• Increase in dividend tax to 20% from existing 10% except in case of open-end equity schemes and US 64.
• Abolition of 54EA/ EB benefits .
• Reduction in capital gains tax to 10 percent from 20 percent.

Click here to view the reactions of experts BUDGET REACTIONS 2000

Budget implications

The Union Budget of India, 1999 brought good things for mutual fund investors. The budget aimed at making mutual funds tax friendly for the individual investor, resulting in large inflows into the capital markets through mutual funds. Union Budget of India, 2000 was a bit harsh for mutual fund industry, and the industry reacted negatively for a day to understand that the impact on small investors were not much.

Income Received From Mutual Funds

The Finance Bill 1999 made income (i.e. dividends) received from all mutual funds tax free in the hands of investors ). Investors need not pay any tax on dividend received from a mutual fund for a period of three years effective from April 1, 1999 . For the investor it does not matter what kinds of mutual fund scheme they have invested in. Dividend whether received from equity, equity & debt or a debt scheme will all be tax-free for the investors.

While dividends in the hands of the investor are free from tax, mutual funds are now required to pay a "distribution tax" of 20% from the financial year 2000-2001 ( instead of 10% as distribution tax last year . The distribution tax is not to be paid on all types of mutual fund schemes. Effective April 1,1999, for a period of three years, open-end equity oriented schemes will be exempt from paying the distribution tax.

Tax implication for income received on open-end equity oriented scheme:

As per the Finance Bill 1999, income distributed under the US-64 scheme and other open-ended equity oriented scheme of UTI and Mutual Funds are exempt from the levy of this tax for a period of three financial years starting from 1.4.1999. An open-end equity oriented scheme is defined as one where more than 50% of the scheme's investible funds are invested in domestic equities. The 50% is computed taking the annual average of the monthly averages of the scheme's equity holdings. The monthly average, in turn, is calculated by taking the opening and closing percentage of a particular month's equity holdings.

The distribution tax is different from "TDS" or tax deducted at source. In the case of TDS, the tax has to be deducted at the time of payment or redemption by the issuer of the security and deposited with the Government. This tax is deducted by the issuer from income payable to the investor and the investor gets credit of the same while filing his annual return of tax. In cases where the investor is not liable to pay tax he may claim an exemption from TDS by filing a Form 15H with the issuing body of the security. Distribution tax is, however, a tax that has to be paid by the mutual fund, not the investor. It is not a direct tax paid by the investor therefore, he cannot file for exemption from distribution tax. Hence, while the dividend pay out will be tax-exempt in the hands of the investors, in all schemes where the mutual fund has to pay a distribution tax, the dividend pay out will be affected to that extent by the 22% distribution tax.

As per the current provisions of the budget, long term capital gains arising from the sale of listed securities and shares as defined under the Securities Contracts (Regulation) Act, 1956 (SCRA) are now chargeable to tax at a maximum rate of 10 %. As per the earlier Income Tax law, units of mutual funds did not qualify as listed securities under the Securities Contracts (Regulation) Act, 1956 (SCRA) but as per the provisions of Union Budget 2000-2001 units of all Mutual funds will be considered as listed securities and long-term capital gains from units of mutual funds will be taxed at 20 per cent after giving benefit of cost inflation indexation, or a flat rate of 10 % which ever is lower. That is, persons would have the option of either availing of cost indexation on the capital gains and paying 20 per cent capital gains tax or paying a flat rate of 10 per cent without cost indexation. As a result, the maximum capital gains tax payable has been capped at 10 per cent.

Deletion of sections 54 EA and 54 EB of the Income Tax Act, 1961.

The above two sections provided relief from capital gains tax if investments were made in specified securities and locked in for a period of 3 years in the case of 54EA and 7 years in the case of 54EB. Mutual fund units were one of the specified securities and this resulted in a lot of money realised as profit from sale of securities being reinvested in the market through mutual funds.

With the withdrawal of the exemption to mutual funds, investors have lost out on a very viable alternative for tax saving and funds also would be faced with the problem of 'hot money' as there would no longer be any lock in period for investments. However this facility will be available till 30th September 2000 for all capital gains acrued till 31st march 2000.

The above is a general description of the tax laws. Tax laws may change in the future and the applicability of these laws may vary from person to person, depending on your particular circumstances. You should consult with your own tax advisor with respect to the tax benefits available from a mutual fund investment.