• OUTLOOK ARENA
  • SPECIAL REPORT
  • JANUARY 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

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407