Do mutual funds pay taxes on the dividend received from companies?

Are mutual funds required to pay taxes on the dividend received from the companies they are invested in? If so, why?
- SK Sharma

No, mutual funds do not pay taxes. Until around two years back, there used to be a dividend distribution tax that was levied on all the dividends paid by companies to any type of investor, be it an individual investor or mutual funds. So for an investor holding a company stock that is giving any dividend, the dividend distribution tax used to be deducted by the company and deposited. And dividend in the hand of the investor was tax-free. However, now it has changed.

Dividend distribution tax has been abolished, and the incidence of tax is on the investors now. But a mutual fund is a tax-free entity. They don't even pay any long-term capital gains or short-term capital gains tax. This is one of the biggest advantages of investing in a mutual fund. If you invest in a stock portfolio yourself, you would be liable for short-term capital gains tax at 15 per cent if your holding period is less than a year and long-term capital gains tax at 10 per cent for more extended periods. In the case of debt funds, gains are taxable at 20 per cent after indexation if your holding period is three years or more, and for a shorter time frame, it is taxed at your marginal rate. But mutual funds don't pay any taxes; the investors pay all taxes depending on their holding period.

This article was originally published on November 30, 2021.