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ELSS – An investment for tax and growth - Views on News from Equitymaster
 
 
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  • Jan 31, 2001

    ELSS – An investment for tax and growth

    The Equity Linked Saving Scheme (ELSS) is one of the investment avenues available to an investor to avail of rebate under Section 88 of the Income Tax Act.

    Investments in (or contributions to) ELSS are eligible for rebate with a ceiling of Rs 10,000. In other words, of Rs 60,000, an investor can invest upto Rs 10,000 in an ELSS to avail of rebate under Section 88. With a contribution of Rs 10,000, an investor will earn a rebate of Rs 2,000 i.e. @ 20% of contribution. That is not to say that investors cannot invest more than Rs 10,000. They very well can, although they will earn a rebate only on Rs 10,000, which is the ceiling for ELSS contribution.

    Investors need to understand the implications of the rebate calculation in order to fully appreciate the advantages of investing in an ELSS. Of Rs 10,000 contributed towards ELSS, the investor gets rebate of Rs 2,000. Effectively his contribution is only Rs 8,000. Assuming that there is no dividend income or capital appreciation after a lock-in of 3 years, he will get Rs 10,000 – his original investment. A growth of Rs 2,000 on an effective investment of Rs 8,000, works out to a 25% absolute appreciation and an annualised compounded rate of 7.7% over 3 years. And all this is tax-free.

    Open-ended, ELSS  NAV(Rs) 6-mths 12-mths 3-yrs *Inception
    Alliance Cap. Tax 1996 64.6 2.1% -6.8% 88.0% 60.4%
    Zurich(I) Tax Saver (Div) 18.2 7.0% -7.3% 76.9% 46.4%
    Tata Tax Savings 11.8 -4.0% -47.1% 51.7% 27.5%
    Magnum Taxgain 23.1 -10.5% -52.6% 42.7% 13.9%
    Canpep 1993 19.5 -0.8% -17.3% 33.3% 14.1%

    *Compounded Annual Growth Rate

    Lock-in
    At first glance, a 3-year lock-in in an ELSS product may seem unreasonable to investors. But investors must consider the fact that all investment products under Section 88 have a lock-in period. As a matter of fact, ELSS along with the tax saving schemes of ICICI and IDBI have the lowest lock-in period.

    Investment avenue Lock-in
    ELSS 3 years
    NSC 6 years
    PPF partial withdrawal after 4 years
    Institutional bonds 3 years

    Tax-free growth
    Investing in ELSS has other significant advantages. Dividend declarations by the ELSS are tax-free in the hands of investors. Capital gains if any, will get the benefit of indexation (under Sections 48 and 112) and will be taxed at a flat rate of 20%. The investor, if he wants a total tax-free growth, can even invest the amount of gains (under ELSS) in avenues covered by Section 54F (purchase/construction of residential house) and 54EC (NABARD bonds).

    High risk-high return
    Among all investment avenues available under Section 88, ELSS has potential for highest returns. Investments in public provident fund (PPF), National Savings Certificate (NSC), and institutional bonds earn income of a ‘fixed’ nature, i.e. they give returns of a fixed nature and not more. On the other hand, ELSS being an equity product, can boost returns far beyond any other fixed income instrument like a PPF or NSC. These returns could be by way of dividend or capital appreciation in the net asset value (NAV) at the end of 3 years. (We haven’t included life insurance policy in our study because they are by nature not an ‘investment’ in the truest sense of the word, and are essentially instruments for financial security).

    Investment avenue Risk Return
    ELSS High High
    NSC Low Low
    PPF Low Low
    Institutional bonds Low Low

    However, higher returns come at higher quantum of risk. The very reasons that can boost returns of an ELSS, can also depress returns. By dealing in equities, the fund manager can only give you returns depending on the performance of the stock markets. So if equities are witnessing some exciting times, this will reflect in the NAV of the ELSS. Conversely, if stock markets are down, the NAV will also fall.

    It could also happen that the NAV rises with an equity boom, but the investor cannot exit the fund because of the lock-in and when he is ready to exit after the lock-in, equity markets are depressed and the NAV slides, robbing him of the interim gains.

    Suitability
    The bottom line is ELSS is not for investors past retirement, or even those approaching retirement (above 50 years). It is product with a high risk-high return profile and is ideal for investors below 50 years. Investors who are fully or partly invested in fixed income instruments like PPF, NSC and infrastructure bonds can consider investing in ELSS for a change, to boost returns by taking on an added element of risk. To see the best performing ELSS products,click here

     

     

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