Mutual Fund Investment: How Budget 2020 will impact mutual fund investors

mutual fund, mutual fund investment, Budget 2020, budget 2020 for mutual funds, DDT, TDS, income tax, TDS on mutual fund gains, LTCG

Budget 2020 has proposed to introduce Tax Deduction at Source (TDS) at 10% on the dividend income above Rs 5000 before it is distributed to the investors.

Budget announcements usually have some bearing on how we strategise to reach our financial goals through our investments. However, Budget 2020 is likely to have a far-reaching impact on mutual fund investments for a host of reasons. While some announcements made by Finance Minister Nirmala Sitharaman are being welcomed by mutual fund investors, there are a few new decisions that can have a negative impact. Let’s take a closer look at these moves.

1. New tax regime: A positive for mutual fund investments

Budget 2020 introduced a new tax system effective from FY20-21 wherein taxpayers can benefit from lower slab rates by forgoing a majority of tax-deduction benefits to lower their tax burden. Taxpayers will also have the option to continue with the existing tax system. However, the new tax regime would allow taxpayers to invest freely in instruments of their choice without having to worry about tax-saving pressures, and they can explore mutual fund products that don’t necessarily save taxes. In the existing tax regime, investors need to invest in tax-saving instruments, wait for the lock-in periods to get over to use their funds and, at times, compromise with ROI for saving taxes. Tax-saving compulsions often force investors to pick instruments that aren’t necessarily in their financial interest. In the new tax regime, they can simply invest to create wealth as per their risk appetite, financial goals, and liquidity needs. So, the new tax system will suit such investors who don’t like to be stuck with long lock-ins and forced investments to save taxes.

2. TDS on mutual fund gains: A negative for mutual fund investments

Budget 2020 has proposed to introduce Tax Deduction at Source (TDS) at 10% on the dividend income above Rs 5000 before it is distributed to the investors. So, if the investor falls in higher tax slab, they would now adjust the TDS payment from their tax obligation while filing the tax returns, whereas if the investor falls in a lower tax slab, they may be required to claim the TDS refund by filing their tax returns, which is an inconvenience. Dividend-generating investments are normally suited to older investors. Young investors who don’t need to rely on the liquidity provided by dividends should opt for growth schemes for faster appreciation of their wealth.

3. DDT in the hand of mutual fund investors: A mixed impact

In the existing system, the dividend on equity mutual funds and debt funds is taxed at 11.65% and 29.12%, respectively, while distributing it to the shareholders. However, in Budget 2020, it has been proposed to levy DDT in the hands of the mutual fund investors as per their applicable tax rate. So, for example, if the investor falls in the 30% tax bracket, they will pay tax on the dividend at a 30% rate. So, when the DDT becomes applicable in the hands of investors, those in higher tax brackets will pay more in taxes. At the same time, investors in lower tax brackets will pay lesser tax. This announcement will have a mixed impact on investors.

Now, it would be advisable for investors to switch their existing mutual fund investments to growth options to save DDT outgo. Similarly, instead of the dividend payout option, investors can save tax by opting for a systematic withdrawal option (after considering the exit load, if any) to avoid TDS and DDT.

There was confusion in the minds of many investors after the budget announcement that TDS will also be applicable to the capital gains on fund redemption. However, the government has clarified that the 10% TDS will be applicable only on the dividend paid by the mutual funds and not on capital gains.

As mentioned, the TDS proposed in Budget 2020 can be claimed back if your tax liability is lower than the deducted amount, and the DDT in the hand of investors will impact them if they depend on regular dividend income. So mutual fund investments are at a crossroad, and it’s time for you to make your choice of either investing in schemes with dividends or schemes with growth.