RECENT ECONOMIC REFORMS AND EQUITY CULT

[Dr. Sanjiv Agarwal]

If hike in diesel prices and controlled supply of subsidized cooking gas cylinders created a political furor all over, the other reform measures such as allowing FDI in retail, substantial reduction in taxes on overseas borrowings by Indian Companies from 20% to 5% and final announcement of Rajiv Gandhi Equity Scheme (RGES) as announced in Budget brought much awaited frenzy on the stock markets.

It is also hoped that interest rates would also be reduced shortly resulting in surge in demand for loans and housing loans. The setting up National Investment Board will also help large projects and capital market. The boost in equity market as well as demand for money would also help government in suppressing the rising demand for gold. With more foreign capital coming in, Indian rupee will improve further against dollar.

Last week Indian stock markets zoomed post reform announcements so much so that the BSE sensex was at the year's high. These reform measures and a will (at least now visible) to push some more reforms and the toughness reflected in the Prime Minister's rare recent address to the nation has enhanced the market and the investor's confidence. The markets have reacted positively, particularly in insurance, financial sector, infrastructure and capital goods sectors.

After almost half of the current financial year has gone by and the budget announced scheme of Rajiv Gandhi Equity Savings Scheme (RGES) has been notified now only. In RGES, tax incentives will be given to first time investors in equities. REGS shall on one hand promote and rejuvenate the equity cult in the county and on the other, likely to become a tool for government to offload PSU stocks on proposed disinvestments. Infact, in some cases, it could be a win-win situation for both the ends.

Salient features of the Scheme

(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 equity 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 ≤ Rs. 10 lakhs are eligible under the Scheme. 

(c) The maximum Investment permissible under the Scheme is Rs. 50,000 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 Rs. 4000 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 installments 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. 

Conditions for Investment in RGES

• Only individuals can apply and the scheme is not for corporate investors
• Annual total Income in the year of investment should be less than Rs. 10 lakhs
• Investment only upto Rs. 50,000/- shall be allowed for income tax exemption
• There will be a general lock-in of three years for currency of account but trading lock – in for one year
• New investors will have to maintain a minimum balance for prescribed days.

Those investors whose annual income will be less than Rs. 10 lakh will get a fifty percent tax rebate on investments of up to Rs. 50,000/- in equities under RGES. Thus, a maximum of Rs. 25,000/- tax gain could be availed on an investment of mere 50,000/. It will have a lock-in period of three years including one year lock-in for trading also. The securities for investment would include a spectrum of companies under BSE 100, shares of PSU maharatna, navratna and miniratna companies including follow-on issues of these companies and initial public offers from state owned companies having  annual turnover of more than Rs. 4000 crore. It will also include mutual fund investments.

The RGES Equation

Negatives

Positives

only for new investors, riskier too cannot invest in all stocks ceiling of Rs. 50K is lower tax benefit only once in life time 3 years lock in, trading lock in no secondary market investments allowed lock is to render investments illiquid lock – in is confusing stringent conditions for eligible mutual funds may add up more new dormant accounts even by existing investors to take tax benefit promotes equity cult would help mutual funds investment only in eligible securities will provide security to investors channelize savings into market and developmental activities substantial tax benefits more of demat accounts settlement though depository system

The RGES shall have multi benefits – one, will bolster equity culture and flow of savings into the market which had virtually stopped; two, curb investment in gold which government wanted to check and three, widen the retail investor base. RGES is aimed as an alternative financial instrument which will encourage more people to invest in liquid securities.

Like all financial products which have reached out substantially to the retail investors (post office savings, life insurance policies etc) through tax benefits, this tax break for direct investment in equity is expected to substantially encourage the retail participation in securities market as well as to enhance their participation in the growth of Indian industry. Entry of more retail investors are expected to further deepen the securities markets as they bring in long-term stable funds, which can counteract the volatility created by the liquidity providers of the market. The Scheme, thus, also furthers the goal of financial stability and promotes financial inclusion. Since Exchange Traded Funds and Mutual Funds have also been brought under the Scheme, the Scheme should provide encouragement and re-assurance to the first time investors.  taxmanagementindia.com

The scheme itself suffers with conflict of security from investor's angle and lack of appetite in new investors. Those who may be in position to invest may not be considered as 'new investors'. Moreover, since an investor will be new only once, (afterwards, he becomes an existing investor), the income tax benefit would be available only once in his or her life time as any subsequent investment will not be considered for tax benefit, investor being not new.

It would become a problem for the regulators to check as to who is a new investor. Those who would like to take benefit may open a new account every year with new name or address or in joint names. To check such cases, it would be desirable to make mention of PAN number mandatory for investors so that multiple applications could be checked. Opening a new demat account with different depository participants would also need a check.

The tax deduction shall be governed by new section 80CCG of the Income Tax Act and SEBI will soon operationalise the scheme. However, the investors would be advised to invest wisely and cautiously as all equity investments may not be alike.

Tax deduction is one motivation, but expectations of return on investments and capital appreciation should be the motto. After all, we have recently relearned from our Prime Minister that money does not grows on trees.

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