Clarificatory Notification on ELSS (Notification 259/2005) dated 13 Dec, 2005

The CBDT has issued a clarificatory notification amending the earlier issued ‘Equity Linked Savings Scheme, 2005’.

The first part pertains to the amendment of the definition of ‘year’. A year will now refer to a year commencing from the date of allotment or holding of units (as against the earlier definition of year meaning an year commencing from 1st April)

The second part of this amendment inserts a new clause to include open-ended plans. The Unit Trust or other mutual funds can operate one open-ended equity linked saving plan, subject to the prior approval of SEBI. The intention it appears is not to restrict the equity linked saving plans to close-ended schemes only; and at the same time allow the existing open-ended schemes to continue to be operational.

Related Links:
  1. Full Text of this notification.
  2. Original postEquity Linked Saving Scheme, 2005 [Notification No 226/2005]‘.
  3. Full text of original notifiction.

Equity Linked Saving Scheme, 2005 [Notification No 226/2005]

The CBDT has vide Notification No 226/2005 dated 3rd November, 2005 notified new rules for Equity Linked Saving Schemes.

On the whole, this notification is regressive & will cause more inconvenience to the investors; rather than benefit them.

The key highlights of this scheme are:

  • Investments to be of a minimum amount of Rs.500 and in multiples of Rs.500 thereafter
This is a welcome step, since the minimum investment, either in lump-sum or through the System Investment Plan (SIP) route was Rs.5,000
  • The mutual fund to allot units not later than 31st March each year. The plan to be open for a minimum period of one month during the year 2005-06 & at least for three months in the subsequent years

This is a regression since all the ELSS’s currently available are open-ended, & hence provide the flexibility to invest and / or withdraw (reddem) at any time during the year , without being restricted to any specified time period. This also helps the investor manage his/her cash flow better, and in addition, can help time the market better
  • The mutual fund to announce the re-purchase price after one year from date of allotment & every six months thereafter for the next two years (second & third years); & subsequently the re-purchase price to be declared at a frequency of not less than one month

The currently available schemes being open-ended, give an investor the option to exit at any time based on the NAV’s declared daily. Hence, from now on the investors will face a problem due to the re-purchase price being declared only half-yearly / monthly; restricting their exit options.

  • The re-purchase price to factor in at least 50% of the unrealised gains of the plan after deducting a maximum of 5% of the average NAV as management, selling and other expenses

This causes severe concern since under the earlier regulations 100% of the unrealised appreciation was factored in the re-purchase price due the fact that NAV’s were declared on a daily basis

  • A plan can be terminated at the close of the 10th year from the year in which the allotment of units is made or, at the option of the fund, if 90% or more of the units under any plan are repurchased before completion of ten years. The outstanding units to be redeemed at the final repurchase price to be fixed by the fund

This forces the plan to be of a maximum duration of 10 years, instead of it being a open-ended plan; with the attendent benefits & pitfalls.

The following some points which need not have been specified, but nonetheless do find mention in the notification, especially since the three-year lock-in period is applicable for all investments which accrue any tax benefit to the investor:

  • Investment to be held by the investor for a minimum period of three years
  • Units issued under the plan can be transferred, assigned or pledged after three years of its issue
  • Investment to be acknowledged by certificate of investment / statement of account

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Recognised Provident Funds Allowed to Invest in Equities & Mutual Funds

The CBDT has amended the Income Tax Rules vide Notification No 220/2005 dated 3rd November, 2005. This amendment allows Recognised Provident Funds to invest in equities & other securities.

Rule 67 of the Income Tax Rules, 1962, governs the investment avenues available to a Recognised Provident Fund.

Minimum Investment to be made as under:

Investment Avenue Min Invt Moneys received on maturity of investment made before 1st April, 2005 [as reduced by obligatory outgoings] can be invested as under:
  1. Central government securities, or
  2. Mutual funds dedicated to investment in government securities#
  • The total portfolio of central & state government securities [sr no’s 1 & 3] can be divided into tradable & non-tradable categories
  • A maximum of 10% of the total government securities at the end of the preceding financial year can be treated as tradable & used for active management
  • The tradable portion as determined above & the investments made in mutual funds [sr no’s 2 & 4] should be marked-to-market at the end of the financial year
  • The investment in any single mutual fund cannot exceed 5% of the total fund value at any point of time
  1. State government securities, or
  2. Mutual funds dedicated to investment in government securities#, or
  3. Other negotiable securities guaranteed by either the central government or any state government
  1. Bonds / securities of public financial institutions / public sector company / public sector bank, or
  2. Term Deposit Receipts of up to three years issued by a public sector bank, or
  3. Collateral Borrowing & Lending Obligation issued by the Clearing Corporation of India Ltd
  • Under this head, up to 5% of the investment can be made in the equity shares of any company*
  1. Any of the Above
  • Under this head, up to 10% of the total fund can be invested in either debt instruments of any company* or in equity linked schemes of any mutual fund#

*: Investment in companies with an investment grade debt rating from at least two credit rating agencies eligible

#: Investment in mutual fund regulated by SEBI eligible

In case the investment ratings of any of the investments falls, then the option to exit from such investment should be exercised, and the funds released should be invested as above.

Investments made on or after 1st April, 2005 but before the issue of this notification [based on the earlier notification] shall be deemed to have been made in the manner as specified herein.

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Instruments / Schemes Notified for the purposes of Section 80C of the Income Tax Act, 1961

The Central Government has vide notifications 222/2005 to 225/2005 and 227/2005 notified the following instruments / schemes as being eligible for section 80C from the Assesment Years 2006-07.

  1. Provident Fund established under the Public Provident Fund Scheme, 1968
  2. National Savings Certificates (VIII Issue)
  3. ULIP [Dhanraksha 1989] issued by the LIC MF
  4. Specific Schemes of the LIC [ New Jeevan Dhara, New Jeevan Dhara-I and New Jeevan Akshay, New Jeevan Akshay-I and New Jeevan Akshay-II Plans]
  5. UTI Retirement Benefit Pension Plan

Note that this does not per se cover the ELSS [Equity Linked Saving Schemes] of other Mutual Funds. A clarification on this is awaited.

The CDBT has also issued a separate notifcation 226/2005 ‘Equity Linked Saving Schemes, 2005’. I’ll be posting my comments these separately tommorrow.

All the Notifications are available on the CBDT website. Click here for quick reference.

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