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Can Investing in Mutual Funds helps to save taxes beyond section 80C?
An investor education & awareness initiative.
Amended as on Apr 1, 2023: Please note that as per amendments in Finance Bill 2023, from April 1, 2023, profits made on investments in debt mutual funds are now taxed as short-term capital gains if these funds invest <=35% in equities. This means, debt mutual funds are now taxed as per the income tax rates as per an individual’s income.
Also note that with effect from Apr 1, 2020, Dividend Distribution Tax (DDT) was abolished, and mutual fund dividends were made taxable in the hands of investors. Dividend income is now considered as ‘income from other sources’ and investors need to pay tax on it as per their individual tax slabs.
This article is currently in the process of getting updated, as it was originally written at a time when tax rules were different. Please treat this note as the latest updated tax information in the meanwhile.
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 three broad categories of mutual funds as per Indian tax laws; these are:
The tax impact
Tax on income distributed by Mutual Funds
Income distributed by Mutual funds is taxable in the hands of investors, and will therefore be taxed as per your individual income tax slab.
Tax on capital gains
Other than equity oriented funds
**i. Specified Mutual Funds – Exposure to domestic equity shares is upto 35%***
Any investments made in Specified mutual Funds on or after April 1, 2023, are deemed to be short term and accordingly, all capital gains are taxed at a rate determined by your income tax slab, regardless of the tenure for which you hold them. However, if you have acquired such funds prior to 1 April 2023, then the tax treatment would be similar to Non equity oriented funds other than specified mutual funds (refer point (ii) below).
ii. Non equity oriented funds other than Specified Mutual Funds – Exposure to domestic equity shares is more than 35% but less than 65%
Hybrid funds – the tax impact
The taxation of hybrid funds will depend upon the exposure they hold in domestic equity securities and accordingly will be classified in one of the three categories described above.
A special equity-oriented fund
There exists an equity-oriented fund that helps you save tax under section 80C of the Income Tax Act, 1961 (this tax deduction is over and above the other tax benefits such as lower rates, lesser period of holding for long term gains, etc. you receive on equity-oriented funds). The equity-linked saving scheme (ELSS for 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 an income in the form of income distribution (which are taxable). To receive such income , you must select the ‘Income Distribution cum capital withdrawal option’ option in your ELSS investment. While the interest earned on PPF is tax-free, you can’t make use of this interest immediately; 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.
Key Takeaways
Disclaimer: All Mutual Fund investors have to go through a one-time KYC (Know Your Customer) process. Investors should deal only with Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/redress complaints, visit dspim.com/IEID. This is an investor education & awareness initiative by DSP Mutual Fund.
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Mutual fund investments are subject to market risks, read all scheme related documents carefully. © DSPAM 2024.
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