Tax authorities were demanding AMCs to pay tax on redemptions and on issue of bonus units.

In a relief to fund houses and investors, the Central Board of Direct Taxes (CBDT) has clarified that AMCs won’t have to pay any tax on redemptions and on issue of bonus units.

Tax authorities were demanding AMCs to pay additional income tax under sub-section (2) to section 115R of the Income Tax Act on payment made to investors at the time of redemptions and issue of bonus units to investors.
"Mutual funds have to pay tax before declaring dividends. The tax authorities went a step further and asked some AMCs to pay tax before paying redemption proceeds to investors. Similarly, in the case of bonus units, bonus is converted as income and issued to investors. The CBDT had asked AMCs to pay tax on bonus units also. The industry had made a representation to CBDT on the same," said Jimmy Patel, CEO, Quantum Mutual Fund.

“Sub-section (2) of section 115R of the Act provides that any amount of income distributed by (i) a specified company or (ii) a mutual fund to its unit holders shall be chargeable to tax and such entities shall be liable to pay additional tax on such distributed income at the rates prescribed therein. The income so distributed by such entities is the dividend paid to unit holders and is liable to tax under this section. However, redemption of units would not attract levy of tax under sub section (2) to section 115R of the Act as such income is not of the nature of ‘income distributed’ to unit holders and hence lies outside the purview of this section,” said a CBDT circular issued on February 11.

CBDT clarified that issue of bonus units is akin to distribution of income by way of dividend and is hence exempted from paying any additional income tax.

Bonus units are issued to existing unit holders as a way to reward them. Unlike dividends where investors get money, bonus units result in additional units being created in the fund. Not many fund houses give bonus units to investors any more.

In another case, Central Board of Direct Taxes (CBDT) had earlier asked some AMCs to cough up income tax for investment made in pass through certificates (PTC) in year 2008-2009