MUTUAL FUNDS AND SIPS: TAX CHANGES DEMYSTIFIED

Here’s the lowdown on how the new tax structure has been introduced in Budget 2018

In the Budget 2018, two major taxation decisions related to equity investments have been proposed: first is a 10 per cent Dividend Distribution Tax (DDT) on dividend options of equity funds and the second, the reintroduction of long-term capital gains (LTCG) tax applicable for gains exceeding Rs 1 lakh from the sale of equities to be taxed at 10 per cent without indexation.

Mutual Fund Taxation Decoded

The tax outgo is dependent on three essential parameters: residential status, type of mutual fund investment and the holding period. An individual’s residential status plays an essential role as taxation rates are different for both resident Indians and non-resident Indians (NRI) investors. The second essential component is the type of mutual fund investment. For instance, any fund which invests 65 per cent or higher in equity comes under the equity fund category and is taxed accordingly. Similarly, funds with a lower equity component than 65 per cent continue to be considered as debt funds for taxation purposes. For all equity funds, a holding period of less than 1 year is short-term, while over 1 year is considered long-term. On the other hand, for debt funds, any investment for less than 3 years is considered short-term and tax rates are applicable accordingly. Mutual Fund Investments and LTCG Tax

The gains from sale of any stock or equity-oriented fund, exceeding a minimum limit of Rs 1 lakh after January 31, 2018, will now be taxed at 10 per cent without indexation. The tax is not retrospective and all gains before January 31, 2018 are exempt from the ambit of this tax. For instance, if one has invested in an equity fund with NAV of Rs 10 on August 9, 2017 and the price of NAV has grown to Rs 15 on January 31, 2018. Today, if you redeem after your investment completes one year, say on August 10, 2018 and the NAV on that day is Rs 18, then you will have to pay tax on Rs 3 (18-15) instead of Rs 8 (18-10) as the date of acquisition has changed from the actual date (August 9, 2017) to the grandfathered date (January 31, 2018). The tax will have to be paid only on the gains exceeding Rs 1 lakh.

Mutual Fund Investments and Dividend Distribution Tax (DDT)

Earlier, for mutual funds with a dividend option, there was no DDT for individual investors. The amount received as dividend by the mutual fund company was tax-free in the hands of an investor. Debt mutual funds pay dividend distribution tax of 28.84 per cent (25 per cent tax + 12 per cent surcharge + 3 per cent cess).

In the Budget 2018, DDT at the rate of 10 per cent is now applicable to every individual equity investor. Earlier, equity-oriented mutual fund scheme was out from DDT. However, from now, mutual fund houses will have to pay a DDT of 10 per cent on dividends declared under equity schemes. DDT is paid by the mutual fund houses and not by investors. However, investors would be impacted as the company pays the tax out of the declared profits and it will reduce the dividends to that extent.

Mutual Fund Investments and Security Transaction Tax (STT)

For sale of all equity-oriented mutual funds, a STT of 0.001 per cent is levied by the fund company for all such sales. The STT continues to be the same for all equity-oriented mutual funds along with the DDT taxation.

Final Outlook

With LTCG tax and 10 per cent DDT, investment in growth and dividend mutual fund investments are almost at par. LTCG would not impact smaller investors and they do not have anything to worry about, point out financial experts. If the final post tax return on investments continues to be lucrative, the new taxation decision should not lead to any alarming change in the mutual fund asset allocation. In addition, if an investor does not have the need for regular income from mutual fund then growth plan is a better option over a dividend plan.