Tax Amendments w.e.f 1st April 2020 render dividend options less lucrative

Background

Most investors opt for dividend options as a regular source of income. While this has never been the most optimal way to plan for cash flow requirements, the amendments announced in Budget 2020 eliminates all ambiguity.

Genesis

While most did not understand the real reason to what led to the popularity of dividend plans and simply continued to opt for dividend plans because everyone else was doing it, it all began with a favourable taxation policy.

Very Old Story

Till April’18, there was no Dividend Distribution Tax applicable on equity-oriented mutual funds while it continued to attract capital gains tax. Thus, opting for dividend would ensure that the amount received as dividend was practically equivalent to realising gains to a great extent without paying any tax on it.

Old Story

Come April’18 budget season, a Dividend Distribution Tax of 10% was introduced on equity-oriented mutual funds, payable by mutual funds but tax-free at the hands of investors. Capital gains continued to be the same for Short Term Capital Gains (STCG) at 15%, but there was a new introduction of Long-Term Capital Gains on equity-oriented products at the rate of 10% (on gains exceeding INR 1 Lakh in a financial year).

Now, DDT at 10% was still lower than the 15% tax on STCG. While in the longer term it was still prudent to withdraw instead of take dividend due to a variety of reasons (will get to that in a bit), most short-sighted investors continued to invest in dividend plans. There was some sanity among debt investors as the DDT on debt funds were ~25% and tax on capital gains were per applicable personal tax rate – hence, dividend plans in debt funds were not particularly popular to say the least.

Cut to Today

1 April 2020 onwards, DDT in all forms has been abolished. Dividends will be taxable at the hands of the investor at the applicable personal tax rate. Also, for dividends above INR 5,000, A TDS (Tax Deducted at Source) of 10% has been introduced.

Now, dividends are not lucrative from a taxability standpoint as well.

Now, what’s best for investors seeking periodic income?

Going ahead, a Systematic Withdrawal Plan is expected to be more tax efficient for investors. With dividends being taxed at personal tax rate and capital gains tax being at a lower flat rate, investors stand to benefit by choosing to pay the capital gains tax arising during the Systematic Withdrawal Plan instead of the Dividend Distribution Tax.

Here are a couple of more reasons which make SWP a better choice:

1. DDT is paid on the whole amount paid out as Dividend; Capital Gains Tax is paid out only on the gains component of the redeemed amount – while this translates to lower tax outflow, it also ensures there no tax if you’ve incurred an overall capital loss in a financial year.
2. SWPs are more flexible – start, stop, modify as you please. This gives you more control on ensuring your investments continue to be aligned with your goals & personal conditions.
3. SWPs ensure there’s certainty on the frequency, date and amount of cash flow receivable unlike dividends where it is per AMC discretion.

It is important that investors seek professional assistance on determining the ideal amount he/she should redeem through the Systematic Withdrawal Plan to ensure alignment with overall investment objective.

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