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Mutual funds: Investors get an encore

July 08, 2004 16:01 IST

In our pre-budget analysis we had outlined some issues that were top on the retail investor's wish list as far as mutual funds were concerned. Now that the budget is declared, it appears that the finance minister has read the retail investor's mind accurately enough to hit the nail right on the head.

Budget proposals

Dividends on equity and equity-oriented schemes are tax-free in the hands of investors. So fund houses will not pay dividend distribution tax on equity funds, which makes dividends tax-free in the hands of investors. Dividends on debt funds (which includes monthly income plans) to individuals and HUFs will attract 12.5% distribution tax. In case of corporates the distribution tax will be levied at the rate of 20%.

Capital gains
Status quo has been maintained on long-term and short-term capital gains tax on mutual fund investments. To clarify, long term capital gains tax on tradeable securities has been done away with completely and now such transactions will incur a 0.15% tax on the cost of purchase. Likewise, short-term capital gains tax on tradeable securities will now be levied at a flat 10%. However, mutual funds do not come within the ambit of tradeable securities and these measures do not apply to mutual fund investments.

Dividend/bonus stripping
The finance minister has indicated that he will take steps to curb dividend/bonus stripping.


Retail investors should continue to opt for the dividend option in debt and equity funds. There was a similar provision in the previous budget and fund houses took this as a cue to dole out dividends in a big way. Of course the bullish current in equity markets also helped their cause. With the tax-free status accorded to dividends on equity funds, fund houses won't shy from declaring dividends whenever the NAV appreciates reasonably. Likewise, in case of debt funds, investors looking for a regular income stream, should choose the dividend option.

Capital gains
With the status quo on long-term gains tax, investors will continue to pay tax at 20% with indexation and 10% without indexation whichever is lower.

Dividend/bonus stripping
With the finance minister's decisive stand on curbing this malpractice, investors will be unable to benefit from this lacuna anymore. So claiming short-term capital gains loss for setting off against capital gains will not be possible.

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