Prior to April 2020, mutual fund dividends were tax-free in the hands of investors i.e they didn’t have to pay income tax on the dividend income from their mutual fund investments. The fund house would deduct Dividend Distribution Tax (DDT) from the distributable surplus (profit) of the fund to calculate net distributable surplus. This amount was distributed in proportion to the units held in the fund by all those investors who had opted for dividend option.
Now, the the mutual funds don’t need to deduct DDT at the source, but the investor is liable to pay income tax on dividend from mutual funds as per his/her highest income tax slab. While in the DDT regime, a uniform tax rate impacted the investors who had opted for dividend option, now the impact of tax on dividend income will vary from investor to investor. An investor in the 30% income tax slab will see a higher dividend tax outgo compared to someone in a 20% tax slab.
Earlier, the growth option investor wasn’t impacted by DDT as the profits made by the fund were reinvested to grow the asset base of the fund. Thus, a growth scheme investor saw an increase in the NAV of his/her units while continuing to hold the same no. of units while a dividend option investor experienced a fall in NAV post the declaration of dividend.
With dividend distribution tax on mutual funds getting abolished, now both Growth and Dividend option will experience the same distributable surplus. Earlier, a part of this surplus was deducted at source for paying tax by the mutual fund that reduced the net distributable surplus available to the dividend option investors.
A dividend reinvest option allows investors to reinvest the dividend but earlier this reinvested dividend amount was lower than the NAV increase Growth option investors experienced because all dividends were declared only after deducting DDT. Now the choice between Growth and Dividend option will depend on your preference for long-term wealth creation vs. need for additional source of income in the present time.