The government’s proposal to remove interest deduction against dividend and mutual fund (MF) income came as a surprise for an industry which was expecting some simplification under the new Income Tax Act, 2025. If the proposal comes into effect, the interest expenditure allowed to the extent of 20% of gross dividend or MFs income will no longer be applicable.
“The removal of this deduction creates a tax drag primarily for schemes where income is distributed or where investors borrow to invest,” said Vaiibhavv Chugh, chief executive officer-mutual fund at Abakkus Investment Managers. Schemes in fixed income and hybrid categories will be mostly impacted, he added.
FM on amendments to the Income Tax Act
During the FY27 Union Budget announcement on Sunday, Finance Minister Nirmala Sitharaman proposed amendments to Section 93 of the Income Tax Act to disallow deduction of “any interest expenditure incurred in relation to dividend income or income from units of mutual funds” and to classify such revenue under “income from other sources”.
In other words, if an investor has borrowed money to invest in a mutual fund scheme, and the scheme declares a dividend in the future, earlier there was a provision to offset the interest cost on the loan partially from the tax on dividend income. This Budget proposes to remove this benefit.
What do industry experts say?
This government’s move also makes leveraged strategies such as loans against MFs significantly more expensive and less tax efficient, industry experts said. Loans against MF means that a person can borrow money by pledging MF units as collateral and provides immediate liquidity access without having to sell investments.
Currently,if an individual earns income of ₹10 lakh from MF and incurs a cost of ₹3 lakh for interest on borrowings for investing in the scheme, the allowable deduction would be up to ₹2 lakh. The proposal is expected to come into effect on or before the beginning of FY27 and no such deduction will be permitted thereafter.
“Surprising that it (the proposal) deserved a mention by the FM (finance minister) in the budget speech because only 20% of interest was allowed to be set off against dividend income and income from mutual funds,” said Juzer Gabajiwala, director at Ventura, adding that the impact of this measure would be marginal for investors. He also said that such a proposal was not expected and that there were “too much micro management issues in the budget.”