An analysis of how the new rules impact the outgo of investors who stay with the extant tax regime and those who shift to the new one.
Passing the buck
Presently, MFs deduct DDT first
and then hand over the dividend to unit-holders. From April 2020, the dividend amount
will be added to the taxable income of the investor and taxed as per his/her tax bracket
Budget 2020 has removed dividend distribution tax (DDT) and made dividends taxable in the hands of investors. Also, it has introduced tax deduction at source (TDS) at 10 per cent if the dividend declared by mutual funds exceeds ₹5,000 in a year.
Presently, mutual funds deduct DDT first and then hand over the dividend to unit-holders.
From April 2020, the dividend amount will be added to the taxable income of the investor and taxed as per his/her tax bracket.
Currently, when mutual funds declare dividends, they pay tax at the rate of 10 per cent and 25 per cent on equity and non-equity schemes, respectively, and pay only the balance to investors.
In addition to the above tax rates, there is a surcharge (at 12 per cent of tax) and cess (at 4 per cent of tax plus surcharge). So, for retail investors, the effective DDT on equity funds works out to 11.65 per cent, and on non-equity funds 29.12 per cent.
There are two options in dividend plans — payout and reinvestment. In the dividend payout option, the dividend declared is paid out to investors. In dividend re-investment, the dividend declared is not paid out but used to purchase additional units in the scheme.
Whether paid out or reinvested (also in liquid exchange-traded funds (ETFs)), dividends are subject to DDT presently but will be taxed in the hands of the investor from April 2020.
Given the changes in the taxation of dividends, who gains and who loses? Also, which plan —- dividend or growth — will be suitable for retail investors? We look at the options under both the old tax regime (with higher tax rates) and the optional new tax regime (with lower tax rates).
Old tax regime
For individual investors who choose to stay with the old tax regime, the effective marginal (maximum) tax rates are as follows. If the annual taxable income is up to ₹5 lakh, there is no tax, thanks to the rebate benefit. If the taxable income is between ₹5 lakh and ₹10 lakh, the marginal rate of tax is 20.8 per cent (including cess).
The marginal rate is 31.2 per cent for those with taxable income between ₹10 lakh and ₹50 lakh; 34.3 per cent for taxable income between ₹50 lakh and ₹1crore; 35.8 per cent on taxable income between ₹1crore and ₹2 crore; 39 per cent on taxable income between ₹2 crore and ₹5 crore; and 42.7 per cent on taxable income above ₹5 crore.
Note that there is a surcharge (at different rates) if your taxable income exceeds ₹50 lakh. Cess at 4 per cent on tax plus surcharge applies to all.
Equity funds: Currently, DDT on equity funds is 11.65 per cent.
From April 2020 onwards, the dividend will be taxed at the marginal tax rates mentioned above.
So, from April, dividend plans in equity funds will benefit investors with taxable incomes of up to ₹5 lakh. That’s because they will not have to pay tax on dividends received, while now they suffer DDT at 11.65 per cent.
But for investors with taxable income above ₹5 lakh, there will be a higher tax outgo on dividend plans from April onwards.
That’s because the effective tax rate on the dividends (between 20.8 per cent and 42.7 per cent as mentioned above) will be higher than the current DDT of 11.65 per cent.
Such investors will be better off with the growth option, and if they seek regular cash flows, they can opt for the systematic withdrawal plan (SWP) in the growth option.
In the growth option, there is no dividend; only capital gains made on the sale of units are taxed. In the case of equity mutual funds, gains on sale of units held for 12 months or less are considered short-term capital gains (STCG) — this is taxed at 15 per cent; including cess, the tax rate is 15.6 per cent, and including surcharge on higher-income earners, the tax rate can go up to 21.37 per cent.
Long-term capital gains (LTCG) on sale of equity funds (held for more than 12 months) are taxed at 10 per cent — including cess, the tax rate is 10.4 per cent, and including a surcharge on higher-income earners, the tax rate can go up to 14.25 per cent.
LTCG of up to ₹1 lakh a year on equity funds is exempt from tax.
Ergo: For those with taxable income above ₹5 lakh, the rate of tax on both STCG and LTCG on equity funds will be lower than the dividend tax from April 2020.
Non-equity funds: Currently, the DDT on non-equity funds (including debt funds) comes to 29.12 per cent. From April 2020, with dividends taxed in the hands of investors, the tax on dividends will be nil for those with an income of up to ₹5 lakh; 20.8 per cent for those with income between ₹5 lakh and ₹10 lakh; and 31.2-42.7 per cent for those with incomes over ₹10 lakh. So, those with incomes up to ₹10 lakh will benefit from a lower tax on dividends compared with the current DDT rate.
In growth plans of non-equity funds, STCG (on units sold after holding them for 36 months or less) is taxed as per the investor’s tax slab (marginal tax rate), while LTCG (on units sold after 36 months) is taxed at 20 per cent (plus surcharge and cess, as applicable) after indexation benefit.
So, from the perspective of tax incidence, there will be no difference between the dividend plans and the STCG in growth plans.
For those in the 20 per cent and 30 per cent tax slabs who seek to reduce tax, the growth plan in non-equity funds will be better than the dividend plan, if the units are sold after holding them for at least 36 months to qualify the gains as LTCG.
The 20 per cent tax on LTCG can go up to 28.5 per cent (including surcharge) for high-income earners. But given the benefit of indexation, the tax outflow will be lower than that on dividend plans.
For regular cash flows, such investors can go for SWPs after holding the units for more than 36 months.
New tax regime
Under the optional new tax regime, the marginal tax rates (including cess and surcharge) are as follows: nil for those with annual taxable income of up to ₹5 lakh, 10.4 per cent for incomes between ₹5 lakh and ₹7.5 lakh, 15.6 per cent for incomes between ₹7.5 lakh and ₹10 lakh, 20.8 per cent for incomes between ₹10 lakh and ₹12.5 lakh, 26 per cent for incomes between ₹12.5 lakh and ₹15 lakh, and 31.2-42.7 per cent for incomes above ₹15 lakh.
Equity funds: Currently, in equity funds, the DDT rate is 11.65 per cent. From April 2020, the tax in dividend plans will be lower for those with a taxable income of up to ₹7.5 lakh (falling within 10.4 per cent marginal tax rate).
But for investors with an income above ₹7.5 lakh and has a marginal tax rate of 15.6 per cent or more, the tax outflow will be higher in dividend plans.
For those in the tax slabs of 15.6 per cent and higher, and seeking regular cash flows, it will be better to go for growth plans, hold the units for more than 12 months to qualify the gains as LTCG, and then opt for SWPs.
Non-equity funds: Currently, the DDT in non-equity funds is 29.12 per cent, while dividends will be taxed at marginal rates from April 2020. In these schemes, the tax outflow in dividend plans will be lower than the DDT at present for those with incomes of up to ₹15 lakh (marginal tax rate of up to 26 per cent).
For those in the tax slabs of 31.2 per cent and higher, and seeking regular cash flows, it will be better to go for growth plans, hold the units for more than 36 months to qualify the gains as LTCG, and then opt for SWPs.
Original Source: https://epaper.thehindubusinessline.com