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Dividend v growth scheme

FINANCE Minister, P. Chidambaram, had made some changes in last year's Union budget in the dividend distribution tax on debt oriented mutual fund schemes. Accordingly, the dividend distribution tax is now 12.5 per cent of the income distributed to unit holders who are individuals or HUF.

In the case of corporate unit holders, the rate was raised to 20 per cent. However, dividend from equity oriented mutual fund schemes remains exempt.

It has been clarified that equity linked mutual fund schemes also get the benefit of the new capital gains tax regime meant for pure equity shares. This was a major fillip for investors in equity linked mutual fund schemes as the tax on short term capital gains is only 10 per cent while long term capital gains are completely exempt.

Under the dividend plan of mutual fund schemes an investor has the option to receive the dividend or reinvest it in units.

The other option is the growth or cumulative scheme. In this case, there is no dividend declared. The appreciation in the corpus is reflected in the value of the NAV. The difference between the dividend reinvestment option and the growth option is that in the former case, the investor gets additional units depending on the dividend amount and the NAV of the scheme on the record date for the dividend. And the NAV is adjusted to the extent of the dividend declared per unit. In the growth option, there is no change in the number of units but the NAV value increases with the market value of the scheme's investments.

The choice between a dividend reinvestment option and a growth option is decided by the incidence of tax. In the case of equity funds, if the investor holds on to his investment for more than a year, the capital gain earned on sale of the units is a long-term gain and is completely tax-free. Dividends declared by equity mutual funds are also tax-free. Hence, deciding between dividend and growth in this case is not an issue. However, if equity mutual fund units are held for less than a year, any capital gain on their sale is a short-term gain and is taxable at 10 per cent. Here, it makes more sense to opt for the dividend plan.

As for debt funds, if the units are held for more than a year, the long term capital gain earned on sale is taxable at 10 per cent without indexation or 20 per cent with indexation. Dividends declared by debt funds attract a dividend distribution tax of 13.07 per cent in the case of individual investors and 20.91 per cent for corporate investors. If the investor needs some income he can opt for the dividend payout option. If he is looking for capital appreciation, it makes sense to opt for the growth option.

With the tax-free status accorded to dividends on equity funds, fund houses will not shy away from declaring dividends whenever the NAV appreciates reasonably. Likewise, in the case of debt funds, investors looking for a regular income stream should go for the dividend option.

S. Varadharajan

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