The government has proposed a 10% tax on dividends doled out by equity-oriented mutual funds as part of its overall levy of taxes on equity investments that also saw the finance minister re-introduce long term capital gains (LTCG) tax.
“I also propose to introduce a tax on distributed income by equity-oriented mutual fund at the rate of 10%. This will provide a level-playing field across growth-oriented funds and dividend distributing funds,” said Finance Minister Arun Jaitley, while presenting the Union Budget 2018-19.
While this is likely to act as a dampener for the mutual fund industry that has been seeing a steady flow of inflows, the move would also deter some amount of mis-selling wherein investors put in money in a particular scheme only for getting regular dividends.
‘Will impact fund flow’
“This move may impact flows into funds where investors were primarily entering with the expectation of regular dividends,” said Kaustubh Belapurkar, Director - Manager Research, Morningstar Investment Adviser India.
In fact, dividend schemes were now slightly disadvantaged as opposed to growth schemes as LTCG below ₹1 lakh was exempt from tax, he said.
Distributors and fund houses marketed many balanced funds to investors by highlighting the regular tax-free dividend payout option, which was a big draw at a time when interest from bank deposits were taxable.
“Dividend distribution tax on equity oriented mutual funds will help stop mis-selling of balanced funds that declare a monthly dividend. Mis-selling has meant that the average balanced fund size is now Rs.5,092 crore versus average equity large-cap fund at Rs.2072 crore,” said Aashish Somaiyaa, MD & CEO, Motilal Oswal AMC.
The ongoing stock market rally has seen many investors enter the market through the mutual fund route. In calendar year 2017, mutual funds invested over Rs.1 lakh crore in the equity market. Interestingly, the last few months of 2017 saw domestic institutional investors on a buying spree even as foreign investors were mostly net sellers.
“Fund houses have to realign the income distribution strategy; dividend stripping may get controlled while the investors may end up paying tax even in the short term,” said Jimmy Patel, MD & CEO, Quantum AMC.
“This doesn’t augment well for the mutual fund industry as ULIPs as per current reading are outside LTCG purview and with commissions riding high on insurance mobilisation retail savings may get diverted to ULIPs,” he added.
