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ET Wealth Wisdom Ep 57 (ET Online)

DDT or no DDT, no one should have invested in MF dividend plans

04:56 Min | February 14, 2020, 2:14 PM IST
In this episode, we tell you about how the proposal to tax dividend income from mutual funds will impact you and why regardless of the changes announced in this Budget, dividend plans of equity funds were always a bad idea.
Transcript
Hosts: Tania Jaleel, Shambhavi Mehrotra
Producer: Paramveer Singh

Nirmala Sitharaman's Budget 2020 has had a few points that are still making it the talk of the town, even though it's been a good 2 week

We all know the big one.. the optional tax structure.. check out episode 56 of our Wealth Wisdom series to find out if you will actually benefit from the switching to the new tax regime

Another thing that many in the financial space have been talking about is the proposal to abolish the Dividend Distribution Tax or DDT and the shifting of equity and equity mutual funds' dividends to the investor's taxable income

Hi everyone, I am SM and I am TJ, and welcome to another episode of ET Wealth Wisdom. This week, we will tell you about how the proposal to tax dividend income from mutual funds will impact you and what should be your strategy now

Ok.. so Shambhavi.. break it down for us.. how does DDT work and how will the new arrangement work

Alright, listen carefully - In the DDT arrangement, tax is deducted by the company or mutual fund paying the dividends at a constant rate that is applicable to everyone. Due to this, small investors and retirees getting small amounts as dividends end up paying the same tax as rich individuals and businesses with much higher dividend incomes.

Under the new arrangement which comes into force on 1st April, there will be no deduction of tax by the payer. There is a deduction of TDS but like any other TDS, it is refundable if it's higher than your taxability. The net impact is that dividends get added to a taxpayer's income and effectively get taxed according to the tax bracket that the taxpayer comes under.

Now you might wonder, why are people miffed with this then?

Those not happy with this proposal are those heavily invested in dividend plans and who fall in the higher tax brackets. Up till now, they were paying DDT at 10% plus surcharge (effectively 11.648%). Now, those in the higher income tax slabs will have to pay that much more tax on dividends.

Dhirendra Kumar of Value Research, wrote in a recent column that these investors have been going at it the wrong way. DDT or no DDT, no one-absolutely no one-should have invested any money in the dividend plans of mutual funds, he writes. He does not end there… he says that instead of complaining about tax, just redeem your investments from dividend plans and shift to equivalent growth plans.

You know I can understand Kumar's sentiment.. I mean this is the dictionary definition of dividend: A sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves)."

So, when a company makes a profit, they bring some of it back in the business, and distribute the rest to shareholders as dividends. The management of the company has a choice in the matter. Plenty of companies distribute very little or no profits as dividends for a variety of reasons, writes Kumar.

So, why does Kumar say mutual fund dividend plans should be avoided?

Well, that is because the funda of dividends that applies to a company does not at all apply for mutual funds.

That is right. In a mutual fund, ALL the profits belong to investors, except for management expenses of up to about 3%, says Kumar. Whether the money comes to you as dividend or as withdrawal, there is no difference, except for the effect of taxation.

Confused? Here's an example: If your investment in the dividend plan of a mutual fund is worth Rs 1 lakh and then you get Rs 5,000 as dividend (without considering tax), then the worth of the investment will be reduced to Rs 95,000. Effectively, it's just a withdrawal of your money. It is NOT dividend as in company dividend.

Your choice of whether to invest in the dividend plan of a mutual fund or the growth plan should only be dictated by taxation, writes Kumar.

And basis this, you should have been in the growth plan even before this Budget, and the same after this Budget, opines Kumar. If you need regular income from your mutual fund investments, just withdraw the amount you need regularly. If you do that, you'll end up paying much less tax for the same amount, because the withdrawals will be subject to capital gains tax, not income tax.

Strong views.. but with logical reason and careful math.

And on that note, that will be all from us for this week. Come back next week for wealth wisdom

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