Will TDS apply to mutual fund capital gains from April 2020?

Does the finance bill 2020 propose to deduct ten per cent tax on mutual fund capital gains (along with dividends) at source? An explanation.

image of a cake being sliced. Representative of tax deduction at source for mutual fund dividends and possibly capital gains as discussed in this article.

Published: February 2, 2020 at 9:08 am

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Budget 2020 introduced tax on Dividends from Shares and Mutual Funds as per slab.  The finance bill has also introduced a TDS (tax deduction at source) at the rate of 10% for dividends exceeding Rs. 5000. Does this TDS also apply to mutual fund capital gains from 1st April 2020? Update:  The IT Dept has clarified that TDS will not apply to capital gains. The reasoning for this is given below.

Explore our budget coverage: (1) New tax regime (section 115BAC): you cannot avail these deductions! (2) Individuals to pay Tax on Dividends from Shares and Mutual Funds! (3) List of tax deductions in New tax regime (section 115BAC)  (4) Is the interest earned from PPF, EPF, SSY Taxable in new tax regime?

A couple of points before we begin. (A) TDS is not harmful in any way to the taxpayer. It will bring in greater accountability. Of course, mutual fund sellers and tax avoiders will fear TDS. An honest tax-paying citizen should have no issue with this.  (B) This is my interpretation of the tax laws with information available in official sources could be subject to change. If you have a different interpretation please cite relevant sections in the comments section.

Chapter III, section 10 of the income tax act deals with “INCOMES WHICH DO NOT FORM PART OF TOTAL INCOME”. This makes a distinction between ” income received in respect of the units of a Mutual Fund” and “income arising from the transfer of mutual fund units”

Income in respect of mutual fund units refers to dividend income. The quantum of such income is determined by the quantum of units held. Income from transfer of mutual fund units refers to redemptions and capital gains.

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According to the budget 2020 memorandum, the finance bill proposes to

insert a new section 194K to provide that any person responsible for paying to a resident any income in respect of units of a Mutual Fund specified under clause (23D) of section 10 or units from the administrator of the specified undertaking or units from the specified company shall at the time of credit of such income to the account of the payee or at the time of payment thereof by any mode, whichever is earlier, deduct income-tax there on at the rate of ten per cent. It may also be provided for threshold limit of Rs 5,000/- so that income below this amount does not suffer tax deduction.

What does “income in respect of units of a Mutual Fund specified under clause (23D) of section 10” refer to? This is an extract from the section:

(35) any income by way of,—

(a) income received in respect of the units of a Mutual Fund specified under clause (23D); or

(b) income received in respect of units from the Administrator of the specified undertaking; or

(c) income received in respect of units from the specified company:

Provided that this clause shall not apply to any income arising from transfer of units of the Administrator of the specified undertaking or of the specified company or of a mutual fund, as the case may be.

Thus the law distinguishes income arising from the transfer of mutual fund units (capital gains) and income arising in respect of mutual fund units (dividends). My understanding is that the finance bill 2020 has not amended or removed this distinction.

Therefore it is my opinion that only mutual fund dividends and not capital gains will be subject to tax deduction at source (TDS) from 1st April 2020.

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com

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9 Comments

  1. Thank you Pattu sir. On what u said in the beginning, TDS is essential and must not worry a true taxpayer. But my concern here mainly was, what if my CG is less than 1L and i am not liable, why should i pay 10% TDS and then file in the ITR to get it back after 1.5 yrs.
    But thanks for the clarification thru this write-up, which many of the so-called ‘top’ reporters failed to address.

  2. Why do you assume that only tax avoiders fear TDS? This is a misplaced notion if you ask me and paints many honest people with a broad negative brush.

    TDS is hated by many people because it affects compounding and you often need to claim the TDS amount a year later after filing taxes. Thus the amount which could have been sitting in your FD or some other fixed income product gaining interest goes to the government coffers instead even if you are not in taxable income bracket and don’t owe any taxes.

    One can file FORM 15G/H but if someone has tens of FDs and RDs and other debt products, it’s a major hassle to keep filing so many of these forms in different banks/financial institutions every year.

    1. Another point is govt pays only 6% interest and that only if the refund is higher than 10% of total tax. What makes this even worse is, we have to pay tax on this interest the year we get the refund as per our slab.
      TDS is completely skewed towards the govt making a taxpayer a loser.

  3. Btw, with DDT(for firms, MF) gone – what happens to the dividend that is received by – say an Index Mutual fund and then an investor sells those MF units.
    Is the DDT subsumed by the capital gain tax in the hands of the an individual?

    Thanks

  4. I have been confused since the Budget was announced about whether capital gains on mutual funds exceeding Rs. 5,000 will also be taxed at 10 percent TDS. Thanks Pattu sir, for clearing the confusion.

  5. You are only one who analysed it quickly and correctly. Thank you. TDS is good for those who are above 5 lakh income bracket. Asuming someone earning monthly 10000 and investing 1500 in SIP. TDS is not good for them as it does not encourage them to continue investing. TDS on capital gain may not help in popularizing MF in rural areas.

  6. I have following queries:
    1. This threshold limit of INR 5,000 is fund specific or accross all the mutual funds and comanies and it will be implemented.
    Is there a provision of submission of Firm 15 H & 15G and to whom. The reason being , all the recepients of dividends may not necessarily have income higher than taxable income.

  7. You are correct Sir. DDT has been removed at the Co end and in Lieu of that TDS has been introduecd. It has nothing to do with Capital gain Tax or redemptions of the mutual Fund.

  8. Thanks pattu sir
    I have a doubt
    How are the mutual fund companies going to cut TDS for people who are invested in the growth plan
    Will they have only capital gains tax

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