Dividends are payments made by a company to owners of its stock. They are a way for companies to distribute revenue back to investors. This payment is generally made out of profits made during a particular year.
A mutual fund scheme can declare a dividend for its unitholders from realised profits in its portfolio.
Why you must look for dividend yielding stocks
Current tax regime
Dividend Distribution Tax (DDT) is paid by entities that distribute dividend.
Equity mutual funds pay a DDT of 11.65% and debt mutual funds, 29.12% (including surcharge and cess).
Indian companies distributing dividends are liable to pay DDT at 15%; once surcharge and cess are taken into account, the effective rate of DDT is 20.56%. (source)
Indian companies have to pay DDT tax even if the company is not liable to pay any tax on its income. DDT is applicable whether it is paid out of current or accumulated profits.
Once DDT is deducted, the dividend is tax free in the hands of the investor.
Why this investor does not care for dividend paying stocks
Going ahead…
DDT has been abolished from that end and now will be taxed in the hands of the investor.
In Budget 2020, it has been proposed to levy DDT in the hands of the investors as per their applicable tax rate.
So, if the investor falls in the 30% tax bracket, s/he will pay tax on the dividend at a 30% rate. Those in tax slabs below 20% will pay lesser tax.
7 rules for smart dividend investing
Impact on investor
The new tax treatment increases the tax burden on investors in the higher tax brackets. They are bow better off taking their returns as capital gains rather than dividends.
Equity: Long term capital gains tax (LTCG) is 10%, above a tax-free capital gains exemption of ₹1 lakh per financial year. Short term capital gains tax (STCG) is 15%.
Debt: LTCG is 20% (after indexation). STCG is added to the relevant tax slab of the investor.
It would be wise to switch from your dividend options to growth options to save DDT outgo. If you need the cash flow, consider a systematic withdrawal plan, or SWP.
Senior citizens or investors whose income is not subject to tax could continue to remain in the dividend plans. But do note, that TDS deduction is applicable for dividend paid in excess of Rs 5,000 a year. So if your income is not subject to tax, you will have to ask for a refund.
It goes without saying, that filing of returns will now be that much more cumbersome.
Some data points, as of December 2019
- Rs 3.09 lakh crore of assets of the mutual fund industry (of a total of Rs 23.29 lakh crore) have been invested in dividend plans.
- Only 13% of the total mutual fund AUM is held under the dividend option.
- Category wise, only 11% of equity AUM is held under the dividend option. Rest of the money is in the growth option.
- Only 5% of the fixed income AUM and 10% of money market assets are invested in dividend option.
- The quantum is higher in the hybrid fund category with a total of Rs 1.31 lakh crore (of Rs 3.74 lakh crore) or 35% of the assets in the dividend plan.
