Who I am
I am the tax levied on dividends distributed by mutual fund (MF) schemes. I am applicable only on dividends distributed by debt MF schemes. If an equity fund distributes dividends, I am not levied. At present, my rate is 13.52% (12.5% dividend distribution tax + 5% surcharge + 3% cess) on income distributed by debt funds other than liquid funds. For liquid funds, I am charged at the rate of 27.04% (25% dividend distribution tax + surcharge and cess).
Why I am in the news
Budget 2011 increased the dividend distribution tax (DDT) for corporate investors to 30%, up from 25% a year back in case of liquid funds and up from 12.5% in case of all other debt funds. This is a significant move as it removes the arbitrage opportunity that companies had in parking their surplus cash in MF schemes, especially liquid funds and ultra short-term funds. Since I come at a lower rate in case of MF dividends (25% in case of, say, liquid funds) against tax charged on interest earned from a savings bank account (where I come at the rate of 30%), companies found it tax-efficient to put their excess cash in MFs.
Attraction for easy money
For a number of years, companies have flocked to MFs in large numbers, especially in liquid funds on account of a better tax rate. Of the Rs3.86 trillion in debt funds (including liquid funds), industry estimates suggest that about 60% belongs to companies which invest in such schemes to take advantage of the prevailing tax arbitrage. To plug this loophole, Budget 2004 increased my rate to 20% (up from 12.5% a year back) for corporate investors. I was further increased to 25% in case of liquid funds for all investors including retail. Still companies stood to gain about three percentage points (after accounting for surcharge and cess on DDT) in liquid funds. Besides, I still charged 20% to companies in case of debt funds (other than liquid funds) till now. Budget 2011 has plugged these loopholes.
I will now be applicable at the rate of 30% on all dividends that all debt funds pay to companies. Retail investors will continue to be taxed at 12.5% for debt funds and 25% for liquid funds, excluding surcharge and cess in both cases.