A mutual fund is a financial instrument which is a pool of money gathered from many investors to invest in securities like stocks, bonds, money market instruments and other assets. These funds are managed by professionals who are responsible for allocating the fund’s assets with the aim to generate returns for the fund’s investors. The portfolio is built around the investment objectives specified in its prospectus. Thus, an individual investor gets an access to professionally managed diversified funds at a low price. Investors share the gains or losses in proportion to their investments in the respective funds.
The value of the mutual fund company depends on the performance of the securities it buys. A mutual fund holds many different stocks so a share in a MF is known as Net Asset Value per share. When an investor wants to purchase or redeem a mutual fund unit, the transaction is carried out at its current NAV. Income from the mutual funds is either by of Dividend or by way of appreciation in the value of its units. Mutual funds are a preferred mode of investment for many because of their own unique advantages. Different investors like to invest in distinct types of funds as per their choice.
The taxability of your income will depend on which option you choose. The income from mutual fund along with the dividend and growth option are discussed in this article. The investor can choose either the dividend option or growth option depending on the financial objectives.
- Dividend option: The profits earned by a mutual fund are not reinvested in it but are distributed among the investors by way of dividends. Distribution of dividends could be made on a quarterly, half-yearly or annual basis. However, there is no guarantee as to the amount or the frequency of dividends. Dividends are paid by redeeming equivalent units of the scheme.
- Growth Option: Under this option, the profits are accumulated and reinvested in the scheme. They are not paid as dividends directly. It is reflected in its NAV whenever the scheme makes profit. Only by selling the units of the scheme, one can get the amount of dividend.
Taxation treatment-
- Taxation under the Dividend Option-Dividend income is liable to tax like regular income only. The amount of dividend shall be added to the other income of the taxpayer and shall be taxed at the applicable tax slab which could be from 5% to 30%.
- Taxation under Growth Option-Is should be noted that since the investor is not receiving any regular income, the increase in the value of a unit is not at all taxable. It becomes taxable only when it is encashed, depending on the type of mutual fund (debt fund, equity fund or hybrid fund) duration of holding the investment will decide its nature, short- or long-term capital gain. Under this option long-term capital gains over Rs.1 lakh on equity funds will be taxed at the rate of 10%. (An investment done prior to 1.04.2018 and sold afterwards, appreciation till 31.01.2018 will be tax exempt, appreciation in value thereafter will be taxable.) If they are sold within a year of its investment, the returns are treated as STCG and taxed at a special rate of 15%. In case of debt funds when the holding period is more than three years, the tax applicable is @ 20%.
Equity funds/Hybrid equity-oriented funds are liable for short term capital gains tax when held for less than 12 months but for long term capital gains when held for more 12 months and more. Debt fund or Hybrid-debt oriented funds are taxable as short-term capital gains when the holding period is less than 36 months (about 3 years) but charged to tax as per long term capital gains when the holding period is 36 months and more.
Which option should be preferred by the investor?
It depends on the individual goals while choosing either of the options. Dividend option is good in the times of bullish markets. As the NAV of a fund increases, the probability of it declaring dividends is more. Those who want to earn regular income can find this option better as it ensures regular withdrawals of profit from the market.
Under the growth scheme, the returns are reinvested, and they get compounded. This results in wealth generation. The investors who want to invest for a long time or accumulate corpus for retirements and growth may find them suitable. If you do not need regular income, you can opt for it.
The NAV of the dividend option of a mutual fund scheme might be different from that of a growth option. Usually, the growth option has a higher NAV than the dividend option.
Thus, the above discussion signifies the taxation part of the mutual fund income options along with the availability of income/compounding aspect in the hands of the investor.
Bhoi Smrutirekha Dharanidhar