March 18, 2012

Rajiv Gandhi Equity Saving Scheme: The Factsheet

With equity-linked saving scheme (ELSS) or tax-saving mutual fund (MF) schemes on their way out effective April 2013 if the proposed direct taxes code (DTC) kicks in then, Budget 2012 has provided some sort of an alternative. However, unlike ELSS that is a mutual fund, the new option will solicit direct investments in equities.

The scheme

Called the Rajiv Gandhi Equity Saving Scheme (RGESS), those investors whose annual income is less than Rs. 10 lakh can invest in it. You will be able to invest in this scheme up to Rs. 50,000 and get a deduction of 50% of the investment. So if you invest Rs. 50,000 (maximum amount you can invest), you can claim a tax deduction of Rs. 25,000 (50% of Rs. 50,000).

This will translate to a maximum benefit of Rs. 5,000 (investors whose annual income is a maximum of Rs. 10 lakh falls under the 20% income-tax bracket). Those whose annual income is Rs. 10 lakh or more will not be able to invest in RGESS. Just like ELSS, your money will be locked in for three years.

Benefits from RGESS are limited though, if compared with ELSS. ELSS is available for all investors and offers deduction up to Rs. 1 lakh under section 80C. Also, your entire amount invested, subject to a maximum of Rs. 1 lakh, gives you tax deduction benefits.

For FY13 though, both ELSS and RGESS will be at your disposal, provided the capital market regulator, the Securities and Exchange Board of India (Sebi), releases guidelines and allows these schemes to launch. “Since the DTC has been postponed by a year, this year will be a sort of bonus for retail investors; both RGESS and ELSS will be available,” says Rajiv Deep Bajaj, vice-chairman and managing director, Bajaj Capital Ltd, one of India’s largest retail distributors of MFs and financial products.

MFs or direct equities?

Budget 2012 is silent on how this scheme would operate. In his Budget speech, the finance minister said this scheme would be available for investments made “directly in equities”, but went to add that “the scheme will have a lock-in period of three years”. In simple words, it is unclear that RGESS is available only if you buy equity shares directly or whether MFs will also be launch such “schemes”. “The effort to increase retail participation in equity markets is a long-term positive. However, we believe that this should be extended to equity funds as well. Small investors are better off accessing the equity markets through funds with a good track record rather than directly, which requires expertise and resources,” says Harshendu Bindal, president, Franklin Templeton Asset Management (India) Ltd.

Apart from just mentioning or introducing this scheme, Budget 2012 doesn’t elaborate much on RGESS. If you take the finance minister’s words literally, MFs will not be allowed to launch RGESS. The Budget speech uses the words “direct equities”, which means that you will need to buy equity shares directly to be able to get this tax deduction benefit.

However a person from the finance ministry with direct knowledge of the matter hints that RGESS would avoid the mutual fund route. “ELSS is meant for indirect participation in the stock market, with no involvement of the asset holder. RGESS aims at encouraging direct participation in the stock market”, said the person. The source added that RGESS would help “in development of equity culture”.

Defining ‘first-time’ investors

Although Budget 2012 remains silent on how it aims to identify “first-time investor”—the group of investors that RGESS will target, once launched—the person quoted earlier tells us that those who do no yet have a depository (demat) account would be the target investors for RGESS. “It is roughly estimated that there are around 15 million Permanent Account Number (PAN) holders with income between Rs. 2 lakh and Rs. 10 lakh, that do not have a demat account at present. These income tax payers would be the universe from which beneficiaries of the scheme would be drawn”, says the finance ministry person. “Once they define ‘new retail investor’, one needs to also prove that the investor is a new retail investor,” says Hiresh Wadhwani, partner and national director (finance services), Ernst and Young.

What to do?

Wait for further clarification. Since RGESS is an investment scheme that warrants stock market investments, Sebi will regulate it and issue guidelines. Also, clarity is needed on how the government will ensure that your equity investments are locked-in for three years and whether premature redemptions will be allowed under special circumstances or not.

ELSS schemes don’t allow premature redemptions. For now, continue investing in ELSS if you’re seeking tax deduction limits since ELSS will continue for one more year.