MF News ‘Post LTCG tax, growth plans are better than dividend plans now’

‘Post LTCG tax, growth plans are better than dividend plans now’

Rajeev Thakkar, Chief Investment Officer, PPFAS Mutual Fund shares his views on reintroduction of LTCG tax.
Team Cafemutual Feb 9, 2018

Market fall – Why? LTCG tax or global macros?

Post an event happening, there are various reasons, which are put out. In fact, on the day of the budget the fall was not that much. The fall was more pronounced the next day and later.

All we know is that the valuations have been stretched for a while now and we are selling stocks where we do not have comfort in the valuations and buying stocks wherever the opportunity seems good. On a net basis we have cash and equivalents of approx 18% as on January 31, 2018.

Does the market become very attractive now post the fall?

While the media headlines may make it seem that a lot has changed, effectively the fall in stock prices has been moderate in most cases. In pockets of euphoria, valuations are still stretched. That does not mean that opportunities will not be there. It is just that a 5% to 10% fall after such a steep run up does not mean too much. At the same time the underlying businesses are not affected by the stock market gyrations and quality businesses will continue to do well.

What has changed?

A strong underpinning of the rally was the fact that interest rates were very low and money was gushing into stocks, bitcoins and what not. The days of close to free money in terms of interest rates may be coming to an end. Given that growth has picked up globally, unemployment rates are low, commodity prices have picked up and wage rates are growing in the US, inflation may make a comeback and there is no reason now for Europe or Japan to keep pumping in tens of billions of dollar equivalents into their markets. Bond yields the world over are reflecting this.

Long term capital gains tax

There is a way to evade this tax.... Shhhh.....(Don't let the taxman hear this!)

How? Simple. Do not sell your investments (unless you need the money, in which case you have to pay the tax, sorry).

Each round of musical chairs in terms of shifting stocks or mutual fund units will result in either a short term capital gains tax of 15% or long term capital gains tax of 10% if the holding period is more than a year. A tax efficient investment plan is to lower the portfolio churn.

Dividend plans

PPFAS does not have a dividend plan in its equity fund. Dividends are just paying you your own money. The fund's NAV immediately goes down to the extent of dividend. With the budget proposals, dividend option just does not make sense.

Say you invest Rs. 100 in a fund and the funds NAV goes up to Rs. 110 after a year.

If the fund pays you Rs.10 as dividends the net dividend to you after tax would be RS.9. In other words, tax on dividends will be Rs. 1. On the other hand if you redeem units in a growth plan of the same fund worth Rs.10, Rs.9.09 will be your principal amount (Rs.10/1.1) and only Rs.0.91 will be your capital gains on which you will pay a tax of Rs.0.09. That is right 9 paise in a growth plan vs Rs.1 in the dividend plan.

In a similar fashion, even in a debt fund if you let the money accumulate in the fund in a growth plan for 3 years, the tax post indexation will be minimal as compared to taking dividends.

In simple words

  • Growth plans are better than dividend plans now
  • Even if you need regular cash flows, opt for Systematic Withdrawal Plans (SWP) instead of Dividend Plans

Fund selection

Given the need to hold investments for long and in order to reduce churn, selecting a good multi cap fund would be the best in our view rather than trying to time various thematic funds or keep shuffling between large, mid and small cap funds. This is the need the Parag Parikh Long Term Value Fund seeks to address.

What are we doing?

At our end, nothing much has changed. We are focussed on reading annual reports, quarterly releases and in evaluating businesses. We continue to focus on bottom up stock investment rather than pay too much attention to macro events.


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1 Comment
Nakul Madhavji · 1 year ago
If you continue your example till the end when the customer redeems everything, the tax of Caoital Gain of 10% equates to the tax on Dividends of 10%.
Either option, he is sailing in the same boat.
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