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Goodbye ELSS!

What to do with your ELSS once DTC comes into play?

We never did envisage the day when the tax saving schemes of mutual funds would become a thing of the past. After March 2012, this entire category of equity based tax saving schemes would be history.

Frankly, this is a blow to investors.

These schemes were the only tax saving instruments that combined tax saving with the higher return that is possible only through equity and the lowest lock-in period amongst all the other schemes. In fact, for many young investors, they were the gateway product through which they entered the stock market. It was after exploring this avenue that they began to get a taste for investing in diversified equity funds.

Fund managers certainly were fond of these products. The 3-year lock in period ensured that investors could not walk out anytime and so sudden or frequent redemptions were not a prime concern here. This enabled them to take a longer-term perspective on their portfolio.

Of all the routes available under Section 80C, the NPS is the only one that offers some sort of equity exposure; a maximum 50 per cent of an individual's NPS corpus can be invested in equities. Unlike the 3-year lock-in period of an ELSS, withdrawal from NPS can take place only at the time of retirement.

Imagine the plight of an affluent retired individual who currently relies on ELSS for tax savings. Once DTC comes into force, what tax-saving options would he be left with? A PPF account? Not a wise option since it matures after 15 years and offers limited liquidity after five years. NPS? Not possible since it is only open to individuals between 18 and 55 years of age, and certainly not retired individuals. Term insurance? What is the point since it is only beneficial to your beneficiaries when you pass away. This senior citizen will have no viable option available but to pay his tax.

What do current investors do?
According to the revised discussion paper (June 2010), “Investments made before the date of commencement of DTC, in instruments which enjoy exempt-exempt-exempt (EEE) method of taxation under the current law, would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument.”

Individuals who want the tax benefit by investing in ELSS have only till March 31, 2012 to avail of it. Which brings us to the next question, what will happen to your ELSS? Will all these tax saving schemes morph into plain vanilla equity diversified schemes? Once the tax saving benefit is pulled out, the lock-in period of 3 years makes absolutely no sense. We will have to wait and watch to see how funds deal with it.