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What's the dividend tax

The dividend tax is 18 and not 22%, asset management companies are telling investors. And, the magic potion seems to be working!

Stung by the 22% dividend tax on debt funds and monthly income plans, asset management companies have finally unearthed a magic potion to soothe investors' taxing nerves. Asset management companies are telling investors that the dividend tax works out to only 18% and not 22%, as has been drummed about since last budget.

This is how the calculation goes. For instance, a fund declares a dividend of Rs 100. With a 22% dividend tax, the total outflow is Rs 122. It is here that the mathematical trick comes into play. Fund marketers drive home the point that dividend tax should not be seen as a part of the dividend (Rs 22 on Rs 100) but as part of the total outflow (Rs 22 on Rs 122). This translates into a tax outflow of only 18.03% on the dividend paid.

"It's a mere jugglery of numbers but it is perfectly fine. Investors are actually losing only 18% of the total outflow and not 22%, as has been made out to be. On the other hand, the exchequer continues to earn the levied dividend tax,'' says the marketing head of a private sector mutual fund.

Distributors and local fund heads say this revelation gives comfort to existing and prospective investors. "An effective tax rate of 18% is also a large levy, especially when equity funds dole out tax-free dividends. However, this comes as a pleasant surprise for investors and is psychologically, comforting,'' adds the Delhi head of a mutual fund.

It may be recalled that in 1999, the government had levied 11% tax on dividends from closed-end funds and open-end funds with less than 50% allocation to equities. The tax rate was hiked to 22% last year. "Ironically, the current scenario is such where debt funds with small payouts attract a 22% tax while equity funds with hefty dividends do not attract any tax. Thus, investors are opting for growth option in bond funds, otherwise ideal for regular income while it's the dividend option in equity funds,'' says the CEO of a mutual fund.