Mutual Return Options & their Tax Implications

An investor can receive returns at varying intervals. There are, however, tax implications for all the options available—growth, dividend or dividend reinvestment.

With a mutual fund an investor has the convenience of structuring his returns in a way that suits his requirement. The choice is between growth, dividend and dividend reinvestment options.

Growth option:

Returns are reinvested and no dividend is paid out. The aim is capital appreciation and compounding; suitable for investors with long-term goals. The impact of compounding on returns increases with the period of investment.

Dividend option:

Dividend is paid out, provided the fund has earned returns, either ad-hoc or at regular intervals; suitable for investors who need periodic cash inflow. Returns. Let’s say Rs 100 is invested in a growth option and dividend option of the same scheme. At 10 per cent, this grows to Rs 110 after a year in both the options. In the dividend option, at 5 per cent dividend, investor will get Rs 5.50 as dividend, and Rs 104.50 will remain invested. The next year, the growth option will give returns based on Rs 110 while the dividend option will return on Rs 104.50.

Dividend reinvestment option:

In this option, dividend is reinvested in the fund and the investor is allotted additional units. This option is good for long-term capital appreciation. Tax implications. Dividend from equity schemes is tax-free in the hands of the investor. However, there is short-term capital gains (STCG) tax of 11.33 per cent on growth option of equity schemes. Long-term capital gains (LTCG) from growth option or dividend option are tax-free. A debt scheme pays dividend distribution tax (DDT) of 14.20 per cent (28.32 per cent for a liquid fund) on the dividend given. This is an indirect charge on the investor. In the growth option of a debt fund, there is LTCG of 11.33 per cent if units are redeemed after one year, but there is no STCG. In a dividend reinvestment option, short-term investors in the 20 per cent and higher tax brackets pay no taxes. Others have to pay STCG at the marginal rate of taxation applicable to them.