How to Double Your Tax Savings by Investing in ELSS Without Using Any New Funds; Check Details

The current financial year’s deadline for completing the tax-saving exercise is March 31, 2022. This date is significant for individuals who have opted for the old/existing tax regime and must make new investments in specified products for the current financial year to qualify for a deduction under section 80C of the Income-tax Act of 1961. However, if you are short on funds and have previously invested in equity mutual funds/equity shares, there is a trick that can help you save tax in the current financial year.

Long-term capital gains (LTCG) on equity mutual funds and equity shares are currently exempt up to Rs 1 lakh in a financial year under current income tax laws. If you invested in equity shares and equity mutual funds in the previous financial year and withdraw the money now, i.e., in the current financial year, you will be exempt from LTCG up to Rs 1 lakh in this financial year. Gains on equity shares/equity mutual funds will be considered long-term capital gains if held for more than a year, otherwise they will be considered short-term capital gains, which will be taxed at 15%. As a result, you must ensure that you only withdraw units that are more than a year old.

According to Dr. Suresh Surana, founder of RSM India, a tax consulting firm, “In accordance with Section 112A of the Income-tax Act, any long term capital gains exceeding Rs. 1 lakh derived from units of equity-oriented mutual funds/equity shares would be subjected to tax at 10%. Thus, such long-term gains enjoy a threshold exemption of Rs. 1 lakh i.e., gains up to Rs. 1 lakh would be tax-free.”

This tax-free withdrawal, which takes advantage of the Rs 1 lakh annual LTCG exemption, increases overall tax savings. If you reinvest this amount, your fresh equity investment will be eligible for the Rs 1 lakh exemption again if you withdraw it after a year.

You can use the proceeds from the equity mutual funds/equity shares that you just withdrew to make your next ELSS investment for tax savings. “Further, Section 80C under Chapter VI-A provides for a deduction with respect to investment in ELSS mutual fund up to Rs. 1.5 lakhs subject to certain conditions. However, in case where any taxpayer makes any investment in ELSS mutual fund, the source of such investment being long term capital gains covered within the ambit of Section 112A of the IT Act, the deduction under Chapter VI-A shall be allowed from the gross total income as reduced by such capital gains in accordance with Section 112A (5) of the IT Act,” explains Surana.

As a result, under current tax laws, churning your investment for tax optimization is perfectly legal. “The funds from the sale of equity mutual funds can be utilized for the purpose of making investments in the ELSS mutual fund, which is eligible for deduction u/s 80C, subject to the cumulative deduction limit of Rs. 1.5 lakh,” Surana adds.

You can use the withdrawal proceeds of an equity mutual fund that is more than a year old, as well as an ELSS fund that has completed its three-year lock-in period. A similar concept can be applied to previous investments in equity shares as well as new investments in ELSS mutual funds for tax savings in the current financial year.

According to Abhishek Soni, CEO of Tax2Win.in, an ITR filing website, “Deduction under section 80C can be claimed on the basis of investments made in the specified avenues available under this section during the financial year. Also, the deduction can be claimed even if you make the fresh investments from the proceeds received from selling of ELSS mutual funds.”

Here’s an example of how this will work. Assume you invested Rs 1 lakh in ELSS mutual funds in January 2017. It completed the three-year mandatory lock-in period in January 2020 and can now be redeemed without paying any exit load. This investment is currently worth Rs 1.92 lakh. If you redeem from this mutual fund scheme, you will receive Rs 92,000 in LTCG gains. Because it is less than Rs 1 lakh, this gain is tax-free.

Please keep in mind that you should not have made any other gains from the sale of equity shares or equity mutual funds besides the one mentioned above in the example to ensure that these gains are tax-free in your hands for this financial year. You will not be able to fully utilize this benefit if you have gains from selling equity shares or other equity MFs in the current financial year 2021-22.

Once the funds are credited to your bank account, you can re-invest them in the ELSS mutual fund scheme to claim a deduction under section 80C for a maximum of Rs 1.5 lakh for the current financial year. This way, you can claim a deduction under Section 80C for the current financial year without having to use new funds.

According to Ashwin Karmarkar, Partner at Vintage Finvest, a financial advisory firm, “If the redeemed funds are invested in ELSS mutual funds, then you will be able to claim deduction under section 80C of the Income-tax Act for maximum up to Rs 1.5 lakh. This deduction can be claimed provided you opt for old tax regime in current financial year.”

“Investing in ELSS mutual funds not only helps you save tax but also helps you earn inflation-beating returns,” Karmarkar says. Three-year and five-year ELSS mutual fund category average returns are 15.35 percent and 13.05 percent, respectively.

Please keep in mind that common deductions such as section 80C, 80D, and so on cannot be claimed against long-term or short-term capital gains. As a result, if your only source of income is capital gains, this trick will not help you save tax. However, if your only source of income is salary, this can be useful if you don’t have the funds to invest in tax-saving avenues.

Source: The Economic Times