Mutual funds are considered as tax-efficient investment vehicles which helps you to minimise tax liability by reducing the overall taxable income. The most important point in mutual fund investment tax planning is that an incident of taxes arises only upon the sale of a mutual fund unit’s scheme. You may get 5-6% interest from a fixed deposit scheme. However, the interest income is fully taxable as per the applicable income tax slab, thus the effective post-tax return for an investor in the highest tax bracket will be tantamount to 3.5%-4.2%, not even beating inflation in recent times. The tax saver app is available on many portals explaining the amount of taxes on mutual funds and how you can save taxes while creating wealth at the same time while investing in mutual funds.
Mutual funds offer investors returns in the form of dividends and capital gains. Both dividends and capital gains are taxable in the hands of mutual funds investors. The capital gains arising from the sale of mutual funds depend on the holding period and type of mutual fund. ELSS, a special type of mutual fund which comes with an added advantage of tax savings upon investing in the scheme, is covered under section 80C of Income Tax Act 1961. ELSS offers a straight reduction in your taxable income to the tune of Rs 1.5 lakhs under the aforementioned section of the prevailing tax laws.
Let us understand the ELLS more simply.
Equity Linked Savings Scheme
Investors can reduce taxable income i.e., save taxes by investing in Equity Linked Savings Scheme (ELSS) Mutual Funds. ELSS mutual funds qualify for deduction from investors’ taxable income under Section 80C of the Income Tax Act 1961. The maximum investment amount eligible for tax deduction under Section 80C stands at Rs 1.5 lakhs. As per the prevailing provisions, Investors in the highest tax bracket can therefore save up to Rs 46,350 in taxes (Rs 1.5 lakhs X 30.9% tax + cess) by investing in ELSS mutual funds. The overall ceiling of Rs 1.5 lakhs includes all eligible items like employee provident fund (EPF) contribution, PPF, life insurance premiums, NSC and ELSS mutual funds, etc. A tax savers app provides an estimate of the tax deduction and estimated tax payable for a financial year.
ELLS has a lock-in period of three years which means that you have to leave the money in notified funds for a minimum period of three years. ELSS offers the shortest lock-in-period of three years when compared to other tax-saving instruments like PPF, NSC, and post office savings deposits. ELSS is considered to be a very good option for investors who are willing to take moderate to high risks.
Tax on Equity Mutual Funds
Equity funds are those mutual funds where fund managers predominantly invest in equity and equity-related securities. If an investor redeems an equity mutual fund within a period of 12-months from the date of purchase, then short-term capital gains are attracted at a flat rate of 15%, irrespective of investors’ income tax bracket. Investors attract long-term capital gains on selling equity fund units after a holding period of one year or more. These capital gains of up to Rs 1 lakh a year are exempted from tax. Any long-term capital gains exceeding this limit attract LTCG tax at the rate of 10% with no benefit of indexation.
Tax on Debt Funds
Debt funds are those mutual funds where fund managers predominantly invest in debt and debt-related securities. If an investor redeems debt mutual funds within three years from the date of purchase, then short-term capital gains are attracted. These gains are added to investors’ taxable income and taxed at a normal income tax slab rate. Long-term capital gains are attracted when investors sell units of a debt fund after a holding period of three years. These gains are taxed at a flat rate of 20% after indexation plus applicable cess and surcharge on tax.
Thus, ELSS mutual funds offer a unique solution concerning income tax planning and reduction on taxable income. It offers the benefit of tax reduction along with capital appreciation over a longer-term horizon.