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Taxation on ELSS

  July 2,2022
Do You Know How Your ELSS Gains Are Taxed?
Equity Linked Savings Scheme (ELSS) is a tax-saving mutual fund you can invest in and reduce your taxable income. However, the gains made from ELSS investment are taxable.     
What differentiates ELSS from other tax-saving instruments under section 80C is that ELSS has the shortest lock-in period of three years, and the fund manager needs to invest at least 80% of the fund's portfolio in equity investments. 
There are two ways to gain from ELSS funds: capital gains after redemption of the fund’s units and dividend income.
This article will show how your gains from ELSS funds, whether you have invested lump sum or through SIP and dividend income, will be taxed.  
Tax on Capital Gains 
ELSS is an equity fund. According to the current rules, gains from redemption from equity funds within 12 months are considered short-term capital gains. On the other hand, gains made on units after the units are withdrawn after 12 months are considered as Long Term Capital Gains (LTCG). 
As you can’t redeem your units before 36 months, the capital gains on ELSS are considered long-term capital gains. So, in the case of ELSS funds, the capital gains above Rs. 1 lakh in a financial year are taxed at 10%. However, you need to remember that this Rs.1 lakh limit will consider your other equity investments, such as equity mutual funds and stocks.   
Lumpsum investment 
It is simple to know the capital gains tax on lumpsum investment as you can easily track the number of years your investment stayed invested. 
Let us consider an example.  
Assume Amal deposited Rs 5 lakhs in an ELSS fund on April 3, 2018. It was redeemed for Rs 7 lakh on June 4, 2021. During the three years that he stayed invested, he made a gain of over Rs. 2 lakh, if we assume that the fund had given an 8% return in the last three years. 
So, now he must pay 10% LTCG tax on the capital gains after deducting Rs1 lakh, which is Rs.1 lakh (Rs2 lakh – Rs1 lakh). Thus, his LTCG tax on ELSS investment will be Rs.10,000 (10% of Rs.1 lakh). 
SIP investment 
Investing a fixed sum of money every month through SIP can help you systematically plan your tax-saving investments without worrying about tax saving at the last minute. 
However, calculating the applicable capital gains on investments made through SIP may be difficult, as every installment is locked for three years. So, if you start investing in an ELSS fund through SIP in January 2022, then the units allotted to you in January 2022 will be locked till January 2025.  
For instance, if Amal invested Rs. 12,500 in an ELSS through SIP every month from April 2018 to Jan 2022. If he wants to redeem his investments now, he can only redeem the units that he invested before Feb 2019.   
Depending on the returns earned by every SIP installment, the fund house will calculate applicable tax on gains from each installment. The fund house would calculate the gains based on the Net Asset Value(NAV) on which the SIP investment and exit are processed.
So, if we consider that the NAV during April 2018 was Rs. 10, it grew to 40. Then the gains from the 1st installment would be Rs. 37,500. 
SIP Instalment NAV Units Exit NAV Value of the units Gains
12,500 10 1250 i.e. (12,500/10) 40 50000 i.e.(1250*40) 37,500 i.e. Value of the units-SIP instalment 
 The fund house would calculate the gains similarly for every installment until Feb 2019.
So, this was all about tax on capital gains from ELSS investment. Let us now see how the government would tax dividend income. 
If you invest in an ELSS mutual fund scheme, you can select whether or not to receive a dividend. If you choose the pay-out of income distribution cum capital withdrawal option, you will be eligible for a dividend if the fund announces one. You can earn dividends throughout the 3-year lock-in period as well. However, the dividend you receive is added to your taxable income. It is then taxed according to the tax bracket in which your income falls. For example, if your income is in the 30% tax bracket, the dividends you earn from your ELSS funds will also be taxed at 30%.
ELSS is an excellent tax-saving instrument, especially if you want to stay invested for the long term. However, you need to be aware of the taxation of capital gains and dividend income on ELSS investment. You can talk to us to know more.

This blog is purely for educational purposes and not to be treated as personal advice. Mutual fund investments are subject to market risks, read all scheme-related documents carefully.