Mutual funds offer two options - growth and dividend. In growth option, there is no pay-out from the fund and gains from the investment portfolio remain in the NAV.
In the dividend option, there are periodic pay-outs at fund houses’ discretion. Apart from this pay-out, investors can redeem as and when they want at the prevailing NAV. Remember that the NAV declines to the extent of dividend paid in such an option.
In order to give more clarity to investors, SEBI has renamed dividend option in mutual funds. From April 1, 2021, dividend option is called as ‘Pay-out of Income Distribution cum capital withdrawal’ option.
Backdrop
The possible reason for this change of nomenclature is something that happened earlier. Dividend option in mutual funds were sold like a bonus. For instance, aggressive hybrid funds, erstwhile balanced funds were sold with a pitch of ‘1% dividend per month’ which was over and above NAV returns.
With the new name, hopefully, investors will not perceive dividends as something extra like bonus which is over and above NAV. The new name explicitly mentions that income is distributed after withdrawal of capital.
Implication
One aspect requires explanation as to how is it capital withdrawal?
Investors can redeem anytime and any appreciation that is there in the NAV i.e. not paid out by the AMC, is taken home by the investor, along with the principal invested earlier. This is simple and easy to understand.
Apart from this, even when the fund house is paying out dividend, there may be capital withdrawal. To understand this, let us take an example of a dividend option scheme which pays dividend half yearly. Let us say, the NAV when the last dividend paid was Rs 10. Subsequently, the market went up and the NAV went up to Rs 11. Then the AMC would distribute Re 0.80 and the NAV drops to Rs 10.2. Now, think of it this way that instead of being invested in the scheme for a long time, you invested just before the dividend distribution when the NAV was say Rs 10.9. in this case, while you get a dividend of 80 paisa per unit of NAV, only 10 paisa is NAV appreciation (Rs 11 minus Rs 10.9) and 70 paisa is your money coming back to you (Rs 10.9 minus Rs 10.2).
In the above example, the withdrawal is from principal and not capital appreciation. And since this is dividend, such an investor has to pay taxes on it.
Taxation-wise, there is no change. Dividend or income distribution remains taxable in the hands of the investor at the marginal slab rate of investors. Till 31 March 2020, there was a dividend distribution tax and receipts in the hands of the investor was tax-free.
Conclusion
Investors, distributors and advisors have to be aware of developments. While this change does not give any actionable point but you have to know what is going on. This is one of those developments.
Debtguru Joydeep Sen is a corporate trainer and author