From 1 June 2013, any dividends paid out by debt mutual funds to individuals will have to deduct Dividend Distribution Tax (DDT) of 25%, regardless of the type of scheme. Equity mutual funds (>65% in equity shares) will not pay such a DDT, as earlier.

As of now, non equity mutual funds have to pay the following Dividend Distribution Tax when paying out:

 

Individual or HUFNon-individual

Type of Fund

Money Market /Liquid Fund

25%

30%

All other non-equity Funds

12.5%

30%

The 12.5% is now being changed to 25%.

This dividend is not taxed in the hands of the fundholder, but then the NAV will come down that much. For example if I hold a fund with an NAV of Rs. 11, and it decides to pay out Rs. 1 per unit as dividend, it will pay a DDT of Rs. 0.25 and the NAV will fall down to Rs. 9.75. Effectively, that tax is paid by you.

The relevant extract in the memorandum is:

Under the existing provisions of section 115R any amount of income distributed by the specified company or a Mutual Fund to its unit holders is chargeable to additional income-tax. In case of any distribution made by a fund other than equity oriented fund to a person who is not an individual and HUF, the rate of tax is 30% whereas in case of distribution to an individual or an HUF it is 12.5% or 25% depending on the nature of the fund.

In order to provide uniform taxation for all types of funds, other than equity oriented fund, it is proposed to increase the rate of tax on distributed income from 12.5% to 25% in all cases where distribution is made to an individual or a HUF.

This is a bummer for all those that have bought the dividend option of any non-equity fund, including:

  • Gilt Funds
  • Bond Funds
  • Income funds
  • Balanced funds (where equity is less than 65%)
  • Fund of Funds
  • Gold Funds

Solution: Buy the Growth option instead. You can set up a systematic withdrawal plan (SWP) that simulates dividends, and not have to pay this tax in whatever form. Since the change in DDT applies from 1 June 2013, so you have the time to now move your debt investments to the growth option.

Note: Uma notes that you may actually pay more – there’s a 10% surcharge that applies, so the real tax including cess is a little above 28%. However a switch to growth option may involve an exit load (if you shift before the exit load term). Also, if there are any capital gains, you will have to pay short or long term taxes on them.

An Exception: However if you are a non-resident investor and buy a mutual fund designated as an “infrastructure debt fund” (IDF) then the applicable tax is just 5%.

Note2: The above “exception” may not be true. After Uma’s note, I checked the actual finance bill, it seems to say that a 5% tax will apply BEYOND the above distribution tax. 

They told us DDT was toxic. Now we know it applies to anything that forms that acronym.

Now, tell them about it: