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LTCG Tax Calculation for ELSS Mutual Funds

12 January 2022
5 minutes

Investors love to invest in the equity market, which is one of the most volatile and higher returns markets. However, they are wary, as the chances of incurring a loss or lower return are higher in the equity sector. The taxes are also higher when investors trade in equity. The good news is that there are newer and better investment schemes in the market, such as the equity-linked savings scheme (ELSS). ELSS  has become a prominent investment option today with higher returns, tax exemptions, and a lower risk factor.

ELSS is the name given to tax-saving mutual funds where the portfolio is mostly invested in equity funds or equity-related funds. It is also known as the tax-saving scheme as it offers an exemption of tax under Section 80C of the Income Tax Act. The scheme comes with a lock-in period of three years, before which you cannot redeem the investment. Furthermore, the income and profit earned at the end of the three-year period will be considered LTCG (Long Term Capital Gains) and will be taxed @10% if the investment or the return value exceeds Rs 1 lakh.

Benefits of ELSS

The benefits of investing in ELSS are as follows: 

  • The investment in ELSS is on the lower side, which can be as low as Rs 500 per month, or it can be in the form of a lumpsum investment. For safe investors, a lower investment option comes as a relief as they can save and diversify their portfolios by investing in this scheme. This is suitable for regularly earning investors.
  • You can invest in ELSS in the form of SIP, where you only put in a small amount every month and avail of the tax benefits while the investment grows gradually.
  • ELSS schemes mostly diversify the portfolio into various equity sectors such as small-cap funds, mid-cap funds or large-cap funds.

Calculation of Tax on ELSS Schemes 

Investment in ELSS comes under LTCG (Long Term Capital Gains) as the lock-in period of the scheme is 3 years, after which you can continue your investment in the scheme without any capping.

There is also the added benefit of tax exemption. After exempting Rs 1.5 lakh, the amount will be taxed under LTCG at 10% without any indexation benefit (benefit of adjusting the principal price after the effect of inflation on the same).

Now to understand this better, let’s assume that an investor has invested Rs 3 lakh in the ELSS scheme. After the 3 year lock-in period, the investor has redeemed the ELSS at Rs 3 lakh where, as per the above criteria, Rs 1.5 lakh will be exempted from tax.

Thus, taxable income after deduction of Rs 1.5 lakh from Rs 3 lakh equals Rs 1.5 lakh. 

As per the LTCG scheme, the investor has to pay tax on the amount after deduction of Rs 1 lakh from the amount, which comes to Rs 50,000  (150000-100000).

This sum of Rs 50000 is subjected to 10% tax under the LTCG, which is Rs 5000.

Thus, the investor has to pay Rs 5000/- on the ELSS of Rs 3,00,000/- 

In short: 

Particular Amount 
Investment value 3,00,000
Exempted value from Tax 1,50,000
Amount after exemption 1,50,000
LTCG scheme (Deduction) -1,00,000
Amount Subjected to Tax  50,000
Amount of Tax as per 10%  5,000

The calculation may look tricky for an average investor. Here are some quick and easy points to remember:

  • First, remove Rs 1,50,000 from your investment value of the ELSS tax scheme. 
  • After the lock-in period, LTCG will apply to the ELSS scheme. 
  • Deduct Rs 1,00,000 from the remaining amount. 
  • The final amount is subject to 10% tax. This will be your final amount of tax on the ELSS scheme.

ELSS has become more popular among investors as they enjoy the diversification of their portfolios with a minimum risk factor, along with the tax benefits. But ELSS is still a highly market-based investment scheme that is subject to market volatility. Hence, before making any investment in any ELSS, an investor should check the segment that the ELSS is invested in.

Key Takeaways 

  • ELSS can be termed as one of the best wealth creation tools as, along with tax benefits, it is also a disciplined approach towards investment, especially if investors choose to invest via SIP.
  • If the investor chooses the dividend option, they can benefit from cash inflow via dividends during the lock-in period. 
  • Considering all other forms of investments, ELSS serves as the best option by ensuring the safety of returns, diversification of funds, and taxation benefits. 

FAQs

Q1. Which is the more preferred scheme, ELSS or PPF?

A. Investors who want secured returns invest in PPF, whereas most other investors love to invest in ELSS. 

Q2. Is ELSS highly volatile?

A. ELSS is managed by fund managers who ensure that the market volatility does not affect the investor’s principal investment. However, since the investment is 80% of the equity market, certain fluctuations can be termed as a risk factor for the investor.

Q3. Is the ELSS scheme good for the long term?

A. After the three-year lock-in period, investors can redeem their investment or stay invested. But the investor must note that the investment after the deductions is still subjected to 10% tax, though ELSS can give high returns in the long term.

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