Three and half years back,budget 2014 saw two changes in the tax applicable to mutual fund investments. One is the Dividend Distribution Tax (DDT) and the second is the Capital Gains Tax on non equity schemes i.e. all schemes other than pure equity schemes.
The FM has removed an anomaly in DDT where effective tax rate was lower than the actual tax rate. Simply put, if a fund paid a dividend of 8% and DDT is 28.33%, the tax paid was calculated as 28.33% = (x/(8-x)), where x is the tax paid on dividend. Solving for x, the tax paid on dividend is Rs 1.77 or 22.1%, which is lower than 28.33% DDT. All debt mutual funds pay DDT of 25% plus surcharge on dividends, which works out to 28.33%.
Investors earning dividend income to receive lower dividend post the DDT amendment.This became applicable from 1st October 2014.
The FM has removed the benefit of a twelve month holding period for classification of short term capital assets on all non equity mutual fund schemes. The benefit of 10% capital gains before indexation has also been taken away. Hence all non equity mutual fund units are classified as short term capital asset if held for a period of less than thirty six months.
The ruling places mutual fund schemes at a disadvantage relative to bonds, as listed bonds would have the benefit of twelve months holding period with 10% non indexation capital gains benefits. However dividend paid out by mutual fund schemes would carry lower tax rate than interest on bonds due to DDT.
Dividend and Income Distribution Tax
Due to difference in the base of the income distributed or the dividend on which the distribution tax is calculated, the effective tax rate is lower than the rate provided in the respective sections.In order to ensure that tax is levied on proper base, the amount of distributable income and the dividends which are actually received by the unit holder of mutual fund or shareholders of the domestic company need to be grossed up for the purpose of computing the additional tax.
Long-term Capital Gains on debt oriented Mutual Fund
According to the existing provisions short-term capital asset means a capital asset held by an assessee for not more than thirty six months immediately preceding the date of its transfer. However, in the case of a share held in a company or any other security listed in a recognised stock exchange in India or a unit of the Unit Trust of India or a unit of a Mutual Fund or a zero coupon bond, the period of holding for qualifying it as short-term capital asset is not more than twelve months.
The shorter period of holding of not more than twelve months for consideration as short-term capital asset was introduced for encouraging investment on stock market where prices of the securities are market determined. Now it is proposed that an unlisted security and a unit of a mutual fund (other than an equity oriented mutual fund) shall be a short-term capital asset if it is held for not more than thirty-six months.