• HDFC
• 07 Jun 2018
• Knowledge Centre

HDFC, Tester

Changes in the Budget offer the investor with some points to ponder

 

Budget 2018 has brought with it a gamut of changes, albeit with some undesirable alterations. Some of these, when implemented, are going to result in a complete revamp of certain investment products. These include Unit-Linked Insurance Plans (ULIPs) and Equity-linked Savings Schemes (ELSS) funds.

 

In this Budget, Finance Minister Arun Jaitley has re-introduced LTCG (long-term capital gains) tax on stocks. This is the tax paid on profit generated by assets such as shares or share-oriented products held for a particular timeframe. The Government would tax long-term capital gains exceeding Rs 1 lakh at a rate of 10 percent, without any indexation benefits. The definition of a long-term investment in stocks for tax purposes is one year. Till now, LTCG was exempt from tax after it was scrapped in 2004-05 by the then Finance Minister P Chidambaram. Mr. Jaitley has reintroduced it this year.

 

Taxes:

 

Even though investments in both ULIPs and ELSS are still eligible for tax benefits under section 80C (ELSS has to be invested for at least three years and ULIPS for a minimum of five years), investing in the latter would now be viewed in a different light. This is owing to the fact that as per the Budget proposal, gains on redemption of ELSS funds will be taxable. That is, profits from ELSS mutual funds will now be subject to a 10% tax. Nevertheless, profits from ULIPs (whose premium is at least 10% of the sum assured) would continue to be exempt from taxation (till the FM thinks of bringing ULIPs under the tax net).

 

Time-period:

 

ULIPs also enjoyed an edge over ELSS even in short-term investments. ULIPs exited in less than a year are exempt u/s 10(10D), while an investor cannot exit from ELSS in less than three years. Further, ULIPs also offer a similar benefit on debt investments, as the investor can choose to allocate funds into equity and/or debt in certain proportions, while investment in debt funds are taxed as long-term, only if held for three years.

 

Costs:

 

ULIPs suffered from high costs compared to ELSS, resulting in lower net gains to investors. However, this situation has changed over time, and now a lot of ULIP policies invested directly have similar costs as of ELSS when one excludes mortality charges. This results in the benefit of a life cover – here, investors above the age of 40 will suffer more. Some ULIPs have high costs even now (and if you buy through a broker/agent your costs will go up further), giving ELSS an edge.

 

Dividend Option:

 

The decision made by Arun Jaitley to introduce Long Term Capital Gains on Equity Mutual Funds has been accompanied by taxing dividends at the same rate too. This move was imperative, as it negated the possibility of the investor switching to Dividend options to avoid taxation on Equity Mutual Funds. Owing to this, all dividends in Equity and Equity-Oriented Funds will now be taxed at 10%. The Government has proposed a 10% tax on dividends from Equity-Oriented Mutual Funds as part of its stance to levy taxes on equity investments.

 

However, there is a breather. Mr. Jaitley stated that all gains made up to 31st January 2018 will be 'grandfathered', that is, they will be exempt from the new regulations.

 

So now, in a changed scenario wherein returns from ELSS would be taxable, we take a fresh look at this investment product, and the implications of the recent changes.

 

Needless to say, the tax on LTCG will make tax-saving possibilities such as the Public Provident Fund (PPF) and ULIPs more tax-efficient than ELSS funds. The reason being that these will continue to be tax-free, while the profit from ELSS funds will be taxed at 10%.

 

In our opinion, investors should not shun ELSS just because of the new tax payable, or revamp their portfolios with a bias towards ULIPs. Owing to the divergent nature of these investing avenues, each has a definite role to play in an investor’s portfolio.

 

Here is one reason why you should hold ELSS funds in your portfolio.

 

Being pure Equity-Based Instruments, ELSS funds are likely to generate greater returns, making them a perfect long-term investment option. For higher returns, ELSS funds retain their relevance. The fact that post-tax returns would be greater than those of PPF and high-cost ULIPs, ELSS funds should definitely not be ignored. Data from Morningstar suggests a return differential of 100-300 bps p.a. in favor of ELSS over ULIPs. This difference over the long term can result in a large absolute difference in returns. Some part of this difference will now be taken away by the LTCG (though being back-ended their per-year impact will be lower).

 

Operationally, ELSS investments can be held fully or in part until any period beyond three years, as compared to ULIPs which are long-term (15-20 years, though partial withdrawal is permitted after 5 years). In ULIPs, however, one gets the flexibility to switch from equity to debt and vice versa without incurring any tax liability.

 

ELSS schemes are more transparent in terms of levy of charges than ULIPs. Once KYC formalities are done, MF investors can invest in any other mutual fund online; but a fresh ULIP investment entails a lot of paperwork and medical tests/IT returns’ verification.
So both the investment avenues have their own benefits and downsides. With an array of choices on offer, investors can have a field day!