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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

 

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