Monday, October 1, 2012


Rajiv Gandhi Equity Savings Scheme

After announcement in the budget The government has finally approved much awaited “Rajiv Gandhi Equity Savings Scheme” (RGESS). Two things which come out clearly from the features of the scheme are: 1) it is a scheme intended to provide tax benefit to first time investors investing directly in equity, mutual fund and exchange traded funds (ETF).  2) It is an attempt to attract investors into stock market and broaden investor base in stocks.
 
The scheme offers tax benefits to investors whose income is up to Rs 10 lakh. This means that the scheme is open for investors paying income tax in two tax brackets—10% and 20%. For an investment up to Rs 50,000, 50% of investment will qualify for tax benefit. For an investor in 10% bracket, the total tax benefit offered by the scheme will be Rs2,500 ( 50% of Rs50,000 is Rs25,000 and 10% tax benefit on this amount is Rs2,500), while for an investor in 20% tax bracket this benefit will be Rs5,000 which can be availed only once. The tax benefits as such do not seem very attractive but in our country where investments are done on the basis of tax benefit, this amount is good enough to catch attention of an investor.
 
Tax benefits on stock investments are not new to the investors in India. Equity Linked Savings Scheme (ELSS)—a tax benefit product—has been in existence for quite some time now but has failed to attract investors. When Compared to ELSS in terms of tax benefits, RGESS looks like almost same. The major difference is that it is available to first time investors alone. The most important question that RGESS raises is, “Can tax incentives alone attract new investors to the stock market and broaden investor base in the country?”
 
As per existing tax provisions in India, investment in stocks is extremely attractive in terms of taxation of returns. There are no long-term capital gains taxes in the country for an investor if he purchases stocks which are traded on recognized stock exchanges and Securities Transaction Tax (STT) is paid on these stocks. Contrary to this, bank deposits and fixed deposits in particular are subject to taxation as per the tax slab in which income of an individual falls. Another attraction of investment in stocks is that it allows an investor to set off capital loss against capital gains subject to some conditions. But in bank deposits there are no such provisions.
 
In spite of there being very attractive tax structure for investment in stocks, investors prefer bank deposits to stock investment. RBI (Reserve Bank of India) data shows that banks deposits have shown consistence increase in deposits year on year basis. Even insurance as a product has shown similar trend. However, total change in stock investments during last ten years is less than a single year change in the bank deposits. In fact during last five years, due to bad performance of stock market, total change in the investment in stocks has been marginal.

Looking at the data and trends in investments in financial assets in India, can a marginal tax incentive actually attract investors in stock market?  If we believe the same , will they remain invested beyond the lock-in period? The answer seems to be an no at this stage. The failure of ELSS as a product is an example of it.
 
Investors have been avoiding equity market because of volatility and speculation in the market. The common investor today feels that volatility in India equity market is too much and have not much confidence with respect to investment in equity.
 
There should be prepared an environment for growth of equity market. This should start from investor education and strict regulatory controls in capital market. Investors need to be given confidence that equity market creates wealth in long term. Corporate governance practices need to be implemented strictly so that investors can believe on companies and their operations.

Regards,
Arvind Trivedi
Certified Financial Planner

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