Here's the plan...take your pick

The new capital gains tax regime is in place but this has raised a very important question for investors. The question is whether there is any difference that remains while choosing a particular plan among mutual fund schemes. There are three plans available for most of the mutual fund schemes present in the market.

These are dividend, growth and dividend reinvestment. While answering this question, one has to look at different categories of schemes and their individual characteristics to understand the implication of the final option chosen.

First, let's take a look at the situation for equity-oriented funds. Investors who opt for the dividend scheme in equity-oriented funds will be witnessing gains in two ways. The first is the return that comes through the payment of dividend. Dividend received by the unit holders is exempt from tax in their hands and hence, this receipt will not be included as income for them.

At the same time, mutual funds do not give out the entire amount of their gains as dividend and hence, investors would be faced with a possible question of capital gain too on this investment. In case the units are held for a period of more than one year, then even the gain, which is booked would be tax-free in their hands.

On the other hand, if the gains are booked before the end of one year, then the gain would be taxed at a rate of 10% for the individual. In this scenario, long-term investors are likely to witness that virtually their entire gains are tax-free.

On the other hand, consider a growth plan of the same equity-oriented scheme. In this case, whenever there is a gain, there will be no question of any dividend payout.
However, all the capital gains would have the same tax effect as seen earlier. In this case, too, the gains booked after a period of one year will be tax-free in the hands of the investor while those booked before a year will be taxed at 10%.

After looking at this situation, it can be witnessed that the position is virtually similar for the investor once a year has passed, as all gains will be tax-free. The only difference could arise when the fund pays a dividend before one year, as in the case of a dividend plan, it would be tax-free while a similar amount booked as capital gain in a growth plan before a year would be taxed at 10%.

Thus, for equity-oriented schemes which includes equity-diversified schemes, sectoral schemes, tax saving schemes, index schemes and balanced schemes, a major difference is removed for the two categories of options available.

 

Now, consider the dividend reinvestment option also available for investors. What happens in such a plan is that the dividend declared by the fund is not paid out to the investors but units equal to the value of the dividend are added to the holding of the investor.

In this case, the dividend declared and reinvested is tax-free in the hands of the investor and hence, there is no question of tax on that amount. The only complication that would arise relates to the calculation of capital gains in this plan as there would be different dates for that particular unit to qualify for long-term capital gains benefit as the units have been allotted at different points, depending upon when the dividend was declared.

Moving on to debt-oriented schemes and the difference starts becoming evident. In a dividend option, the investor is more likely to get a major part of the gains recorded through the dividend route and the amount when received , on this front, will be tax-free in their hands.

One has to note that there is a dividend distribution tax that the mutual fund has to pay when dividend is declared but, for investors, the entire amount that they receive is tax-free in their hands. In case there are any capital gains, then the old rates as discussed below apply.

In case of a growth plan for debt-oriented funds, there can be gains only in the form of capital gains.

In such a situation, when a unit is sold before a period of one year, then the gains would be taxed at the highest rates applicable to the individual because the gain is added to the income of the individual and then taxed at the applicable rate.

On the other hand, if there is long-term capital gain when units are held for a year or more, then the applicable rate for the individual would be 10% without the benefit of indexation or 20% with the benefit of indexation. Thus, in this case, there is some amount of tax to be paid.

As one can see, there still is a difference when it comes to debt-oriented schemes as investors would be better off to invest in dividend plans because the gains, if any, would be liable to a lower tax .