Introduction of a 10% tax
Introduction of a 10% tax on income distributed by equity funds will pinch investors used to earning tax-free dividend. The dividend distribution tax (DDT) will hit those who have opted for the regular dividend option in equity funds. A systematic withdrawal plans (SWP) could be a suitable alternative now.
Over the past few years, many fund houses had been pushing the dividend option of equity-oriented balanced funds to investors as a safe way of earning assured monthly incom ..
This nudge to rely on dividend income from equity funds prone to market volatility put investors on the wrong path, say experts. The worry was that these funds would fail to pay dividends if markets soured, leaving investors in a spot. However, the introduction of a tax on dividend income will now effectively stop funds from resorting to such gimmicks. "This will put an end to the blatant mis-selling as these products were not being sold for the purpose for which they were created."
The biggest mistakes are made when something that embodies risk is presented as low-risk under the garb of regular tax-free dividends. "Mis-selling is aggravated when this equity product is offered to fixed deposit investors in the higher tax brackets with the lure that there is no TDS and dividend is tax-free. This will no longer be the case, "Expectations of regular income from an equity-oriented fund was not a desirable trend. The tax may take away the lure of dividend income to some extent."
Both growth and dividend option of equity schemes benefited from zero taxation earlier. This tax on dividends now makes the growth option preferable as investors can continue to claim exemption on capital gains up to Rs 1 lakh. Under the dividend option, any dividend paid by the scheme will attract the 10% tax, irrespective of the amount. The dividend will be deducted by the mutual funds itself and not taxed in the hands of the investor.
Instead of opting for dividends, the SWP route now becomes more relevant for fetching regular income from equity funds. SWPs guarantee a steady income and let investors customise the income according to their needs. On the other hand, dividends are at the discretion of the fund house and could fluctuate with the fund's performance. Initiating an SWP after a year from purchase of the equity fund will allow an investor to earn a guaranteed monthly income. Besides, a small investor may be able to avoid tax on his gains altogether if the long term capital gains accrued on the amount withdrawn under the SWP remains below the Rs 1 lakh threshold. "SWP is a superior option than dividend even without the tax levy on the latter. Under SWP, the investor can withdraw an amount matching his specific requirements, while dividend option leaves him at the whims of the fund company."
Apart from balanced funds, the tax on dividends will also impact arbitrage funds, where income generation is already on the lower side. Arbitrage funds provide returns similar to liquid or bond funds but entailed equity-like taxation. "We may see money moving out of arbitrage funds which were a hit in recent years due to tax advantages. However, arbitrage funds still remain a better alternative to to liquid funds. "Although yields from arbitrage funds will climb down, they will still deliver better post-tax return than liquid funds,".
The 10% tax on capital gains realised after one year of holding removes the earlier tax efficiency enjoyed by investors in equity mutual funds. This may come as a setback for those who have just started investing in equity funds. However, this vehicle remains the ideal option for long term wealth creation. "Equity still remains the lowest taxed investment vehicle and it will not impact the growing equity and SIP culture amongst retail investors."
Over the past few years, many fund houses had been pushing the dividend option of equity-oriented balanced funds to investors as a safe way of earning assured monthly incom ..
This nudge to rely on dividend income from equity funds prone to market volatility put investors on the wrong path, say experts. The worry was that these funds would fail to pay dividends if markets soured, leaving investors in a spot. However, the introduction of a tax on dividend income will now effectively stop funds from resorting to such gimmicks. "This will put an end to the blatant mis-selling as these products were not being sold for the purpose for which they were created."
The biggest mistakes are made when something that embodies risk is presented as low-risk under the garb of regular tax-free dividends. "Mis-selling is aggravated when this equity product is offered to fixed deposit investors in the higher tax brackets with the lure that there is no TDS and dividend is tax-free. This will no longer be the case, "Expectations of regular income from an equity-oriented fund was not a desirable trend. The tax may take away the lure of dividend income to some extent."
Both growth and dividend option of equity schemes benefited from zero taxation earlier. This tax on dividends now makes the growth option preferable as investors can continue to claim exemption on capital gains up to Rs 1 lakh. Under the dividend option, any dividend paid by the scheme will attract the 10% tax, irrespective of the amount. The dividend will be deducted by the mutual funds itself and not taxed in the hands of the investor.
Instead of opting for dividends, the SWP route now becomes more relevant for fetching regular income from equity funds. SWPs guarantee a steady income and let investors customise the income according to their needs. On the other hand, dividends are at the discretion of the fund house and could fluctuate with the fund's performance. Initiating an SWP after a year from purchase of the equity fund will allow an investor to earn a guaranteed monthly income. Besides, a small investor may be able to avoid tax on his gains altogether if the long term capital gains accrued on the amount withdrawn under the SWP remains below the Rs 1 lakh threshold. "SWP is a superior option than dividend even without the tax levy on the latter. Under SWP, the investor can withdraw an amount matching his specific requirements, while dividend option leaves him at the whims of the fund company."
Apart from balanced funds, the tax on dividends will also impact arbitrage funds, where income generation is already on the lower side. Arbitrage funds provide returns similar to liquid or bond funds but entailed equity-like taxation. "We may see money moving out of arbitrage funds which were a hit in recent years due to tax advantages. However, arbitrage funds still remain a better alternative to to liquid funds. "Although yields from arbitrage funds will climb down, they will still deliver better post-tax return than liquid funds,".
The 10% tax on capital gains realised after one year of holding removes the earlier tax efficiency enjoyed by investors in equity mutual funds. This may come as a setback for those who have just started investing in equity funds. However, this vehicle remains the ideal option for long term wealth creation. "Equity still remains the lowest taxed investment vehicle and it will not impact the growing equity and SIP culture amongst retail investors."
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