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Wealthy dividend seekers better off in MFs

If a firm, individual or Hindu Undivided Family (HUF) receives a dividend income of more than Rs 10 lakh per annum, it will be taxed at 10% on a gross basis

Wealthy dividend seekers better off in MFs

Call it a coincidence or simply acche din. The mutual fund industry has not been at the receiving end of this year's budget. In 2014, the budget took away a comparative tax advantage enjoyed by debt mutual fund schemes over bank deposits. The 2015-budget withdrew service tax exemption on services provided by mutual fund agents to mutual funds. In comparison, mutual funds didn't have any nasty surprises in this year's budget. In fact, three tax proposals may help the industry to grow.

Consider the dividend tax proposal on wealthy taxpayers in the budget. It could be a blessing for mutual funds. If a firm, individual or Hindu undivided family (HUF) receives a dividend income of more than ₹10 lakh per annum, the budget proposes to tax the income at 10% on a gross basis. This additional 10% tax is over and above 15% Dividend Distribution Tax (DDT) paid by companies on dividends declared. "So, effectively if you invest through mutual funds, you don't incur any such dividend taxes. I have a feeling wealthy investors will opt for the MF route to get more from dividend income," says Anil Rego, CEO, Right Horizons.

The proposal to levy 10% income tax on dividend income in excess of ₹10 lakh in the hands of the receiver is applicable only to the dividends received as shareholders from companies and not on dividends received from mutual funds. Also, mutual funds are not required to pay this tax on dividends received by them as shareholders from companies as this tax is applicable only on dividends received by individuals, HUF and firms.

The budget also has a proposal to tax the services provided by mutual fund agent/distributor to a mutual fund or asset management company under forward charge. In 2015 budget, the exemption to services provided by mutual fund agents/distributors to an asset management company was withdrawn and these services were put under reverse charge liability. That is, the Asset Management Company was made liable to pay a service tax for the services received from such agents/distributors. With these services now put under forward charge, the AMC does not have to pay the service charge. The agent or distributor is liable to pay service tax. Since small agents are eligible for small service provider exemption (threshold turnover of ₹10 lakh per year), only a very small number of agents will be liable to pay service tax. In effect, from April 1, 2016, mutual fund agents/distributors who earn below ₹10 lakh as commissions will be exempted from paying service tax.

Lastly, the contentious taxation on Employees' Provident Fund (EPF) withdrawal could also prompt some individuals to take a closer look at Equity Linked Savings Schemes (ELSSs). The entire corpus in EPF could be withdrawn tax-free earlier. However, now an individual can only withdraw 40 per cent of the corpus, accumulated with contributions made after April 1, tax-free at the time retirement. The person will have to use 60 per cent of the corpus to buy annuity if he wants to escape paying taxes. Sure, opting out of EPF is not an option for many individuals as it is part of their salary package. However, many individual make extra contributions voluntarily to EPF to claim tax deduction under Section 80C and for tax-free income on retirement. Those individuals can consider investing in ELSSs now. ELSSs qualify for a tax deduction under Section 80C and they come with a mandatory lock-in period of three years. Investors can pull the money out after three years and they don't have to pay any taxes on returns. Equity mutual funds held over a year qualify for long-term capital gains tax which is nil at the moment.