Earlier Bachhat had written about how one can
use ultra-short
term debt funds to maximize post tax returns. The article spoke about investing in dividend
reinvestment plan of such funds, since dividend are effectively taxed at lower
rate than short term capital gain rates and hence such funds are tax effective.
The tax
rates on debt mutual funds were revised earlier during this year and hence the said article
is not relevant in the current scenario.
Based on the revised tax rates, we have tried to analyse and tabulate
which type of option (growth or dividend) should be chosen for investment in
debt mutual funds.
Revised tax rates on debt fund
For an
individual investor, short term capital gains in a debt mutual fund is taxable at
tax slab under which such individual falls.
Long term capital gains are taxable @ 20% with indexation benefit and
10% without indexation benefit. Surcharge
@ 10% for taxable income of more than Rs. 1 crore and cess @ 4% shall apply
additionally.
For
dividend distributed, dividend distribution tax is applicable. Earlier there was difference in dividend
distribution tax rates between liquid / money market funds and other debt
funds. Now this difference has been
eliminated and now dividend distribution tax on all debt funds shall be 25%
(effective tax rate of 28.325% including surcharge and cess).
Growth or Dividend Option
One can
maximize his returns from debt funds by choosing the correct option which has
least tax implication. Things to be
considered before choosing a plan are:
- Time period for investment
- Tax bracket under which an individual falls
- Need for regular income
Based on
the above three criteria, the best option to choose from is as below:
When regular income is required
Since
dividend distribution tax rate (28.325%) is higher than the effective tax rate
for investors falling under 10% or 20% tax slab, it is beneficial for them to
opt for growth option in case they are looking for investment horizon of less
than 1 year and choose systematic withdrawal plan wherein a fixed amount shall
be redeemed and paid to the investor at periodic interval. SWP shall provide source of regular income to
them. However before opting for SWP under
growth option, one needs to check out for exit load and commence SWP only after
the exit load period.
For
individuals falling under 30% tax slab and in need of regular income, the tax
benefit between dividend and growth option is minimal with dividend option
slightly beneficial than the growth option.
For investment
horizon of more than 1 year, it is beneficial for all investors looking for
regular income to choose systematic withdrawal plan under the growth option.
When regular income is not required
For investors
not looking for regular income, growth option is best irrespective of investment
horizon. However, there can be marginal
tax benefit for investors falling under 30% tax slab by choosing dividend reinvestment
option for investment horizon of less than 1 year.
Bachhat’s take
By increasing the dividend distribution tax rate, the tax
advantage of dividend option which was available till late year has been
eliminated, save for investors falling under 30% tax slab. If an investor decides to invest in a debt
mutual fund, he needs to take into consideration above aspects to increase his
post-tax returns. However one needs to
keep in mind that the above analysis is relevant only till the tax rates are kept
constant. In case of any revision in tax
rates (which may happen at the earliest in 2014 budget), the above may not hold
true.
