Strategies to avoid dividend distribution tax (DDT)

Shift to growth options

A mutual fund scheme comes with two options - dividend and growth. Under the dividend option, the fund house pays dividend according to the call of the fund manager, generally where there is sufficient appreciation in the assets. The net asset value of the fund comes down by a similar proportion as the payout post-dividend. In the growth option, the investor gets the total amount only at the time of redemption. Besides saving dividend tax, investors gain more from growth options due to the compounding effect (see table: Dividend Dilemma).

 

Worth noting here is that according to the new regulations by the Securities and Exchange Board of India (SEBI), dividends can only be declared from realised gains. Hence, pre-defining the frequency of declaring dividend in equity schemes is very difficult.

 

Dividend Dilemma              NAV            Amount       Year    Units    Growth    Dividend - Pre-dividend    Dividend - Post-dividend    Growth Plan    Dividend Plan    Dividend payout   0   1,000   10.00   10.00   10.00   10,000   10,000   —   1   1,000   11.00   11.00   10.50   11,000   10,500   500   2   1,000   12.10   11.55   11.05   12,100   11,050   500   3   1,000   13.31   12.16   11.66   13,310   11,655   500   4   1,000   14.64   12.82   12.32   14,641   12,321   500   5   1,000   16.11   13.55   13.05   16,105   13,053   500                               2,500                    Total    16,105    15,553

 

Opt for an SWP on your equity fund

If you are on the lookout for periodic payments, opt for a Systematic Withdrawal Plan (SWP). This allows you to withdraw money from your fund according to a pre-decided schedule, basically the reverse of a Systematic Investment Plan (SIP). Depending on your need for a monthly or quarterly income, an investor can choose a withdrawal pattern. Alternatively, one can even opt for withdrawal only on capital appreciation, thus protecting the capital amount.

If this appeals to you, opt for an SWP only after the first year of the investment, as most funds levy an exit load on redemptions before completion of a year. In the case of equity funds, it also saves on short-term capital gains tax.

 

Opt for an SWP on your MIP

Monthly Income Plans (MIPs) are a regular source of income for many investors, especially retired individuals who park a part of their retirement corpus in MIPs and receive dividend payouts frequently. As MIPs come under the debt fund category, the dividend would now be taxed as per an individual's income-tax slab. Investors in MIPs should also consider SWPs instead of dividends to save taxes on them. Again, opting for an SWP after a year of being invested helps in saving the exit load. We illustrate (see table: SWP and Dividend) how much one can save on tax by opting for an SWP on a growth option instead of an MIP with a dividend option.

 

SWP and Dividend

 

SWP Month    NAV    Units outstanding    Units Redeemed           Mar-10   10.00   1,000   -   NAV appreciation/month   90.91   Apr-10   11.00   909   90.91   Gains adjusted for exit load of Rs 10/month   80.91   May-10   12.1   826   82.64   Total income   6,000   Jun-10   13.31   751   75.13   Exit Load@1%   60   Jul-10   14.64   683   68.3   Taxable gain   485   Aug-10   16.11   621   62.09   #Tax@30%   146   Sep-10   17.72   564   56.45   Net income   5,794   Investment Rs 10,000; Monthly Withdrawal Rs 1,000; All fig except units in Rs; #We have taken the highest tax slab for calculating tax liability

 

Monthly Dividend      NAV                   Month    Pre-dividend    Ex-dividend    Dividend           Mar-10   10.00   10.00   –   Total income   6000   Apr-10   11.00   10.00   1,000   Exit Load   0   May-10   12.10   11.10   1,000   Tax   1800   Jun-10   13.31   12.31   1,000   Net Income   4200   Jul-10   14.64   13.64   1,000           Aug-10   16.11   15.11   1,000           Sep-10   17.72   16.72   1,000           Note: The table compares tax outgo on incomes from an MIP under SWP and dividend options in the first year