Budget 2018: How dividend distribution tax affects mutual fund investors

Are you a mutual fund investor? Have you chosen dividend option while picking a mutual fund? Has the growth option in mutual funds become a better alternative in Budget 2018 after FM Arun Jaitley proposed a 10% Dividend Distribution tax (DDT) on dividend options of equity funds in his speech on February 1?

If response to the above questions is in affirmative, read further to find out how DDT will affect your mutual funds portfolio.

Mutual fund investments have seen a huge rise in inflows. Domestic funds had invested a staggering over Rs 1 lakh crore in the stock market last year, much higher than over Rs 48,000 crore infused in 2016 and more than Rs 70,000 crore in during 2015.

But crash in markets has made investors and traders jittery about the prospects of their investments in equities. Since equities also form a big portion of mutual funds inflows, the tax is likely to affect the net returns in this asset class.

Deepak Jasani, head retail research at HDFC Securities commented on how new investors should approach these MFs after the introduction of DDT.

Jasani said, "What is relevant for investors in Mutual funds is the net return earned on their investments. Even after the introduction of DDT, if the expected net return from these funds is higher than other alternatives on a post tax basis, they could continue to invest in these schemes (preferably in SIP mode). However if the expectations are not high or are uncertain they could wait in fixed income alternatives till there is more clarity on expected returns."  

On the 10 percent tax rate, Jasani said, "Tax rate on both growth option as well as dividend option is the same i.e 10 percent. Hence the key thing to consider is the post tax rate at which they can reinvest the dividend proceeds into some other alternative. For comparing the dividend reinvestment option, the expected rate of return on the dividend amount by the scheme compared with other alternative has to be compared."

On the impact of DDT on FIIs and domestic investors, Jasani said, "Local Investors should be concerned with post tax return earned from Indian equities over their time horizon compared with other alternative avenues. For FIIs, the expected trend in USD/INR Rate is also important as that could impact their dollar returns."

Kaustubh Belapurkar, director - manager research, Morningstar Investment Adviser India said,  "The introduction of a 10 per cent dividend distribution tax "may impact flows into funds where investors were primarily entering with the expectations of regular dividends. In fact dividend schemes are now slightly disadvantaged as opposed to growth schemes as LTCG below Rs 1 lakh is exempt from tax."

"Fund houses have to realign the distribution strategy, dividend stripping may get controlled while for the investors may end up paying tax even in the short term," Quantum Mutual Fund CEO Jimmy Patel said.

On an optimistic note, Motilal Oswal AMC's chief executive Aashish Somaiyaa said the dividend distribution tax on equity-oriented mutual funds will help stop mis-selling of balanced funds that declare a monthly dividend.

"I think the introduction of 10 per cent tax on dividends has ensured there is no arbitrage between dividend and growth schemes and that's how it should be," he said.

Principal Mutual Fund's Rajat Jain said that while tax on LTCG will have a sentimental impact, he expects "investors to adjust to this new tax regime and believes they decide on their asset allocation keeping in mind that equity investments have yielded good returns over the long-term".