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Budget Blues

Mutual Fund Dividends Taxable Small savings rate cut by 50 basis pointsIndian funds can invest in overseas bonds Ceiling on Investment in GoI Tax-free Bonds at Rs 2 lakh No tax rebate for incomes above Rs 5 lakh

1.Dividend from mutual fund is no longer tax-free in the hands of investor. The dividend distribution tax on funds has been abolished. Till now all open-end schemes with less than 50% in equities and the closed-end schemes were subject to a dividend tax of 10.2 percent. And the dividend from open-end equity fund was not even subject to distribution tax.
Implication and Strategy: This will lower total return to investors in the higher tax bracket on the dividend from fund. Earlier only a flat rate of 10.2 per cent distribution tax was levied. Now, most fund investors will be better off being with the growth plan of any fund, as the capital gains tax structure remains unchanged and is beneficial now.

2. The budget implemented the Y.V. Reddy Committee recommendations partially. Now the interest rates on small savings will be market determined and revised annually. This will be based on the average actual yield on a benchmark government security. As a starter, the rate on all small savings has been lowered to 9 percent, down 50 basis points. Similarly, the rate on Government of India Tax-free Bonds has been reduced to 8 percent. A ceiling of Rs 2 lakh on investments made by every individual or entity in tax-free bonds has been introduced.
Implication: This reduction is lower than the market expectations. However, the rates are expected to bring down the overall rates. With this decline and the ceiling on investment in tax-free bonds, the relative attractiveness of mutual funds is likely to go up.

3. Slabs to avail tax rebate u/s 88 of the Income Tax Act have been introduced. The 20 percent rebate will be applicable to citizens earning income up to Rs 1.5 lakh. For income between Rs 1.5 lakh and Rs 5 lakh, the applicable tax rebate will be 10 percent. And all individuals with incomes above Rs 5 lakh will not be eligible for any tax rebate.
Implications: Big earners can not escape tax now.

4. Indian Mutual Funds can now invest in the rated securities of foreign countries. They are already allowed to invest in the ADRs and GDRs, subject to a ceiling of 10 per cent of net assets managed. The total investments that can be made by the fund industry are capped at $500 million.
Implications: This initiative can broaden the investment gambit of bond funds. But how meaningfully and when, is the key issue. In similar spirit, three years ago domestic funds were allowed to invest in overseas equity, which has yet to happen for regulatory go ahead.

5. Although the income tax slabs have been untouched, the 2 percent Gujarat earthquake surcharge has been replaced with 5 percent national security surcharge on all incomes above Rs 60,000 p.a.
Implication: The tax rates for investors falling in the second tax slab- Rs 60000-Rs 150000 will be 21 percent, and for those in the highest tax slab, the rate of taxation will be 31.5 percent.