Dividend is like a bonus or reward a company or fund house doles out to its shareholders or investors. It can be given in the form of liquid cash or benefits or even stocks.
Let’s not confuse dividends with interest or income. Dividend is a gesture of goodwill and it is up to the company or AMC to share a portion of the profit with its unitholders. Hence, there is no guarantee that they will continue to pay out. So, if the company is not doing well, don’t expect them to pay dividends out of their reserves. Interest and income from investments, on the other hand, are paid regularly whether the company makes profit or not.
2. How investors earn dividends
One reason why dividend option do not hold much favour is because the dividends make a dent in the net asset value of the fund. This is why it is often considered equivalent to unit redemptions.
For instance, if you own 100 shares with an NAV of Rs. 10 – and the dividend announced is Rs. 1 per unit, which is taken from the NAV. This will bring down the NAV value from Rs. 10 to Rs. 9. In this example, your dividend will Rs. 100. But the value of the mutual fund units drops to Rs. 900 from Rs. 1000.
3. Dividends in mutual funds
Many mutual funds generally give their investors two options – growth option or dividend option. It is important for you as an investor to understand that a steady dividend from a company is not the same as dividends from mutual funds. While the former reflects the profitable running of the company, the latter doesn’t benefit the investors in the same way. Let us see how.
Considering that distribution of dividends doesn’t fetch any additional gain to the investor, financial experts often encourage people to go for growth option, especially if they have a longer investment horizon and long-term financial goals. If this is so, you might be wondering why the need of a dividend. The main reason is that it encourages people with low-risk appetite and short-term goals to invest. This also brings down the risks associated with equity funds as profits are distributed regularly.
4. Tax implications
|ELSS||Equity Funds||Debt Funds||Company|
|Claim up to Rs. 1.5 lakh as deduction as allowed under Section 80C||Section 10(35) exempts dividend income from SEBI-approved schemes||Section 10(35) allows exemption of dividend income from SEBI-approved schemes||Section 10(34) exempts tax on dividend to individual/HUF by Indian companies|
|Dividend gained and reinvested in ELSS is exempt from taxation under 80C||Subject to DDT (Dividend Distribution Tax) paid by the fund house||The AMC must pay Dividend Distribution Tax to the government before distributing dividends to investors||Section 115BBDA levies 10% tax on dividend income from companies that exceeds Rs. 10 lakhs|
|Dividend given, but not reinvested, is not eligible for 80C deduction||10% LTCG if the capital gains exceed Rs.1 lakh in a financial year||Taxes to be imposed as per the tax slab rate||Section 115BBD makes dividend income from overseas companies as fully taxable under “Income from other sources” as per individual tax slab rate|
|3 year lock-in period is applicable – from the time you reinvest the dividend||Section 115-R imposes 10% DDT on equity fund house||Section 115-R mandates 28.84% DDT on debt funds and liquid funds. This includes surcharges and cess||Section 115-O levies 17.304% DDT on domestic companies. This includes 12% surcharge and 3% education cess|
5. Disadvantages of opting for dividend
Dividend plan vs growth plan is a debate as old as mutual fund itself and it is not expected to stop anytime soon. As mentioned above, it all depends on what you want out of your investment and your risk profile. So, if the dividend plan doesn’t address your investment goals, it can be disadvantageous as mentioned below.
In growth option, the tax rate ranges from 0 to 15% based on your tax slab rate and existing laws. For instance, if the capital gains is below 1 lakh, LTCG tax will be zero. However, in dividend option, the 10% tax is mandatory.
You may choose dividends to receive steady cash flow. But what if you do not require this money at the time? Then the investment value is being compromised, aside from paying taxes on dividends.
If you are confused whether to opt for growth plan or dividend plan, Cleartax can help you. Using our online calculators and other tools, you can assess your risk profile and investment horizon on our portal. Indeed, investing with Cleartax Invest is a quick and result-oriented way to invest in mutual funds.