ELSS Mutual Funds: Effect of DTC and Current Status

by Manshu on April 5, 2011

in Mutual Funds

There is still a year to go before DTC (Direct Tax Code) kicks in, and there seems to be some amount of confusion in people’s minds on how DTC will affect the tax saving ELSS mutual funds.

To understand the effect of DTC you need to first know how ELSS mutual funds give you tax benefit. These mutual funds are covered by Section 80C, which mean that the money you invest in these funds is reduced from your taxable income (up to a limit of Rs. 1 lac) and hence you pay less taxes. With that said – let’s take a look at how DTC impact on your existing as well as new ELSS purchases.

Effect of DTC on your existing ELSS MFs

The funds that you’ve already bought have given you the tax benefit in the year you bought them, and after the year of purchase there is no tax benefit from them.

Given that, you shouldn’t be worried about the ELSS funds you have already bought.

The only thing I’ll add to that is some people choose for the dividend re-investment option, and the re-investment is treated as a fresh investment. This is important because ELSS funds have a lock in period of 3 years, and your new units are locked for a further 3 years. With that in mind, change your dividend reinvestment option to a simple dividend or growth option.

ELSS Purchases from now till April 2012

Since DTC will kick in from the next financial year, you can still buy them this year and get tax benefit under 80C this year.

ELSS Purchases After DTC Kicks In

Under DTC – ELSS mutual funds will no longer enjoy the tax benefits that they currently do. I don’t know whether they will still have the 3 year lock in period, but it doesn’t make any sense to have the lock in period if they’re not going to have any tax benefit.

Will DTC affect the performance of the existing funds?

There was an interesting comment where a reader asked that since the popularity of ELSS funds is bound to go down, the assets under management are likely to come down, and will that have any effect on the performance of these funds?

I can’t think of any reason why it will play out like that. If anything, it should be easier for a fund manager to produce better returns because the base is lower.

These were some thoughts that came to my mind while answering ELSS related questions here, please feel free to leave a comment if you have any questions or observations on these.

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{ 41 comments… read them below or add one }

Sumant April 5, 2011 at 6:38 pm

“With that in mind, change your dividend reinvestment option to a simple dividend or growth option.”

Can this be done? I had checked this and the fund guys told me this would be equivalent to redeeming units and re-buying. It seems we can’t just change from div reinvestment to dividend payout or growth.

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Manshu April 6, 2011 at 10:14 am

I haven’t done this myself but I did find this link which describes that you can request the fund to transfer your investment.

http://www.valueresearchonline.com/story/h2_storyView.asp?str=15583

So, what did the fund guys tell you Sumant? How does one get out of the MF in this case at all then? It’s like you’re stuck till eternity isn’t it?

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Furqan Qureshi April 7, 2011 at 6:37 am

You can can certainly change Dividend Option from Reinvestment to Payout. However, you can switch to Growth Option only if your investment has completed 3-year lockin period.

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Manshu April 7, 2011 at 6:54 am

Thanks for your response Furqan but how does one go about doing this? Your help is appreciated.

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Furqan Qureshi April 7, 2011 at 11:57 pm

All an investor need to do is write a letter to the concerned MF and request change of Option from Dividend-Reinvestment to Dividend-Payout. If investment has crossed 3-year lockin then the investor may request switch from Dividend to Growth Option also.

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Manshu April 8, 2011 at 3:46 am

Thanks Furqan.

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ankur garg April 5, 2011 at 8:14 pm

thank u dear for this article. i too was think over it few days back. i agree with your view that in case tax benefit is withdrawn from these investment options, the concept of lock in period will definately be withdrawn.otherwise no one will invest their money in these schemes.
actually i am a bit doubtfull whether introduction of DTC will surely make them out of tax benefit schemes.though it is mentioned in proposed structure of DTC but still i am hopefull for them.
lets see…..

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Manshu April 6, 2011 at 10:15 am

They may retain it but so far there hasn’t been any noise about it. Let’s see how it goes.

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Ashok April 7, 2011 at 10:50 pm

You can actually redeem your ELSS before 3 years if you can produce a certificate from the IT department that you have not used this investment for tax-saving.
See this:
http://209.162.182.241/story/h2_storyView.asp?str=101119

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Manshu April 8, 2011 at 6:53 am

Interesting, thanks for sending the link – I didn’t know about this.

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Ashok April 8, 2011 at 11:19 am

I have never done this nor do I know anybody who has ever done this. But getting a certificate from IT department?? That would need loads of luck and patience :-) !!

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Manshu April 8, 2011 at 11:22 am

Haha – yeah you bet. I know friends who’re trying to close travel reports from two years ago!!!

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jagbir April 6, 2011 at 7:41 am

Good article. ELSS is one of the best instrument to build wealth and save tax. It’s not only offers short duration, equity exposure but also given best returns compared to any other tax saving instrument. Alas! DTC is discontinuing it.

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mithlesh April 6, 2011 at 11:49 am

I think if after DTC, ELSS is discontinued , there will be more popularity for NPS because that will be only tax saving instrument left with equity exposure. Probably they would make withdrawal exempt from tax in NPS. I have been investing in ELSS funds for last three years and they are an excellent tax saving option. One should make use of it and invest some more this year before it disappears forever.

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Manshu April 6, 2011 at 2:14 pm

Who knows, they might be doing it for that very reason!

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Zaheer April 7, 2011 at 3:04 am

I have my ELSS in ICICI direct. I want to close the account and transfer the holdings to Motilal Oswal . Is it feasible. Please guide me on the same.

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Manshu April 8, 2011 at 11:06 am

I don’t know how this is done. You can check with your Motilal rep and he might be able to help.

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Furqan Qureshi April 9, 2011 at 11:24 pm

What I can understand of Zaheer’s query is that he may be holding MF units in demat form. If its true then he needs to submit off-market transfer request to ICICI Direct thru Demat Instrtuction Slip that he received at the time of opening account with ICICI Direct.

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mithlesh April 10, 2011 at 12:15 am

You have to fill up transfer form for each mutual fund holding and then submit to the concerned mutual fund office. But before that, there may be some other formalities like making holding mode to offline before transfer etc. So, its better you check with motilal rep as suggested by Manshu and they will help you.

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Ashok April 7, 2011 at 10:58 pm

Regarding performance of ELSS after DTC, I feel it will definitely go down.

Imagine a fund house, say HDFC Mutual Fund (purely taken for example purposes) which has a high-profile HDFC Equity fund (AUM 8000 crores and growing) and a HDFC Tax saver (AUM 400 crores and declining). To which fund will HDFC assign their best and talented fund managers to? If a fund managers salary/bonus is linked to the AUM (as they obviously would be) which fund would the talented and ambitious fund managers prefer to manage? So over a period of time, only newbies and less-talented fund managers will be managing the smaller funds and ELSS. That will happen in all fund houses.

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Manshu April 8, 2011 at 11:01 am

But isn’t that true even today? I mean every fund house has got their popular funds and then everything else. So, how is what happens today different from what you describe?

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Ashok April 8, 2011 at 11:17 am

I am assuming that ELSS AUM is also increasing now. In a post DTC world, ELSS AUM will only decrease, thus reducing their popularity among fund managers to manage ELSS.

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Manshu April 8, 2011 at 11:23 am

Ah okay – I see a self fulfilling prophecy coming the way of ELSS funds post DTC :)

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Zaheer April 8, 2011 at 11:40 am

I feel that ELSS funds can be merged with other non-taxing funds so that it is in best interest of the Fund Manager and the investors to get the best returns.

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vicky April 8, 2011 at 11:25 pm

i want to invest in ELSS to save taxe, but as i came to know from your publications that these
schemes has a lock- in period of three years, and after DTC these schemes will become irrelevant.
if i invests one of these schemes in FY 2011-12 for one year and after it, put it in a cold bag. what
would be the effect of three year lock-in-period on scheme?

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Manshu April 9, 2011 at 7:05 am

You will get the tax benefit in this year itself so even if it gets stopped next year the tax benefit is still there to be had. Also, it is not becoming irrelevant but losing a major benefit.

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vicky April 9, 2011 at 9:48 am

hi sir,
first of all thanks a ton for replying. i am requesting to you please consider my query. i am a new entrant to the service, and after subtracting PLI, NPS, i am still short of Rs.30,000 for touching limit of Rs 100000 as tax deductible amount.
i was thinking to invest this 30,000 in ELSS but whether i think it has two problem
(1) it would be just a short term measure for new entrant like me as DTC is coming.
(2) it would lock my saving for 3 years.

further the tax i would pay on this amount is just around Rs. 3000. at the same time i want to invest in equity growth schemes, where return is good and which are also open ended.
so, as i am financial illetrate, please advise me what should i do? what should i opt?

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Manshu April 10, 2011 at 5:35 pm

Actually all tax saving instruments have a lock in period and in that ELSS has the shortest lock in period. So, if you don’t want to lock in your money then the other option is to just pay the tax.

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vicky April 9, 2011 at 9:57 am

at the same time please also suggest me-
i subscribed postal life insurance endowment plan for tax benefit. its annual installment is Rs. 28200. i want to invest Rs. 2500/ month in short term fund of one year, so that i would be able to pay the PLI installment , as well as yield good return on this. please suggest debt or any other scheme for this purpose.

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Manshu April 10, 2011 at 5:34 pm

Sorry, but I’m not familiar enough with that to suggest you anything.

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vicky April 12, 2011 at 9:10 am

hi,
i am a 26 year old, earning Rs32000/month. till now i haven’t made any investment.
now i want to invest in mutual fund through a sip of Rs15000/month for a period of 15-20 years
in different schemes. please suggest me desired portfolio. till now i am willing to invest in-

(1) franklin india bluechip- 25%

(2) hdfc200 – 25% of total saving

(3) fidelity equity- 20%

(4) dspbr micro cap- 10%

(5) idfc premier equity- 10%

(6) hdfc equity multi- 15%.

please answer my question, because i am waiting for investment.
thanks a ton.

regards
surendra mohan,
nagpur.

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Manshu April 12, 2011 at 9:15 am

I’m sorry Vicky, but individual investment advice is not given on this site because its not possible to tailor advice to your situation in just comments or emails. Please consult a financial planner to get advice tailored to your situation.

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rajat April 16, 2011 at 9:40 pm

Hi,
I am barely six months into my first job. The FY that just passed did not have any taxes for me. I want to aim if not full then atleast 70% tax saving. As it is apparent, I have this last chance to invest in ELSS, my question to you people is that what are the chances of the popularity (and hence probably the Returns !) of ELSS dipping after they are excluded from 80C, which as of now seems the case. As the very first line of my post suggests, i do not have alot of money to invest. So given the clouds of uncertainty hovering around the ELSS, should i go for the same.?Suggestions sought. Thanks.

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Manshu April 17, 2011 at 12:36 pm

Rajat – as I’ve written in the post I don’t see any reason why the returns would dip, however some commenters have posted reasons on why they think it could dip.

This is a matter of opinion and unless the event actually plays out you can’t be sure what will happen and all you will get is opinions from people.

It looks like you’re just beginning your investing career, and if you invest in equities then you do have to understand and be comfortable with risk which of losing money. That usually happens only after you have a little bit of savings stashed away in safe instruments. So, DTC or no DTC I’d recommend building some emergency funds, investing in some other safe instruments and only then thinking about mutual funds.

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rajat April 17, 2011 at 9:26 pm

That is indeed a pragmatic suggestion. I totally get what you are hinting it. Thanks.

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Manshu April 18, 2011 at 6:01 pm

I appreciate your response Rajat – all the best!

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raktim June 29, 2011 at 5:53 pm

I have invested in a SIP in an ELSS scheme. The SIP will continue for 3 years.But next year as DTC comes this investment will no longer be under 80C. what should i do?

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Zaheer June 30, 2011 at 10:55 am

Direct your broker to discontinue your SIP once DTC comes into effect

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kushank March 25, 2012 at 3:29 am

Hi manshu,

I was looking forward to invest in ELSS next year, However since it will longer enjoy the exemption ,can you suggest which other equity instrument i can invest in to get the tax benefit . Ulip which is high on charges, and also fundamentally against financial planning( since it combines insurance and investment together. i am not to keen on investing in it.

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Manshu March 25, 2012 at 3:30 am

It will actually enjoy the exemption for one more year since DTC will be implemented the year after that.

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vishal January 18, 2013 at 10:32 pm

Dear Manshu Ji,

Pls give a clarity whether the investments made in ELSS from 1 April 2012 to 31 March 2013 will be considered for tax benefits under sec 80 C or not.

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