Widely read:
Q. What are the various tax-saving options offered by mutual funds?
A. There are two types of tax-saving funds, equity-linked savings schemes (ELSS) and pension funds. ELSS schemes are basically diversified equity schemes, which have a three-year lock-in. Investments here—subject to a maximum of Rs 10,000—receive a tax rebate of 0 to 20 per cent depending on the income slab. As these are equity instruments they have the maximum risk-return potential among all asset classes. What this means is that return has a propensity to vary with great intensity. Although an average tax-saving mutual fund delivered 16.36 per cent in 2002, the range of returns was extreme. Thus, in that year, the best tax-saving fund delivered 42.61 per cent and the worst was down 3.16 per cent. The best way to overcome the vagaries of stock markets is to diversify. Diversification can be across funds and, more importantly, across time periods. By investing regularly every year in these funds one can set up a long-term systematic investment plan.
The other route for saving taxes is pension funds, even though there are currently only two such funds in operation, Franklin Templeton's Templeton India Pension Fund and UTI's Retirement Benefit Plan. Introduced for the first time in 1997, pension funds are hybrid schemes, which have a debt orientation, and carry the same tax benefit as ELSS.
Both ELSS and pension funds offer tax rebate under Section 88 of the Income Tax Act. The total limit for investments under this section is Rs 70,000 and the specific limit for ELSS is Rs 10,000. Besides an entry load of 1.5 per cent a pension fund also carries an exit load of 3 per cent if redeemed before the age of 58 years. Just like tax-saving funds these schemes also have a lock-in of three years.
Q. I have funds locked up in a mutual fund that has witnessed substantial erosion in its NAV. Is there some way to utilise this loss to save tax?
A. While a loss is any investor's worst nightmare, you can utilise a loss to your advantage. A loss can always be set off against gains to save taxes. Moreover, it pays to be proactive in unlocking dead, loss-making investments so that at least their tax-saving potential can be realised. Did you invest in a technology fund that is now languishing at maybe half the NAV at which you bought it? It is possible that you may want to hold on to such a fund because it may look like a reasonable prospect at the moment. However, the losses the fund has made in the past may still be of some use to you if you have realised some other long-term capital gain on which you are paying tax.
You could sell off your loss-making fund and use that to reduce or eliminate your tax burden. If you'd like to hold on to a loss-making fund you could sell it and then buy it again. You'll have to factor in the entry and exit loads—if any—into your calculations but the amount you save in taxes could make it well worth the price.
You could do something similar even with a loss-making illiquid security such as a poorly-traded closed-end fund or even the stock of a dead company. If you can't find a buyer, then you could persuade someone you know to buy such an investment, for example, your spouse or any other family member. This way, the investment stays in the family—so to speak—and yet you can still book a loss and get the tax benefits of setting off some other gain.
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