Mutual Fund Tax Efficiency

Is section 10(23D) still valid ?
Some context - Indian Finance Act 2020 has abolished Dividend Distribution Tax (DDT) and, with effect from April 1, 2020, dividends declared by Indian companies would be taxable in the hands of shareholders.
section 10(23D) - Section 10(23D) of the Income Tax Act provides that any income earned by a Mutual Fund registered under the SEBI Act, 1992 or the Regulations made thereunder, shall not be included in computing its total income of a previous year.
Consider the company Infosys and Axis Blue Chip Fund
So previously any dividend declared by Infosys, they had to pay a DDT rate of 20.5 % I think and so any dividend received either by a retail investor or a Mutual Fund like Axis Blue Chip was already net of this tax and did not have to pay any tax.
But now the retail investor has to pay dividend tax according to its income, but I am not sure how does it happen in case of Mutual Funds.

  1. Am I wrong in my assumption that when Infosys declared dividend the 20.5 % tax was deducted for Mutual Funds or were they given the entire amount because of the section 10(23D) ?
  2. If the above assumption is correct and if section 10(23D) still holds good, isn’t a dividend received by a Mutual Fund now not taxed at all ? And if the MF is a Growth Type Fund where all type income is reinvested, they can significantly better grow the money as they don’t have to pay any tax on the dividend. My doubt comes from the fact that I have not seen any MF house advertising this benefit, as IMO this gives them a huge edge, my guess is they are getting taxed somewhere on that dividend, if so where is this happening ?

P.S. I know that the returns on the Fund will be taxed when I eventually sell my Portfolio but that can be several years down the line at 10% marginal rate of LTCG with significant compounding already taking place with that extra dividend amount that was not taken even in taxes invested back.
P.P.S I also know there are dividend paying type of MFs so I am not talking about those, strictly talking about Growth Mutual Funds.

@Quicko I know this is not strictly a personal Income Tax thing but any light that you can shed on it will be appreciated.


@ShubhS9 @NithinKamath @Bhuvan Can someone please shed some light on this ?

@San78 Can you.

Yes, this is right. Dividends (or any other income) received by Mutual Funds are not subject to any tax, under section 10(23D).

So is it still applicable after the change of rule that dividends are taxed in hands of investors ? Investors here referring to MF and if so just 2 questions why is GOI not collecting that tax from MF and if they are not then did MFs just got a lot better in compounding wealth compared to retail investors and others who don’t enjoy the 10(23D) Exemption ?
Thanks for participating in the thread.


For the same reason that they are not collecting any tax directly from MFs. Note that section 10(23D) excludes all incomes of MFs from taxation. Think about the amount of capital gains taxes (mostly short term, I assume) that the GoI is not collecting from MFs; that should dwarf the amount of dividend tax that is being exempted, by a humongous margin. Dividend amounts earned by MFs should be peanuts compared to their capital gains.

While I don’t have a source for this, I assume that the reason behind these exemptions is that MFs are meant to be a special purpose vehicle for people to pool in their money and invest. So it makes sense not to tax the incomes of MFs, but instead tax the incomes of the people involved when they take out a profit from the MF.

MFs have always had this advantage; just consider the amount of capital gains taxes that they don’t pay. I am not sure that DDT used to apply to dividends paid to MFs, but even if it did, the amounts involved would be minuscule compared to the CG tax that was exempted.

By the way, if you would like to check the DDT part, one easy way would be to look up the P&L statements of big companies with a lot of MF shareholding and consistent dividend payment history (e.g: PSUs such as IOC or Coal India, or INFY), and see if their DDT comes to exactly 15% (or whatever the percentage was — remember to include surcharge, cess, etc.) of the dividends distributed in the years in which DDT was in effect. They report gross DDT amounts in their statements. If you check out a few different companies and see the percentages, then you can surmise whether dividends paid to MFs attracted DDT.

1 Like

Thank you for the detailed answer, I was not aware about the point about Exemption on Capital Gains for MFs. Will try to verify the DDT thing as you suggested.

This is a big statement to make on the basis of just dividend taxation. As such big companies pay paltry sum in dividend and it in no way affect compounding wealth.
To give you an example, nifty 50 dividend yield for past year would be around 1.2%, by not paying tax on this, MF would generate extra 0.4% every year. Is it that huge?
Don’t forget, most MF have an expense ratio in excess of 1%.

1 Like

To put things into perspective yeah 0.4% would make a decent dent over a long period of time
Taking your example Nifty50 div yield to be 1.2% paid to retail investor net received by investor is 0.84%. Assuming Nifty compounds with 10% pa
Over 10 years
Retail Investor (1.1084^10) = 2.798 times your investment = 179.8 % returns
MFs (1.112^10) =2.890 times your investment = 189 % returns
Over 20 years
Retail Investor (1.1084^20) = 7.833 times your investment = 683.3 % returns
MFs (1.112^20) =8.357 times your investment = 735.7 % returns

Also Keeping in mind there are funds that focus on both high yield dividend companies and growth trying to maintain a balance so those would compound better in comparison to Nifty50. Also above calculations are on one time lump sum investment, SIPs would compound better.
Also my doubt was around why don’t they advertise this part that they are tax efficient, and as mentioned by @ZeroIndian even when MFs churn their portfolio they don’t pay Capital Gains, in My opinion these should be better advertised.
But yeah I agree the dividends tax avoided would be paltry in comparison to the Capital Gains Tax saved when they churn their portfolio.
P.S If anyone is interested to know what drove me down this rabbit hole - Total Return Index

Great maths skill. But you are taking this out of perspective.
Add 1% expense, which MF investor need to pay and direct retail investor need not pay and see what happens to your numbers.

Yes, MF have huge benefits for average investor. But selecting MF for saving tax on dividend, well that would hardly be a top benefit.And precisely that’s why it is not advertised by anyone.

Also this is not a new development. MF always had this advantage.

1 Like