Hello readers. Greetings of the season!

            As the New Year has arrived, some of us have resolved to indulge in disciplined financial planning in an effort to achieve our financial goals. By means of this article, I aim at helping in the same by offering an insight into the benefits of investing in Mutual Funds and its tax implications.

            Let me begin by describing the meaning of a Mutual Fund. It is a financial product that pools money of different individuals and invests on their behalf into various assets such as equity, debt or gold as per the objective of the scheme. Based upon the investor’s financial goals and risk appetite, there are several funds to choose from.

            The benefits of investing in Mutual Funds include simplicity, affordability, professional management, diversification and liquidity.   Owing to such benefits, Mutual Funds have gained popularity among small investors. It becomes imperative to highlight here that the benefits of investing in Mutual Funds are even greater to large investors who fall in the highest tax bracket, given the tax benefits that investments in Mutual Funds entail.

            The Income Tax Act, 1961 offers two major deductions on investment in certain kinds of Mutual Funds.

1. Equity Linked Savings Scheme:

            Under Section 80C of the Act, an amount equal to the investment in Equity Linked Savings Scheme is deductible from the taxable income of an assessee subject to a maximum limit of Rs. 1,00,000/- (such limit is inclusive of other deductions offered under Section 80C, 80CCC and 80CCD). The deduction is available even if the investment is made through the SIP (Systematic Investment Plan) Route which calls for regular investing and higher financial discipline. The investment in ELSS has a minimum lock-in period of 3 years. This is much lower in comparison to other tax saving instruments such as Public Provident Fund (15 years), National Savings Certificate (6 years) and five-year fixed deposits. Like any other Mutual Fund, ELSS are available under dividend and growth schemes. Under dividend scheme, returns are paid to the investor from time to time. Under growth scheme, return is in the form of increased NAV at the end of the lock-in-period.

            The limitation of investment in ELSS is that it is based on equity and hence subject to market risk. Further, it has a minimum lock-in-period which does not provide for premature withdrawal.

1. Rajiv Gandhi Equity Savings Scheme (RGESS):

            Under Section 80CCG, a deduction has been provided for the first-time investors in equity market. Tax benefit is available to investors whose annual income is less than Rs. 12 Lakhs. The quantum of deduction is 50% of the amount invested up to a maximum investment of Rs. 50,000/-. The prescribed conditions have to be followed for a period of 3 years. The deduction is available on investment in prescribed securities or funds. Many Mutual Funds and Exchange Traded Funds (ETFs) have been prescribed under the same.

            The table below summarizes Income Tax provisions applicable on distribution of dividend by a Scheme and taxability of income and capital gains in the hands of investors.

**Surcharge at the rate of 10% shall be levied in case of individual/ HUF unit holders where there income exceeds Rs. 1 Crore.

***Surcharge at the rate of 5% shall be levied for domestic corporate unit holders where the income exceeds Rs. 1 Crore but less than 10 Crores and at the rate of 10%, where income exceeds 10 crores.

^Assuming the investor falls into the highest tax bracket.

            From the table, it can be seen that the taxability of returns from Mutual Funds is much lower than the highest tax slab of 30.9% in most cases, which reinforces the fact that Mutual Funds offer great benefits even to large investors.

            Further, it can be inferred that investing in equity oriented Mutual Funds gives greater tax benefits in comparison to other Funds. There are certain other benefits as well of investing in equity oriented funds. But before that, it becomes important to highlight the meaning of equity oriented Mutual Funds.

            For the purpose of Income Tax, an equity oriented Mutual Fund is the Fund which invests at least 65% of its fund corpus into equity and equity related instruments.

            Studies in the past have suggested that equity has delivered higher inflation-adjusted return than any other asset class over the longer horizon. The advantage is even greater when the investment is allowed the benefit of compounding. Compounding has a magical effect in building a corpus if the investor starts early and invests regularly. However, it must be kept in mind that equity funds are preferable for long-term financial goals.

At the same time, the importance of debt funds in managing and de-risking the portfolio should not be ignored.

            Though Mutual Funds are a good investment avenue, one must also include other financial instruments in his portfolio to minimize risk and cater to his financial goals adequately.

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