Sat. Feb 29th, 2020

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Budget 2020 : Impact on Mutual Fund Investors

4 min read
In this article, we will discuss the impact of Budget 2020 on mutual fund investors. Union Budget removed dividend distribution tax (DDT) on mutual funds and also introduced TDS on dividends paid by mutual funds. Lets see how these moves will impact mutual fund investors?
Impact of DDT Removal on Mutual Fund Investors

Impact of DDT Removal on Equity & Debt Mutual Fund Investors

Dividend Distribution Tax on Mutual Funds Removed & TDS Introduced in Budget 2020

Introduction

In this article, we will discuss the impact of Budget 2020 on mutual fund investors. Union Budget removed dividend distribution tax (DDT) on mutual funds and also introduced TDS on dividends paid by mutual funds. Lets see how these moves will impact mutual fund investors?

Comprehensive Mutual Fund Reviews
Comprehensive Mutual Fund Reviews

Budget Impact on Mutual Fund Investors

AMFI’s Budget Proposals for FY2020-21

  • Association of Mutual Funds in India (AMFI) had put forward a 17-point budget proposal for 2020 Budget.
  • Some of the proposals were :
    1. To remove Long Term Capital Gains (LTCG) on gains from equity mutual funds
    2. To abolish Securities Transaction Tax (STT) and Dividend Distribution Tax (DDT)
    3. To abolish the capital gains tax on switching of units in the same scheme of mutual funds (Switching from Growth option to Dividend option or vice-versa)
    4. To reduce the holding period of Long-term Capital Gold ETF
    5. To introduce the Debt Linked Savings Schemes (DLSS) to deepen the Indian Bond Market
    6. Uniform Tax Treatment for Retirement / Pension Schemes of Mutual Funds and NPS

Dividend Distribution Tax on Mutual Funds Removed

Budget 2020 : Removal of DDT Impact on Mutual Funds Investors
Budget 2020 : Removal of DDT Impact on Mutual Funds Investors
  • Finance Minister Nirmala Sitharaman in the Union Budget 2020-21 has proposed to remove the dividend distribution tax (DDT) on the dividends declared by mutual funds to the unit holders.
  • Earlier, mutual funds used to deduct the DDT and then hand over dividend to the unit holders. For Equity mutual funds, DDT deducted was at the rate of 11.64%, whereas for Debt funds, DDT rate was almost 29.12%.
  • Now, once the DDT is removed, the dividend amount will be added to investors’ taxable income and taxed as per the individual tax bracket.
  • In case of Equity Mutual Funds with Dividend plan, for Investors in higher tax bracket (>10%), it is better to shift to growth plans where Capital Gains (LTCG) are taxed @ 10%.
  • The earlier and proposed DDT taxation on dividends by equity as well as debt mutual funds are compared and explained in the above flow chart.
Impact of DDT Removal on Equity & Debt Mutual Fund Investors

TDS Introduced in Budget 2020

Budget 2020 Introduced TDS on Mutual Fund Dividends Paid By Mutual Funds
Budget 2020 Introduced TDS on Mutual Fund Dividends
  • In addition to the DDT abolition on Mutual funds, it was also proposed to levy 10% TDS on dividend/ income paid by mutual funds to unit holders if the amount of such dividend/ income exceeds Rs. 5000 in a financial year.
  • On 4th Feb 2019, Central Board of Direct Taxes (CBDT) has clarified that under the proposed section, a Mutual Fund shall be required to deduct TDS at 10% only on dividend payment. No tax shall be required to be deducted by the Mutual Fund on income which is in the nature of capital gains.
  • However, the provision of TDS at 10% of the dividend announced for payouts in excess of Rs.5,000 is a dampener. This will leave less cash in the hands of the investors, when they get larger payouts as dividends.
  • Here, If the individual investor falls in a tax slab wherein the rate of tax is higher than the rate of TDS, then the investor is expected to pay the residual tax amount. If the investor falls in lower income tax slab, then he can claim for refund wherever applicable, while filing income tax returns.

About ELSS & Debt ETFs

  • Under 2020 Budget, taxpayers have the option to choose between old tax regime and new tax regime. To opt for new tax slab, one must forgo 80C deductions. AUM of ELSS funds as on Dec 2019 is Rs.103,003.9 crores. It will be interesting to see how will be the AUM trend of ELSS funds after the removal of 80 C deductions under the new tax regime because people mostly invested in ELSS funds to save taxes.
  • Debt based ETF – Bharat Bond ETF floated by the Government in 2019 was a huge success. In this budget, Government has proposed to float a new Debt – ETF consisting primarily of government securities.
  • Only time will tell, how successful will be the new debt ETF and what will be the effect of budget on AUM of ELSS mutual funds.

What Mutual Funds Investors Should Do?

  • The government’s plan to tax dividend at the hands of investors could make dividend plans in equity and balanced schemes unattractive.
  • If we look at equity funds, investors will get more benefits staying in growth plan rather than opting for dividend plans. So, it is better for the dividend plan investors move towards growth plans.
  • For the power of compounding to work better, i.e. to create wealth in the long run, it is better to switch from dividend plans to growth plans because dividend plans hamper wealth creation due to dividend payments.
  • For investors looking for regular income, the question which arises is whether to choose Dividend Plan or Systematic Withdrawal Plan (SWP). In the long run, it is always better to choose growth plan along with SWP.   

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