Rajiv Gandhi Equity Savings Scheme is good only in parts

The government has put in place a very complicated system of RGESS, which is likely to be a non-starter from day one, as the pain of complying with the formalities is more than the pleasure of saving a maximum amount of Rs5,000 from the scheme

The broad contours of proposed Rajiv Gandhi Equity Savings Scheme (RGESS) have just been announced by the Central Government.  The finance ministry, while announcing the details of the scheme hopes that the scheme will improve the depth of the domestic capital markets, as it aims to promote an equity culture in India. While time alone will tell whether these objectives will be achieved, the scheme as it appears is like a curate’s egg, only good in parts, and requires clarity on several fronts for the smooth operation of the scheme.

 

Details of the RGESS:

 

The salient features of the scheme as announced in a press note dated 21September, 2012 are as under:

 

a. Scheme is open to new retail investors, identified on the basis of their PAN numbers. This includes those who have opened the demat account but have not made any transaction in stocks and /or in derivatives till the date of notification of this scheme and all those account holders other than the first account holder who wish to open a fresh account.

 

b. Those investors whose annual taxable income is Rs10 lakh are eligible under the scheme.

 

c. The maximum Investment permissible under the scheme is Rs50,000 and the investor would get a 50% deduction of the amount invested from the taxable income for that year.

 

d. Under the Scheme, those stocks listed under the BSE 100 or CNX 100, or those of public sector undertakings which are Navratnas, Maharatnas and Miniratnas would be eligible. Follow-on Public Offers (FPOs) of the above companies would also be eligible under the scheme. IPOs of PSUs, which are getting listed in the relevant financial year and whose annual turnover is not less than Rs4,000 crore for each of the immediate past three years, would also be eligible.

 

e. In addition, considering the requests from various stakeholders, Exchange Traded Funds (ETFs) and Mutual Funds (MFs) that have RGESS eligible securities as their underlying and are listed and traded in the stock exchanges and settled through a depository mechanism have also been brought under RGESS.

 

f. To benefit the small investors, the investments are allowed to be made in instalments in the year in which tax claims are made.

 

g. The total lock-in period for investments under the scheme would be three years including an initial blanket lock-in period of one year, commencing from the date of last purchase of securities under RGESS.

 

h. After the first year, investors would be allowed to trade in the securities in furtherance of the goal of promoting an equity culture and as a provision to protect them from adverse market movements or stock specific risks as well as to give them avenues to realize profits.

 

i. Investors would, however, be required to maintain their level of investment during these two years at the amount for which they have claimed income tax benefit or at the value of the portfolio before initiating a sale transaction, whichever is less, for at least 270 days in a year. The calculation of 270 days includes those days pursuant to the day on which the market value of the residual shares/units has automatically touched the stipulated value after the date of debit.

 

j. The general principle under which trading is allowed is that whatever is the value of stocks/units sold by the investor from the RGESS portfolio, RGESS compliant securities of at least the same value are credited back into the account subsequently. However, the investor is allowed to take benefits of the appreciation of his RGESS portfolio, provided its value, as on the previous day of trading, remains above the investment for which they have claimed income tax benefit.

 

k. For the purpose of valuation of shares, the closing price as on the previous day of the date of trading will be considered so that new investors are certain about their debits and credits into the account.

 

l. In case the investor fails to meet the conditions stipulated, the tax benefit will be withdrawn.

 

Analysis of the pros and cons of the scheme

1. The scheme is applicable to first time investors in the stock market. This obviously means that the scheme is meant for those people who do not know anything about the stock market. There is an advertisement in daily newspapers released by National Stock Exchange advising people to follow three guiding principles before investing in the stock market. They are “soch kar, samajkar, investkar”. It means that you have to think, understand and then invest in the stock market so that you do not burn your fingers. So who will guide the first time investors in the stock market to understand the risks involved in investing in stock market? The scheme has no provision to cast any responsibility on any of the market participants to take up this job and the investors are left to fend for themselves. 

 

2. The maximum investment permitted under the scheme is Rs50,000 and the investor would get a 50% of the amount invested as a deduction from the taxable income for that year. And this is restricted to those whose annual taxable income is up to Rs10 lakh. This means that any one eligible under the scheme invests Rs50,000 in the permitted stocks will get a deduction of Rs25,000 from his taxable income. This in effect means that this investor will get a maximum tax saving of Rs5,000 in a year, as he falls in the tax bracket of 20% under the Income Tax Act.

 

Is it worth the trouble of first opening a demat account after complying with KYC norms, then opening a broking account with a stock broker after complying with necessary formalities, then start buying the stocks without knowing what to buy, and finally run the risk of losing whole or a part of the capital all for getting a tax benefit of this paltry amount of Rs5000? Of course, if you are lucky, you may earn some extra profit, if the stock pick is right and the market favours you and the index goes up.

 

3. To be eligible for tax benefit, you have to invest in stocks specified in the scheme. They are all those stocks covered by BSE 100 or CNX 100 index and those of public sector undertakings which are categorized by the government as ‘Maharatnas’, ‘Navaratnas’, and ‘Miniratnas’. The follow on offers and initial public offers of PSUs whose annual turnover is not less than Rs4,000 crore are also eligible for investment under the scheme. So you have to first identify these eligible stocks, lest you may fail to get the tax benefit if you make a mistake. No doubt brokers will be able to indentify the eligible stocks, and they will even recommend the stocks to the investors. However, without any responsibility for the performance of the stocks recommended by them, because, nobody can predict the movement of the market with any amount of accuracy.

 

As per the website of department of public enterprises, www.dpe.nic.in, a total of 89 central public sector undertakings have been listed under the Ratna category, but many of them are not listed in the stock exchanges. There are five Maharatnas, 16 Navartnas, 52 Miniratnas in Category I, and 16 Miniratnas under Category II, and it is not clear whether listed companies in all these categories are eligible for investment under the scheme.

 

4. The new addition to the scheme is the Exchange Traded Funds (ETFs) and mutual funds that have invested in the RGESS approved securities mentioned above and such funds are listed and traded in the stock exchange and settled through the depository mechanism. Investments in these funds are also eligible under the scheme. The ministry has added ETFs with an ulterior motive of pushing the ETFs proposed to be set up to sell PSU shares shortly. In the case of mutual funds, as of now, there may not be any specific fund set up exclusively for investing in the stocks permitted under the RGESS scheme and listed in the stock exchanges. Hence, investors may have to wait till new schemes are set up by the mutual funds covering these stocks and shares. This is the only positive aspect of the scheme as it is preferable for new investors in the stock market to invest through the mutual funds route to reduce market risk considerably. There is a provision to invest in instalments in the year in which tax claim is made.

 

5. There is a lock-in period of three years including a blanket lock-in of one year. So if you sell the shares within a year, you will forfeit the tax benefit and you are liable to pay tax on the principal amount during the year of sale, but there is no provision to offset loss if any, incurred by you on this sale. However, the scheme has a very complex system of sale and repurchase after one year and it is not worth resorting to sale within next two years, because it is not only cumbersome, but also you have to ensure that your original investment of Rs50,000 should be in place during at least 270 days each in the second and third year.

 

On the whole, the government has put in place a very complicated system of RGESS, which is likely to be a non-starter from day one, as the pain of complying with the formalities is more than the pleasure of saving a maximum amount of Rs5,000 from the scheme.

 

The Securities and Exchange Board of India (SEBI) is expected to issue detailed guidelines to operationalise the scheme within the next two weeks when more clarity may emerge.  

 

(The author is a banking and financial analyst and writes for Moneylife under the pen-name ‘Gurpur’).

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