Tax benefits on ELSS investments are expected to go by next April in new DTC

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Good things don’t last forever, goes the saying. Ask investors in equity-linked savings schemes.

For years, first-time investors tip-toed into stock markets through ELSS, earning handsome gains and pocketing the tax-savings. The mandatory three-year lock-in period was fine with them, since other similar tax-saving products had longer lock-in periods.

As investors poured into these schemes, dozens of schemes blossomed and the industry boomed.

Those days may be over. With the Union Cabinet clearing the new Direct Taxes Code (DTC) on Thursday, tax benefits on ELSS investments up to Rs 1 lakh are expected to go by next April. And investors looking for greener investment pastures are retreating from ELSS.

The numbers speak for themselves. In the financial year ended March 2010, there were at least 48 ELSS products, and the industry sold ELSS units worth Rs 3,600 crore, 8% more than the investments in the previous fiscal.

However, with the approaching tax-break sunset, there is a virtual stampede to exit these schemes, despite the fact that tax benefits continue for investments made in 2010-11. During April-July, ELSS investors redeemed Rs 340 crore, as against Rs 117 crore they invested during the same period last year. In July alone, investors have redeemed ELSS investments worth Rs 139 crore.

ELSS has served investors and the equity market well. For many investors, ELSS was the stepping stone to the stock market, which helped expand the equity culture.

Apart from the tax benefit, ELSS attracted investors because they were rather ‘liquid’ schemes. You could receive regular dividends throughout the lock-in period, if you opted for the dividend option.

In fact, ELSS is the only investment option under Section 80CC of Income Tax Act which provides interim cash flow during the lock-in period. Besides, while PPF, NSC and tax-free bank FD have a five-year lock-in period, ELSS is tax-free with a three-year lock-in. Mutual funds usually offer two types of ELSS: Open-ended and closed-ended.

The latest DTC paper mentions only six tax-free schemes enjoying the EEE (exempt-exempt-exempt) status. These are government provident fund, PPF, NPS, recognised PFs approved life insurance products and annuity schemes. Investments enjoying EEE status are tax-exempt during the three stages of investment, accrual and withdrawal.

DTC has also suggested that the rules for contribution and withdrawal be harmonised and made uniform so that savings are made by the taxpayer for the long term. There have been some voices of support for tax-minded investors, but there doesn’t seem to be many listeners. The Association of Mutual Funds of India (Amfi) has written to the Central Board of Direct Taxes (CBDT) to reconsider the case. “For retail investors, ELSS is a popular scheme as they get income tax deduction benefits,” says AP Kurian, chairman, Amfi.

Capital markets regulator Securities and Exchange Board of India (Sebi) too has asked CBDT to retain the tax benefits. However, experts do not have much hope on this: The revised discussion paper on DTC has not even touched upon this issue.

Srikanth Meenakshi, director, FundsIndia.com, an online investment service platform, says that the end of tax benefit will sound the death-knell for ELSS. “Without the tax benefit, it would be hard to make the case for a separate class of funds that looks and invests like any other broadly diversified equity fund,” Meenakshi underlines.

As ELSS tax benefits vanish, investors looking to save taxes would have to parktheir money up to Rs 1 lakh a year in employees provident fund, public provident fund, unit-linked insurance plans, pension plan premiums, life insurance premiums, National Savings Certificates, New Pension Scheme and five-year fixed deposits with banks and post offices. These investments are exempt from tax on annual income under Section 80CC of Income Tax Act.

In 2009, when Sebi banned entry load on mutual fund schemes, distributors stopped selling MF schemes and there were large redemptions. However, ELSS continued to clock steady inflows through the turmoil, ensuring long-term funds for the industry.

For years, from January to March, taxpayers flocked to mutual fund houses to purchase ELSS. Next year will be different.