Equity-Linked Savings Schemes (ELSS) are a popular investment option in India, especially for those looking to save on taxes while potentially earning returns through equity exposure. ELSS funds are a type of mutual fund that primarily invests in equity and equity-related instruments, making them eligible for tax deductions under Section 80C of the Income Tax Act, 1961. However, the tax implications on the capital gains arising from the transfer of ELSS units are important for investors to understand, especially when it comes to the provisions under Section 10(38).
Section 10(38) provides specific tax exemptions for long-term capital gains (LTCG) arising from the transfer of listed equity shares and equity-oriented mutual funds, including ELSS units. In this blog, we will explore the tax rules for capital gains on the transfer of ELSS units under Section 10(38), the conditions for exemptions, and the changes brought by recent amendments in the tax laws.
What is Section 10(38)?
Section 10(38) of the Income Tax Act, 1961 provides an exemption on long-term capital gains (LTCG) arising from the transfer of listed equity shares or equity-oriented mutual funds (including ELSS units) held for more than 12 months. Under this section, LTCG from the transfer of such assets is exempt from tax, provided that the transaction is subject to securities transaction tax (STT).
However, a key amendment has been made to Section 10(38) in the Finance Act, 2018, which imposes a tax on long-term capital gains exceeding ₹1 lakh on the transfer of such assets, including ELSS units.
Key Provisions Under Section 10(38):
| Provision | Details |
|---|---|
| Tax Exemption on LTCG | LTCG from the transfer of listed equity shares and ELSS units held for more than 12 months is exempt from tax, subject to certain conditions. |
| Securities Transaction Tax (STT) | The transaction must be subject to STT to qualify for the exemption under Section 10(38). |
| Taxable LTCG (Post-2018 Amendment) | LTCG exceeding ₹1 lakh on the transfer of equity shares or mutual funds (including ELSS) is taxed at 10% without indexation. |
| Long-Term Holding Period | 12 months is the minimum holding period for ELSS units to qualify for LTCG tax treatment. |
Tax Rules for Capital Gains on ELSS Units
The tax rules for capital gains on the transfer of ELSS units follow the basic provisions outlined for listed equity shares and equity-oriented mutual funds under Section 10(38). However, since ELSS units are subject to specific investment rules (such as a 3-year lock-in period), the tax implications can vary depending on the holding period and the date of transfer.
1. Long-Term Capital Gains (LTCG) Tax on ELSS Units
To qualify for LTCG tax treatment on ELSS units, the investor must hold the units for more than 12 months. If the units are held for less than 12 months, any gain is classified as short-term capital gains (STCG) and is taxed differently.
| Holding Period | Tax Treatment |
|---|---|
| Less than 12 months | Short-Term Capital Gains (STCG), taxed at 15% (plus surcharge and cess). |
| More than 12 months | Long-Term Capital Gains (LTCG), exempt under Section 10(38) (subject to STT) until the 2018 amendment. |
| Post-2018 Amendment (LTCG above ₹1 lakh) | 10% tax on LTCG exceeding ₹1 lakh (without indexation) |
2. STT and its Role in Capital Gains Taxation
For the capital gains from ELSS units to be exempt under Section 10(38), the STT must be paid on the transaction of sale. STT is typically levied at the time of buying and selling ELSS units on a stock exchange. The STT ensures that the transaction is recognized as a taxable equity transaction, thereby qualifying for the exemption or tax benefit under Section 10(38).
3. Impact of the 2018 Amendment on LTCG Taxation
Prior to the Finance Act 2018, LTCG arising from the transfer of listed equity shares and ELSS units held for over 12 months was exempt from tax under Section 10(38). However, as per the 2018 amendment, the LTCG exceeding ₹1 lakh in a financial year on the sale of such assets is taxable at 10% (without the benefit of indexation).
This means that if an individual sells ELSS units held for more than 12 months and the capital gain exceeds ₹1 lakh, the amount exceeding ₹1 lakh is subject to 10% tax. For example, if the gain is ₹1.5 lakh, the taxable gain will be ₹50,000 (the amount exceeding ₹1 lakh), and 10% tax will be levied on that amount.
Example of Capital Gains Tax on ELSS Units
Let’s walk through an example to better understand the tax treatment of capital gains from ELSS units:
| Details | Amount (₹) |
|---|---|
| Sale of ELSS Units | ₹10,00,000 |
| Cost of Acquisition (purchase price) | ₹6,00,000 |
| Capital Gain | ₹10,00,000 – ₹6,00,000 = ₹4,00,000 |
| Exemption Limit | ₹1,00,000 |
| Taxable Capital Gain | ₹4,00,000 – ₹1,00,000 = ₹3,00,000 |
| LTCG Tax Rate | 10% |
| Tax Payable | ₹3,00,000 × 10% = ₹30,000 |
Step 1: Capital Gain Calculation
- The capital gain from the sale of ELSS units is ₹4,00,000.
Step 2: Exemption Calculation
- The first ₹1 lakh of the capital gain is exempt from tax under Section 10(38).
Step 3: Tax Calculation
- The remaining capital gain of ₹3,00,000 is taxable at 10%.
- The tax payable on the taxable capital gain of ₹3,00,000 is ₹30,000.
Key Considerations for ELSS Investors
- Holding Period: The minimum holding period for LTCG tax treatment on ELSS units is 12 months. If you sell before this period, the gain is classified as STCG and taxed at 15%.
- STT Compliance: Ensure that STT is paid on the transaction for the capital gains to be eligible for exemption under Section 10(38).
- Taxable LTCG: After the 2018 amendment, LTCG exceeding ₹1 lakh on the sale of ELSS units is taxed at 10%. Keep track of your capital gains in a financial year to manage the tax burden effectively.
- Exemptions: Investors may explore tax exemptions under Section 54EC or Section 54F if they reinvest capital gains in eligible bonds or residential property.
Conclusion
Equity-Linked Savings Schemes (ELSS) are an effective way for individuals to invest in equity markets while benefiting from tax deductions under Section 80C. However, the tax implications on the capital gains arising from the sale of ELSS units must be understood clearly to avoid surprises at tax time.
Under Section 10(38), LTCG from the transfer of ELSS units held for more than 12 months is exempt from tax, provided STT is paid on the transaction. The 2018 amendment introduced taxation on LTCG exceeding ₹1 lakh, which is now taxed at 10%. Investors should be mindful of the tax rules when selling ELSS units to ensure that they are in compliance with the latest tax regulations.
Additional Resources
Learn more about Tax Provisions on the official Income Tax India website.
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