How to claim tax benefits on mutual funds (ELSS)?

Posted On: 10 February 2025

Equity-Linked Savings Schemes (ELSS) are a popular investment option in India, offering dual benefits of wealth creation potential in long term and tax savings. These mutual funds allow taxpayers to claim deductions under Section 80C of the Income Tax Act, 1961, under the old regime while also benefiting from equity-linked return. However, understanding how to claim these benefits effectively is crucial to optimising your financial outcomes.

This is a detailed guide on claiming mutual funds tax benefits, the taxation rules, and key considerations for ELSS investments.

Table of contents

What are the tax benefits under Section 80C of the Income Tax Act, 1961?
Why should a taxpayer choose ELSS?
When can tax benefits on ELSS funds be claimed?
How to claim tax benefits?
Key factors influencing mutual fund taxation in India
How profits are generated in mutual funds

What are the tax benefits under Section 80C of the Income Tax Act, 1961?

Section 80C of the Income Tax Act, 1961 permits taxpayers to claim deductions of up to Rs. 1.5 lakh annually under the old regime on specific investments, including ELSS mutual funds. Here’s how these benefits work:

Deduction limit: You can invest up to Rs. 1.5 lakh in ELSS funds annually and reduce your taxable income by the same amount.
Lock-in period: ELSS investments come with a mandatory lock-in period of three years, which is shorter than other tax-saving instruments like Public Provident Fund (PPF) or National Savings Certificate (NSC).
Long-term capital gains (LTCG): Gains from ELSS are taxed at 12.5% if they exceed Rs. 1.25 lakh in a financial year.

ELSS becomes a suitable option for individuals looking to save taxes while potentially earning higher returns compared to traditional fixed-income instruments.

Why should a taxpayer choose ELSS?

ELSS mutual funds stand out among other Section 80C of the Income Tax Act, 1961, investments due to their unique features.

Return potential: Since ELSS invests predominantly in equity and equity-related instruments, it offers the potential for higher long-term returns compared to fixed-income options like PPF or NSC.
Short lock-in period: The three-year lock-in period is significantly shorter than other tax-saving options such as PPF (15 years) or tax saver fixed deposits (5 years).
Dual benefits: Investors not only save taxes but also benefit from capital appreciation over time.
SIP option: Systematic Investment Plans (SIPs) allow you to invest small amounts regularly, making it easier to manage finances and cultivate disciplined investing habits.
Tax efficiency: Dividends earned during the lock-in period are tax-free, and LTCG tax applies only if gains exceed Rs. 1.25 lakh annually.

For individuals with a high risk appetite and long-term investment horizon, ELSS combines long-term growth potential and tax savings.

When can tax benefits on ELSS funds be claimed?

Tax benefits on ELSS investments can be claimed in the financial year in which the investment is made. For example,

If you invest Rs. 1.5 lakh in an ELSS fund during FY 2024–25, you can claim this deduction while filing your Income Tax Return (ITR) for that financial year.
The lock-in period starts from the date of investment. However, even if you redeem units after three years, gains exceeding Rs. 1.25 lakh will be subject to LTCG tax at 12.5%.

How to claim tax benefits?

Claiming tax benefits on ELSS investments involves a few straightforward steps.

1. Invest in eligible funds:

Ensure that the mutual fund scheme qualifies as an ELSS under Section 80C of the Income Tax Act, 1961.
Check details on the fund house’s website or consult your financial advisor.

2. Maintain investment proofs:

Keep receipts or statements from your fund house as proof of investment.
For salaried individuals, submit these proofs to your employer before the end of the financial year to avoid higher TDS deductions.

3. File ITR correctly:

While filing your ITR, declare your ELSS investments under Section 80C of the Income Tax Act, 1961.
Use ITR-1 if you have no capital gains or ITR-2 if you have redeemed units and realized gains.

4.Track capital gains:

If you redeem units after three years, calculate LTCG accurately.

5. Automate with tools:

Use tools like capital gains statements provided by platforms for accurate calculations.

These steps diligently will help you can ensure seamless claiming of your Mutual Funds Tax Benefits.

Key factors influencing mutual fund taxation in India

Understanding taxation rules is essential for optimising returns from mutual fund investments.

Type of fund: Taxation differs for equity funds (like ELSS), debt funds, and hybrid funds.
Holding period
- Short-term capital gains (STCG) apply if equity fund units are sold within one year; taxed at 20%.
- Long-term capital gains (LTCG) apply if units are held for over one year; taxed at 12.5% beyond Rs. 1.25 lakh annually.
Dividends vs capital gains
- Dividends are taxable as per your income slab.
- Capital gains taxation depends on the holding period and type of fund.

How profits are generated in mutual funds

Mutual funds generate profits through two primary methods.

1. Dividends/interest income:

Funds distribute dividends from their earnings during the holding period.
Post Budget 2020, dividends are taxable as per the investor’s income tax slab.

2. Capital gains:

Profits earned when mutual fund units are sold at a price higher than their purchase price.
Gains are classified as STCG or LTCG based on the holding period and other factors.

Conclusion

Investing in ELSS mutual funds not only helps reduce taxable income but also offers an opportunity for wealth creation through equity-linked returns. With its short lock-in period and potential for high returns, ELSS stands out among other Section 80C of the Income Tax Act, 1961, options like PPF or NSC. However, understanding how to claim these benefits—whether through proper documentation or accurate ITR filing—is crucial for optimising investment outcomes.
Moreover, investors must remain mindful of taxation rules related to LTCG and dividends while planning their withdrawals post-lock-in period. Tools like automated capital gain statements can simplify this process further.

FAQs:

Do mutual funds require us to pay taxes on them?

Yes, mutual funds are subject to taxation based on their type (equity or debt) and holding period. For equity-oriented funds like ELSS.

STCG is taxed at 20%.
LTCG beyond Rs. 1.25 lakh is taxed at 12.5%.

What considerations should one make before selecting mutual funds that save taxes?

The five factors to be considered are -

Risk appetite
Lock-in period
Historical performance
Expense ratio
Fund manager expertise

Can investing in mutual funds help me receive an income tax refund?

Yes, by investing in eligible schemes like ELSS under Section 80C of the Income Tax Act, 1961, you can reduce your taxable income and potentially receive a refund if excess TDS has been deducted.

Are investments made through MF subject to wealth taxes?

No, wealth tax has been abolished in India since FY 2015–16. However, capital gains earned from mutual funds are taxable as per applicable rules.

What is the capital gains tax exemption found in Section 54EA?

Section 54EA of the Income Tax Act, 1961, provides exemptions on long-term capital gains if they are reinvested into specified assets such as bonds within six months of sale. This does not apply directly to mutual funds but can be leveraged for other investments.

Do we need to show mutual funds in ITR?

Yes, all mutual fund transactions—whether dividends received, or capital gains realized—must be disclosed while filing ITR under relevant sections like "Income from Other Sources" or "Capital Gains.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.