While presenting Union Budget 2020, Finance Minister Nirmala Sitharaman announced that the government would abolish the dividend distribution tax (DDT).
The Union Budget also introduced a deduction of tax on dividends paid by mutual funds.
Though the dividend received through mutual funds is not getting taxed anymore, the same will be added to the income of the investor and taxed at the marginal rate of tax.
Not only this, the Finance Bill 2020 contains a provision that the mutual funds need to deduct tax at source (TDS) at 10 percent if the dividend payout is more than Rs 5,000.
So, mutual funds investors particularly high-networth individuals (HNIs) or Ultra HNIs that have opted for dividend option of a scheme have to take huge hit as they will have to pay a tax on the dividend included in their income.
Currently, a slew of HNIs and ultra HNIs have invested in dividend options offered by mutual funds to avail the benefits of lower effective tax rates.
There is no standard definition of HNIs in India, it is largely based on Net Worth, Investible surplus, and assets declared by individuals
The number is different from one company to other but, in India, individuals who have more than 2 crores investible capital are considered HNI or HNWI and Individuals with Investible surplus of Rs 25 lac – Rs.2 crores are considered as Emerging HNI.
WHAT NEXT?
Mutual fund officials are of the view that HNIs will be forced to opt for the growth option and dividend option will no longer appeal them.
"Looking at all the tax implications, we believe the dividend option will no longer be appealing for the HNI category," said a Chief Executive Officer of a fund house.
Jimmy Patel, Chief Executive Officer of Quantum Mutual Fund, has a different view.
"It depends on HNIs whether they want to pay surcharge and tax in the dividend option of mutual fund schemes. In the growth option also they will be charged long term capital gains if they hold the investments for more than three years.," he said.
Equity shares and equity-oriented mutual funds are subject to the same set of capital gains tax rules.
The holding period for equity investment to be considered long-term is one year. If you sell your holdings before one year, any profit made will be termed short-term capital gains (STCG). The current STCG tax rate is 15 percent.
If sold after one year, the capital gains of over Rs 1 lakh will be subject to 10 percent long term capital gains (LTCG) tax plus cess, without indexation benefits.
According to data from iFAST Financial India, so far the 43-player mutual fund industry offers 2,283 schemes including all the categories. Of which, 452 are equity schemes and all equity schemes offer a dividend option.
The assets under management of the Growth/Equity Oriented Schemes increased 1 percent or by Rs 8,231 crore to Rs 8.04 lakh crore in December 2019 over November 2019.
According to AMFI, the assets under management of HNIs in equity schemes stood at Rs 304,640 crore compared to the total equity AUM of 8,05,797 crore in December 2019.
The total number of HNI folios as on Dec-end 2019 stood at 38,63,740 accounts while the total folios in equity schemes were 6.25 crore.
Earlier mutual funds deducted DDT of 11.64 percent on dividends declared by the equity mutual funds.
For the bond funds, the DDT was charged at 29.12 percent. Removal of DDT will benefit investors who are taxed at a lower rate of tax as compared to the dividend distribution tax.
This is especially the case when one receives dividends from bond funds. For an individual in the 20 percent tax bracket, the earlier rate of DDT of 29.12 percent was penalising.
However, the provision of TDS at 10 percent of the dividend announced for payouts in excess of Rs 5,000 is a dampener. This will leave less cash in the hands of the investors, but only when they get larger payouts as dividends.
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