You have figured out your asset allocation, you have zeroed down the funds that you want to buy. But at the time of filling the form, one question stumps you. Should it be growth or dividend? Basically, you are confronted with three options-growth, dividend payout, or dividend re-investment. Some also offer the bonus option.
In the dividend payout option, you are paid the dividend, and the NAV falls. In the dividend re-investment option, the dividend is not paid to you, but additional units are purchased at the revised NAV. The bonus option is similar to dividend re-investment, except that the fund announces the bonus ratio instead of dividend. In the growth option, the NAV simply keeps on growing, and whenever you redeem the units, you get your entire earnings by way of capital appreciation. In effect, the growth and bonus option result in exactly the same returns, except for the fact that bonus option is a way to defer your capital gains tax liability.
Except the dividend payout option, all the three options are the same. The only difference between them is their tax treatment. The rational choice is to choose an option where the tax liability is the lowest. Of course, the choice may be superseded by some specific requirements like the need for a regular income. All these options have been developed to make the most of India's ever-changing tax laws of yore.
As per the current tax laws, dividend income from an equity oriented fund is tax-free. The sale of such units will attract a short term capital gains tax of 10 per cent if held for less than one year, while the units are exempt from long term capital gains tax. In case of debt oriented funds, though dividend income is tax-free in the hands of the investors, such a dividend attracts a dividend distribution tax of 12.5 per cent (plus surcharge and cess), which is borne by investors. As regards the capital appreciation, such funds will be subject to a long-term capital gains tax of either 10 per cent without indexation, or 20 per cent with indexation, whichever is lower. The short term capital gain, if any, will be clubbed with the income of the individual investor, to be taxed as per the slab system.
Thus, an equity fund investor with a one-year-horizon can choose any option today. However, for a time horizon of less than a year, it is better to go for dividend payout or re-investment option as it reduces your tax liability. But debt funds are not so simple, as you have to balance out between the capital gains tax and the dividend distribution tax.
For a person whose total income falls below the minimum taxable limits, it is advisable to go for a growth or a bonus option. This will save the investor from dividend distribution tax and nor will he be subject to capital gains tax. If you are a tax payer and plan to hold a debt fund for less than one year and fall under the 10 per cent tax slab, then go for the growth option or the bonus option as this will save you from the 12.5 per cent dividend distribution tax, while your capital gains tax will be at the lower rate of 10 per cent. However, if you fall in a higher tax slab of 20 or 30 per cent, then it would make more sense to go for the dividend payout or re-investment option, which will save you more on the capital gains tax, even after factoring in the dividend distribution tax in most of the cases.
As regards the long term investment in a debt-oriented fund, it would be advisable to go for growth or bonus option. This is because the capital gains tax liability on such an investment cannot be more than 10 per cent and you will not shell out the 12.5 per cent dividend distribution tax.
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