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Beware of LTCG tax while recycling your ELSS mutual funds

Mutual fund advisors call it a bad habit, but some mutual fund investors cannot help recycling their ELSS or tax saving mutual fund investments at regular intervals. However, the task is going to be a bit complicated this year, as ELSS funds (or any equity funds, for that matter) do not qualify for zero long-term capital gains tax anymore, say mutual fund advisors.

For the benefit of new comers, recycling of ELSS is the practice of redeeming the investments after the mandatory lock-in period of three years and reinvesting the money to claim the tax deductions again. Some mutual fund investors believe it is a great way to earn tax breaks, but most financial advisors frown upon it.

Mutual fund advisors generally don’t favour the re-investment of ELSS proceeds to save taxes every year as they believe the practice hampers the investment plan of the investors and doesn’t let the money grow. They add that the strategy might help to claim tax benefit every year, but it will hinder the growth of investment over a long period.

“You have to add new money to create wealth. If you just keep investing the same money, it will only add to hassle and risk, not money. Pulling out money every year from an equity scheme is not a wise decision at all,” advises Babu Krishnamurhy, Chief Sherpa, Finsherpa Investment Services.

However, what queers the pitch this year is the change in taxation of equity mutual funds. After the re-introduction of long term capital gains (LTCG) tax on equity schemes in the previous budget, investors will have to pay a tax of 10 per cent on their long-term capital gains exceeding Rs 1 lakh in a financial year.

“Investors still practice it (recycling of ELSS investments). Some of them don’t know about the impact of LTCG, most others don’t have gains exceeding Rs 1 lakh yet,” says Puneet Oberoi, Founder, Excellent Investment Advisorz.

Mutual fund advisors are asking investors to include the taxation in their calculations before going ahead with the recycling of their ELSS investments. They believe that this practice will further erode their capital after the introduction of LTCG tax. “Now that they will be paying taxes, however little it might be this year, the money that you pulled out will not go back into the system. This hampers the growth of the money,” says Puneet Oberoi.

Mutual fund advisors believe most investors won’t be paying the LTCG tax on the long term capital gains on their tax saving mutual funds this year as the markets have not done well. Since the re-introduction of LTCG tax, the markets have remained volatile and equity mutual funds have taken a hit. To make gains of Rs 1 lakh in one year on Rs 1.50 lakh, the ELSS category has to offer around 19 per cent returns annually.

“Mostly, the gains this year won’t be applicable for LTCG, but in the years to come, investors have to keep in mind that this practice is harmful to their capital. We can’t assume that ELSS will never return around 19 per cent in a year,” says Babu Krishnamoorthy.

Puneet Oberoi says that many retired personnel come to him who recycle their ELSS investments to save taxes. “For retired investors who don’t have regular income to save every year, recycling of ELSSs seems like an option. In some cases, we ask them to go ahead, but generally, we ask investors to put in fresh money,” says Puneet Oberoi.
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