A dilution levy is an allocation of a fund's trading costs to the investments which have created those costs. It is used to protect the majority of investors from the costs of trading by a minority.
Without a dilution levy, these trading costs would be paid by the fund, which would disadvantage existing investors (as they are effectively paying someone elses trading costs).
It is not paid to any third party, but goes directly into the fund to be shared across all investors.
For example, if a new investment of £10,000 created £20 of trading costs for the fund, this £20 could be passed on explicitly as a dilution levy, meaning the total invested would be £9,980. The £20 dilution levy would then be paid into the fund, compensating it for the trading costs.
Not all funds apply dilution levies and funds often make no adjustment on the basis that investors' overall trading costs are generally similar, so sharing them between everyone is fair overall.
The amount also varies depending depends on the type of assets the fund invests in. For example, it will usually be higher for funds which invest in assets that are harder (and hence more expensive) to trade, such as small companies or property.
When funds do apply a dilution levy it is typically between 0% and 2% of the transaction.
An alternative approach used by some funds is to apply a "bid/offer spread".