Insights

Should you go for the dividend option post budget?

July 19, 2014 . Vidya Bala

imagesIn our note on budget’s impact (FundsIndia Debt fund strategy post budget) we had mentioned that there is one more change that the budget has proposed in mutual funds. That is a change in the way dividend distribution tax (on debt mutual funds) is calculated.
The change will of course, result in high taxes going to the government’s kitty and will be effective October 1, 2014.
Note that equity funds do not suffer DDT.

At present, if a fund declared a dividend of say Rs 80, then DDT would be 28.3/10080 = 22.64. This would be deducted from your NAV. Now the budget has come with a formula that says Rs 80 is after tax. Hence the dividend or distributable surplus before tax is 80100/(100-28.3)=Rs 111.6. The DDT is therefore 111.6-80= Rs 31.6. Thus effectively, your DDT (which is deducted from NAV) goes up.

Of course, while the tax is not going to be paid by you directly, as has always been the practice it will be deducted from your NAV. Hence, to the extent you lose.

How do you ensure you don’t lose too much?

It is now apparent that those in the 10-20% tax bracket should opt for growth option to stay tax efficient, while those in the 30% tax bracket you may go for either the dividend or growth option.

This will be the case as long as your time frame is up to 3 years. For any period longer than that, it may make sense to simply go for growth option as you would enjoy indexation benefit.

6 thoughts on “Should you go for the dividend option post budget?

  1. Thank you for the information. I have invested in Principal Mutual Funds which gives tax benefit and I can check history of my NAVs and Dividend including funds on Equity, Debt, Balanced, and Liquid.

  2. Hi Vidya,

    I really love the way you keep up the blog and answer our questions.

    I belong to 30% tax bracket and income is less than 1 crore and fairly new to the Debt MF investments. My earlier investments were mostly in FMPs with tenure of more than 365 days, to enjoy indexation benefits 🙂

    I have two queries with regards to the changes in the calculation of tax for debt funds and want you expert suggestions on the same:
    1. In case of debt funds now that one can claim LTCG benefits only after 3 years. I was thinking of parking my excess funds with a good Liquid/Short term fund with dividend reinvestment option. My question is section 94(7) on dividend stripping applicable for debt mutual find also?
    (If yes, I would have to include the dividend earned also as part of my income. This will result in double taxation as I have already paid DDT for that amount. So I would be better off keeping the Debt fund for longer duration to evade section 94(7) and lessen my tax.)
    Please clarify.
    2. Is Bonus stripping a better option than the stripping which I believe there are no changes and one can hold the MF units for more than an year and adjust the losses with the gains for other MF units?

    Thanks in advance.

    Regards,
    Kiran

    1. Hi Kiran,

      Sorry about the delayed response.
      1. Dividend stripping is applicable for debt funds. Your understanding of the provision and its impact is right.
      2. Bonus stripping is something investors are resorting to now after change in LTCG laws.
      thanks

  3. Thank you for the information. I have invested in Principal Mutual Funds which gives tax benefit and I can check history of my NAVs and Dividend including funds on Equity, Debt, Balanced, and Liquid.

  4. Hi Vidya,

    I really love the way you keep up the blog and answer our questions.

    I belong to 30% tax bracket and income is less than 1 crore and fairly new to the Debt MF investments. My earlier investments were mostly in FMPs with tenure of more than 365 days, to enjoy indexation benefits 🙂

    I have two queries with regards to the changes in the calculation of tax for debt funds and want you expert suggestions on the same:
    1. In case of debt funds now that one can claim LTCG benefits only after 3 years. I was thinking of parking my excess funds with a good Liquid/Short term fund with dividend reinvestment option. My question is section 94(7) on dividend stripping applicable for debt mutual find also?
    (If yes, I would have to include the dividend earned also as part of my income. This will result in double taxation as I have already paid DDT for that amount. So I would be better off keeping the Debt fund for longer duration to evade section 94(7) and lessen my tax.)
    Please clarify.
    2. Is Bonus stripping a better option than the stripping which I believe there are no changes and one can hold the MF units for more than an year and adjust the losses with the gains for other MF units?

    Thanks in advance.

    Regards,
    Kiran

    1. Hi Kiran,

      Sorry about the delayed response.
      1. Dividend stripping is applicable for debt funds. Your understanding of the provision and its impact is right.
      2. Bonus stripping is something investors are resorting to now after change in LTCG laws.
      thanks

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