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Investing in Mutual Funds - Dividend Distribution Tax on Debt and Equity Funds

Updated on June 6, 2011
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Below is important information for investors who are interested in investing in mutual funds mainly debt mutual funds and equity mutual funds and want to know about the tax liability of mutual funds. Taxation is an important aspect in personal finance and investment and you need to pay taxes for any short term or long term capital gains you may accumulate from investment in anything whether it is stocks, shares, bonds, real estate, commodities, or mutual funds, so go on and read this info which I have arranged in a question and answer format. It is important to note that investment in shares and mutual funds is subject to market risk and you should go through the investment offer carefully before investing money.

Investing in Debt Funds - Dividend Distribution Tax on Debt Funds

Question: I want to invest in debt mutual funds, but I want to know the dividend distribution tax on debt funds for ultra short term debt and medium term. I know that dividend distribution tax for ultra short term debt funds is 25%. Is this any different for medium term debt funds?

Answer: No, taxation for medium and short term debt funds is the same. Well dividend distribution tax is deducted and then dividends are paid to investors. Tax on debt funds for short term capital gains tax is as per individual tax bracket, so if you are in 30% tax bracket, you will have to pay 30%. Long term capital gains tax is (i) with indexation 20% on gains (ii) 10% without indexation. Indexation is used to reduce the profits and thus the tax on it.

For dividend distribution tax on money market funds, i.e., ultra short term for example cash funds or liquid funds, dividend distribution tax is 25 % for individuals and 33% for corporate. For rest all types of debt mutual funds, it is 14.25% for individual and 33% corporate.

Investing in Equity Mutual Funds - Dividend Distribution Tax on Equity Funds

Question: I want to invest in equity mutual funds and I know the dividend payout for equity mutual funds do not pay dividend distribution tax, so dividend reinvestment option in equity funds is same as Growth Option, but can you please guide me on the dividend reinvestment option of medium term debt funds. Will dividend distribution tax be deducted before reinvesting?

Answer: Yes, in this case, dividend distribution tax will be deducted and then the amount will get reinvested in form of units. AMC has to deduct the dividend, no matter of dividend reinvestment option and submit it to the tax department.

Question: In case of dividend reinvestment, do I get units after paying dividend distribution tax from the money kept aside for dividend, if so be the case, I will not be as beneficial as I would be in a growth scheme? Dividend reinvestment, as I understand, is where the mutual fund pays dividend and again takes it back and allots me units. The very fact that it is paying dividend, we will have to pay tax.

Answer: Yes it is very true, the moment dividend is paid, dividend distribution tax is charged. Well for growth scheme, the taxation high or less than 1 year in the short term capital gains tax is 33% for corporate and highest tax brackets as compared to 14.25% in dividend reinvestment for individuals. So in short term, if you want to keep money for less than 1 year, dividend reinvestment option is better and if you want to keep it for more than 1 year, growth option is better.

Best of luck for mutual fund investment in India

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