Investing for dividends

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On Friday, Birla Sun Life will pay a dividend of ₹ 6 a unit on its Birla SL 95 Direct scheme. DSP BlackRock will pay dividend of ₹ 3.5 a unit on its DSP BR Opportunities Direct scheme on the same day.

During the dividend paying season, there are a couple of interesting trends, say those in the sector. One, since the dividend rate and pay out date is declared in advance, many investors enter the scheme a few days before to take advantage of the high dividend paid out. Two, some wait till the dividend is paid out, so that they get more units due to the falling net asset value (NAV).

Why would investors want to go through such an exercise?

The answer lies in investor psyche and some mis-selling as well. Investors believe getting into a scheme with an NAV of ₹ 94 is cheaper than getting into a scheme with an NAV of 100 –the old- fashioned ' invest in a new fund offer vis-a-vis an existing scheme' sales pitch because new fund offers seem cheaper. When the fund house pays dividends, you are simply getting back part of your investment. If the NAV of the scheme was ₹ 100 and the scheme paid ₹ 6 as dividend, the NAV falls to that extent, to ₹ 94.

However, some tax advantage does exist when investing in an equity linked savings scheme (ELSS) a few days before the dividend declaration. Since the investment gets locked into an ELSS for three years, getting back part of the investment means you invest less for higher tax benefit. That is, if you invest ₹ 1 lakh and receive a dividend of ₹ 20,000, the entire investment of ₹ 1 lakh qualifies for tax benefits, though in reality, after the tax- free dividend pay out, only ₹ 80,000 has been invested. In other words, there are two benefits: Rs 20,000 tax- free dividend and tax benefit of ₹ 1 lakh under Section 80 C.

This anomaly has crept in despite the tax department's tough laws on dividend stripping a few years earlier. In the past, investors used to put money a few days before the dividend was declared and get two kinds of benefits.

One - Tax free dividend income. In addition, they would sell the units of the scheme after receiving the dividend and declare a capital loss.

The tax department has plugged this loop hole by disallowing tax benefits if the units are sold immediately. But in case of ELSS, there is a small anomaly that still exists. This anomaly is likely to go away once the Direct Taxes Code comes into effect. The latter does not include ELSS as a tax saving instrument under Section 80C.

However, most financial planners don't advise using such strategies for tax benefits because the amount saved, often, isn't very substantial. Also, such strategies divert the attention from well performing funds to good dividend paying ones. Market players say many entities advertise high- dividend pay outs even if the scheme has not done well, to attract money during this season. For retail investors, the strategy should be to focus on well performing funds.

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