Debt funds to pay dividend distribution tax of 25% up from 12.5% from June 1.
Fund houses and distributors are likely to promote growth plans of debt funds going forward after the budget hiked dividend distribution tax (DDT) on debt funds for retail investors in dividend plans from the current 12.5% to 25% from June 1.
“Investors should now focus on growth plans to take advantage of long term capital gains. Investors can use systematic withdrawal plan (SWP) which are more tax efficient. Investors who opt for dividend plans could get hit by 80 to 90 basis points and hence the post-tax returns would come down. The arbitrage between post-tax returns in FDs and debt funds has narrowed down but debt funds continue to be more tax efficient,” said Rajiv Anand, MD & CEO, Axis Mutual Fund.
Fund houses pay DDT for dividend income distributed by debt funds, which is tax free in the hands of investors. Debt funds currently pay DDT of 12.5%+ 5% surcharge + 3% cess when they distribute income to resident individuals. Equity funds do not pay any DDT on the dividend distributed to investors.
Jimmy Patel, CEO, Quantum Mutual Fund says that ultra-short term debt plans will face the maximum impact. “The tax arbitrage between a liquid and a non-liquid fund will cease to exist. So in that sense, the increase in DDT makes it that much less attractive for the individual to invest in a non-liquid fund over a liquid fund. Ultra short term debt plans will face the maximum impact after the proposed hike in DDT in debt funds. However, dividend plans of short term FMPs will also be affected. Yes, on a post-tax basis, everything else remaining the same, the net post tax return in the hands of the investor from dividend plans would be lower.”
“Investors with a time horizon of less than a year investing in liquid funds and short term plans usually opt for dividend plans. Earlier there was 17% tax arbitrage for investors in the highest tax bracket. Now there is no incentive to invest in a dividend plan,” said Gajendra Kothari of Etica Wealth Management.
The year 2012 has been stellar for debt funds with the industry clocking inflows of nearly Rs 1.95 lakh crore from April 2012 till January 2013. Debt funds constitute nearly 73% of industry AUM of Rs 8.26 lakh crore assets.
