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Amended as on Apr 1, 2023: Please note that as per amendments in Finance Bill 2023, from April 1, 2023, profits made on investments in debt mutual funds are now taxed as short-term capital gains if these funds invest <=35% in equities. This means, debt mutual funds are now taxed as per the income tax rates as per an individual’s income.

Also note that with effect from Apr 1, 2020, Dividend Distribution Tax (DDT) was abolished, and mutual fund dividends were made taxable in the hands of investors. Dividend income is now considered as ‘income from other sources’ and investors need to pay tax on it as per their individual tax slabs.

This article is currently in the process of getting updated, as it was originally written at a time when tax rules were different. Please treat this note as the latest updated tax information in the meanwhile.

The letter T stands for many things, one among them being tax. All the letters that are annexed to T when it stands for tax usually stand for different kinds of taxes. Two such instances are DDT and STT. Both these taxes are related to investing. Let’s understand these taxes and their implications for your investments.

About DDT

When a company announces dividends, it is liable to pay a tax on the amount that is paid as dividend. This tax is called the Dividend Distribution Tax (DDT). Investors can receive dividends from two types of companies: Domestic and Foreign. The tax situation for each of these is varies.

In the case of domestic companies, investors won’t have to pay any tax on the income they earn from the dividends that are announced by the domestic companies that they may have invested in.

On the other hand, if the investors who have invested in foreign companies then the dividends paid by the company will be taxable and the tax will have to be paid by the investors.

The dividend distribution tax is also applicable to mutual fund investments but since investments in domestic equities (i.e. Indian companies) are exempted from this tax, this applies only to debt mutual funds. So, when a debt fund declares a dividend, it deducts this tax and then makes the payout to investors. In other words, you receive the dividend after the deduction of DDT.

How much DDT?

In the case of individual investors, the mutual fund deducts DDT at 28.84%. This includes a surcharge of 12% and an education cess of 3%.

Let’s understand DDT with an example.

Rahul purchases 100 units of XYZ Debt Fund on 1 September at Rs 15. He selects the dividend payout option (dividends are declared and paid directly to the investors). During the year, the fund declares a dividend at 10% of the scheme’s face value of Rs 10 (i.e. dividend amount is Re 1 per unit). DDT is deducted from the dividend at the rate of 28.84%; that is, Rs 0.7116 is payable to Rahul after DDT {Re 1 minus Rs 0.2884 (Re 1 x 28.84%)}. The dividend due to Rahul is Rs 71.16 (Rs 0.7116 per unit x 100 units).

Impact

This tax only applies to investors who have chosen the dividend payout or dividend reinvestment option (dividends are declared but reinvested at the NAV of the fund after the declaration). In the case of investors who have chosen the growth option (dividends are not declared and remain invested in the fund) , DDT is not levied. Hence, if you have invested in a debt mutual fund but don’t need the dividend for your sustenance, it’s preferable to opt for the growth option.

Now that we understand about DDT, let’s move on to STT.

About STT

The securities transaction tax (STT) was introduced in India a few years ago to avoid tax evasion in case of capital gains. Earlier, many people avoided declaring their profits on the sale of stocks and avoided paying capital gains tax, so the government could only tax those profits, which were declared by people. So to fix this problem, the Finance Minister P Chidambaram in the Union Budget 2004-05 introduced this tax.

This tax levied on transactions made on the stock exchange (on equity and derivatives transactions) and in the case of investments in equity funds. It is levied on the value of the transaction and collected by the stock broker/mutual fund and deposited with the government.

If you take a look at your equity fund account statement, you will see STT levied on it.

Different kinds of transactions have different STT rates. Let us understand this better by referring to the table below:

This can further be refined to include details about the type of securities and the corresponding rates of taxation.

Let's understand STT with an example.

Rahul redeems 2443.86 units of his equity mutual fund on which STT is levied as follows:

When STT is levied on your equity investment, you are eligible to pay short-term capital gains tax at a lower rate of 15% (when you hold your equity investment for less than a year). STT does not provide any benefit on your long-term capital gains (when you hold your equity investment for more than a year) since long-term capital gains on equity are tax-free.
Note: The tax structure given above is as per current Income Tax laws and may change in the future.