What is DDT?
Dividend given by a stock or a mutual fund is subjected to a tax called Dividend Distribution Tax (DDT). When a stock or a mutual fund declares a dividend, the DDT is paid by the company or the mutual fund house directly to the government. So in effect this payment is transparent to you as the investor. The tax-suffered dividend is paid to your account. In your hands the dividend amount is “tax-free” as tax has already been deducted without your knowledge!
What is the tax rate for DDT?
For a stock or equity mutual fund, the tax rate is 15% plus 12% surcharge plus 4% cess which results in 17.472%. For a debt mutual fund, the tax rate is 25% plus 12% surcharge plus 4% cess giving a net of 29.120%.
Example 1: A mutual fund house declares a Rs. 3 dividend per unit of its equity fund for investors. An amount per unit of Rs. 3 * 17.472 / 100 = 0.52416 per unit is the DDT and is paid by the fund house to the government. As a consequence, the NAV will fall by Rs. 3.52416.
Example 2: A mutual fund house declares a Rs. 3 dividend per unit of its Debt fund for investors. An amount per unit of Rs. 3 * 29.120 / 100 = 0.8736 per unit is the DDT and is paid by the fund house to the government. As a consequence, the NAV will fall by Rs. 3.8736.
What has changed in Budget 2020 as DDT has been removed?
In Budget 2020, the proposal is to remove DDT. The dividend will be taxed in the hands of the investor. Once this proposal is approved, from 1st April 2020, the companies or fund houses will not have to pay the DDT to the government. Investors who receive any dividend from stocks or mutual funds will need to show it under “Other income” and the receipt will be taxed at your marginal rate of taxation.
Will there be a TDS?
Yes, there will be a TDS on the dividend payment if it exceeds Rs. 5,000. This TDS should be visible in your ITR and in 26AS. If you fall under the 0% tax bracket, you may still have to face a TDS. We need to wait to see if fund houses accept form 15G/H and credit your dividend without TDS.
Example: An investor has 100 units of a fund which has declared a dividend of Rs. 3 per unit. The investor will receive Rs. 300 in his/her account. This Rs. 300 is to be declared in the ITR as other income. As a consequence, the NAV of the fund will fall by Rs. 3.
Is it better for me as investor to choose to invest in the dividend option?
I can recommend investors who fall in the 0% tax bracket to invest in dividend option. For other investors who are in higher tax brackets, you need to be aware that the dividend income needs to be shown under “other income” in your ITR and it will be taxed at your marginal rate of tax. So you need to take an informed decision and decide whether dividend option is better or growth option is more suitable for you.
What about investors in the 30% bracket?
If you are in the 30% tax bracket (old slab and new slab) then dividend option means you have to pay tax at 30% plus cess on your dividend income as well. It will be better for you to move to Growth option. In growth option, you will pay tax only on sale of mutual funds.
It is better now to buy mutual funds vs buying direct equity?
There is now a new benefit of owning equity mutual funds due to the DDT abolition. As we all know, equity mutual fund buy a basket of stocks. When the underlying stock pay dividend to Mutual funds, there used to be a DDT tax implicitly applied till 31st March 2020. However, from 1st April 2020, there is no DDT. This means the mutual funds will receive higher dividend payout from the stocks owned. If you have purchased a stock directly, you need to show this dividend in your income tax return and pay tax on it. If you are in the 30% bracket, you will pay out that much additional tax. However, if you invest in an equity mutual fund, there is no tax to be paid by the equity mutual fund.