Allow housing societies to invest in tax-free bonds

I was called in by a co-operative housing society that had successfully completed its redevelopment. The society had received a large corpus from the builder and wanted to invest it in a safe avenue. So far, the society had been investing its monies with a few good cooperative banks, as this was an approved avenue under the Maharashtra Cooperative Societies Act, 1960 (MCS Act).

Beside interest on deposits, the society was allowed to take a deduction under section 80P of the Income Tax Act effectively giving a post-tax return of eight-nine per cent. However, now the amounts are much larger and the society wanted to spread its investments across instruments to reduce risks. I was supposed to assist in finalising a good investment option.

Unlike a normal investor, the society's investment avenues are strictly governed by the MCS Act. The Act provided that the society could invest either in any other good cooperative bank (as defined there) or in any of the securities specified in the Indian Trust Act 1882. Turning to the Indian Trust Act was like travelling through a time machine back to the British Raj days.

Investment in Central and state government securities is allowed. That section had been amended from time to time (with new amendment Bill that has been pending for some time now) but the latest security to be mentioned there were units issued by the Unit Trust of India (not UTI mutual fund mind you). The only leeway I could spot was a clause that allowed investment in "any other security expressly authorised by the instrument of trust" (which meant that if the trustee directed a particular security in the trust deed than the trust monies could be invested in that security) as well as "in any other security authorised by the Central Government by notification in the Official Gazette".

The society had only byelaws - it had no "instrument of trust" and if there was a notification of the Central government under this clause, it was a closely guarded secret. So this clause was not proving to be of any help. I was keen to explore the ability to invest in Gilt Mutual Fund schemes, as they were far more tax efficient than direct investment in government securities as well as tax-free infrastructure bonds.

Some of the MFs we contacted suggested that if the byelaws of the society authorised investment in any specific securities such as tax-free bonds or Gilt MFs, it could then invest in those instruments but we could not get any written clarifications on this. The society did not want to take a risk and it decided to invest in fixed deposit with the few good cooperative banks.

With the redevelopment boom, co-operative housing societies are going to have a lot of funds. All these funds have to be invested in cooperative banks today because of the associated tax deduction and the difficulties of direct investment in government securities.

A lot of this money is bound to land up in the cooperative banks controlled by politicians. No wonder co-operative bank board elections are fought with as much fervour as local bodies' elections, if not more. It is this political stake perhaps that keeps the Central government from either issuing a notification allowing instruments such as tax-free bonds or Gilt funds as an approved security or finally actually amending this Act to modernise it. The MF industry has either not realised the opportunity or lacks the heft with the government or its regulator to get some of their schemes notified under this clause.

Now, I could be totally wrong and perhaps such a notification already exists. If so please do let me know.

The author is a Sebi-registered investment advisor