AN EXPENSIVE DIVIDEND

Equity mutual funds just became less attractive with the dividend distribution tax

In the budget this year, Union finance minister Arun Jaitley announced that dividend income from equity and equity mutual fund schemes would henceforth attract dividend distribution tax (DDT) of 10 per cent. What does this mean for your existing mutual funds that pay a regular dividend? Does it call for a tweak in your overall investment strategy?

The dividend option of mutual funds has been popular with investors looking for a regular cash flow, especially from equity-oriented hybrid funds. However, as Radhika Gupta, CEO, Edelweiss Mutual Fund, says, “Equity Mutual Funds offering monthly dividend have become less attractive after the introduction of taxation on dividend income in the last budget.” What are your options then for existing and fresh investments?

EXISTING INVESTMENT If you have selected the dividend option in your existing investment or systematic investment plan (SIP), change over to the growth option. You can do this by submitting a written application to your fund house. For tax-saving schemes or equity-linked saving schemes (ELSS), you need to wait until the lockin period gets over.

However, you need to keep a few things in mind while considering the other investment option. The switch from one option to another is treated as redemption from one option and investment in the other option of the same scheme. It may, therefore, attract an exit load as well as shortterm capital gains tax if the period of your investment was less than 365 days.

NEW INVESTMENTS Experts advise exercising the growth option for fresh investments under the new tax regime. “The growth option is the best option in the post-equity Long Term Capital Gains (LTCG) tax scenario, particularly because of the 10 per cent DDT on dividends from equity,” says Rahul Parikh, CEO, Bajaj Capital. Not reinvesting this dividend in a similar instrument entails an opportunity cost, he adds. If reinvested and then held for more than a year, it again attracts LTCG tax on profit above a lakh.

If you need a regular cash flow from your investment, you may still consider the growth option. “Mutual funds offer facilities like the Systematic Withdrawal Plan or SWP, in which investors can opt for regular cash flow in the growth option depending on their individual requirements. In this option, capital gains up to Rs 1 lakh are exempt from tax,” says Gupta. The advantage of SWPs is that an investor can regulate the amount of cash flow in accordance with his needs, unlike the dividend option which relies on distributable surplus and prevailing market conditions.

All is not lost in the new tax regime. Some wise planning and you can still make handsome returns on your investment.