@TAXIQ.IN
I have a question regarding investment instruments and taxes.
If I invest in direct equities and rely solely on the dividend income, it will be tax-free up to 13.25 LAcs (₹12 Lacs as dividend +1.25 Lacs as LTCG) per year. However, if I invest via MFs and let this dividend accumulate, then it will be taxed (upon realising) as Long-Term Capital Gains (LTCG) above ₹4 Lacs.
Assumptions:
The equities have a strong legacy (From Nifty 50).
No other income is declared, so LTCG up to ₹4 Lacs is tax-free.
Question is bit confusing . If you are investing via MFs, then the dividend gets added to Nav and you don’t need to pay any taxes until you sell the units .
yes thats my question…If I invest in mutual funds and want to book a profit of up to 12 Lacs, it will be taxed as LTCG, unlike direct equity investments. Additionally, there will be no grandfathering for mutual funds (on previouslu accumulated dividend) if I let the money accumulate over several years.
So, the original plan above basically consists of these key aspects -
a. aim to accumulate dividends in the range of 12L each year
b. limit realizing gains to < 1.25L each year
c. based on the scrips in NIFTY50 (Note: typical dividend yield of 1.5%)
Quick math based on historical data suggests that
a portfolio cannot simultaneously fully satisfy these 3 conditions.
Please review the details / rough estimations.
(please review if missed anything…)
To start with, a mutual fund tracking an index, will rebalance periodically,
in terms of a relatively changing composition of existing scrips
as well and sometimes divesting completely off of a few scrips and investing in new scrips.
Emulating this using direct investment in equity will add to the costs.
For the sake of simplicity, let us ignore rebalancing for now.
One may stick to the current constituents of the NIFTY50, and not rebalance one’s direct equity holdings as often as NIFTY50 index does. Even in that scenario, to achieve the magnitude of dividends around 12L/year, the investment required will be such that the planned realized capital-gains of 1.25L each year will be minuscule compared to the unrealized capital-gains carried over in most years.
Looking at NIFTY50 dividend yield, it has been around 1.5% for more than a decade now,
A 12L dividend in a year from investing directly in equities in NIFTY 50,
would involve around 8cr invested in directly in equity. (8Cr *1.5/100 = 12L)
Assuming even around ~12% return on an average, it ends-up being around 1Cr gain each year (on an average), of which one intends to realize only 1.25L each year,
Thus, even in this scheme, which doesn’t track NIFTY50 over time across rebalances,
one would end-up accumulating >98% of one’s capital-gains each year to be taxed as LTCG eventually (if sold at a profit several years later).
Even using the maximum dividend yield of ~6% from some specific scrips in NIFTY50, one will end-up with ~95% of one’s unrealized gains carried over in this scheme (i.e. above 1.25L that one wishes to realize/book).
Maybe need to pick specific scrips with
the ratio of returns from dividends and returns from capital-gains
in the same ratio of 12L : 1.25L to maximize tax benefits that one can claim?
Using the same numbers, if one were to estimate the dividend income on direct equity that provided ~1.25L of capital gains in a year (on an average), one would be investing around 10L and be receiving around 15K in dividends.
With typical variance in equity returns each year, one would still end-up with several years where one’s annual gains exceed the 1.25L limit of annually exempt LTCG, and other years with unrealized capital losses.
Alternately, without periodic rebalancing, if one ends-up holding on to losing/stagnant stocks, then there might not be any capital-gains to optimize taxes itself !
Considering the above,
a more likely occurring tax-optima can be found by
utilizing as much of the initial tax-exempt slab of 4L to book the LTCG income.
So, maybe something like
Investing ~39L directly in equity scrips corresponding to NIFTY50.
Receiving an estimated/projected income of ~58K in a year as dividends. (~1.5%)
Realize the entire estimated/projected long term capital gain income of ~4.66L (~12%)
…and still end-up paying zero income-tax,
NOTE: These are just estimations/projections based on historical dividend yields and average equity returns. The latter are likely to vary significantly each year.
Maybe an alternative approach to optimize for the incentives provided by the current tax regime would be
to invest part of one’s capital in sovereign debt (GSECS, SDLs)
currently offering 7-8% returns as interest payments every 6 months.
to invest the rest in equity MF or equity index ETF
and withdraw each year (and reinvest) amounts that result in
upto 1.25L LTCG (if any)
or any additional amount based on any buffer available in one’s initial 4L tax-exempt slab for the year.
…or maybe not worry about optimizing for taxation,
and instead focus on optimizing for overall-returns or optimizing for overall-risk instead?
As far as I understand, “dividends” from IDCW funds are considered as “income from other sources” and are taxed at the individual’s applicable tax rate.
@Quicko@TAXIQ.IN
Very interesting discussion.
I have a follow up query.
In an IDCW scheme, how is the remaining investment treated after dividend payout? If units are sold later, is it considered as a partly capital gain or purely withdrawal of principal?
For example, I invest ₹1 crore in an IDCW fund. After one year, it appreciates by ₹12 lakh, which the AMC pays out as dividend (within the tax-free limit). How is the remaining ₹1 crore treated upon selling? pure principal or does it still include capital gains?
It’s purely capital gain. But 1cr(cost of acquisition)-1cr(net sale value) is zero. So, zero capital gain. So if it’s equity, you can wait till it appreciates to 1.0125Cr to get LTCG capital gain exemption of 1.25L
Thanks @BB789
I have tried to get it from some official and authentic source but failed. It would be great if you could please share some reference links. @Quicko@TAXIQ.IN can ypu please help me in this?
