'Is Section 80C the only section in the income tax law that helps me save tax? Is there nothing else available?' exclaims Swati in dismay. She is discussing her investments with her financial advisor. With the financial year-end just around the corner, Swati is keen to save taxes to the maximum extent.
Rohit, her financial advisor, looks at her in amusement. ‘Swati, did you know that your mutual fund investments can help you save tax in multiple ways?’
‘You mean beyond section 80C?’ asks Swati
‘Yes, there are various other types of mutual funds apart from the equity-linked savings scheme (ELSS). Although ELSS gives you benefits under section 80C, other mutual funds also provide several other tax-saving opportunities… let me explain this in detail,’ Rohit responds.
Following is what Rohit explains to Swati:
Mutual funds classified
Before we get into the tax benefits available on mutual funds, you should understand the two broad categories of mutual funds as per the income tax laws; these are:
Equity-oriented funds – the tax impact
Tax on dividends
Dividends distributed by equity-oriented funds are tax-free in your hands. However, the mutual fund pays a dividend distribution tax (DDT) before distributing the dividend to unit holders. In other words, you receive your dividend after deduction of DDT. In the case of individual investors, the mutual fund deducts DDT at 11.648% (this includes 12% surcharge and 4% health and education cess)
Tax on capital gains
Non-equity oriented funds – the tax impact
Tax on dividends
Dividends distributed by debt-oriented funds are tax-free in your hands. However, the mutual fund pays a dividend distribution tax (DDT) before distributing the dividend to unit holders. In other words, you receive your dividend after deduction of DDT. In the case of individual investors, the mutual fund deducts DDT at 29.12% (this includes 12% surcharge and 4% health and education cess)
Tax on capital gains
A special equity-oriented fund
Mutual funds offer an equity-oriented fund that helps you save tax under section 80C (this tax deduction is over and above the other tax benefits you receive on equity-oriented funds). The equity-linked saving scheme, in short, is an equity fund offered by mutual funds that is an eligible investment under section 80C.
Section 80C lists eligible investments and expenses that help save taxes. Among the investments are premium payments for life insurance, unit-linked plans offered by insurance companies, some post office investments (where the public provident fund (PPF) is the most popular tax-saving investment), employment provident funds, superannuation, five-year bank deposits, and ELSS. The maximum investment eligible under this section is Rs 1.5 lakh. Once you make this investment, the amount is deducted from your taxable income; in other words, your taxable income is reduced to this extent and your tax is computed on this reduced amount.
ELSS – the benefits
Among all the eligible investments under this section, ELSS is the most suitable for three compelling reasons:
1. ELSS has the shortest lock-in period. To be eligible for this tax deduction, you need to stay invested in the eligible investment for the period specified. In the case of PPF, you need to remain invested for 15 years; in the case of unit-linked plans, bank deposits, and national saving certificates (NSCs), the period is five years; for ELSS, the period is only three years. Having the shortest lock-in period makes ELSS more advantageous.
2. ELSS offers equity returns. Historically, equity investing has proven to offer the highest returns over the long term. Since ELSS funds invest in equity, you have the opportunity to earn potentially high returns. Other investments in ELSS are primarily debt investments, which offer low to moderate fixed returns. While it’s true that equity entails a higher level of risk, the risk is significantly lower since ELSS is a long-term investment (risk in equity investing is known to reduce with every passing year of staying invested). Mutual funds also offer the systematic investment plan (SIP) investing strategy in ELSS to reduce risk. SIP is an investment strategy where you invest a fixed amount every week, month, or quarter in the ELSS fund. Equity markets are usually volatile. By investing through SIP, your overall investment cost averages downward, thereby reducing risk.
3. ELSS offers tax-free income. Dividends earned on your ELSS investment are tax-free. To receive these dividends, you must select the ‘dividend payout’ option in your ELSS investment. In comparison, interest earned on bank deposits is fully taxable. While interest earned on PPF is also tax-free, you don’t receive this interest; it remains in your PPF account and is available to you only at the end of the lock-in period of 15 years.
Rohit turns to Swati and sees the smile on her face. He has successfully explained to Swati that mutual funds offer tax benefits at every phase of one’s investment journey.