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I have invested in an ELSS fund.

Will I have to pay tax on the profits when I sell the units of the fund? Also, how is the tax calculated if I buy the units at separate times? For instance, if I invest a little every month via an SIP and I sell all the units at one go, how will the profit be calculated for the amount invested in January and then February and then March and so on and so forth?

For how many years will I get this tax benefit? And how much can I invest in ELSS?

- Sneha

Let's get some basics right first.

An ELSS is an Equity Linked Savings Scheme. This is a diversified equity fund with a tax benefit. The amount you invest in ELSS -- upto a limit of Rs 1,00,000 -- is deducted from your income under Section 80C.

An ELSS differs from a diversified equity fund in that it has a lock-in period of three years.

If you invest in an ELSS, you get the tax benefit only in the year of investment; you do not get any tax benefits for investing in a diversified equity fund. The amount you invest in one financial year (April 1 to March 31) will be deducted from your taxable income that year.

If you sell shares or such mutual funds after one year of buying them, you pay no capital gains tax. In other words, you will not be taxed on the profit you make. So, if you invest Rs 50,000 in an ELSS and it grows to Rs 90,000 after three years, you will have to pay no tax on the principal amount (Rs 50,000) or on the profit (Rs 30,000).

Here's another example: let's say you invest every month in an ELSS via a Systematic Investment Plan. And, every month, you decide to invest Rs 5,000.

The tax applicability is decided on a first in, first out basis. If you started a SIP of Rs 5,000 in April 2003 and put in another Rs 5,000 in May and this goes on, you would accumulate a number of units over time. Now, let's say you begin to sell these units in May 2006. The units that will be considered are the first ones you bought (April 2003); they are the first to be bought and hence will be considered the first to be sold.

Like we mentioned earlier, the tax benefit for investing in ELSS falls under the Rs 1,00,000 limit of Section 80C. You can invest upto this entire limit, unlike the Public Provident Fund which has a limit of Rs 70,000.

However, you must take into account a few factors before making your decision. The first is how long you want the money locked in. With an ELSS, it is just for three years; with PPF, it is for 15 years. The National Savings Certificate is for six years.

The other factor is how much of a risk you are willing to take. PPF and NSC are very safe since they are backed by the government. But ELSS is much more risky since it is a stock market related instrument.

We rate mutual funds based on their returns and the risk taken to get those returns. A five-star rating is the best while a one-star is the worst. Go through the list of tax saving funds and pick up those with a good rating.

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