ELSS Tax Saving: How to double your tax saving through ELSS investment without any fresh funds

The last date to complete the tax-saving exercise for the current financial year is March 31, 2022. This date is important for those individuals who have opted for the old/existing tax regime and must make fresh investments for the current financial year in specified products to avail deduction under section 80C of the Income-tax Act, 1961. However, if you are short of funds and have made investments in equity mutual funds/equity shares in previous years, then there is a trick that can help you save tax in the current financial year. Read on to know more.

As per current income tax laws, long-term capital gains (LTCG) made on equity mutual funds and equity shares are exempt up to Rs 1 lakh in a financial year. If you have made investments in equity shares and equity mutual funds in the previous financial year and withdraw the money now, i.e., in the current financial year, then LTCG will be exempt up to Rs 1 lakh in this financial year. Gains will be considered as LTCG if the holding period of equity shares/equity mutual funds is more than one year or else it will be considered at short term capital gains, which will be taxed at 15%. Therefore, you have to ensure that you only withdraw the units which are more than a year old.

Dr Suresh Surana, founder, RSM India – a tax consultancy firm says, “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 utilizes the Rs 1 lakh annual exemption under LTCG, enhances overall tax savings. If you reinvest this amount your fresh equity investment will again enjoy this Rs 1 lakh exemption if you withdraw it after more than a year.

For your next investment in ELSS for tax saving, you can very well utilize the proceeds of equity mutual funds/equity shares that you just withdrew. “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.

Therefore, this churning of your investment for tax optimization is very well allowed under the current tax laws. “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,” adds Surana.

You can utilize not only the withdrawal proceeds of an equity mutual fund which are more than one year old but also an ELSS fund that has completed its lock-in period of 3 years. Further, a similar concept can be applied for the previous investment made in equity shares and fresh investment in ELSS mutual funds for tax saving in current financial year.

Abhishek Soni, CEO, Tax2Win.in – an ITR filing website says, “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 is an example to explain how this will work. Say, in January 2017 you invested Rs 1 lakh in ELSS mutual funds. In January 2020, it completed the mandatory lock-in of three years and can be redeemed now without payment of any exit load. The current value of this investment is Rs 1.92 lakh. Now, if you redeem from this mutual fund scheme, the LTCG gains will be Rs 92,000. This gain will be tax-exempt as it is below Rs 1 lakh.

Do note that you should not have made any other gains from selling of equity shares and equity mutual funds except for the one mentioned above in the example to ensure that these gains remain tax-exempt in your hands for this financial year. If you have gains from selling of equity shares or other equity MFs in the current FY 2021-22, then you will not be able to fully utilise this benefit.

Once the money is credited into your bank account, you can use the funds to re-invest it again in the ELSS mutual fund scheme to claim deduction under section 80C for maximum up to Rs 1.5 lakh for the current financial year. This way you can claim deduction under section 80C for this current FY without using fresh funds.

Ashwin Karmarkar, Partner, Vintage Finvest – a financial advisory firm says, “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.”

Karmarkar says, “Investing in ELSS mutual funds not only helps you to save tax but also helps in earning inflation-beating returns.” The category average returns from ELSS mutual funds for three year and five-year mutual funds is 15.35% and 13.05% respectively.

Do note that common deductions such as section 80C, 80D etc. cannot be claimed against long-term and short-term capital gains. Thus, if your only source of income is capital gains then using this trick won’t help you to save tax. However, if your source of income is salary, then this can come in handy if you don’t have the funds required to invest in tax-saving avenues.