DDT on fund of funds may go

The Central Board of Direct Taxes (CBDT) is considering a proposal to remove an anomaly in the dividend distribution tax (DDT) prevalent in the mutual fund industry, by extending tax exemptions to "fund of funds" (FoFs) floated by mutual funds on a par with equity mutual fund schemes.

According to sources close to the development, equity mutual funds do not pay DDT. But since FoFs are treated as debt funds, they have to pay over 14 per cent DDT. This is despite the fact that FoFs invest mostly in equity-oriented schemes of other funds.

Bringing FoFs on a par with equity funds will also mean that capital gains tax is uniform for both the funds. Now, FoFs pay both short-term and long-term capital gains tax, whereas equity funds pay only short-term tax.

In the short-term capital gains tax for FoFs, the gains are added to the part of the income and then taxed according to the income bracket of the person. In the long-term, the taxation rate is 10 per cent without indexation and 20 per cent with indexation.

An FoF is an investment fund that uses an investment strategy of holding portfolios of other mutual funds, rather than investing directly in shares, bonds and other securities.

While on the one hand, the CBDT is considering tax exemptions for FoFs, on the other, the board is reviewing the withholding tax paid by Indian entities while making payments in the form of technical fees and royalty to foreign partners for using their services In India.

Indian entities also pay withholding tax while making interest payments on foreign currency-denominated borrowings to overseas entities. The review is being done with the objective of streamlining the withholding tax and the rates prevalent in various double taxation avoidance treaties (DTAA).

The prevalent withholding tax in India is usually 10 per cent, though the same prevalent in various treaties is between 15-20 per cent.