax exemption on long-term capital gains from equity funds. Therefore, the gains from investments will remain tax-free.
ELSS funds are similar to the closed-end equity funds in the market now. Experts say within the ELSS category, investors can choose the dividend option for a similar equity exposure. "Closed-end equity NFOs (new fund offers) have seen a significant collection, and it seems to suggest equity investors are not averse to locking in for three years or more," says Sinha.
Experts say now, too, investors willing to risk a little on their investments may consider ELSS. Harsh Roongta, chief executive of Apna Paise, says, "There are many goods to a tax-saving equity fund. One is these offer you tax savings. Second, good fund managers get time to invest for the long term due to the three-year lock-in. For investors who want tax breaks, this is definitely a good vehicle."
Tax-saving funds strive to make the most of the three-year lock-in, as a fund manager has time for long-term investment calls. Pankaj Sharma, executive vice-president, DSP Blackrock MF, says: "ELSS funds usually have a buy-and-hold kind of a portfolio due to the certainty of investment for some time; therefore, you don't find much churn in these funds."
But returns from equity investment depend on market movements. Equities offer better returns in the long run; in the short term, anything could go wrong. Data from valueresearchonline.com show tax-saving funds returned 19.26 per cent in a five-year period, beating peers in diversified funds by about 75 basis points. In a year's span, however, these returned just 4.4 per cent, against 5.44 per cent by diversified funds.
As market trends play a huge role in equity-fund returns, investors should invest in equities for periods of at least three years. Sinha says, "There's a case for locking-in money for more than three years in equities."
Sharma says: "It's a great way to save taxes, but risk-averse investors should not follow this route. For younger and risk-taking investors, this is a more potent investment. Indian markets have gone through a time correction, and the cycle looks much better from here."
