Prajna Capital - An Investment Guide

From a tax point of view, taking a dividend reinvestment option is no different from receiving the dividend in you bank account and then making a fresh investment of the same amount. The dividend received will be taxed like any other dividend ( Dividend Distribution Tax or DDT ) and resulting purchase of fresh units will be treated like any other fresh capital investment. Any capital gains that you realise when you sell will be treated as long-term or short-term depending on the period of investment. Therefore, what you refer to as principal amount is not a single principal amount but a separate principal amount for each individual dividend reinvestment. Each one of these individual investments will therefore become long-term on a separate date 365 days after it was invested. This is a basic principle that is applicable to all types of funds. In the liquid fund case, there will definitely be a tax liability on the capital appreciation on the principal amount at the time of redemption...

Tax treatment of returns from Monthly Income Plans ( MIPs ) depends on the way you derive them. If you opt for dividend plan, then like all debt funds, MIPs are liable for Dividend Distribution Tax ( DDT ) which is 12.5 per cent for debt funds. If you choose the growth plan, all gains will be treated as short-term or long-term depending on your period of holding. Any short-term gain (less than 1-year holding) from debt funds is added to your income. Long-term gain from MIPs is taxed at 10 per cent without indexation or 20 per cent with indexation, whichever is lower. Deriving gain from an MIPs Growth option through Systematic Withdrawal Plan ( SWP ) could be more tax efficient than dividend plan. SWP is redemption of units worth predefined amount and periodicity. Besides, you will also have a greater control on your cash inflows.