Time to rejig your mutual fund strategy: With dividend tax burden on investors now, here are options

As the changes proposed by Finance Minister Nirmala Sitharaman, in her budget speech earlier this year, come into effect, one major move is leaving investors troubled. Dividend, a payout by the company to its shareholders, was earlier taxed at the company’s end whereas investors were left unfazed. Now, under the new rules, the dividend is going to be taxed at the investor’s end. This makes it difficult for even mutual fund investors who have opted for the dividend plan, where investors receive a sum of asset value as dividend. With the dividend plan not looking very lucrative from an investors view point how should investors plan their mutual fund investments under the new tax scheme?

Dividend is your income now, and will be taxed as such

“Earlier it was the Asset Management Company (AMC) that deducted dividend tax and then gave it the investors, now what will happen is that most of the retail investors whose marginal tax is less than 15% will not be impacted but, tax liability will be higher for those whose marginal tax is more than 15%,” Omkeshwar Singh, Head Rank MF, Samco Securities told Financial Express Online.

Under the new regime dividend distribution tax (DDT) will be taxed on the investors end at the corresponding tax slab. “Effectively it’s an income for investors now so will be taxed at their income tax slab,” said Jitendra Solanki, a Sebi-registered investment adviser. Thus, dividends received from mutual funds will now be added to your income, milking more tax from wealthy individuals in the higher tax brackets.

Explaining what happens to investors below the Rs 5 lakh income bracket, Pankaj Mathpal, Certified Financial Planner and CEO, Optima Money Manager, said, “It’s the same as the dividend from debt funds added to the income. Whether short-term capital gain (STCG) or dividend both are added to income in case of debt funds.”

Alternative strategies

“One should consider Systematic Withdrawal Plan (SWP) rather than dividends for income generation,” said Jitendra Solanki. The other option available to investors is the growth plan where dividend payments are not made. Instead, money is again invested and an investor’s wealth compounds. With no change in how long-term capital gains are taxed, Rahul Jain, Head, Edelweiss, Wealth Management says it makes sense for investors to switch to growth plans.

“First they were not paying any tax now it could go up to as much as 30%, which is a lot, so people will move to the growth option for sure.” Jain’s views are seconded by Solanki, who says, “For higher tax slab, a shift to growth option is beneficial now. Since it will be counted as an income now they will have to pay tax at 30% now. Long term capital gains tax is lesser at 20% with indexation. Therefore, growth is a better option now. For lower tax slab, though dividend is better but, there is TDS (tax deducted at source) now which means that people will end up claiming refund every time. So, in order to avoid TDS also, the growth option is better.”

Experts across the board advise investors to switch to the growth plan keeping in mind tax efficiency.  While adding that mutual fund investment is for generation of wealth, Omkeshwar Singh said that the best option is for investors to invest in growth plans as tax on capital gains remains unchanged. “Whether it’s equity funds or debt oriented mutual funds growth option will be more efficient for mutual fund investors. MF investors can even switch from dividend to growth options of their existing schemes as well,” said Pankaj Mathpal.