Dividend tax on MFs investing in money markets raised

The Union Budget has marked up the dividend distribution tax (DDT) on mutual funds investing in money market and liquid markets to 25 per cent for all investors.

The Finance Minister said the funds enjoy concessional tax rates allowing for huge arbitrage opportunities.

According to mutual fund managers, though this provision may shift a few to the long-term bond market, investors will still enjoy higher tax benefits vis-a-vis fixed deposits of banks.

Post-tax returns of investors in liquid and money market funds will be hit by the dividend distribution tax rate going up from 22.44 per cent to 28.32 per cent (including surcharge and cess) for corporates and from 14.03 per cent to 28.32 per cent for individuals. However, for non-liquid funds, the dividend distribution tax remains the same.

"This should encourage investors to shift towards long-term debt schemes as compared to liquid funds," said Mr Sanjay Prakash, Chief Executive Officer, HSBC Investments in India.

However, the returns, even after the increased tax on dividends, would go up to 5-5.5 per cent post tax, while that on deposits in banks would fetch around 2.5 per cent. This clearly shows money market and liquid funds still offer better returns, said Mr Ramanathan K., Head - Fixed Income, ING Vysya Mutual Fund.

The move is negative say fund managers. "It will impact sales to some extent and the post-tax returns of customers will be hit," said Mr Ajay Bagga, CEO, Lotus India Mutual Fund.

Fund managers said liquid funds are still the best option for investors placing funds in bonds of short duration (less than a week) as they do not have any other alternative. "Money will continue to flow from investors keen on the short term," said Mr Mahendra Jajoo, Vice President, Head-Fixed Income, ABN Amro Asset Management.

"In the longer term, we believe cash funds and bank deposits play different roles and have their own place in treasury portfolios," said Ms Ashu Suyash, Managing Director and Country Head, Fidelity Fund Management Pvt. Ltd.