In our note on budget’s impact (FundsIndia Debt fund strategy post budget) we had mentioned that there is one more change that the budget has proposed in mutual funds. That is a change in the way dividend distribution tax (on debt mutual funds) is calculated.
The change will of course, result in high taxes going to the government’s kitty and will be effective October 1, 2014.
Note that equity funds do not suffer DDT.
At present, if a fund declared a dividend of say Rs 80, then DDT would be 28.3/10080 = 22.64. This would be deducted from your NAV. Now the budget has come with a formula that says Rs 80 is after tax. Hence the dividend or distributable surplus before tax is 80100/(100-28.3)=Rs 111.6. The DDT is therefore 111.6-80= Rs 31.6. Thus effectively, your DDT (which is deducted from NAV) goes up.
Of course, while the tax is not going to be paid by you directly, as has always been the practice it will be deducted from your NAV. Hence, to the extent you lose.
How do you ensure you don’t lose too much?
It is now apparent that those in the 10-20% tax bracket should opt for growth option to stay tax efficient, while those in the 30% tax bracket you may go for either the dividend or growth option.
This will be the case as long as your time frame is up to 3 years. For any period longer than that, it may make sense to simply go for growth option as you would enjoy indexation benefit.
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