The Hindu Business Line : One fell swoop on ELSS

EQUITY linked saving schemes (ELSS) have been popular with taxpayers as they allow some tax benefits while permitting investment in equity, which is generally recognised to yield high returns in the long run. Unfortunately, tax rebates on such schemes were restricted to investments of Rs 10,000 only, with other rebates available separately for investments in Provident Fund/PPF, life insurance, health insurance, infrastructure bonds, and so on.

It took the Vijay Kelkar committee to point out the obvious — that the Government had no business to force a particular structure of savings on every taxpayer irrespective of his/her needs or preferences. Thus, taxpayers heaved a sigh of relief when the Finance Minister, Mr P. Chidambaram, amended the tax laws (effective April 1, 2005) to permit tax benefits on savings of up to Rs 1 lakh irrespective of the savings avenues chosen by the taxpayer.

This saw a decline in the preference for some schemes that were propped up solely because of the associated tax benefits, while it led to considerable increase in the inflows to ELSS by many taxpayers because of their higher returns. Further, the schemes also enjoy the benefit of transparency as their net asset values (NAVs) are announced daily and their returns on weekly, monthly, quarterly and annual basis are tracked by financial magazines and Web sites and are generally available to taxpayers to help them decide which schemes are performing well and deserve their investment.

However, in a surprise notification of November 3, the Central Board of Direct Taxes (CBDT) has communicated new requirements for ELSS to be eligible for tax exemption under Section 80C of the Income-Tax Act. As per the notification:

1) The investment will have to be kept for at least three years from the date of allotment of units, after the expiry of which, the investor will have the option of redeeming his money. A minimum of Rs 500 should be invested in the said plan and in multiples of Rs 500 thereof.

2) The ELSS shall be open for a minimum period of one month during the financial year 2005-06 and for at least three months during the subsequent years. The mutual fund will be required to announce the repurchase price a year after the date of allotment of the units and, thereafter, on a half-yearly basis. However, after three years from the date of allotment of units, when the repurchase of units is to commence, the mutual fund will be required to announce the repurchase price every month or as frequently as may be decided by them.

3) Such ELSS would be terminated after the expiry of 10 years from the year in which the allotment of units is made (but if 90 per cent or more of the units under any plan are repurchased before the completion of 10 years, the mutual fund may at its discretion, terminate the plan even before the stipulated 10-year period, and redeem the outstanding units at the final repurchase price to be fixed by it).

This notification is baffling, as:

Requirement 1 already exists and needs no repetition from the CBDT.

Requirement 2 is unnecessary and regressive as all existing ELSS are providing their NAV per unit on a daily basis. To allow them to provide NAVs on a yearly or half-yearly basis is unwarranted as this will lead to lack of transparency and deny regular information to the taxpayers about the relative performance of different ELSS.

Further, almost all the existing ELSS are open-ended in which one can invest on any day of the year. By allowing ELSS to restrict purchase to only one month in the first year and three months a year in the subsequent years, will only deny taxpayers the freedom to invest as and when they want to. It will increase their difficulties of managing cash flow for such investments and reduce their returns as they may have to wait a while before the next opportunity to invest in their desired fund and because they will lose the ability to time their entry and thus may be forced to enter ELSS schemes when the share market is at too high a level.

Requirement 3, which restricts the life of any ELSS to 10 years, is again unnecessary. Currently, most ELSS are open ended. They are more convenient to monitor and invest in. The restriction on life will mean that many investors will be denied the opportunity of investing in their favourite scheme simply because it is already more than seven years old (most of the currently high ranked schemes would fall in this category). Some investors will be forced to exit from such schemes in which they wanted to continue simply because the fund has completed 10 years (many investors may have entered the fund in its sixth or seventh year and may want to continue, especially in an rising market).

Thus, the CBDT Notification of November 3 will only reduce transparency and attractiveness of the ELSS. It will restrict taxpayer's choices and returns from such schemes. There are absolutely no gains for either the CBDT or the Government from this Notification, only costs for the taxpayers. It is thus clear that the notification defies any economic logic and should be withdrawn immediately.

(The author is the RBI Chair Professor of Economics at the Institute of Economic Growth, Delhi University.)

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