Mutual Fund plans come in two varieties – growth and dividend. The growth option gives returns in the form of rising values of mutual fund units. The dividend option gives returns by paying periodic dividends. There are many kinds of dividend plans – dividend payout, dividend reinvestment and dividend sweep. Dividend payout pays the dividend declared into your bank account. Dividend reinvestment, reinvests the dividend in the same fund that has declared the dividend. Dividend sweep invests the dividend in units of another mutual fund of the same fund house.
Do Dividends indicate Profits?
Mutual Fund dividends are very different from stock dividends. They are not an indicator of profitability. High dividends do not mean that the fund is doing very well or otherwise. When a dividend is declared, the NAV (Net Asset Value) of the mutual fund concerned falls by a corresponding amount. For example, if a mutual fund with NAV of Rs 20 declares a dividend of Rs 2 per unit, the NAV will fall to Rs 18 per unit.
Hence, you should not invest in a mutual fund because it pays high dividends.
When to declare a dividend is completely in the hands of the concerned mutual fund. You have no control over this. However you can control, when you want to sell your units and realise your capital gains. This is one major advantage of growth options of mutual funds which give capital gains compared to dividend options of mutual funds which give dividends.
The taxation of mutual fund growth plans vs mutual fund dividend plans is as follows.
Equity Funds Taxation – Growth vs Dividend Plans
Dividends of equity mutual funds attract dividend distribution tax at 10%. This is slightly less than the short-term gains tax which growth mutual funds attract at 15% (for holding periods less than 1 year). However it is the same as the long-term capital gains tax which growth mutual fund attract at 10%.
Debt Funds Taxation – Growth vs Dividend Plans
Dividends of debt mutual funds attract dividend distribution tax at 25%. Along with surcharge and cess, the total DDT reaches roughly 29%. This is very close to the highest slab rate for income tax in India at 30%. In case of capital gains, short term capital gains on non-equity funds (including debt funds) is paid at slab rate. Hence if you are a 30% slab investor, you will pay almost the same tax on growth and dividend options. However if you are a 10% or 20% slab investor, you will pay a lower tax on growth options of mutual funds. In case of long term capital gains tax on non-equity mutual funds, you pay 20% after indexation, regardless of your income tax slab. This is substantially lower than dividend distribution tax at 29%.
Tax Deduction – Growth vs Dividend Mutual Fund Plans
Also, unlike capital gains tax (short-term and long-term), dividend distribution tax (DDT) is deducted and paid by the concerned mutual fund. Hence the net dividend is not taxable in the investor’s hands. On the other hand, the capital gains tax is not deducted by mutual funds and the same has to be paid by the investor separately. Hence capital gains are taxable in the investor’s hands. The only exception of capital gains tax being deducted is for Non-Resident Individuals (NRIs).
You can find out more about mutual fund taxation here.
Summary – Mutual Fund Growth vs Mutual Fund Dividend Plans
Mutual Fund growth plans are better than mutual fund dividend plans for the following reasons
- Mutual Fund Dividends are not an indicator of profitability.
- Mutual Fund Dividends do not create value, they only distribute value.
- You cannot control the timing of when mutual fund dividends are declared.
- Mutual Fund Dividends attract higher tax than capital gains in mutual fund growth plans in several scenarios.