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Decoding Budget 2020 Tax Angle For Mutual Fund Investors

Budget 2020 announced a raft of changes in the personal finance space. Some will directly impact mutual fund investors, such as the change in Dividend Distribution Tax (DDT) and introduction of Tax Deducted at Source (TDS), and some indirectly, such as the introduction of the new tax regime. This article attempts to explain the impact of these changes on mutual fund investors.

Abolishment of DDT
Abolishment of DDT is positive as it will add more money in the hands of the investor while removing the double taxation incidence that occurred previously; DDT was first deducted when received by the mutual fund and then again when received by the investor.

However, this might increase the tax liability for investors in higher tax brackets. For instance, for individuals in the 30% tax bracket, dividend income from equity and debt funds was earlier taxed at 10% and 25%, respectively, excluding applicable surcharge and cess. Under the new law, dividend will be taxed as per the applicable tax rate and investors will need to pay 30% tax on the dividend.

With the new rule, investors who don’t require regular cash flow can switch to the growth option wherein capital gains will be taxed based on the holding period. For equity funds, if investment is held for more than a year, long-term capital tax (LTCG) is 10% on gains above Rs 1 lakh per year and short-term capital gains tax (STCG) is 15% for a holding period of less than one year. In case of debt funds, STCG for less than three years is as per the individual’s tax slab of 10%, 20% and 30%, and if held for more than three years it is 20% after indexation.

Investors in need of regular income can choose the growth option along with systematic withdrawal plans (SWPs), wherein a fixed amount money can be withdrawn from the mutual fund scheme. Investors can decide on the amount and frequency of the SWP unlike dividend income which is at the discretion of the fund house and subject to profits generated by the scheme.

TDS on dividend income over Rs 5,000
The budget has also introduced 10% TDS on dividend income distributed by mutual fund houses to its unitholders if such income exceeds Rs 5,000. The impact of TDS will vary across individuals based on their tax bracket. If an investor falls in the higher tax bracket, the remainder tax would have to be paid by him while filing his returns and if the investor falls in the lower income tax slab, he can claim a refund while filing income tax returns.

New tax regime with lower tax rates and no deductions 
Budget 2020 has introduced radical changes in the personal income slabs. The alternate income tax regime reduces the tax liability of investors, the catch being that investors would need to forgo around 70 exemptions that they used to avail of in the old regime.

Source: Report - A quiver of arrows - CRISIL Research Budget 2020-21 analysis

 The dilemma: Avail the benefits of the new regime or continue with the old one?

1) Taxpayers need to check the exemptions currently being used. A shift to the new regime makes sense only for those not availing deductions currently.

In case of mutual fund investments, if an investor opts for the new regime then equity-linked savings scheme (ELSS) funds will not give tax benefits. However, this also provides an opportunity for investors to use the saved money as per their risk-return profile and invest in an instrument or mutual fund of choice.

2) More importantly, investors should not give in to the basic human tendency to use money for immediate gratification rather than investing for long-term wealth creation. 

Lastly, before committing to a tax regime (old or new), investors need to analyse their individual profile, savings and investment patterns, and seek expert advice if necessary. 

Disclaimer - CRISIL Research, a division of CRISIL Limited (CRISIL) has taken due care and caution in preparing this Report based on the information obtained by CRISIL from sources which it considers reliable (Data). However, CRISIL does not guarantee the accuracy, adequacy or completeness of the Data / Report and is not responsible for any errors or omissions or for the results obtained from the use of Data / Report. This Report is not a recommendation to invest / disinvest in any entity covered in the Report and no part of this report should be construed as an investment advice. CRISIL especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL’s Ratings Division / CRISIL Risk and Infrastructure Solutions Limited (CRIS), which may, in their regular operations, obtain information of a confidential nature. The views expressed in this Report are that of CRISIL Research and not of CRISIL’s Ratings Division / CRIS. No part of this Report may be published / reproduced in any form without CRISIL’s prior written approval.

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