Amid rising volatility in the stocks markets, as investors may be looking to invest into relatively safer equity mutual funds to earn regular income, HDFC Securities says that they may be left with lower returns, especially after Union Budget 2018 imposed a 10% Dividend Distribution Tax. In its latest report, HDFC Securities says that investors should consider two aspects before deciding to continue or buy equity mutual funds for regular income purposes.

  1. The monthly/quarterly dividend will now be taxed @ 10%. The investor will receive the dividend net of tax since DDT is deducted by the fund house itself
  2. Equity mutual funds might not be able to keep up the high dividend yields of the past if the equity markets remain subdued or correct from hereon.

Notably, the government has decided to impose a long-term capital gains tax as well as dividend distribution tax on dividend paid by equity oriented mutual fund schemes. “Post the new provisions, the income derived from dividend and capital gains from equity mutual funds is taxed at the same rate i.e. growth and dividend options are on a level playing field. In fact, investors might prefer moving to growth plans and deferring their tax liability at the time of sale of units as opposed to tax being deducted every month/quarter/year,” HDFC Securities said in its report.

Even though the investors will have to pay the Long Term Capital Gain tax even on profits made from mutual fund investments exceeding Rs 1 lakh, experts say that they will be better off, as at least the dividends may be reinvested in the case of growth options, as the fund will not have to pay the 10% dividend distribution tax.

Prior to the Budget, investors would enjoy tax-free dividends from equity-oriented mutual funds. Due to this tax advantage, equity-oriented schemes with monthly/quarterly dividend options attracted a lot of investor attention during the past 1-2 years. Equity as an asset class enjoyed a very good run during this period which resulted in some of these schemes paying decent dividend yields of around 10-11% p.a which was tax-free until the Budget 2018-19.

“Due to these high tax-free dividend yields, balanced schemes attracted a bulk of retail and HNI fund flow into mutual funds. The corpus of the largest 5 schemes have gone up by an average 5.5 times between Jan 2016 and Dec 2017 (that of ICICI Pru Balanced scheme went up by as much as 10.3 times) to reach Rs 1,26,636 crore which is around 60% of the entire category corpus of Rs 2,06,515 crore,” HDFC Securities noted in its report.