Mutual Fund: Dividend vs Growth Option & its Taxation

Mutual Fund: Dividend vs Growth Option & its Taxation

 1,917 total views

Mutual Fund:

Dividend vs Growth Option & its Taxation

A mutual fund is an investment option wherein money is collected from various investors for investment in the securities like Shares, stocks, bonds & other money market instruments. It is operated by a team of experts with an aim to produce higher returns to match the investment objectives stated in its prospectus. Through mutual funds, small investors can invest in the various shares with better expertise & can indirectly hold different securities thereby mitigating risk with due diversification & timing. Mutual funds levy annual fees for their management & administration. A mutual fund unit represents investments in many different stocks (or other securities) instead of just one holding. The price of a mutual fund is referred to as the Net Asset Value (NAV) per unit. The value of the mutual fund company depends on the performance of its investments. Mutual fund units can typically be purchased or redeemed at the fund’s current NAV. The NAV of the mutual funds doesn’t fluctuate during market hours like shares but it is settled at the end of each trading day. With the drastic reduction in the interest rate of bank FDR, many taxpayers have switched to investment in mutual funds for getting higher returns. Income from mutual funds can be by way of Dividend or by way of appreciation in the value of the units.
Types of Mutual Funds
  1. Equity Mutual Funds:
Equity Mutual funds invest the amount in equity shares of the company. Depending upon the mandates of the mutual fund at the time of launching the scheme, it can invest the amount in Large cap, mid-cap or other sectors funds like banking, Infrastructure, IT, Pharma etc.
  1. Debt or Fixed-Income Mutual Funds
    Debt Mutual Funds invests the amount in instruments which ensures fixed income such as Government Bonds, Corporate Bonds, or other debt instruments. The idea is to generate interest income which it then passes on to the shareholders.
  2. Hybrid Mutual Funds:
    Hybrid Mutual Funds invest the amount in combination of equity and debts in some pre-decided ratio. The idea is to enjoy higher returns from equity and safe returns from the debt market.
Income from Mutual Fund:
Investors can choose between the dividend option or growth option. The choice ultimately depends upon your financial objectives.
  1. Dividend Option:
    In this option, profits made by the scheme are not reinvested in the scheme but distributed among the investors by way of dividends; on a quarterly, half-yearly or annual basis. The fund doesn’t guarantee with regards to the amount and frequency of dividend payment. It’s only when the scheme generates profits that the fund manager declares the dividend. Dividends are paid by redeeming equivalent units of the scheme.
  2. Growth Option:
    In this option, the profit is not paid by way of dividend but accumulated and forms part of the scheme via reinvestment. So, whenever the scheme makes a profit, its NAV rises automatically. The only way to get back the amount in such a case would be to sell the units of the scheme.
Which option is better?
The choice of option has to be based upon the individual requirements & personal financial goals. Dividend option works best when the market is at its peak. Dividend option ensures regular withdrawals of profit from the market. Growth option can be suitable for investors having a long-term investment horizon as it helps in accumulating the corpus for retirements & growth. The NAV of the dividend option of a mutual fund scheme might be different from that of a growth option. In general, the NAV of the growth option is higher than the dividend option.
Taxation of Income from Mutual Fund:
One of the key considerations which may be relevant in making the right mutual fund option is with regard to taxation of the mutual fund.
Taxation under Dividend Option:
It may be noted that the Dividend income has been made taxable and is taxable like any other regular income of the taxpayers. In the dividend option, the investor received a regular dividend and so it will be taxable like any other regular income. The tax rate may vary from 5% to 30% depending upon the other income of the taxpayers.
Taxation under Growth Option:
As far as the growth option is concerned, it may be noted that the investor is not receiving any regular income. The increase in the value of a unit (i.e., NAV) is not at all taxable as nothing is accrued in the hands of the investor. The tax incidence will arise only if the investor chose to encash the amount of the mutual fund. In such a scenario, the tax rate would depend upon the nature of mutual funds whether debt fund, equity fund or hybrid funds. It further depends upon the duration of investments which is relevant to determine whether the gain is Short-Term Capital Gain (STCG) or Long-Term Capital Gains (LTCG).
Holding period for Reckoning Long Term Vs. Short Term
Fund type
Holding Period for STCG
Holding Period for LTCG
Equity funds or Hybrid equity-oriented funds
Less than 12 months
12 months and more
Debt Fund or Hybrid debt-oriented funds
Less than 36 months
36 months and more
Taxation of income from Debt schemes or Hybrid Debt oriented Fund under Growth Option:
a) If invested in a debt fund for less than 3 years, returns are treated as STCG for taxation purposes. STCG is added to the income and taxed as regular income according to the applicable income tax slab.
b) If investment in a debt fund is for a period of more than three years, returns would be considered as LTCG. It will be taxable @ 20% with indexation benefit.
[International fund stocks abroad & Fund of funds are also treated as debt funds for the purpose of taxation].
Taxation of income from Equity schemes (EOMF) or Hybrid Equity oriented fund under Growth Option:
If a mutual fund scheme invests more than 65% of its fund in equity then such mutual fund scheme qualifies as equity oriented mutual fund (EOMF) or equity scheme for the purpose of taxation. Arbitrage funds are treated as equity schemes for the purpose of taxation.
If EOMF are sold within a year of its investment, returns would be treated as (STCG) & taxed at a special rate of 15% U/s 111A.
b) If EOMF is sold after a year of its investment, returns would be treated as LTCG. Any LTCG arising on equity mutual funds shall be taxable @ 10% if it exceeds Rs. 1 Lakh in a year. No indexation benefit is available on such investment. If any investment is done prior to 01.04.2018 but sold afterwards then appreciation till 31.01.2018 will remain tax-exempt due to grandfathering clause and only appreciation in value after 31.01.2018 will be taxable. Further, the NAV as on 31.01.2018 can be accessed at the website of Association of Mutual Funds in India’s (Amfi) website by clicking at  www.amfiindia.com/net-asset-value/nav-history
Above Taxation mode of the mutual fund is summarized in the chart as under:
Fund type
Short-term capital gains
Long-term capital gains
Equity funds or Hybrid equity-oriented funds
15% + cess + surcharge
Up to Rs 1 lakh a year is tax-exempt. Any gains above Rs 1 lakh are taxed at 10% + cess + surcharge
Debt Fund or Hybrid debt-oriented funds
Taxed at the investor’s income tax slab rate
20% + cess + surcharge
 [Readers may forward their feedback & queries at nareshjakhotia@gmail.com. Other articles & response to queries are available at www.theTAXtalk.com]

Leave a Comment

Your email address will not be published.

the taxtalk

online portal for tax news, update, judgment, article, circular, income tax, gst, notification Simplifying the tax and tax laws is the main motto of the team tax talk, solving