The need of the hour is to prepare an environment for growth of stock market. This should start from investor education and strict regulatory controls in capital market. Tax benefits can follow all this

The cat is finally out of the bag. The government has approved much awaited “Rajiv Gandhi Equity Savings Scheme” (RGESS) setting aside all speculations related to the features of the scheme. Two things which come out prominently from the features of the scheme are: 1) it is a scheme intended to provide tax benefit to investors investing directly in equity, mutual funds and exchange traded funds; and 2) it is an attempt to lure investors into stock market and broaden investor base in stocks.
 

The scheme offers tax benefits to investors whose income is up to Rs10 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 Rs50,000, 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 sound very attractive but in a country like India where investments are done on the basis of tax considerations, this amount is good enough to catch attention of an investor.
 

While the objectives of the scheme might sound noble, there are some questions which the scheme opens up for debate. 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 lure investors to the extent desired. When Compared to ELSS in terms of tax benefits, RGESS looks like an old wine in the new bottle to some extent. However, RGESS is different from ELSS in the sense that tax benefit offered under RGESS is available to first time investors alone and hence the most important question that RGESS raises is, “Can tax incentives alone lure new investors to the stock market and broaden investor base in the country?”
 

This question needs some investigation and hence requires analysis of some basic facts. 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 in India prefer bank deposits to stock investment. RBI (Reserve Bank of India) data on change in financial assets (see table below) 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 global recession and bad performance of stcok 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 really lure investors in stock market?  For a moment even if we believe that investors are indeed attracted to this scheme, will they remain invested beyond the lock-in period? The answer seems to be an emphatic no at this stage. The failure of ELSS as a product is an example of it.
 

The government it seems has failed to read the pulse of investor’s requirement once again as far as equity market is concerned. Investors have been avoiding equity market because of certain obvious factors and tax incentives are not right medicine to mitigate fear arising from these factors. Some of the factors which have driven investors out of equity market and are dissuading new investors to join the market are undesirable speculation in the market. Fast changing dynamics of the market and losses arising from the changes have kept investors away from the market. The regulator has failed to educate investors on this front. It is pertinent to note that one of the objectives with which market regulator Securities and Exchange Board of India (SEBI) was formed was education of investors. The common investor today feels that volatility in India equity market is too much and often words like , ‘Casino’, ‘Lottery’ and ‘Matka’ are used with respect to investment in equity.
 

The need of the hour is to prepare 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 and vagaries of return can be overcome by long term investments. Presence of cumbersome processes needs to be simplified. For instance, one KYC should be good enough for all investments including mutual fund, equity and other equity related investments. Corporate governance practices need to be implemented strictly so that investors can believe companies and their operations. In brief, growth of equity culture needs to be an all encompassing exercise. Tax benefits can follow all this.