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Debt Fund Dividends Take a Hit

Budget 2014 saw a change in the methodology of calculating DDT on debt funds, which means investors will lose out on dividends

The much awaited budget has had several proposals with adverse implications for the MF industry. While the taxation of debt funds has received much attention, there's another change which may hit non-equity fund investors as well. In his budget, FM has changed the methodology of calculating dividend distribution tax (DDT) for all debt funds including MIPs and overseas funds. In the earlier scenario, if the fund declared ₹100 as dividend, it used to make a provision for ₹128.3, paying out ₹28.3 to the taxman and distributing the balance to the investor. This allowed the investor to pay less tax since the effective tax rate was 22.07 per cent, and not 28.33 per cent as mandated. (100/128.3 * 100 = 77.92%).

But the FM has now disallowed such netting off and has asked funds to calculate the DDT on gross basis. Once the proposed changes are implemented, DDT will be calculated on gross amount set aside. So, if the fund has to pay ₹100 to the investor, it will have to first deduct DDT at 28.33 % and pay only the remaining. Accordingly, the effective tax paid by investor will be 28.33%. Hence, the investors will lose out to the extent of 6.26 % (28.33% - 22.07%).

This change of 6 percentage points in DDT will affect the inflow in all debt funds and will reduce the income of the mutual fund unit holder as the mutual fund will have to declare a lower dividend and the unit holders will now get lower income.

Impact of change

CurrentlyAfter the effective date
Amount of Dividend100100
Rate of DDT0.28330.2833
Pay out to Investor 77.9271.67
Amount of Tax Payout 22.0828.33
Effective Rate of DDT0.22080.2833