Archive / Investment Adviser (Level 2) / Taxation of Debt Products
nism-series-xb-debt-mutual-fund-dividend-deduction[ INVESTMENT ADVISER (LEVEL 2) ]
Mr. A, resident in India, invested in a debt-oriented mutual fund and received dividend of Rs. 5,00,000. He paid interest of Rs. 1,50,000 on funds borrowed to make the investment. As per NISM Series X-B Chapter 10, what amount of this dividend is taxable in his hands?
[ A ]Rs. 4,00,000, since the deduction for interest expenditure is capped at 20% of the dividend income[ CORRECT ]
[ B ]Rs. 3,50,000, since the entire interest expenditure of Rs. 1,50,000 is allowed as a deduction
[ C ]Rs. 5,00,000, since no deduction for interest expenditure is allowed to a resident unit-holder
[ D ]Rs. 4,50,000, since the deduction allowed is capped at 10% of the dividend income
Takeaway
Option A is correct: a resident unit-holder can deduct interest expenditure incurred to earn mutual fund dividend income only up to 20% of the dividend received, so Rs. 1,00,000 is deductible, leaving Rs. 4,00,000 taxable.
Derivation
NISM X-B Section 10.3.3 permits a resident unit-holder to deduct interest expenditure against mutual fund dividend income, capped at 20% of total dividend income, with no other deductions allowed. Here 20% of Rs. 5,00,000 is Rs. 1,00,000, less than the actual Rs. 1,50,000 paid, so only Rs. 1,00,000 is deductible, leaving Rs. 4,00,000 taxable. A common error is deducting the full interest paid, or assuming no deduction applies at all (that stricter rule applies only to non-resident unit-holders).
Why the others fail
B — Rs. 3,50,000, since the entire interest expenditure of Rs. 1,50,000 is allowed as a deduction
The Income-tax Act caps the deductible interest expenditure against mutual fund dividend income at 20% of the dividend received; it does not allow deduction of the full interest actually paid.
C — Rs. 5,00,000, since no deduction for interest expenditure is allowed to a resident unit-holder
A resident unit-holder is specifically allowed to deduct interest expenditure incurred to earn the dividend, up to 20% of the dividend income; it is non-residents who are denied any such deduction.
D — Rs. 4,50,000, since the deduction allowed is capped at 10% of the dividend income
The cap on deductible interest expenditure against mutual fund dividend income is 20% of the dividend received, not 10%.