Finance Minister has hit the bull’s eye, yet again. A time when the entire investor community was getting attracted towards the glorious returns from debt funds, FM has put the breaks on it by increasing the Dividend Distribution Tax (DDT) on all non-equity funds. Let’s discuss dividend distribution tax, along with the nuances of new tax rate on investors.
Dividend Distribution Tax (DDT) has always been controversial because of its double taxation nature. It’s once again in the news, as in the Union Budget 2013 – 2014, finance minister has doubled the tax rate on dividend distributed by all non equity funds from 12.5 per cent to 25 per cent. This will reduce returns from debt funds and will motivate investors to opt for other options like corporate fixed deposits.
What is Dividend Distribution Tax?
Section 10(34) of the Income Tax Act, 1961 declares that in addition to the income tax paid by a domestic company against the total income for any assessment year, any amount declared, distributed or paid by such company in form of dividends, is subject to additional tax known as Dividend Distribution Tax. DDT is also applicable to debt mutual funds and is the tax that debt funds pay on the dividend distributed to retail investors.
Who needs to pay?
As the companies or mutual funds pay the dividend distribution tax, dividend income is tax-free in the hands of the investor. Before actual payment, companies and debt funds deduct DDT from the declared dividend and rest is distributed to the investor. Hence, common investor doesn’t have any tax liability on the dividend income, but the dividend income is actually not tax free.
Why Investor should be concerned?
It’s an old and controversial tax, but the renewed concern is because of recent ruling by the finance ministry to increase dividend distribution tax. Now, the tax rate on debt fund investments for retail investors is 25%, which was 12.5% earlier. This tax increase is going to impact all debt funds, gold exchange traded funds, and global funds since the post tax returns from these will be lesser now. Liquid funds are already taxed at 25% hence there is no change for them. Different people have different perception regarding the tax increase, as some say government wants more from high net worth individuals while others take it as rationalisation of returns among fixed deposit and debt funds.
How to minimize the impact?
Implementation of this law will impact retail investors who invest in debt funds like monthly income plans, gold ETFs and global funds as their returns will reduce now. This effect can be negated by shifting from dividend option to growth option. Keep in mind, shifting to growth option will make you liable for short term capital gain tax if your holding period is less than one year. Hence, the most profitable option will be to change to growth plan and hold the investment for more than a year.
Current Tax Rate for Different Categories of Funds
Earlier, only liquid funds were taxed @ 25%, but now all non-equity schemes will be taxed at the same rate. Rates for dividend distribution tax (DDT) for individual investors and corporate are shown in the table below, which can be used as reference. It’s recommended to consult income tax web site for current tax rates, before taking any investment decision.
|Dividend Distribution Tax||Individuals / HUF||Corporate/Others|
|Non Equity Schemes (Debt Schemes , Liquid Schemes, Gold ETF, Global Funds)||25%+Surcharge+ Education Cess||30%+Surcharge+ Education Cess|
Source: InvestmentYogi is one of the leading personal finance websites in India