How are dividends from mutual funds different from the interest payouts on fixed deposits from a bank?
They both look the same but there is a difference when it comes to their taxation. The interest that you earn on your deposits gets added to your income and taxed at whatever slab is applicable to you. If your taxable income is up to Rs 5 lakh, it gets tax-free. Otherwise, you fall within the slab of 20 or 30 per cent.
When you get the dividend from a debt mutual fund, it is subject to a Dividend Distribution Tax (DDT) of about 29 per cent, which is deducted by the fund company. So, if there is a dividend of Rs 100, you effectively get only Rs 71, while Rs 29 goes towards DDT. Alternatively, if you choose the growth plan, you are liable for taxation only when you sell them. Only the gain component is taxed. If the holding period is more than three years, it is taxed at 20 per cent after adjusting for inflation. Otherwise, it gets added to your income. So, they are more tax-efficient.
The other big difference lies in the fundamental characters of two investments. In a deposit, you exactly know how much you will get. But in the case of a mutual fund, you don't know exactly how much you will get. It is subject to all kinds of market risk, credit risk and everything of that sort. However, over a long period of time, you eventually end up getting little more in mutual funds.