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Monday, February 6, 2012

Yearend tax planning part 3- ELSS

ELSS or Equity Linked Saving Scheme is another avenue to save the tax under section 80 C.
In earlier two posts of this series I had discussed almost-zero risk avenues to save income tax. But this option carries risk but generally gives much better returns than the previous 80-C avenues- NSC & Tax saving FDs.
But before I delve deeper into ELSS, let me clear that that tax benefits under section 80 C may be done away under DTC (Direct Tax Code) from the FY 13 and onwards.
But as far as present financial year FY 2011-12 is concerned, investors shall definitely get the tax saving benefits.
ELSS is nothing but a mutual funds scheme with a lock-in period of 3 years which invests its corpus in equities (shares of the companies).
Alike other mutual fund schemes ELSS comes with 3 options-
     (1)    Growth Option: When fund value increases (due to appreciation in the price of shares bought) it is reflected in the NAV of mutual fund units. In simple words, when a fund performs well, NAV of its units increases.
     (2)    Dividend Payout: in this option increased fund value is distributed to the investors in the form of the dividend. This is the reason why NAV of the dividend payout option does not increases in comparison with their growth counterparts. As the ELSS invests in equity, dividend is tax-free at the hands of the investor.
    (3)    Dividend Reinvestment Plan: in this plan the appreciation in the fund value is used in buying the units of the same mutual fund scheme. Under this plan NAV of the mutual fund does not increase in comparison with the growth plan but number of units gets multiplied.

Let us understand the aforesaid with an illustration-
Suppose a fund house with a corpus of Rs. 1 crore and there are 10 lakh unit holders. This means initial NAV of each mutual fund unit is Rs. 10. If in the wake of bullish market, fund value of the scheme increases to Rs. 1.2 crore.
      (1)    Under growth plan NAV of each unit shall become Rs. 12.
      (2)    Under dividend payout plan each unit shall fetch a dividend of Rs. 2 and NAV shall remain Rs. 10 as earlier.
      (3)    Under dividend plan for every 5 units of the MF scheme investor shall get 1 new unit with NAV of all units remaining Rs. 10 only.

Why one should avoid SIP in ELSS?

SIP in ELSS creates a complex situation and investor easily gets confused and often misses the tax benefits.
Mr. Shah wanted to invest Rs. 60,000 in ELSS in the year FY 2010-11. And it was March 2011.Instead of investing a lump sum Rs. 60,000 in ELSS; Mr. Shah opted to go for monthly SIP of Rs. 5,000.
But Income tax officer only allowed the deduction of Rs. 5000 only.


The reason was simple. To get the tax benefit in a particular financial year, one has to do the investment in that financial year only.
Mr. Shah started the SIP in March 2011. As financial year closes on 31st March, only Rs. 5000 got invested in FY 2010-11 (March). Therefore only Rs. 5000 was considered for the deduction.
Even if an investor wishes to go for SIP, he should go for SIP with the time horizon not more than a year and care should be taken that all SIP investment should be deposited in that financial year only.
Biggest drawback of SIP in ELSS is investor can’t redeem his investment in one- go after 3 years. If he wishes lump sum redemption then he shall have to wait till last SIP investment to complete 3 years.

What investor should know about Dividend Reinvestment option?

As we know under dividend reinvestment plan, investors get new units (in case of appreciation in the fund value of the mutual fund scheme). But these new units shall not mature along with old units.
Suppose if new units are allotted just a day before completion of 3rd year (3 –year lock-in), these new units shall take further 3 years to mature and thus these new unit can’t be redeemed along with old units.
To avoid all these hassles investor shall be better if he opts for either Growth or Dividend Payout Option.


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