The investment objective of a liquid scheme is to provide investors an opportunity to earn returns through investments in debt & money market securities such as treasury bills, certificate of deposits and commercial papers, without compromisingthe liquidity.It is important because being a debt fund by definition, a liquid fund is required to pay dividend distribution tax (DDT), before distributing dividends to investors.

1. DDT –Dividend Distribution Tax

DDT is levied by the Indian Government on companies according to the dividend paid to company’s investors. As per tax provisions, income from dividend is free in hands of investors. Dividend from domestic company is tax exempt and dividend from foreign company is taxable in the hands of investors. This tax is paid out of the profits /reserves of the company declaring the dividend.

2. Taxation of Debt Funds Earlier and Now

The Finance Minister in Budget 2014 has proposed few changes in DDT on debt funds w.e.f. October’1st, 2014 for all the individuals and Hindu Undivided Family investors will attract an uniform DDT rate of 25%+ 10% surcharge+ 3% Cess. Accordingly DDT on dividend paid by debt funds will be 28.32% for retail individual investors from 22.072% that they paid earlier.

Fund houses pay DDT for dividend income distribution by debt funds which are tax free in the hands of investors. DDT on debt funds currently pay DDT of 25%+10%+3% cess on net basis when they distribute income to resident individuals. However the computation process is changed w.e.f October’1st, 2014, the fund house now require to pay DDT on gross basis which will hike the actual DDT payout. Fund houses and distributor are likely to promote growth plans of debt funds going forward after computation.

3. Impact of Sale on Debt Funds

Analysing the present scenario there is no point of opting for dividend payout option for an individual falling under   10% or 20% tax bracket to opt for the dividend option as it will entail paying higher tax. Though the investors in highest tax bracket of 30% can continue to be invested in dividend option as they pay 28.32% instead of 30.09%.

The investors will lose out to the extent of 6.26% (28.33% – 22.07%).This change of 6 percentage points in DDT will affect the inflow in all debt funds and will reduce the income of the mutual fund unit holder as the mutual fund will have to declare a lower dividend and the unit holders will now get lower income. Dividend payout option has become less attractive, an alternative option is to opt for growth options in the debt funds and fixed deposits which are more tax efficient. Mentioned below is the table that will help analysing the investment strategies for individuals falling under different income groups.


Tax Slab Slab Rate on investmentDDT on investment
Income from 2.5 lakh-5 lakh  
Interest received @10%10,00010,000
Rate of tax10.3% (1030)28.325% (2832.5)
Income 89707167.5
Income from 5 lakh-10 lakh  
Interest received @10%10,00010,000
Rate of tax20.6% (2060)28.325% (2832.5)
Income 79407167.5
Income above 10 lakh  
Interest received @10%10,00010,000
Rate of tax30.9% (3090)28.325% (2832.5)
Income 69107167.5


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