Over the past couple of years, many investors have poured money into dividend options of equity and hybrid funds to earn tax-free dividend. However the finance minister has announced a tax on dividends distributed to investors in mutual funds.
Starting April 1, the finance minister has proposed to introduce a tax on distributed income by equity-oriented mutual funds at the rate of 10%.
Till now, dividend in equity oriented mutual fund schemes — be it an ELSS fund, tax saving scheme, equity scheme, sector fund, balanced fund or equity savings fund — was tax free in the hands of the investor. Once the Budget is passed in parliament, from April 1, the fund house will deduct a 10% dividend distribution tax and pay the investor. So, if you were getting a dividend of Rs.1,000 per month from your mutual fund scheme, you may now get Rs.900 only.
Though the dividend received by an investor is tax exempt, the fund house or the AMC will have to pay a TDS of 10% to the government. This will reduce the cash surplus available for distribution and the dividend distributed will be lower.
Financial planners believe it will be tax efficient for investors to move to the growth plan of mutual funds in equity oriented schemes. If they were in the dividend option for cash flows, they could move to the growth option and opt for a systematic withdrawal plan. While dividend payment is controlled by the fund house and the fund could skip it in a particular month if it does not have distributable surplus or pay a higher amount which may be extra for the investor, SWP ensures a constant cash flow and can be controlled by the investor. He can specify the amount he wishes to withdraw every month and choose a date accordingly. Also growth option can be handy as long term capital gains up to Rs.1 lakh are tax free for investors.
While switching from dividend option to the growth option of the same scheme, investors need to keep a couple of things in mind. You need to see the exit load a fund house charges which varies from one fund house to another. While some fund houses charge an exit load if you switch, many do not charge for a switch in the same scheme. Also a switch is considered a sale transaction and if it is less than a year, you will have to pay short-term capital gains tax for the same which is equal to 15%.