Taxation of dividends distributed by mutual funds is quite simple to understand. According to the current tax laws, dividends are completely tax-free in the hands of the investors, irrespective of the nature of the fund that has distributed this dividend. So, as an investor, any money that you receive as dividend from any mutual fund is not subject to any further taxation. There is, of course, the dividend distribution tax of 12.5 per cent that debt funds deduct before the dividends are actually paid to you but that is an indirect tax that you do not have to bother while calculating and filing your tax returns.
In case of hybrid funds, the rule is simple — if their equity holding (averaged on a weekly basis) exceeds 51 per cent for a year then they are considered for tax purposes to be equity funds, otherwise they are treated as debt funds.
Both the funds that you have mentioned are equity-oriented and are therefore not subject to dividend distribution tax. Generally, apart from hybrids specifically meant to invest mostly in debt (like MIPs), fund managers take care to keep equity above 51 per cent to avoid dividend distribution tax.
This is as far as dividend tax goes. Of course, the tax treatment of capital gains on debt and equity-oriented funds is also quite different. This year's budget drastically reduced capital gains tax on all equity investments and those benefits apply to equity-oriented hybrid funds too.
This article was originally published on October 27, 2004.
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