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

Last Updated on

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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