Budget 2020: Government Proposes 10% TDS On Mutual Fund Income Above Rs 5,000
A roadside vendor places Indian rupee notes in a plastic container at his footwear stall in the Sitabuldi market in Nagpur. (Photographer: Dhiraj Singh/Bloomberg)

Budget 2020: Government Proposes 10% TDS On Mutual Fund Income Above Rs 5,000

The returns on investments in mutual funds may reduce as the Narendra Modi government has proposed a tax on the income distributed by asset managers to unitholders.

Finance Minister Nirmala Sitharaman, in this year’s Union Budget, has introduced a 10 percent TDS (tax deducted at source) provision on the income distributed by a mutual fund to its unitholders if such income exceeds Rs 5,000.

The minister, according to the Finance Bill, 2020, has proposed the insertion of a new section—194K—in the Income Tax Act, which states “any person responsible for paying income arising from units of mutual fund or a specified company must deduct tax at the rate of ten percent of such income”.

Also read: Budget 2020: Planning To Switch To New Income Tax Rates? Think Again!

This comes after the Finance Minister abolished Dividend Distribution Tax and made it taxable in the hands of investors. Previously, mutual funds were subject to DDT while such income was exempt from tax in the hands of unitholders.

The presence of the phrase “any income” in the section can have unintended meaning, according to Shailesh Kumar, director at Nangia Anderson Consulting. “The provision, in its present form, doesn’t make any specific mention whether the term income would only mean dividend income or if it would also mean capital gains.”

Mutual funds are classified into two categories based on how the gains are distributed to unitholders. Mutual funds with “growth plan” reinvest profits back into the corpus and return the amount along with gains after a unitholder’s exit. Under the dividend option, mutual funds provide periodic payouts that arise from profits made by the fund. DDT on distribution of dividend by mutual funds will apply till March 31.

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“It will be a big blow to investors if mutual funds apply TDS on entire redemption proceeds, instead on merely the income component,” Kumar said. “The government must clarify that such TDS of 10 percent will only apply on income component and not on entire redemption proceeds of mutual funds. This may create operational issues for mutual funds.”

The Income Tax Act defines “income” in an inclusive manner to mean profits, gains, dividends as well as capital gains arising from transfer of capital assets. It can also mean any consideration received against transfer of an asset by an individual.

However, Ameet Patel, partner at Manohar Chowdhry & Associates, said the TDS provision would only apply in the case of dividend income distributed by a mutual fund. “A provision similar to 194K existed in the statute book prior to Budget 2020,” he said. “The word income in the context of distribution of income by mutual funds always meant and was interpreted as dividend income.”

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Agreed Sameer Gupta, partner and tax markets Leader at EY. The term “income in respect of units of a mutual fund” points out to dividend income and cannot be widened to mean capital gains arising from transfer of units, he told BloombergQuint.

“The Finance Bill, 2020, uses the term ‘income in respect of units’. On a plain reading and given that this provision was applicable in earlier years as well, ordinarily this shouldn’t include gains on redemption of units.”

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