Back to Basics. What investors should know about IDCW in mutual funds

The dividend plans of mutual funds (MFs) have a new variant in recent times. The term IDCW is bandied about generally. That is because regulator SEBI came out with a circular stating that, from April 2021 onwards, fund houses should use the term Income Distribution Cum Withdrawal (IDCW), instead of Dividend. Is this mode of dividend payment any different from the usual way? Here’s what you must know about how IDCW works and the tax implications therein.

How it works

IDCW works to clarify the principle of distributing income (gains made on the scheme NAV), which is, of course, deducted from the NAV. Here, an Equalisation Reserve account is maintained to park the gains made in a fund, a portion of which can be used to pay dividends to investors. The dividend can be paid daily, weekly, monthly, quarterly, or yearly. However, the amount of dividend and the frequency of payment are completely at the discretion of the fund manager and fund house. One needs to understand that the dividends of mutual funds don’t work the way they do for stock dividends. A company’s dividend payment may or may not have an impact on its stock price. However, when a mutual fund pays out dividend, the NAV of the mutual fund will be reduced by the extent of dividends paid.

For instance, let’s assume you have invested in the IDCW option of Kotak Bluechip Fund regular plan. You might have seen that after the dividend of ₹1.55 was declared on March 25, 2021, the NAV of the plan was reduced from 18.38 to 16.83 ex-dividend. Hence, the dividend received here is not the profit over and above the capital gain, but it is ultimately withdrawn from investor’s capital. Due to this reason, SEBI changed the term dividend option to IDCW to give investors more clarity while the other things remain the same.

Taxation of dividends

Under the IDCW option, investors are broadly offered two sub-options — payout and reinvestment. If you choose the payout option, the dividend amount will be transferred to your bank account while under reinvestment option, the IDCW amount declared will be used to purchase additional units. Despite the differences in both options, the tax treatment remains the same. So, under the IDCW reinvestment option, even though you don’t receive the dividend amount in your bank account, you are supposed to pay the same tax as would occur under the payout option. The IDCW amount is added to your income and taxed at your slab rate. Also, do note that IDCW in excess of ₹5,000 is subject to TDS (Tax Deducted at Source) at the rate of 7.5 per cent.

Switching between options

Switching from growth plan to IDCW or vice versa for the same scheme would attract long-term or short-term capital gains tax, as the process would involve the redemption of, say, the IDCW plan and fresh purchase of units of, say, the growth plan of the same scheme. Also note that such switches may attract exit loads based on the holding period. However, capital gains tax and exit load won’t apply while switching from IDCW reinvest to IDCW payout or vice versa. The process of switching can be done online via CAMS’ website or through platforms such as MFUtility and MFCentral.                

Our take

Investors generally go for the IDCW option of a mutual fund scheme to earn regular income. However, the IDCW payment is completely subject to fund manager’s and fund house’s discretion. Apart from this, IDCW options have taxation disadvantage compared to that of growth plan. If you had invested in the growth plan of an equity oriented mutual fund, there would be long-term capital gains tax of 10 per cent, provided the units are sold after one year and the gain in a financial year is over ₹1 lakh, while the short-term capital gains would be taxed at 15 per cent. However, under IDCW, dividends are taxed at your slab rate. If an investor wants to earn a regular income, tapping the SWP route may work better.

COMMENT NOW