There is one reform that P. Chidambaram initiated in 1997 that still remains somewhat incomplete. Those who came after him, and he himself after returning as FM, have tried their hand at this little but elusive piece. They continue to experiment, though. The reform in question is the taxability of mutual fund dividend. Strangely, something as innocuous as this has remained contentious. Mutual funds are now getting used to anticipating a change every year.

When the FM announced in February 1997, that he had decided to exempt dividends from taxation, and impose a dividend distribution tax instead, there was jubilation. When Yashwant Sinha reviewed the provision in the backdrop of the crisis in UTI, he went on to bring the first complication. He extended the exemption to mutual fund dividends, and imposed a 10 per cent dividend distribution tax (DDT). But in a clear move that was intended to help the UTI, he exempted all open-ended mutual funds with more than 50 per cent in equity, from paying the DDT. The definition was to suit the crisis-ridden US64. But the unintended consequence of this provision was that it opened a good tax arbitrage situation for debt funds, that created a new and large segment of corporate investors in mutual funds.

To a corporate investor paying 35 per cent on interest income, the debt fund became a good ‘pass through’ vehicle. By 2000, banks began to cry hoarse, as they were losing customers to debt funds, and the minister increased the DDT to 20 per cent. Then in 2001, he went back, true to the ‘roll-back’ tradition, and reduced the DDT again to 10 per cent, this time in response to the technology led crisis and the need to bring the small investor back to the markets. In February 2002, the minister ‘troubled by the issues over the past four years’ decided to do away with tax exemptions for mutual fund dividends, and made them all taxable. The story thus kept changing every year, as you can see in the table alongside, with more tweaks and turns to the definition of which kind of fund should pay DDT and who should pay at what rates.

... contd.