Does dividend reinvestment option in ELSS funds make sense after DDT?

Many ELSS investors are switching from dividend reinvestment option to growth option ahead of the introduction of dividend distribution tax of 10 per cent on equity schemes, says mutual fund advisors. DDT will become effective from April 1.

Investors who have not yet completed three years are waiting for the lock-in to get over and switch to the growth option and all new investors are also opting for the growth option now, add advisors.

The finance minister has imposed a dividend distribution tax of 10 per cent on equity mutual funds in the last budget. He also reintroduced long term capital gains tax of 10 per cent on equity mutual funds.


“Since they have to pay DDT, everybody is going for the growth option,” says Chirag Gokani, Founder, Wealthwiz Advisors. According to him, ELSS investors used to opt for dividend reinvestment option as it helped them to invest less to save taxes under Section 80C.

Investments in ELSS qualify for tax deduction of up to Rs 1.5 lakh under Section 80C. If an investor invests Rs 1.5 lakh in an ELSS fund and the scheme declares dividend at the rate of 10 per cent, which gets reinvested, the investor need to invest only Rs 1.35 lakh (Rs 1.50 lakh minus Rs 15,000 dividend reinvested) the next year to claim the maximum deduction under Section 80C. .

Advisors have been recommending growth option to equity mutual fund investors even before the introduction of DDT because of uncertainty of regular timely dividends. “Equity schemes pay dividends only when the scheme makes sufficient profits. Fund manager decides whether it is feasible for the scheme to pay dividend to investors or not. There is no defined frequency,” says Dinesh Rohira, Founder and CEO, 5nance.com

Before the budget proposal, dividends received from equity schemes were tax free in the hands of investors. But, from April 1 onwards, investors will have to pay a DDT of 11.648 per cent (10% + 12% surcharge + 4% cess) on the dividend received on equity schemes.

Advisors say that investors go for systematic withdrawal plan (SWP) if they actually need regular inflows. “Our advice to equity mutual fund investors has always been that if you need money, you may either withdraw from your funds or choose SWP where you can take out money at predetermined time interval. This is a better option than the dividend option,” says Rohira.

“Even in the case of SWP, you cannot escape tax. You will be taxed as per the present tax rules,” adds Rohira.