The Union Budget has doubled the tax on dividend distributed by non-equity funds from 12.5 per cent to 25 per cent. This will impact returns from such funds. The change will hit all debt funds (except liquid funds), gold exchangetraded funds, or ETFs, and global funds of funds.
Earlier, dividend distributed by only liquid funds was taxed at 25 per cent. The government has now sought to standardise the rate for all non-equity funds.
Liquid funds are very short-term funds which invest in money market instruments such as treasury bills, commercial papers and certificates of deposit with tenure of less than 91 days.
Though dividend paid by non-equity funds is not taxed in the hands of investors, funds pay the divdends after deducting the distribution tax.
Some experts say the move is part of plans to impose a higher tax on high net worth individuals while others see it as an effort by the government to reduce the gap between post-tax returns of bank fixed deposits, or FDs, and debt funds amid the fall in money locked in bank deposits.
A large portion of investment in debt funds come from institutional investors and high networth individuals.
"There are no two ways about the fact that with this the gap in returns between FDs and debt funds will come down, but as long as debt funds continue to give better returns, we do not see any major outflow of money from them," says Lakshmi Iyer, senior vice-president and head of fixed income and products, Kotak Mutual Fund.
The move means that retail investors who put money in debt funds such as monthly income plans, or MIPs, gold ETFs, funds of funds and international funds may earn a little less now. However, they can escape the tax by opting for the growth option instead of the dividend option. In the former, the returns are reinvested.
However, in the growth option, the investor will be liable to pay short- and long-term capital gains tax. The short-term capital gains tax can be avoided if the investment is held for one or more year.
"The growth option is advantageous if the investment tenure is more than one year," says Alok Singh, chief investment officer, Bharti AXA Investment Managers.
This is also true for MIPs, which by their mandate pay regular dividends. Instead of dividend plans, one can opt for growth plans. Regular dividend payouts can be replaced by systematic withdrawal plans (SWPs) under which the investor can choose the frequency and quantum of regular payments. However, one disadvantage of SWP is that if the scheme fails to generate higher returns, he investor is paid from the principal, leading to its erosion.
Short-term capital gains are added to the income and taxed accordingly while long-term capital gains on non-equity funds are taxed at 10 per cent without indexation and 20 per cent with indexation.
Interest on FDs is taxed as per the person's tax bracket.
Reproduced From Money Today. Copyright April 2013. LMIL. All rights reserved.
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