RGESS going into first gear soon

Finally, the UPA government has notified the much-talked about Rajiv Gandhi Equity Savings Scheme (RGESS) to encourage small investors to channelise their savings into domestic capital markets.

In effect, the Central Board of Direct Taxes (CBDT) has notified the scheme -- framed after the introduction of Section 80-CCG in the Finance Act 2012 --  with a lock-in period of three years.  Under this scheme, a one-time deduction for income tax purposes will be available to a “new retail investor”.

When it was announced initially in the Budget 2012-13 by the then finance minister Pranab Mukherjee, the scheme looked exotic -- as investments by new retail investors to be permitted in approved shares.  It was perceived that North block thought of RGESS as a easy way out for their PSU divestment plans to facilitate the UPA government for filling budgetary gaps. 

Even as the initial idea meant to encourage first-time retail investors to buy stocks exclusively by giving them a tax break, the scheme was perceived to have as many negatives as positives. 

For one, a new retail (equity) investor by definition knows little about markets and may rely solely on brokers or others to guide him which is fraught with danger.
 
Secondly, although the new retail investor is eligible for a deduction on the actual amount invested in ‘eligible securities’ in the first financial year, subject to maximum deduction limit of Rs 50,000 but the very pain of complying with the formalities is seen as much more than the pleasure of saving in the 20 per cent tax bracket.

So, when the present Finance Minister P Chidambaram announced the details of RGESS recently, he interpreted albeit differently to include exchange-traded funds (ETFs) and mutual funds (MFs) under its ambit as well from what was initially permitted in approved shares. 

IT deduction

Further, if the new retail investor has claimed a deduction in any assessment year, then no income tax deduction will be available for any subsequent assessment years under the scheme. The deduction will be available to a ‘new retail investor’ whose gross total income for the financial year, in which investments are made under the scheme, is less than or equal to Rs 10 lakh.

Eligible securities will include equity shares falling in the list of equity declared as “BSE-100” or “CNX-100”; equity shares of public sector enterprises that are categorised as maharatna, navaratna or miniratna by the Central Government. Also, units of ETFs or MFs with RGESS-eligible securities as underlying, will be counted as eligible securities for investment.

Who is eligible?

Eligibility wise, any resident individual, who has not opened a demat account and has not made any transactions in the derivative segment as on the date of notification of the scheme, will fall under the definition of ‘new retail investor’.

Also, any individual who has opened a demat account before the scheme’s notification, but has not made any transactions in the equity segment or the derivative segment till the date of notification, will be considered as ‘new retail investor’. The holding period of eligible securities is three years, with fixed lock-in of first year and a flexible lock-in period of two years.

Although experts have hailed the decision by government now to expand the investment avenues by including ETFs and MFs, some feel that direct purchase of equity by new retail investors should have been excluded from RGESS altogether.  In this context, Value Research CEO Dhirendra Kumar says: "...not only should equity MFs be a part of the scheme, direct purchase of equity should be excluded from it."
 
In fact, the ETF idea that's being included now is a combination of the original plan and the market regulator Sebi's new recommendations on promoting mutual funds.  The original idea was to get people to open depository accounts and buy shares from brokers.

Experts concede that ETFs and index-based investing have not done well in the country so far, but they believe as the market matures they are bound to get more important.

The real put off from RGESS is its three-year lock-in period.  For instance, if a new investor can sell his shares after one year, but will have to reinvest the initial amount (for which he claimed a tax deduction) back by buying from the same select list of shares.

Where the complications set further in the scheme is when the new investor buys shares worth Rs 50,000 and sells it in the next year for Rs 30,000 while incurring a loss of Rs 20,000, he has to invest only Rs 20,000 which only means that even after a loss he is invited to put more money in stocks with what he has managed to salvage by cashing out.

Notwithstanding the demerits of RGESS, the scheme – after a lapse of over nearly 9-months from the government’s initial announcement –has been finally structured for a good take off.  At this point one can only hope in the days to come it will entice more and more new investors to have a good experience in equity investing.