Mutual fund investing can beat income tax, says expert; here’s how paying tax can make you richer

For most people, saving tax is almost a national obsession. Every earning season begins with the same question: “How do I save tax?” But according to CA Neeraj Arora, the answer may not always lie in avoiding tax — sometimes, paying it strategically can make you wealthier. In a recent discussion on capital gains and tax-saving instruments, Arora explained how mutual fund investing can outperform traditional tax-saving tools like 54EC bonds, while staying fully compliant with income tax laws.

Understanding Capital Gains Tax

When you sell a property, the profit earned is called a capital gain. If the sale happens within 24 months, it’s treated as a Short-Term Capital Gain (STCG) and taxed as per your income slab. If it’s sold after 24 months, the profit becomes a Long-Term Capital Gain (LTCG), taxable at 12.5% without indexation (as per the post–July 2024 rule).

To save tax, many taxpayers rush to invest the gain in Capital Gain Bonds, permitted under Section 54EC of the Income Tax Act. These bonds, issued by entities such as NHAI, REC, PFC, and IRFC, allow you to claim full or partial exemption on LTCG tax if the investment is made within six months of sale. However, there’s a catch — the maximum exemption is Rs 50 lakh per year, and the bonds have a 5-year lock-in period. You also can’t pledge or sell them during that period, and their interest rate hovers around 5.25%, with interest fully taxable.

Arora humorously describes this as the government’s “tax trap”: “You chase the government to save tax, and the government chases you back.” The intent, he says, is not to discourage saving tax but to highlight how limited returns and low liquidity often offset the benefit of exemption.

Understanding Section 54EC

To illustrate, Arora gives an example:

If you sell a property for Rs 50 lakh and earn Rs 30 lakh as long-term capital gain — investing that ₹30 lakh in 54EC bonds makes it tax-free. But if your gain is Rs 80 lakh, you can still invest only Rs 50 lakh, meaning Rs 30 lakh remains taxable.

Now, let’s say you invest Rs 30 lakh in 54EC bonds for 5 years at 5.25%. After taxes, your total grows to about ₹31.7 lakh.

On the other hand, if you choose to pay 12.5% tax (₹3.75 lakh) and invest the remaining ₹26.25 lakh in a mutual fund yielding 9–12%, your corpus after 5 years could exceed Rs 37 lakh.

“In this case,” Arora explains, “you pay tax — but you actually make more money. You stay compliant, liquid, and ahead.”

Smart tax strategy

The logic is simple: while 54EC bonds are safe and government-backed, they offer low post-tax returns. By contrast, mutual funds — particularly short-term debt funds or hybrid funds — can offer higher flexibility and superior compounding.

Capital gain bonds work best for ultra-conservative investors or those nearing retirement, while younger investors may benefit more from paying the LTCG tax and reinvesting in diversified funds with better yield potential.

Arora emphasizes that this approach is completely legal, provided the investor accurately declares income and pays due taxes. “Nothing is as pure and powerful as knowledge,” he says — echoing the tagline of his first coaching centre, Edu Power Plus.

Beyond tax exemptions, Arora’s larger message is about financial awareness. With proper knowledge of tax laws and investment options, individuals can avoid common mistakes — such as chasing every exemption without understanding the opportunity cost.

“Sometimes the smartest way to save tax,” he concludes, “is to pay it — and let your money grow faster elsewhere.”

As India’s retail investors become more financially savvy, such strategies highlight a critical truth: the real wealth lies not in tax evasion, but in informed decision-making.

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