Finmin shuts MFs out of new tax-free equity plan

Written by Sunny Verma | New Delhi | Updated: May 31 2012, 09:41am hrs
The finance ministry has rejected a Securities and Exchange Board of India (Sebi) proposal to market Rajiv Gandhi Equity Savings Scheme (RGESS) through mutual funds, indicating such a move would contradict the principle of deepening capital markets by attracting new retail investors.

Sebi had suggested to the government that under the tax-saving RGESS, first-time investors should enter stock market through experienced institutional players like mutual funds.

The government, however, asserts that RGESS was conceived for a different purpose, that of expanding India's capital market culture. To ensure investor protection, the finance ministry is putting in place safeguards to protect the hard-earned savings of small investors. The cover would ensure that investors are exposed to risks of equity investments in a measured way.

The RGESS allows 50% deduction from an individual's taxable income for investments in equities up to a maximum of R50,000. The tax benefit is available only once to all individuals with an annual income below Rs 10 lakh.

Sebi has sent its views and we appreciate them. But the government does not believe mutual funds should run the scheme. There are enough retail investors who would buy stocks directly under the scheme, a finance ministry official said.

Since the scheme allows purchase of only BSE-100 and NSE-100 stocks with a lock-in period of three years, it is very unlikely investors will suffer losses on in these bluechip companies, he said.

Sebi chairman UK Sinha recently said the regulator had suggested to the finance ministry that under RGESS, savings may be routed to equities through mutual funds.

Sinha argued this would minimise risks associated with direct equity investments for retail investors.

The thinking in Sebi is that first-time investors may not have adequate information about the stock market... They should enter the market through institutional investors (mutual funds), Sinha had said.

The finance ministry official said routing RGESS through mutual funds will defeat the purpose of this tax-free equity savings scheme. This scheme has been built on a different philosophy of attracting first-time investors. Mutual funds are already selling equity-linked savings schemes, which also offer tax incentives, the official said.

Finance minister Pranab Mukherjee introduced RGESS in the Union Budget 2012-13 to encourage flow of retail savings into equity market. Participation of retail investors in stocks is abysmally low and declining over years. Equity investments by Indian households plunged to a quarter-century low of 4% of total assets in 2011, with retail investors locking up their savings in real estate, gold, bank deposits and even cash.

RGESS hopes to attract about 1.5 crore individuals out of the 2.5 crore taxpayers with an annual income up to Rs 10 lakh, who have neither had a demat account nor owned any share into the stock market. Their participation will provide stability in the market and create a new counterweight to volatile foreign portfolio capital.