Equity Linked Savings Scheme

An Efficient Tax-Saving Tool

helps you to plan your taxes
Drashti Investments drashti.investments@rediffmail.com

ELSS

The Smart Investor Vol. II

What is ELSS?

ahul has to make investments for this financial year in order to avail of tax benefits. He knows about a few investment instruments that will help him reduce his overall tax liability. He therefore has to decide upon an investment plan that will give him maximum returns and also enable him to save tax. He consults his cousin Mr Shah, an investment banker with over 20 years of experience in the field. Mr Shah explains the benefits of investing in an Equity Linked Savings Scheme (ELSS) to him.

R

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Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

I have to make investments for the purpose of tax-planning for this financial year. Where and how much can I invest in order to avail maximum tax benefit? I have heard of ELSS. Does it give me any tax benefit? There are many tax-saving instruments, like NSC, PPF that have a fixed maturity period and give fixed returns on the amount invested. Conversely, ELSS is an equity linked tax-saving investment instrument. Until the financial year 2004–05, section 88 of the Income Tax Act had fixed an overall ceiling of Rs 100,000 for investments in tax-saving instruments, including a cap of Rs 10,000 for investment in ELSS. The investor would get a rebate based on his taxable income. However, the budget for the financial year 2005–06 has scrapped section 88 and has replaced it with section 80C. Under this section, investments upto Rs 100,000 are eligible for deduction from gross total income and the ceiling on investment in ELSS has been removed. This investment is deducted from the total income, hence reducing the total taxable income. Assume that you have an annual gross income of Rs 400,000 and out of this you have invested Rs 100,000 in tax-saving instruments. Say out of this in the previous financial year you invested Rs 10,000 in ELSS, while in the current financial year you invest the entire Rs 100,000, which is ten times the previous year’s limit of Rs 10,000, in ELSS. The calculation of your taxable income under both sections will be as follows:

Here’s some good news!

Particulars Gross total income (-) Deductions Taxable income Tax liability (-) Rebate Net Tax liability

FY 2004–05 Amount (Rs) 400,000 Nil 400,000 94,000 15,000 79,000

FY 2005–06 Amount (Rs) 400,000 100,000 300,000 40,000 Nil 40,000

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That is good, but what are the other features of this year's budget? The most positive feature of this budget is that section 80C is applicable to all individuals regardless of their income level. Until last year, individuals with a gross total income of Rs 5,00,000 and above did not get any tax benefit under section 88. However, tax benefits on ELSS investments are now open to all individuals irrespective of their income level. I have invested in mutual funds, but what is the difference between diversified equity schemes and ELSS? Both ELSS and diversified equity schemes have the same risk profile. They are high risk - high return investment avenues. The major difference is in terms of the mandatory lock-in period of three years applicable to ELSS. It is always advisable for investments in equitylinked instruments to be for the long term, as it is How is only over this time frame that equities have the ELSS potential to unlock value and outperform other comparable assets. The lock-in period fixed for ELSS supports this view and also allows the fund manager to plan a strategy that will be beneficial in the long-term. Various researches on mutual funds have found that ELSS funds have shown impressive performances over three years. The average three year Compounded Annualised Growth Rate (CAGR) performance of leading five tax-saving funds and diversified equity funds is 58.7 per cent* and 57.08 per cent* as of December 31, 2005 respectively. And if you consider the tax benefits associated with ELSS, their performance looks even better than that of diversified equity funds. In addition, some ELSS schemes offer additional benefit of Personal Accident Death Insurance cover.

better?

*Source: www.valueresearchonline.com

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Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

What are the benefits of investing in ELSS over other tax-saving instruments?

• Investments in ELSS enable an investor to claim deductions under section 80C upto Rs 100,000.
equity-linked potential • Since this is anhigher risk) as scheme, thetoearningtax-saving is very high (although at a compared other instruments. The Systematic Investment Plan (SIP) is an effective way of investing in ELSS as the concept of rupee cost averaging and the power of compounding work well. the shortest, three as to other tax • The lock-in period isThe maturity periodyears,NSCcompared is six years and saving instruments. for and PPF 15 years respectively. long-term capital on • According to current tax laws, dividends receivedgainstheseinvestment inare equity oriented funds and the on investments tax-free under section 10(38) and section 10(35) respectively in the hands of the investor. ELSS vs other tax-saving instruments
Parameter Returns Interest Receipt Tenure Tax Benefits Minimum Investment Maximum Investment PPF 8% On maturity 15 years Sec 80C and Sec10 Rs 500 per annum Rs 70,000 per annum NSC 8% On maturity 6 years Sec 80C Rs 100 Rs 100,000 per annum ELSS 25 – 30%# Depends on performance Minimum 3 years Sec 80C Rs 500 No upper limit*

* There is no upper limit on investment is ELSS. However, investments of only upto Rs 100,000 are allowed to be claimed as deductions under section 80C. # The performance of the top five funds in India over a period of three years. Past performance may or may not be sustained in the future. Investors may note that though as of now the Finance Act, 2005 does not tax any withdrawals from ELSS, it may be possible that as and when the proposed EET system becomes fully operational, any redemptions from ELSS may be subjected to tax. In order to work out the roadmap for smoothly moving towards the EET system, the Bill has proposed to set-up a committee of experts. Such committee will examine the mix of savings instruments that would qualify under the new system and propose suitable tax incidence. Investors should note the above before making any investment under ELSS.

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What about liquidity in ELSS investments? Can I redeem my investment before the lock-in period ends? No. The amount cannot be withdrawn before the maturity period. However, ELSS is definitely beneficial as compared to other tax-saving instruments, as the lock-in period is just three years compared to the maturity period of six years (NSC) and 15 years (PPF) respectively. Also, the earning potential of ELSS is high, although at higher risk. Premature withdrawal from other tax saving instruments is allowed on specific conditions. Investors can opt for the dividend option in ELSS; dividends are taxfree, thus ensuring some liquidity and the opportunity to capture gains during the lock-in period.

It’s EASY, know your risk profile!

What should be my investment strategy for ELSS funds? Your investment strategy can be as follows: 1. Your risk appetite should at all times determine the total investments in tax-saving funds. Don't go overboard in the segment simply because of the opportunity to rake in impressive returns, thereby ignoring the risk involved. 2. Use the SIP route for investing in tax-saving funds. Not only does it do away with the need for timing markets, but it also reduces the strain on your wallet at the end of the financial year when most investors conduct their tax-planning exercise.

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Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

I have some investments in other mutual fund schemes, consisting of both debt and equity. How are the returns on both types of schemes taxed? The following table shows the various tax implications on both equity and debt fund investments:
Equity-oriented Type of Tax Payer Resident Indian HUF Partnership Corporate NRI PIO Overseas Corp Body FIIs Private Trust Charitable Trust Short-term gains 10%* 10%* 10%* 10%* 10%* 10%* 10%* 10%* 10%* Nil† Long-term gains Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil Dividends Short-term gains 30%*# 30%*# 30%* 30%* 30%* 30%* 30%* 30%* 30%*# Nil† Debt-oriented Long-term gains 10%* 10%* 10%* 10%* 10%* 10%* 10%* 10%* 10%* Nil Dividends

Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil

Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil

Notes: * Subject to applicable surcharge. On individuals and HUF, if taxable income exceeds Rs 1000,000 there is a surcharge of 10%. Partnerships and Companies pay surcharge of 10% on the first rupee of their income. # On short-term gains of Debt oriented funds, tax is payable as per applicable slab. On the first slab of income upto Rs 100,000 tax is Nil; On the slab between Rs 100,000 and Rs 150,000 tax is @ 10%; On the slab between Rs 150,000 to Rs 250,000 tax is @ 20%; and on income over Rs 250,000 tax rate is @ 30%. † Assuming that the charity trust has the exemption certificate from Income Tax Department. LTCG on Equity Funds are exempt under section 10(38); Dividends are exempt under section 10(35); LTCG on Debt Funds suffer tax at lower of @ 20% with indexation or 10% without indexation.

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The views expressed in the booklet are personal views of the Author(s). The views constitute only the opinions of the Author(s) and do not constitute any guidelines or recommendation on the course of action to be followed. These are not necessarily the views of Reliance Capital Asset Management Limited. Reliance Capital Asset Management Limited does not accept any responsibility/liability/obligations in respect of any information provided herein. Sponsor: Reliance Capital Limited • Trustee: Reliance Capital Trustee Co. Ltd. • Investment Manager: Reliance Capital Asset Management Limited • Statutory Details: The Sponsor, the Trustee and the Investment Manager are incorporated under the Companies Act 1956. Risk Factors: Mutual Funds and securities investments are subject to market risks and there is no assurance or guarantee that the objectives of the Scheme will be achieved. As with any investment in securities, the NAV of the Units issued under the Scheme can go up or down depending on the factors and forces affecting the capital markets. Past performance of the Sponsor/AMC/Mutual Fund is not indicative of the future performance of the Scheme. The Sponsor is not responsible or liable for any loss resulting from the operation of the Scheme beyond their initial contribution of Rs.1 lakh towards the setting up of the Mutual Fund and such other accretions and additions to the corpus. The Mutual Fund is not guaranteeing or assuring any dividend/bonus. For scheme specific risk factors, please refer to the Offer Document of the respective scheme. Please read the offer document carefully before investing.

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