Mutual funds and investors would love it, but the banking industry would cry foul the government is actively considering a Budget proposal to exempt debt mutual funds from having to pay dividend distribution tax (DDT) of nearly 14%, including education cess and surcharge.

The rationale behind the move is as follows: equity mutual funds are alredy exempt from DDT and creating a level playing field for debt mutual funds would increase retail participation in the debt market.

Companies pay about 23% as DDT. Since mutual funds are collective investment vehicles, the income they receive from their investment in equities, it was felt, should pass through to investors without attracting tax at the level of the investment vehicle, so as not to discourage people from investing in equities through mutual funds.

Levelling the playing field for debt mutual funds by removing DDT on them would certainly make them more attractive for savers. Income from a fixed deposit with a bank is not tax-free, whereas the same money invested in a debt MF would yield at least the same rate of return and be wholly tax-free, if the proposal goes through.

If DDT on debt mutual funds is removed, it will attract retail investors who currently park their funds as fixed deposits in banks," said an industry expert.

According to data provided by ValueResearch, as on November 30, AUM in equity-oriented mutual funds, which includes equity and hybrid equity mutual funds is Rs 1,14,986 crore.

In comparison, Rs 2,27,558 crore is the AUM in those MFs which are not exempted from DDT. These include balanced equity mutual funds, which have less than 65% of their assets under management (AUM) in equity. DDT is also applicable to capital protection funds, which predominantly invest in debt.

Income from mutual funds falls under two categories dividends and capital gains. As per existing tax provisions, dividend income from equity-based mutual funds is tax-free in the hands of the investor.