Bad News for ELSS Investors

The Indian Income Tax policies as per the budget this year has had its share of good as well as bad news. While everyone expected a significant hike in tax slabs and section 80C, the reality was far from what was expected. To know more about the Indian Income Tax policies click here

Though there wasn't much change in these areas, there was however one significant news. This news affects all Mutual Fund Investors who invest in ELSS Mutual Funds to reap the benefits offered under Section 80C. The purpose of this article is to elaborate on that new policy and to analyze how it affects us.

So, lets get started!!!

What is ELSS?

Well, this is something we have covered in various articles in my blog in the past. ELSS stands for Equity Linked Saving Scheme and is a variety of Mutual Fund that invests in the stock market as well as provides tax benefits to investors under the section 80C of the Indian income tax policies. To know more about ELSS you can refer to the below articles:

What is ELSS

Saving Tax through Investments

Now that we have covered the basics, lets get down to business.

What is the current state of ELSS in India?

Until now, Equity Linked Service Scheme (ELSS) has been one of the first-choice mutual funds for Indian investors. As you might have read in the article on what is ELSS, It has two main benefits:
1. It helps you to save tax and
2. It helps you to invest in the stock market.

The 3 year lock-in period ensures that the investment is long-term and also is protected from market fluctuations. Market Statistics reveal that Rs 23,700 crores worth of ELSS schemes have been invested in May 2010 as compared to Rs 11,800 crores in May 2007. Between 60-120 lakh people regard ELSS as a tax-saving investment and are invested in the various ELSS schemes available in India.

What is DTC?

DTC stands for Direct Tax Code. It determines what income in India is taxable and the kind of taxes individuals who earn an income in India have to pay.

Impact of DTC 2011 on ELSS Investments

The DTC code 2011 has significantly affected ELSS Investments in India. This is because:

Starting April 1, 2012, no new ELSS Mutual Funds will be exempted from taxes taking away one of the biggest motivators of ELSS Investment. This is likely to hit the investors as well as the Mutual Funds industry hard.

How does this affect us?

Well, this is really bad news because – Starting April 1st 2012, all fresh investments into ELSS schemes will no longer be eligible for tax benefits. Which essentially means that ELSS mutual funds are no longer an option for tax saving.

I personally feel that the best option to save tax for the younger generation has been taken away from Investors.

Is it sensible to still invest in ELSS?

The important point to be noted here is that according to the revised 2011 Direct Tax Code, only ELSS Mutual Funds initiated after April 1, 2012 will not be exempted from tax deductions. This does not apply to already existing ELSS funds and investments made before the aforementioned date, so it would be to wise to avail this offer while it is still available. So, you can still invest in ELSS mutual funds for this financial year 2011 – 2012 and reap the benefits they offer before the validity period runs out…

What will happen to the ELSS Funds Starting April 2012?

They will become regular Equity Mutual Funds. They will still continue to operate as regular equity oriented mutual funds that investors can invest in, with two major differences:

1. There will be no tax benefits on investing in ELSS funds &
2. There will be no 3 year lock-in period.

To sum it all up in one word – ELSS schemes will no longer be a separate class of Mutual Funds and would become regular Equity Oriented Mutual Funds.

What has happened because of this new DTC Ruling?

Despite the fact that tax benefits for ELSS funds already in existence will continue, there has been a rush among investors to exit these schemes. ELSS was considered a sort of starting point for budding investors as they made their entry into the equity market, but with the coming of the DTC this looks certain to change. From next year onwards, there are no tax benefits for investing in these schemes and hence they will become less and less favourable for investors and people will start exiting them, big time. So, the NAVs of your funds might drop significantly.

What should we do now?

Below are some options that are available for us. They are based on your situation:

1. If you are a seasoned ELSS Investor (Someone like me who started investing in ELSS schemes years ago) and your investments are past the 3 year lock-in period then:

a. Check the performance of the fund in the past one year and if their performance is not at par with the best performing Equity Diversified Mutual Funds – Exit them and invest in a well performing regular Equity Diversified Mutual Fund Scheme
b. If your fund is performing very well, keep your fingers crossed and review the funds performance once every 2-3 months and exit the scheme at the point where you feel the fund isn’t performing as well as it is supposed to be.

2. If you have just started investing in ELSS Schemes in the past one or two years:

a. Wait till your investments complete the mandatory 3 year lock-in period. Once it completes 3 years, check out your options as mentioned in point 1 of this section and exit the funds, the moment you feel the fund NAV is falling significantly.

3. If you are a new Investor considering ELSS as an investment option:

a. You have only one year to take advantage of the tax benefits
b. So, invest in the best ELSS mutual funds available in the market and keep your exposure limited
c. Do Not Invest in newer or smaller ELSS MFs that aren’t performing as well as their experienced cousins

Is it the End of the Road for ELSS Schemes?

Well, to be honest, the answer is Most Probably Yes. There might be no fresh investments into ELSS schemes and hence, they might run out of business in the next 4-5 years. So, personally I would suggest you check out other investment options for tax saving and regular Equity Diversified Schemes for Mutual Fund Investments.

But, and this is a big BUT, a point to remember is that, this DTC is just a draft bill and is yet to be passed as a law. If in the next one year (before April 1 2012) the bill doesn't become a Law, ELSS funds might continue to provide tax benefits to Indian investors.

So, lets keep our fingers crossed and hope for the best!!!