Wednesday, February 20, 2013

Rajiv Gandhi Equity Savings Scheme - Is it worth considering it?


The scheme: 

We have a new tax saving scheme called "Rajiv Gandhi Equity Savings Scheme" which gives tax advantages for first time equity investors.  The maximum amount of investment allowed for the current Financial year is Rs50,000.  Out of which you can claim 50% as tax deduction.  So, you get tax benefit of anywhere between Rs2500 to Rs5000, depending on your tax slab.  Somebody who is in the 30% tax slab, that is, earning more than Rs10 lakhs, would not be eligible to invest in RGESS scheme.

The investments in RGESS scheme is over and above the already existing Rs1 lakh exemption limit u/s 80C. Therefore, there would be some rush from investors to avail of the additional tax benefit.

Lock in period and Partial withdrawls:

RGESS rules allows investors to partially withdraw after 1 year lock in period.  Compared to other tax savings schmes, where you have to lock in for 3 years, this sounds interesting.  But hold on.  There are requirements to maintain the balance of the original amount of investment you have made for 270 days in year two and three, if you withdraw partially after 1st year.  The least said about the partial withdrawl rule is better.  Otherwise, it will confuse you and I am sure the target audience for this scheme, the first time investors, would be terribly confused by these requirements.

The Finance Minister Mr P Chidambaram has indicated that there is complete revamp of RGESS would happen in this year's budget.  So, its better to wait for the new avatar before you commit money in RGESS.

Important points you should know:

  • RGESS has a lock in period of 3 years. 
  • Only people with less than or equal to Rs10 lakhs of Gross Total Income can invest.  Also, they should not have had prior equity buying experience.  
  • You need to open a demat account, if you want to invest in RGESS 
  • To apply for this RGESS scheme, you need to file a Form A declaring that you have never ever bought any equity shares.  The Form A carries your PAN number and the demat details, which will be checked and confirmed in 4-5 days time, that you have never invested in equity shares. 
  • As per the current regulations, you can invest only once in RGESS.  That is, if you invest this year, the rules automatically debars you from investing in the next year.  

So, whats the bottomline - Should I invest or not?

Invest, only if you have an above average risk appetite.  Since the investments are 100% in equity markets, it may go up and down and so you should be prepared to see the swings in share prices.  Else, pay the additional tax of Rs2500 or Rs5000 and enjoy rest of the money!!!!

Thursday, February 7, 2013

FMPs - Alternative To Bank Fixed Deposits With Tax Efficiency


This time of the year, you see lot of FMPs hitting the market.  Wondering what is FMP!

FMP stands for Fixed Maturity Plans offered by Mutual Funds in India.  Mutual Fund houses collect money through an FMP scheme and lend that money to borrowers for a fixed maturity periods or buy commercial papers or bonds which matches with the scheme maturity date.  The FMPs are debt instruments and they dont have any equity exposure at all. Also, the FMPs would invest in rated securities which gives additional comfort as far as the quality of credit instruments held by the FMP scheme.

It is being positioned as an alternative to bank fixed deposits by the fund houses.   Yes, FMPs are an interesting alternative with highly tax efficient structure due to indexation benefits on Capital Gains.  We will see how this beneficial from a tax perspective.

The process works like this.

What happens in a bank fixed deposit?
You invest Rs10000 and receive back Rs11000. The difference between the original investment and the maturity value is treated as interest income and taxed as "interest from other sources" in case of bank deposits.

What happens in a FMP?
Taking the same example above, the amount invested is considered as the cost of purchase of a financial asset, in this case, mutual fund units and the maturity amount is taken as the sale consideration.  So, the difference between the purchase price and the sale consideration is treated as profit on this asset.

Whats the big deal about this?
When it is treated as interest, it gets added to one's taxable income and get taxed at the applicable income tax rates of the individual (in case of bank fixed deposits)

When it is treated as profit, then the Capital Gain provisions kick in for tax calculations.  As you may be aware, Capital Gains have preferential tax treatment and the highest tax rate is 20% which is lower than the 30% tax rate for general income tax calculations.  Also, you get indexation benefit from financial assets held more than 1 year.  The beauty is if it is held across two different financial years, you get double indexation benefit.  For example, you purchase a 390 days FMPs on 10th March 2013 and it will mature on 05th April 2014.  So, in this case, you will get indexation benefit for 2 years, that is, for FY 2013-14 and 2014-15.  This is called double indexation.

Can it replace the Bank Fixed Deposits completely? 

Okay, then the moot question is can it completely replace the Bank Fixed Deposits in one's portfolio.  The simple answer is NO.

The following are the reasons why you need to maintain a balance between bank fixed deposits and FMPs:

Liquidity:   The liquidity provided by bank fixed deposits are unmatched currently by FMPs . FMPs are close ended instruments which are listed on the stock exchanges but the volumes are not very encouraging.  For that matter, trading in debt instruments in India is still at a very nascent stage putting at little risk the liquidity of FMPs.

No up front disclosure of Interest rates:  Secondly, there is no guaranteed interest rates by the Mutual Fund houses in respect of FMPs.  Bank Fixed Deposits disclose the interest rates up front but in FMPs it can not be disclosed by Fund Houses due to SEBI restrictions on the same.

Opaqueness in FMP scheme holdings:  It is not disclosed by the Fund House prior to your investment where and which instruments they would be subscribing to.  As such, you have to go with the stated objectives in the Key Information Memorandum of the scheme.  But having said that, I would not give too much weightage to this argument because even banks don't disclose where they invest or lend at the time of taking deposits from the investor.

Suitability of FMP:

Who should invest in FMPs?

1.  People who are in the highest tax bracket as it provides tax efficiency

2.  Investors who have adequate bank deposits to meet emergency situations and looking to diversify beyond bank deposits


So are you looking for tax efficient alternative to Bank Fixed Deposits?  Look no further than FMPs.

Please feel free to write back to us (venkytuty@gmail.com) if you require any further information on FMPs or help in making investment in FMPs.