You have possibly learnt all there is to know about the new tax regime and whether it makes sense for you to move to it or not. If you are earning over ₹7.5 lakh a year, you would have probably come to the same conclusion most people in your shoes are coming to right now. Stick with the old regime because the deductions and exemptions truly make it gold.
Now if you are a mutual fund investor, this budget does change some things. There are three key items that have been announced in this budget—taxation on dividends, removal of dividend distribution tax (DDT) and changes in the tax treatment of side-pocketing in mutual fund portfolios.
Dividends are now taxable as income in the hands of investors. Accordingly, tax deducted at source (TDS) will be paid at 10% for residents (dividend above ₹5,000). This impacts dividend options of equity and hybrid funds that have garnered an assets under management of ₹2 trillion and satisfy the need for regular income.
This value is 20% for NRIs on dividends more than ₹5,000 per year. NRIs will now also be taxed as a resident in India for any income that they earn in India if they are not paying tax on it in any other jurisdiction for reasons of domicile or residency status.
Dividend options of mutual funds are now even more unattractive than they were before. Stick with growth or switch to it if you have not. However, for regular income needs, using systematic withdrawal plans would be wiser, as it had been before.
DDT has been abolished now. This could have been a welcome move but combined with taxation on dividend, this is akin to taxing the same economic activity twice. Dividends are now taxed in the hands of investors who hold the securities rather than at the company’s end. Those with significant dividend income will see a significant increase in the tax they now pay.
The decision to tax dividends in the hands of investors rather than at the company’s end makes issuing dividends a less attractive option for companies with larger promoter holdings. For those in the higher tax brackets, this might attract a tax of 42.74% as opposed to 11.65% on equity and 29.21% on debt products.
The year 2019 saw many debt funds facing multiple rating downgrades of some of the securities held by them. DHFL and Vodafone Idea were a couple of the companies that saw their debt securities get hammered after a rating downgrade. Investors in certain debt funds which held these securities saw a significant crash in their net asset values. A passive debt fund investor definitely doesn’t expect this and might be looking at heavy losses because they are not actively tracking the market.
The Securities and Exchange Board of India has now pushed asset management companies to create segregated portfolios for the affected securities, also called side-pocketing. A side-pocket option allows a fund house to separate bad or risky assets from other liquid investments in a debt portfolio which could get impacted by the credit profile of the underlying instruments.
A segregated portfolio ensures that investors who wish to exit the fund can withdraw at least the healthy portion of the fund without booking any losses, while they continue to hold units in the segregated portfolio.
While the mutual fund companies have issued units in segregated portfolios at zero cost, the budget has specified that the cost of acquisition should be in proportion, and the holding duration should also be in line with that of the original portfolio. The indexation benefits, if any, will be intact on the segregated portfolio. However, we believe investors should be able to carry losses in their tax returns, in case the segregated portfolio shows no recovery. It will be complex for SIP investors to calculate capital gains tax payable by them in case they withdraw from these funds.
There are three things which would have been good to see in 2020 but didn’t see the light of day. Many advisers were expecting parity in the treatment of insurance and mutual funds under Section 80C and tax treatment of capital gains. Long-term capital gains (LTCG) does not make sense in a country with such low levels of retail participation in the financial markets. Doing away with LTCG can be combined with an increase in the LTCG duration. This is required to signal to investors that equity is an asset class that needs time. Given that we are a risk-averse country, the introduction of a debt-based savings scheme under 80C can support financialization of savings. Hopefully, the next year will be different.