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Economy

Dividend Distribution Tax on Debt Mutual Funds Hiked to 25%

From 1 June 2013, any dividends paid out by debt mutual funds to individuals will have to deduct Dividend Distribution Tax (DDT) of 25%, regardless of the type of scheme. Equity mutual funds (>65% in equity shares) will not pay such a DDT, as earlier.

As of now, non equity mutual funds have to pay the following Dividend Distribution Tax when paying out:

 

Individual or HUFNon-individual

Type of Fund

Money Market /Liquid Fund

25%

30%

All other non-equity Funds

12.5%

30%

The 12.5% is now being changed to 25%.

This dividend is not taxed in the hands of the fundholder, but then the NAV will come down that much. For example if I hold a fund with an NAV of Rs. 11, and it decides to pay out Rs. 1 per unit as dividend, it will pay a DDT of Rs. 0.25 and the NAV will fall down to Rs. 9.75. Effectively, that tax is paid by you.

The relevant extract in the memorandum is:

Under the existing provisions of section 115R any amount of income distributed by the specified company or a Mutual Fund to its unit holders is chargeable to additional income-tax. In case of any distribution made by a fund other than equity oriented fund to a person who is not an individual and HUF, the rate of tax is 30% whereas in case of distribution to an individual or an HUF it is 12.5% or 25% depending on the nature of the fund.

In order to provide uniform taxation for all types of funds, other than equity oriented fund, it is proposed to increase the rate of tax on distributed income from 12.5% to 25% in all cases where distribution is made to an individual or a HUF.

This is a bummer for all those that have bought the dividend option of any non-equity fund, including:

  • Gilt Funds
  • Bond Funds
  • Income funds
  • Balanced funds (where equity is less than 65%)
  • Fund of Funds
  • Gold Funds

Solution: Buy the Growth option instead. You can set up a systematic withdrawal plan (SWP) that simulates dividends, and not have to pay this tax in whatever form. Since the change in DDT applies from 1 June 2013, so you have the time to now move your debt investments to the growth option.

Note: Uma notes that you may actually pay more – there’s a 10% surcharge that applies, so the real tax including cess is a little above 28%. However a switch to growth option may involve an exit load (if you shift before the exit load term). Also, if there are any capital gains, you will have to pay short or long term taxes on them.

An Exception: However if you are a non-resident investor and buy a mutual fund designated as an “infrastructure debt fund” (IDF) then the applicable tax is just 5%.

Note2: The above “exception” may not be true. After Uma’s note, I checked the actual finance bill, it seems to say that a 5% tax will apply BEYOND the above distribution tax. 

They told us DDT was toxic. Now we know it applies to anything that forms that acronym.

  • Kiran says:

    As I said on twitter, you are the just amazing 🙂
    I don’t know if switching to Growth option is the right solution though (for people who want to withdraw periodically say every 3 months. If the plan was anyway >1yr, stick to the growth plan). Especially for people in the 30% bracket (10% and 20% bracket can happily shift!). Two reasons obviously:
    a) Liquid plus: The avg. returns are much better than savings. So, that argument is still there.
    b) Savings a/c still will be taxed at 30%. Even if the returns of Liquid plus are similar, you still get the measly 5% benefit.

    • Kiran says:

      Ok..the last comment was all muddled up. All I wanted to say was:
      If you want to withdraw small amounts (or any amount)/planning to withdraw money within the space of 1 year and if you are in the 30% income tax slab bracket, then you can continue to stick to dividend plan (because there is still a measly 5% benefit to stick with the dividend plan).
      However, if you don’t plan to withdraw money within 1 year, or you are in the 10% or 20% income tax slab bracket, then switching to growth option is the right solution.
      Of course, shifting back to savings a/c would be foolish since most debt funds are anyway giving more than 5% as returns (not guaranteed of course).

      • Kiran, your equation only works if you plan to withdraw the FULL money within a year. Think of what happens if you want a 9% income to be paid out, and you will exit the full amount on the 366th day. Every month, you set up a withdrawal of 0.75% of your portfolio (so for a 10 lakh entry amount, you withdraw Rs. 7,500 a month).
        This has far lower tax implications than the dividend option. And most people will qualify as wanting this kind of product 🙂

  • Uma Shashikant says:

    Adding my two bits:
    a. The DDT is subject to 10% surcharge across categories. This increases effective DDT to all investors.
    b. Investors should take care to ensure switch from dividend to growth option does not attract loads. Different funds have different policies here. Such switch will be redemption for purposes of capital gains tax.
    c. The proviso for IDF says additional 5%. Given the nature of the scheme and its target being institutions, I would think this means 30% for IDF, making it on par with DDT applicable to institutions for liquid and other debt funds.

  • ARP says:

    “For example if I hold a fund with an NAV of Rs. 11, and it decides to pay out Rs. 1 per unit as dividend, it will pay a DDT of Rs. 0.25 and the NAV will fall down to Rs. 9.75. ”
    I think this is incorrect. It is the yield that would fall rather than the NAV. In the current case, if the fund has Rs 1 available for disbursement it can disburse so. The NAV would fall from Rs 11 to Rs 10.
    In the new case, the fund will disburse Rs 0.80, and pay Rs 0.20 DDT. The new NAV still remains Rs 10, whereas the yield falls.

    • Nope, that’s not exactly how it works, I think – the fund tells you how much you will receive (so a Rs. 2 dividend declared means you get Rs. 2 per unit). And then the DDT gets cut from the NAV. I rechecked here with a couple bond funds and that seems to be correct.

      • ARP says:

        Deepak,
        If the fund generates Rs 1 (profit / gains) which it plans to distribute, it will distribute Rs 1. It cannot generate additional $0.25 to pay tax on top of it – because there are no funds.
        In the old case, it could distribute Rs 1. It the current case, it cannot sell assets worth Rs 0.25 in-order to distribute the Rs 1 gain it has generated. It will therefore distribute Rs 0.80 and pay Rs 0.20

        • Dheer, that is true. But then they will announce Rs. 0.80 as dividend. I specifically said “if they want to pay out Rs. 1 as a dividend”, not “they want to distribute a profit of Rs. 1”. A fund like a debt fund will always have liquid assets to support it, so it can always sell to pay out the tax. However, like you say, they typically figure out how much they want to pay in total, and only announce the dividend that they will actually pay out (so that their cash flow is set right)…

  • sreejithp says:

    So how about ddt for NRIs (on debt funds)?

  • Arun Jayant says:

    Questions regarding Balanced Funds:
    1. Refer
    http://www.valueresearchonline.com/funds/fundanalysis.asp?schemecode=600
    HDFC Prudence Fund’s mandate allows its Equity component to vary from 40% to 75%. So, how’s the DDT calculated in such a case?
    2. Also, is it true that the DDT doesn’t apply if you’ve opted for the Growth option of a Balanced Fund?

  • sajith says:

    The article uses DDT rate and Not effective DDT rate.Assuming dividend of rs 100 and ddt of 25,Dividend received will be 80 on which 20 would be the ddt(25 % of 80 is 20).
    Therefore the DDT suffered will be 20 % and not 25 %

    • Vidya says:

      This effective DDT used by planners is a theoretical calc. Look at it this way. Let us assume you have a liquid fund under dividend option. Currently DDT plus SC plus cess is 27.03%. Let us suppose you bought the fund at nav of rs 1000 and it has grown 8% to 1080. Now assume the fund declares rs 80 as dividend. That means Rs21.6 (27.03% of 80) will be deducted as DDT from the NAV. The NAV falls to 978.4 (1080-80-21.6). Now theoretically assume that you sell at this point or simply calc your yield at this point. What is the money you totally get? it is 978.4+80=1058.4. Hence yield is 58.4/1000*100 =5.84%.
      Now do your math by taking the gross return of 8% less effective DDT of 20% stated by you. what is the yield? it is 6.4%. Now this is incorrect because the actual returns post tax (as calculated above) is much lower.
      Many a time, 22% is called the effective tax rate by planners. This is theoretical and does not tally, if you actually work the net returns in a simple, cash flow based manner.
      Let us face it….the increase in DDT has shrunk the net yield that we will get in hand. That is what matters at the end…number games not withstanding.