ICICI Direct Research on ELSS funds.

With the calendar year coming to an end and the financial year end just three months due, it is time to review the finances and do the tax planning before it gets too late. Equity linked savings schemes (ELSS) are one eligible tax saving investment with the potential of equities. ELSS floated by various mutual fund houses is a diversified mutual fund scheme that invests minimum of 80% of the funds into equities. The added advantage is that investment up to Rs. 100,000 in ELSS is eligible for deduction under Section 80C of the Income Tax Act, 1961. Thus, for example, if your total annual income is Rs. 5,00,000 and you invest Rs. 1,00,000 in ELSS, then your taxable income will be only Rs. 4,00,000. Tax, thus saved for individuals in the highest income tax bracket, are as high as Rs. 30000 (without considering surcharge and cess).

Investment made in ELSS gets locked in for a period of three years. i.e. if you invest as on January 1, 2010, the amount can be withdrawn only after January 1, 2013. However, ELSS has the shortest lock-in period of all the tax saving instruments under Section 80C.

Also, ELSS being an equity-based investment has the potential to deliver better returns compared to any other fixed return instrument (NSC/PPF/FD/Bonds) over an extended time horizon. If we consider the last decade where the market weathered the dotcom bubble and the worst ever financial crisis, the average three-year return of the BSE 200 (benchmark of most of the ELSS scheme) calculated on a daily rolling return basis is ~76%. The minimum return is -52%, which was after the dotcom bubble that being an exceptional scenario. However, on the upside, the maximum three year return of the decade is a whopping 336% of BSE 200. HDFC Tax Saver, one of the best performing schemes has a max three year return of 445% for the decade. Though the returns look much above the debt tax savings instruments interim volatility in the three year period is much higher and investors needs to be patient for the same. The lock in of three years here helps to curb the natural instinct to sell during crashes.

We have done a mutual fund managers survey of 11 major AMCs fund managers to gauge the overall view for the equity market. Most of the fund managers are confident of 15-20% earnings growths over the next two years for Indian companies. Majority of them believe India may continue to outperform among its emerging market peers. The outlook across is positive unless the global turmoil plays havoc again, the chances of which are less.

Equities though may not have similar performance as witnessed in 2009 or 2010 but surely have the potential to deliver higher annualised return over and above the 8-9% generated by other debt investments over a three year period. We recommend investors invest a portion (percentage based on the risk appetite) of the total Rs. 1 lakh pie available under Section 80C in this scheme. We recommend HDFC Tax Saver Fund, Fidelity Tax Advantage and ICICI Prudential Tax Plan for the current year tax savings investment to be made before March 31, 2011.

Tax Saving Option

Investment Option Return Minimum
Lock in Period Comments
National Saving Certificate 8% 100 100000 6 Years Interest is Taxable
Public Provident Fund 8% 500 70000 15 Years Completely Tax free
Bank Fixed Deposits 6.25 % – 7.5% 200 100000 5 Years Interest is Taxable
Senior Citizen Saving Scheme 9% 1000 1500000 5 Years Minimum Age-55 to avail the option
Equity Linked Saving Scheme Market driven but can expect 12-15% 500 – 5000 100000 3 Years Completely Tax free with lowest lock in

Equity linked tax saving schemes and Direct Tax Code. DTC will be applicable from April 1, 2012. Under the proposed DTC, ELSS will no longer continue to be eligible investment u/s 80C. However, as per the DTC provision investment made before April 1, 2012 shall follow the existing tax regime. As per existing provisions, current investment in ELSS falls under the EEE (exempt, exempt, exempt) tax regime, which means the amount invested before March 31, 2012 will be allowed as deduction from the gross total income. Dividend received on the same shall be tax free and the redemption amount received will also be tax free. Hence, for the current year one can go ahead without worry and invest in the tax saving instrument with the highest return potential.

If it is assumed that ELSS will not be eligible for tax deduction from 2012 as proposed under DTC, it is better to put maximum of the Rs. 1,00,000 available for tax deduction in ELSS in the current as well as in the next year to benefit from the equity investment option available currently.

HDFC TaxSaver the objective of this fund is to achieve long term growth of capital.

Fidelity Tax Advantage Fund the objective of this fund is to generate long-term capital growth from a diversified portfolio of predominantly equity and equity-related securities

ICICI Prudential Tax Plan the objective of this fund is to generate long-term capital appreciation through investments made primarily in equity and equity related securities of companies. Accordingly, the NAV of the Scheme is linked to performance of such companies. However, there can be no assurance that the investment objective of the Scheme will be realized

Please do find the complete details and analysis of the above mentioned three funds below