Along with wealth creation, mutual funds help us save tax every year. Given the current stock market rally, mutual fund investment have become more rewarding. Equity Linked Savings Scheme or ELSS mutual fund schemes, investment in which qualify for tax benefit under Section 80C, have delivered 33.35 per cent return on an average in last one year, according to Value Research website. The 3-year and 5-year CAGR of these funds (average return of all the funds in ELSS category) are 13.26 per cent and 19.20 per cent respectively, a search on the Value Research website shows.

ELSS Fund meaning

ELSS funds are mutual fund schemes that invest mainly in equity and equity related instruments and are not confined to any specific sector . The only differenciating factor between an ELSS fund and normal equity fund is that, investment in ELSS funds have a lock-in period of 3-years. It means, you can not reedem/sell your ELSS fund units before 3 year.

Tax benefit of ELSS funds

As per current tax rules, investment up to Rs 1.5 lakh in ELSS funds qualify for tax benefit under Section 80C of Income Tax Act. Investment in ELSS funds fall under the EEE or exempt, exempt, exempt category. This means, investment in the fund (up to Rs 1.5 lakh in a year), returns from the fund/dividend and maturity proceeds are all tax-free.

Investment options in ELSS funds

While investing in an ELSS fund you can choose either a growth option or a dividend option. In an growth option, profits from investment get accumulated and reinvested in the fund and the net asset value of the fund keeps on increasing. However, in a dividend option, investors get some part of the profit in regular intervals as dividends. Financial planners suggest investing in growth option, which results in better wealth creation over long term.

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One can either invest lumpsum amount in an ELSS fund or invest through systematic investment plans (SIP). Systematic investment plan is a investment option offered by mutual funds under which an investor invests fixed amount at regular intervals (monthly, fortnightly etc.). SIP investment also helps in averaging out the buying price of units and gives better protection against market flactuations.

Here are some other taxation rules related to mutual fund investment

1) Profit from equity mutual fund and debt mutual funds are taxed differently. For the purpose of taxation, if a mutual fund scheme invests 65 per cent or more of its corpus in equity or equity related instruments, then it is considered as an equity mutual fund.

2) Gains derived from equity mutual fund units after holding them for more than 12 months are considered as long-term capital gain and currently no tax is levied on long term capital gains from equity mutual funds. However, if units are sold before holding it for 12 months, then short-term capital gain tax of 15 per cent in levied on them.

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3) Equity mutual funds offer both growth and dividend options. Any dividend received from equity mutual funds are tax-free irrespective of when you receive it.
4) In case of debt funds, which include liquid funds, income funds and gilt funds, investments are considered long term only if units are held for more than three years. Long-term capital gains from debt mutual funds are taxed at 20 per cent with indexation benefit.

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5) However, if units in a debt mutual fund are sold before three years, then gains arising out of that are considered as short-term capital gains, and are taxed according to the tax slab of the investor. Meanwhile, dividends received from a debt mutual fund are exempt from tax in the hands of investors but mutual fund houses pay dividend distribution tax at the rate of 28.84 per cent (including cess) on the dividend amount.