Decoding Budget sops for Mutual Fund investors

Budget 2020 has abolished dividend distribution tax (DDT) on the dividend declared by companies and mutual funds to shareholders/unitholders.

Since the DDT is abolished, the dividend amount will be added to the taxable income of the investor and taxed as per his/her tax bracket.

Currently, mutual funds deduct the DDT first and then hand over dividend to the unitholders. Deductions of 10 per cent and 25 per cent are made on dividends declared by equity and debt schemes respectively. In addition, there is a surcharge and a cess. For retail investors, the applicable tax on equity funds is 11.65 per cent while in non-equity funds, it is 29.12 per cent. For domestic companies, dividend tax on equity funds is 11.65 per cent while in non-equity funds it is 34.9 per cent.

Dividend vs growth schemes

With the abolition of DDT, the dividend plans in mutual funds will lose sheen as the other variant — growth plans — score on taxation.

Under equity funds, the dividend plans will be suitable for investors falling under the lowest tax bracket of 5 per cent (assuming the taxpayer continues in the old tax slab regime). For non-equity funds (assuming taxpayers are in the old tax regime), dividend plans are suitable for investors in the tax bracket of 5-20 per cent.

For others, systematic withdrawal plan (SWP) in growth plans can be a good option. In growth plans, under equity funds, a holding period of 12 months or more is regarded as long term, wherein LTCG (long-term capital gains) over ₹1 lakh is taxable at the rate of 10 per cent, without the benefit of indexation. There is a 15 per cent tax on short-term gains from equity funds, if the units are redeemed before 12 months.

In the case of non-equity funds, a holding period of less than 36 months is defined as short term, and attracts STCG tax, charged as per the investor’s tax slab.

The Budget also proposes to deduct 10 per cent tax at source before MFs distribute dividend over ₹5,000.

Side-pocketing

The Budget has now clarified the holding period and cost of acquisition with regard to units allotted consequent on segregation of portfolio of a mutual fund scheme due to rating downgrade and credit default.

Accordingly, the holding period of the segregated scheme will be reckoned from the date of investment in the main scheme by the investor and not the date of segregation.

Second, the cost of acquisition of the main scheme and segregated scheme will be the proportionate cost as determined on the date of segregation.

Assume that you invested in a scheme whose NAV value was ₹10 on January 1, 2018. On July 1, 2019, when NAV of the scheme was ₹20, segregation of portfolio was created due to a credit event. Post segregation, the NAV value of main scheme was ₹18 and the segregated scheme was ₹2. (in proportion of 90:10 per cent). According to the proposed norms, the cost of acquisition of the main scheme and the segregated scheme should be taken as ₹9 and ₹1, respectively.

G-sec ETFs

In the Budget speech, the Finance Minister has mentioned that the Government plans to launch new Debt-ETF consisting primarily of government securities. There are three Gilt ETFs (or G-Sec ETFs) — Reliance ETF Long Term Gilt, SBI ETF 10 Year Gilt and LIC MF G-Sec Long Term ETF — are already available in the market. However, corpus and the traded volume in the exchanges in these gilt ETFs are still very low. The performance of these ETFs has not been upto the mark so far.

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