Tax on dividend income from mutual funds: What to do?

Presently, dividends received on investment in equity funds are tax-free in the hand of the investor. The current Budget proposes to abolish dividend distribution tax (Presently paid by the AMCs) from April 2020 and accordingly the dividend received by mutual fund investors from April 1st 2020 will be taxed as below –

1. dividend received will be taxed as per the investor’s tax slab
2. dividend income above Rs. 5,000 will attract TDS at the rate of 10%

In the above scenario, what should an investor already invested through the dividend option do?

Investors falling in higher tax bracket should ideally shift from dividend to growth option. In the growth option, the taxation rates are fixed as against the proposed slab rate of taxation in the case dividend option. In equity funds, long term capital gains (for investment period of above 1 year) tax rate is 10% plus surcharge and cess, whereas for an investor in the tax slab of 30% will have to pay tax on dividend at the rate of 30% plus surcharge and cess. Also, as an investment option growth option is always better. In the growth option, the surplus generated remains within the scheme to generate capital appreciation over a period of time. In dividend option, the fund house distributes the surplus generated from the scheme to investors.

What if one needs regular cash flow / income, especially after retirement?

If an investor is looking for regular cash flow, a systematic withdrawal plan (SWP) can be a better option. An investor can withdraw a fixed amount every month or withdraw only the capital appreciation. As the income from SWPs from the growth option of the fund is redemption and not dividend, there is no tax issue. However, capital gains tax will be applicable on appreciation. Also, when the equity fund suffers sharp decline in net asset value the investor would then be withdrawing more from his capital and eventual getting less capital appreciation.


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