ELSS Mutual Funds - Equity Linked Savings Schemes to Save Tax under Section 80C

Some three years ago, the then finance minister P Chidambaram expanded the scope of section 80(C), a section in the Income Tax Act that allows Indians to save tax. Under this section you can invest upto Rs.1 lakh in ELSS mutual funds and reduce your taxable income by the amount of your investment. ELSS mutual funds are Equity Linked Savings Scheme mutual funds that provide equity linked growth and help you save tax.

Here's how it works. If you have a taxable income of Rs.6,00,000. You can invest Rs.1 lakh in a tax saving mutual fund and your taxable income comes down to Rs.5,00,000. This is very useful if you're in the highest tax bracket. By investing Rs.1 lakh in ELSS mutual funds you save on the tax to be paid on it, which is Rs.33,360. This is why you see large ads every year in the last quarter of the year inviting you to invest in ELSS and 'save upto Rs.33,360'. Tax saving mutual fund schemes are offered by all assetmanagement companies (AMCs) including Reliance, HDFC, Tata, Franklin Templeton, ICICI Prudential etc.

There is a lock-in period of 3 years when investing in these ELSS mutual funds. You can opt for the 'growth' option or for the 'dividend' option. If you opt for the growth option, you won't get a dividend and your investment will continue to grow till you decide to redeem the units. You can redeem then anytime after a period of 3 years from the day the units are alloted. If you choose the dividend option, you'll get a dividend from time to time.

While there are no assurances about this or about the performance of ELSS mutual funds or the declaration of dividend, most AMCs declare dividend once a year or sometimes even more frequently, in their tax saving schemes. If you invest Rs.1 lakh in a scheme and receive Rs.15,000 in dividend, coupled with the Rs.33360 you saved as tax, you have effectively received almost half your investment back in the year and still continue to stay invested! This is an attractive propostion if the stock market rises but bear in mind that the Net Asset Value (NAV) of your units falls by the amount declared as dividend. This is usually not an issue because most funds declare dividends only when there has been a substantial appreciation in the investments made.

You can invest in ELSS mutual funds conveniently. All you need to do is download the common application form of the AMC in PDF format. Print out the form using a PDF viewer and fill it out. You can then attach your cheque and submit the form at the office of the AMC in your city. You need to invest in the year you want to save tax. If you want to save on tax this year, be sure to invest before the year ends. It's generally a good idea to invest when the stock market falls because you're able to get the units at a lower price and have greater scope for capital appreciation. A major advantage that tax saving mutual funds have over other mutual fund schemes is that tax saving mutual funds are close-ended. They cannot be sold or redeemed for 3 years. So there is lesser 'churn' in ELSS mutual funds. In case of mutual fund schemes where buy back is freely allowed, unit holders offer redeem the units. This forces the mutual fund manager to sell even when the market is low thereby causing losses to the unit holders. This doesn't happen in case of tax saving schemes because the unit holders are not allowed to sell before a period of 3 years has elapsed. This also helps the fund manager of the tax saving schemes to invest in long-term growth and provide a better return to investors.