By Sheetal Jhaveri
Businessman Bipin Zaveri, 73, opted for a dividend payout -- because his friend chose it. Was he right in doing that? No, he wasn't. Zaveri should select investment schemes and funds based on his goals and the time-frame he has in mind.
He wants to save for his grandchild’s higher education. He plans to gift him this sum once he completes school, which is eight years down the line.
So, it is obvious that Zaveri wants to build capital. To save this amount, he needs to select the right fund, and that means keeping two salient points in mind:
(i) Financial needs and goals
(ii) Time frame
Also, don't forget taxation.
How taxation matters
Let's explore the tax impact on debt and equity funds separately.
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3 options within a fund:
1. Growth fund: No dividend is declared under this option. The value of the investments will change with the increase or decrease in the NAV.
2. Dividend payout: When the fund has surplus money dividend is declared to investors. This dividend is tax free in the hands of the investor.
3. Dividend reinvestment: The dividend declared to the investors is reinvested (instead of payment) at the prevailing Net Asset Value (NAV). There is no entry load for dividend reinvestment. |
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I. Debt funds
Tax on dividend payout and reinvestments option: Debt funds fall under a tax called Dividend Distribution Tax (DDT).
This tax varies for different categories of debt funds; for instance, it is 14.2% for income funds and 28.3% on liquid funds. This is a tax that the mutual funds have to pay when they declare dividend.
Dividend refers to surplus funds, which the fund houses distribute to the investor. It is only after paying this tax that the fund house can distribute the remaining surplus as dividends to all its unit holders.
Tax on growth option: In growth option of debt funds you pay short-term and long-term capital gain tax. Short-term (where units are held for less than 12 months) capital gain is taxable at the slab rates applicable to individuals. Long-term (where units are held for more than 12 months) capital gain is chargeable at 10% without indexation and 20% with indexation.
What you should do
Scenario 1: You are in the higher tax brackets of 20 or 30%.
- If you are investing for less than one year, stick to the dividend option.
- If you are investing for more than one year you opt for growth option unless you need regular income.
Scenario 2: You are in the 10% tax bracket
- You select the option based on your goal so as to accumulate capital or regular income.
Tip: You might argue for dividend reinvestment stating that capital will be ploughed back in the fund but always remember that DDT will be deducted before it gets reinvested.
II. Equity funds
These have no DDT for dividend option. Hence dividend in literal sense is tax free in the hands of investor.
In the growth option, if an investor has booked a short-term capital gain then he ends up paying 16.99%, which is almost 17% as short-term capital gain tax (15% short-term capital gain tax plus 2% Education cess plus 1% Higher Secondary Cess plus 10% surcharge). If the investor books a long-term gain then as per current tax laws he pays no tax as there is no Long Term Capital Gain Tax.
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The author, Sheetal Jhaveri is a financial consultant. She can be reached at dhanplanner@rediffmail.com
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