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Rajiv Gandhi Equity Savings Scheme - A Promising Initiative Or Merely An Eyewash?

| 2/21/2013 9:03 PM Thursday

The Rajiv Gandhi Equity Savings Scheme has been ushered in to encourage new investors to enter the equity market and help them save taxes at the same time. Vivek Paratne and Shashikant tell you more about the scheme and what it really means for its intended audience.

  • RGESS will provide an extra tax benefit, over and above what is available at present under a newly introduced Section 80CCG.
  • The maximum benefit an investor can derive from this scheme is Rs 5000.
  • Back of the envelope calculations show that the total investment expected to flow into the equity market is just around 0.5 per cent of the total market cap of the BSE 100.

Only noble intents cannot make ideas work, they have to be well supported by good planning and equally effective implementation. The Rajiv Gandhi Equity Saving Scheme (RGESS) is one such intent, or rather a scheme that was announced in the Union Budget of 2012-13 by the then Finance Minister Pranab Mukherjee. It was formally launched by the current Finance Minister P Chidambaram on February 9, 2013. This very fact shows that the government is either not very serious or lacks the confidence that the scheme will succeed. You launch a scheme at the time of your budget and you implement it when the next budget is due? So much for achieving what is intended. The intent of the scheme seems to be righteous, but the plan and implementation leave room for further improvement. (See table: What is RGESS?)

The Noble Intent

It is a well known fact that a major chunk of savings in India are channelised into bank deposits, provident funds, gold and insurance. Less than three per cent of the total household savings finds its way into shares and debentures. Therefore, to improve this figure and increase retail investor’s participation in the equity market the government came out with the above scheme.

While the scheme looks good, if we scratch the surface and try to analyse the benefits that the scheme will bring to the investors, it does not look exciting. This scheme would benefit investors who are willing to invest in domestic equity and have a gross annual income less than or equal to Rs 10 lakh. Under this scheme, first time investors in equity will be entitled to a tax benefit on the amount they invest in the equity market. However, only 50 per cent of the amount you invest, subject to a maximum of Rs 50000 will qualify for this scheme. You may invest any amount in the market but your tax benefit will be calculated based on a maximum of Rs 50000. So how much of tax will you effectively save? The scheme is applicable for only those persons who have a gross total income of less than Rs 10 lakhs.  This essentially means you tax slabs are as under:

  • Upto Rs 200000 you pay no tax
  • For income between Rs 200001 to Rs 500000 you pay 10 per cent
  • For income between Rs 500001 to Rs 1000000 you pay 20 per cent

This effectively means you pay a minimum of 10 per cent and a maximum of 20 per cent in taxes on your income. So, if you invest Rs 50000 under this scheme, Rs 25000 (50 per cent of amount invested) will be allowed as a deduction from your gross total income. How much of tax will you save? Investors will save anything between Rs 2500 (10 per cent of Rs 25000) to Rs 5000 (20 per cent of Rs 25000) through this scheme.   

While the monetary benefit of utilizing this scheme for tax saving purposes is very limited there are other hassles to handle too. To benefit from this scheme, investors would have to go through all the trouble of opening a demat account, fulfill KYC norms, open a trading account and finally selecting stocks. After all this hard work the tax savings look unattractive in light of the transaction cost and the complexity involved (especially the lock-in period) in availing the benefit, not to forget the inherent risk associated with investing in equity.

Something for the Markets?

The other major reason why the scheme was introduced was to increase the breadth and depth of the domestic participation in the equity markets. To understand how much the investments would amount to, we did some back of the envelope calculations and found the answer to be utterly insignificant. According to a report, there are 10 million households in India earning between Rs 5-10 lakh per annum. This is the group of people who are likely to derive a maximum benefit from this scheme, and hence, are the target investors. Out of this, we assume that half of them would already have exposure to the equity market. Therefore, there will be only five million investors for the scheme. Even if all of them invest to the extent of the maximum amount available for tax deduction (i.e. Rs 50000), the sum works out to be Rs 25000 crore. This number is less than 0.5 per cent of the total market cap of the BSE 100 (one of the eligible stock selection groups) and less than 20 per cent of the FII inflows that we witnessed in the year 2012. Hence, we believe that it will effectively do very little to serve the purpose of widening the base of the equity markets.

In addition to the securities mentioned, investors can also get the benefit from the scheme by investing in Exchange Traded Funds (ETFs) and mutual funds that have invested in the RGESS-approved securities. There are currently around five fund houses that have come out with the RGESS MF schemes, and this is in all probability likely to increase in the coming months.

If media reports are to be believed, these fund houses are paying commissions as high as six per cent to garner funds under the scheme, as any equity scheme needs to collect at least Rs 10 crore in a new fund offer to keep the fund alive. This race to garner maximum amounts could prompt mis-selling, which will hurt inventors more than serving them. This is accentuated by the fact that this scheme is targeted at first time investors, whose understanding of equity investments and the risks associated with it remain largely on the lower side.

The Solution

In view of the state of retail participation in the domestic equity market, which is at its seven year low, the stated intent of the scheme sounds credible. However, the devil lies in the details, and the complexities involved in this scheme far outweigh any benefits that will accrue from it. Therefore, we opine that the RGESS need to be fine-tuned further and the gross annual income limit of Rs 10 lakh should be enhanced such that the scheme can cover more people and more money can flow into the equity market. Also there is a need to enhance the basic amount that will be exempted through this scheme. But the most important of the lacunae that needs to be addressed is that of the lock-in period involved. Three years is a far longer period for riskier investments like equities. The market changes course overnight at times. Staying locked in for a meager tax benefit of just around Rs 5000 by putting to risk an amount which ten times that saving makes little sense. We have raised this point earlier too. It is now for the FM to decide on what is the need of the hour. As we have been saying good sense needs to prevail on him while presenting his budget on the 28th of this month. We sincerely hope the needful changes will surely be done so as to ensure that schemes like these succeed in the right earnest.

 

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