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Economy

Budget: Mutual Fund Dividends To Companies at 30% Dividend Tax

Now for an interesting hidden (i.e. not yet spoken about) aspect of the budget.

According to the finance bill, any income distributed by debt funds to companies (or anyone other than an individual) will get hit with dividend tax of 30%.

Earlier the rate was 25% for liquid funds and 20% on other funds. Now it’s all been bumped up to 30%, presumably to remove the discrepancy with fixed deposits.

For a while I thought: Why? If companies choose the growth option, they don’t have to take on dividends – but then, if they sell the growth option funds, they get hit with short term capital gains tax on the gains, which is basically 30% (since it’s added to their income). And to gain any benefit they need to hold the funds for a full year or more (in the growth option) which only a few will do.

Individuals (and HUFs) will continue to pay 25% on liquid funds and 12.5% on other debt funds.

This is a negative for MFs in general; more than 80% of all mutual fund assets are in debt funds. They have been able to provide good returns to companies who have large, but short-term corpuses. If  a company had kept 100 crores for a month in a dividend paying debt fund, and it got in about 8% a year, the post-dividend tax yield would have been 6.4% on which there would be no further tax. A fixed deposit yielding the same 8% would have given them a yield of 5.6%. Now, both options are equal.

Of course, for the short term, current debt fund yields are SO much better that it still makes sense to go with MFs. Short term MFs are yielding upwards of 8% a year, and a one month FD is still offered at 4 to 5%. But that gap should narrow in the next six months.

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