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Dividend Reinvestment v/s Growth � Let your taxes decide

Published on Fri, Jun 30, 2006 at 12:38 | Source : Moneycontrol.com

Updated at Mon, Jul 10, 2006 at 17:30

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Sandeep Shanbhag, Director, A N Shanbhag NR Group

Now, see how the capital gains work out. The sale value of 11818.182 units @ Rs. 11 is Rs. 1,30,000, the same as that of the Growth option. However, there is a difference as far as cost is concerned. The cost of the original units stands at Rs. 1,00,000. However, the cost of the additional units on account of the dividend reinvested is Rs. 20,000. The following table encapsulates this data.

Capital Gain calculation	No. of units	NAV (Rs.)	Amount
Capital Gain calculation	No. of units	NAV (Rs.)	(Rs.)
Sale value (10000+1818.182) x 11	11818.182	11	130,000
Less : Cost
Original units	10000	10	100,000
Units representing Dividend Reinvested	1818.182	11	20,000
			120,000
Long term capital gain			10,000
Tax Thereon @10%			1,000

The capital gain tax works out to Rs. 1,000 significantly lower than the Rs. 3,000 that we arrived at for the Growth option. This example considers an investment of Rs. 1,00,000 over one year. Higher outlays over longer periods of time will only amplify the advantage of the Dividend Reinvestment option. (Also read - How to profit from Mutual Funds?)

To sum up
So now we understand --- the battle of Dividend Reinvestment v/s Growth is decided only by the current tax policy. As of now, both are equal, there is no winner or loser. If tomorrow distribution tax is imposed, Growth will be the clear winner. If on the other hand, long-term capital gains tax is imposed, Growth can't touch Dividend Reinvestment.

Last Point
We have considered long-term capital gains tax. But what about short-term? Readers would know that even equity funds suffer a 10% tax on redemptions before one year. Under specific circumstances, this factor may come into play.

Notice in the above example, actually, the units representing dividend reinvested are sold within a day. I did not want to compromise simplicity for accuracy. Therefore, for ease of understanding and to keep things uncomplicated, I have used the long-term gains. However, in practical life, the short-term tax rate would apply.

To put it differently, consider an investment in the Dividend Reinvestment option with a five year horizon. Any dividends reinvested in the last year may be taxable as short-term capital gains if a period of 12 months doesn't elapse between the sale date and the date of reinvestment. Take care of this pitfall.

- Sandeep Shanbag

The writer is Director of A N Shanbhag NR Group, a Mumbai based tax and investment advisory firm. He may be contacted at sandeep.shanbhag@gmail.com

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