The Hindu Business Line : On tax benefit aspects of ELS funds

QUITE a few readers have written to us asking about the current status of Equity Linked Savings Schemes (called ELS or tax saving funds) managed by fund houses and whether investments made this year are eligible for the tax benefit under Section 80C of the Income Tax Act. We deal with this issue here.

A Government press release and a recent amendment to the ELSS 2005 notification have cleared much of the confusion surrounding the tax status of open-end tax saving funds. From these, it is clear that all investments made after April 1, 2005 in existing or new open-end tax-saving funds will be eligible for the section 80C benefit. Therefore, you can go ahead with investments in tax saving funds, old and new, without worrying about whether this will fetch you a tax benefit under section 80C for this assessment year. Do continue with your SIP investments in such funds.

The entire confusion about the tax status of ELS funds came about when the Government formally notified the 2005 budget proposals in November. This notification, borrowing from the original 1992 ELS rules, defined ELS funds as ten-year close end funds with a three-year lock in period. This lead to doubts about whether open-end tax-saving funds would be eligible for tax breaks.

On December 13, the Government clarified through a press release (www.pib.nic.in) that tax benefits under Section 80C will be available for "investments made on or after April 1 2005... .. in any plan formulated under ELSS 1992, ELSS 1992 as modified in 1998 and ELSS 2005".

In effect, this straddles close-end funds, existing open-end tax-saving funds managed by fund houses as well as new tax-saving funds launched with the approval of SEBI. This decision has also been formally notified through an amendment.

There is the only area where ambiguity remains regarding the new tax proposals. The recent ELS (Amendment) Scheme 2005, says that "every mutual fund may, at its discretion operate one open-end ELS plan with the prior approval of SEBI."

This raises a question about the tax status of ELS funds where a fund house already operates more than one open end fund. HDFC Mutual Fund presently operates two open-end tax saving funds- HDFC Long Term Advantage Fund and HDFC TaxSaver. If the new amendment stands, the fund house may have to merge the two schemes.

This may not be a negative for investors as both funds have an impressive track record and, in any case, will be managed by the same investment management team. Investors may seek a clarification from their distributor on this aspect while making investments in these two funds.

We would also like to reiterate three points when you are making your ELS investments:

When choosing tax saving funds, established funds with a good five-year track record are a better option than new funds that are just being launched. With older funds, you have a good idea of how the fund manager has handled the previous bear and bull phases in the stock market.

ELS funds are equity products and do carry downside risk. Therefore, the tax break alone should not dictate your decision to invest in an ELS fund. If you are investing in a tax saving fund, make sure that equity funds do fit into your asset allocation plan.

As with other equity products, systematic investing may help contain downside risk better than investing a lump sum at one go.

Our preferred picks: HDFC TaxSaver, HDFC Long-Term Advantage and PruICICI Tax Plan. Conservative investors may consider Franklin Taxshield and Birla Equity Plan.

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859-860, Anna Salai, Chennai 600002.)

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