Equity Linked

Savings Scheme
An Efficient Tax-Saving Tool

ELSS
helps you to
plan your
taxes

The Smart Investor Vol. II

 What is
ELSS?

ahul has to make investments

R for this financial year in order

to avail of tax benefits. He
knows about a few investment
instruments that will help him
reduce his overall tax liability. He
therefore has to decide upon an
investment plan that will give him
maximum returns and also enable
him to save tax. He consults his
cousin Mr Shah, an investment
banker with over 20 years of
experience in the field. Mr Shah
explains the benefits of investing in
an Equity Linked Savings Scheme
(ELSS) to him.

2 Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

I have to make investments for the purpose of tax-planning for this
financial year. Where and how much can I invest in order to avail
maximum tax benefit? I have heard of ELSS. Does it give me any
tax benefit?

There are many tax-saving instruments, like NSC, PPF that have a fixed maturity
period and give fixed returns on the amount invested. Conversely, ELSS is an
equity linked tax-saving investment instrument.

Until the financial year 2004–05, section 88 of the Income Tax Act had fixed an
overall ceiling of Rs 100,000 for investments in tax-saving
instruments, including a cap of Rs 10,000 for investment in ELSS.
The investor would get a rebate based on his taxable income.
Here’s
However, the budget for the financial year 2005–06 has
scrapped section 88 and has replaced it with section 80C.
some good
Under this section, investments upto Rs 100,000 are eligible news!
for deduction from gross total income and the ceiling on
investment in ELSS has been removed. This investment is
deducted from the total income, hence reducing the total
taxable income.

Assume that you have an annual gross income of

Rs 400,000 and out of this you have invested Rs 100,000
in tax-saving instruments. Say out of this in the previous
financial year you invested Rs 10,000 in ELSS, while in the
current financial year you invest the entire Rs 100,000,
which is ten times the previous year’s limit of Rs
10,000, in ELSS. The calculation of your taxable
income under both sections will be as follows:

Particulars FY 2004–05 FY 2005–06

Amount (Rs) Amount (Rs)

Gross total income 400,000 400,000

(-) Deductions Nil 100,000

Taxable income 400,000 300,000

Tax liability 94,000 40,000

(-) Rebate 15,000 Nil

Net Tax liability 79,000 40,000

The Smart Investor Vol. II 3

That is good, but what are the other features of this year's budget?

The most positive feature of this budget is that section 80C is applicable to all
individuals regardless of their income level. Until last year, individuals with a gross
total income of Rs 5,00,000 and above did not get any tax benefit under section 88.
However, tax benefits on ELSS investments are now open to all individuals
irrespective of their income level.

I have invested in mutual funds, but what is the difference between

diversified equity schemes and ELSS?

Both ELSS and diversified equity schemes have the same risk profile. They are high
risk - high return investment avenues. The major difference is in terms of the
mandatory lock-in period of three years applicable to ELSS.

It is always advisable for investments in equity-

How is linked instruments to be for the long term, as it is
only over this time frame that equities have the
ELSS potential to unlock value and outperform other
better? comparable assets. The lock-in period fixed for
ELSS supports this view and also allows the fund
manager to plan a strategy that will be beneficial in
the long-term.

Various researches on mutual funds have found that ELSS

funds have shown impressive performances over three
years. The average three year Compounded Annualised
Growth Rate (CAGR) performance of leading five
tax-saving funds and diversified equity funds is
58.7 per cent* and 57.08 per cent* as of December 31,
2005 respectively. And if you consider the tax benefits
associated with ELSS, their performance looks even
better than that of diversified equity funds.

In addition, some ELSS schemes

offer additional benefit of
Personal Accident Death
Insurance cover.

*Source: www.valueresearchonline.com

4 Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

What are the benefits of investing in ELSS over other tax-saving
instruments?

• Investments in ELSS enable an investor to claim deductions under section 80C

upto Rs 100,000.

• Since this is an equity-linked scheme, the earning potential is very high

(although at a higher risk) as compared to other tax-saving instruments.
The Systematic Investment Plan (SIP) is an effective way of investing in
ELSS as the concept of rupee cost averaging and the power of compounding
work well.

• The lock-in period is the shortest, three years, as compared to other tax
saving instruments. The maturity period for NSC and PPF is six years and
15 years respectively.

• According to current tax laws, long-term capital gains on investment in

equity oriented funds and the dividends received on these investments are
tax-free under section 10(38) and section 10(35) respectively in the hands of
the investor.

ELSS vs other tax-saving instruments

Parameter PPF NSC ELSS

Returns 8% 8% 25 – 30%#

Interest Receipt On maturity On maturity Depends on performance

Tenure 15 years 6 years Minimum 3 years

Tax Benefits Sec 80C and Sec10 Sec 80C Sec 80C

Minimum Investment Rs 500 per annum Rs 100 Rs 500

Maximum Investment Rs 70,000 per annum Rs 100,000 per annum No upper limit*

* There is no upper limit on investment is ELSS. However, investments of only upto Rs 100,000 are allowed to be
claimed as deductions under section 80C.
# The performance of the top five funds in India over a period of three years. Past performance may or may not be
sustained in the future.

Investors may note that though as of now the Finance Act, 2005 does not tax any withdrawals from ELSS, it may be
possible that as and when the proposed EET system becomes fully operational, any redemptions from ELSS may be
subjected to tax. In order to work out the roadmap for smoothly moving towards the EET system, the Bill has proposed
to set-up a committee of experts. Such committee will examine the mix of savings instruments that would qualify
under the new system and propose suitable tax incidence. Investors should note the above before making any
investment under ELSS.

The Smart Investor Vol. II 5

What about liquidity in ELSS investments? Can I redeem my investment
before the lock-in period ends?

No. The amount cannot be withdrawn before the maturity period. However, ELSS is
definitely beneficial as compared to other tax-saving instruments, as the lock-in
period is just three years compared to the maturity period of six years (NSC) and
15 years (PPF) respectively. Also, the earning potential of ELSS is high, although at
higher risk.

Premature withdrawal from other tax saving instruments is allowed on specific

conditions. Investors can opt for the dividend option in ELSS; dividends are tax-
free, thus ensuring some liquidity and the opportunity to
capture gains during the lock-in period.
It’s EASY,
know your What should be my investment strategy for
risk profile! ELSS funds?

Your investment strategy can be as follows:

1. Your risk appetite should at all times determine the total

investments in tax-saving funds. Don't go overboard in
the segment simply because of the opportunity to rake
in impressive returns, thereby ignoring the risk
involved.

2. Use the SIP route for investing in tax-saving

funds. Not only does it do away with the need for
timing markets, but it also reduces the strain
on your wallet at the end of the financial
year when most investors conduct their
tax-planning exercise.

6 Equity Linked Savings Scheme — An Efficient Tax-Saving Tool

I have some investments in other mutual fund schemes, consisting of
both debt and equity. How are the returns on both types of schemes
taxed?

The following table shows the various tax implications on both equity and debt
fund investments:

Equity-oriented Debt-oriented

Type of Short-term Long-term Dividends Short-term Long-term Dividends

Tax Payer gains gains gains gains

Resident Indian 10%* Nil Nil 30%*# 10%* Nil

HUF 10%* Nil Nil 30%*# 10%* Nil

Partnership 10%* Nil Nil 30%* 10%* Nil

Corporate 10%* Nil Nil 30%* 10%* Nil

NRI 10%* Nil Nil 30%* 10%* Nil

PIO 10%* Nil Nil 30%* 10%* Nil

Overseas Corp Body 10%* Nil Nil 30%* 10%* Nil

FIIs 10%* Nil Nil 30%* 10%* Nil

Private Trust 10%* Nil Nil 30%*# 10%* Nil

Charitable Trust Nil† Nil Nil Nil† Nil Nil

Notes:
* Subject to applicable surcharge. On individuals and HUF, if taxable income exceeds Rs 1000,000 there is a surcharge of
10%. Partnerships and Companies pay surcharge of 10% on the first rupee of their income.
# On short-term gains of Debt oriented funds, tax is payable as per applicable slab.
On the first slab of income upto Rs 100,000 tax is Nil; On the slab between Rs 100,000 and Rs 150,000 tax is
@ 10%; On the slab between Rs 150,000 to Rs 250,000 tax is @ 20%; and on income over Rs 250,000 tax rate
is @ 30%.
† Assuming that the charity trust has the exemption certificate from Income Tax Department.
LTCG on Equity Funds are exempt under section 10(38); Dividends are exempt under section 10(35); LTCG on Debt
Funds suffer tax at lower of @ 20% with indexation or 10% without indexation.

The Smart Investor Vol. II 7

 To know more about investing in mutual funds,
contact your financial advisor
~
Visit: www.reliancemutual.com
~
Email: customer_care@reliancemutual.com
~
Transact online at www.reliancemutual.com
~
Call: 3030 1111

The design, illustrations and content has been generated by Netscribes (India) Pvt. Ltd.

The views expressed in the booklet are personal views of the Author(s). The views constitute only the
opinions of the Author(s) and do not constitute any guidelines or recommendation on the course of action
to be followed. These are not necessarily the views of Reliance Capital Asset Management Limited.
Reliance Capital Asset Management Limited does not accept any responsibility/liability/obligations in
respect of any information provided herein.

Sponsor: Reliance Capital Limited • Trustee: Reliance Capital Trustee Co. Ltd. • Investment Manager:
Reliance Capital Asset Management Limited • Statutory Details: The Sponsor, the Trustee and the
Investment Manager are incorporated under the Companies Act 1956.

Risk Factors: Mutual Funds and securities investments are subject to market risks and there is no
assurance or guarantee that the objectives of the Scheme will be achieved. As with any investment
in securities, the NAV of the Units issued under the Scheme can go up or down depending on
the factors and forces affecting the capital markets. Past performance of the Sponsor/AMC/Mutual
Fund is not indicative of the future performance of the Scheme. The Sponsor is not responsible or
liable for any loss resulting from the operation of the Scheme beyond their initial contribution of
Rs.1 lakh towards the setting up of the Mutual Fund and such other accretions and additions to the
corpus. The Mutual Fund is not guaranteeing or assuring any dividend/bonus. For scheme specific risk
factors, please refer to the Offer Document of the respective scheme. Please read the offer
document carefully before investing.

Corporate Office:
Reliance Capital Asset Management Limited
Trade World, 'B' Wing, 7th Floor, Kamala Mills Compound,
Senapati Bapat Marg, Lower Parel (W), Mumbai - 400 013.