Mutual funds are one of the most popular investment vehicles in India, with a wide range of schemes catering to different investor needs and risk profiles. One of the key features of mutual funds is the ability to generate regular income through dividends. When an investor invests in a mutual fund, the fund may generate returns in the form of income or capital gains. The payments made to investors from the income generated by the mutual fund’s underlying assets, such as dividends, interest, and rental income are regarded as income distributions. The profits earned by the mutual fund when it sells its underlying asset at a higher price than it purchased it for are regarded as capital gains.
In the context of mutual funds, IDCW stands for “Income Distribution cum Capital Withdrawal” and it refers to a payout option where investors receive a portion of the fund’s income and capital gains in the form of regular payouts. These payouts can be made monthly, quarterly, half-yearly, or annually, depending on the terms of the fund.
Under the IDCW option, investors can choose to receive a portion of their investment back periodically as a payout, while the remaining amount remains invested in the fund. This option is suitable for investors who are looking for a regular income stream from their mutual fund investments, while still maintaining their investment in the fund.
What Prompted SEBI to Change the Nomenclature of Dividend to IDCW?
The Securities and Exchange Board of India (SEBI) is a statutory body that regulates, governs, and monitors the functioning of mutual fund schemes including but not limited to IDCW schemes in our country. SEBI takes numerous initiatives to make capital and secondary markets more transparent and investor-friendly welcoming new investors regularly. The recent nomenclature of dividends change to Income Distribution cum Capital Withdrawal (IDCW) by the Securities and Exchange Board of India (SEBI) is one such investor-friendly measure.
The change in nomenclature is an attempt to provide greater clarity to investors regarding the nature of the payouts. Under the earlier nomenclature of dividends, investors were often misled into thinking that the payouts were purely income in nature. However, in reality, a significant portion of the payout could also be a return on the invested capital.
On the other hand, IDCW clarifies that the payout is a combination of income and capital. This helps investors to make more informed investment decisions by giving them a better understanding of the nature of the payouts. It also ensures greater uniformity in the disclosure of dividend income across all mutual fund schemes.
SEBI has also mandated mutual fund houses to disclose the yield on IDCW along with the net asset value (NAV) of the scheme. This in turn provides investors with a clear understanding of the overall returns generated by the scheme and helps them to evaluate the scheme’s performance more effectively.
IDCW payouts can be of two types – regular and special. Regular IDCW payouts are made at periodic intervals, usually quarterly, from the income generated by the scheme. On the other hand, special IDCW payouts are made when the scheme produces capital gains from its investments.
The amount of IDCW payout is calculated based on the number of units held by the investor on the record date. The record date is the date on which the mutual fund determines the list of investors who are eligible for the payout. The NAV of the scheme is adjusted to reflect the payout, and the amount is credited to the investor’s bank account.
Taxability of IDCW Schemes in Mutual Fund
IDCW payouts are taxed as follows:
Dividend Distribution Tax (DDT) – Before the nomenclature change from SEBI, DDT applied to IDCW payouts for companies alone where the DDT rate was 15% which was deducted by the mutual fund before making the dividend distribution. The Finance Act 2020 extended this clause to individual investors too. That said, if your dividend income does not exceed INR 1 lakh a financial year, then you need not pay taxes. If your dividend income is more than INR 1 lakh in a financial year, you must report the extra income under ‘Income from Other Sources’ and pay applicable taxes as per your income tax slab. It is also crucial to note that AMCs deduct a TDS (Tax Deducted at Source) on dividends and only if your dividend income is above INR 5,000 a financial year.
Capital Gains Tax (CGT) – This applies to special IDCW payouts and is calculated based on the investor’s holding period and tax slab. If the investor holds the units for more than 36 months, the gains are considered long-term and are taxed at a lower rate. If the holding period is less than 36 months, the gains are considered short-term and are taxed at the investor’s applicable tax slab rate.
IDCW payouts can provide a regular source of income for investors, while also providing some capital appreciation. However, investors need to be aware of the tax implications of IDCW payouts and factor them into their investment decisions.
IDCW in Mutual Funds – The Methodology
Let us illustrate this with an example:
Imagine you invested INR 1 lakh in a mutual fund scheme whose NAV is Rs 5 per unit and so you get 20,000 units. Now, the mutual fund house declares a dividend of INR 2 per unit. This makes you eligible to receive a dividend or IDCW of INR 40,000 which will be credited to your capital account. In the meantime, the NAV grew to be Rs 10 per unit making your total investment to Rs 2 lakh. Here, if you redeem the IDCW amount, the NAV (excluding dividends) becomes 8. So, your total investment reduces to INR 1,60,000 post-withdrawal of IDCW worth Rs 40,000.
Your fund value will be more if the NAV increases between the time of purchase and the time of redemption and conversely the fund value will decrease if the NAV value falls due to negative market conditions.
What is the benefit of the IDCW option in mutual funds?
The IDCW option in mutual funds provides investors with a regular stream of income while also giving them the flexibility to withdraw their investment at any time.
What is the difference between IDCW and dividend option in mutual funds?
Under the dividend option, the mutual fund scheme distributes a portion of its profits as dividends to investors. Whereas, under IDCW, a fixed percentage of the NAV of the scheme is distributed as income to the investor.
Can investors switch from the IDCW option to other options in mutual funds?
Yes, investors can switch from the IDCW option to other options in mutual funds, such as growth or dividend options, if they wish to do so. It is vital to note that the switch could have tax implications.
Does IDCW affect the returns of the mutual fund scheme?
Yes, IDCW can affect the returns of the mutual fund scheme. Any change in NAV value between purchase to redemption time can have significant effect on the fund value.
Is IDCW available in all mutual fund schemes?
No, IDCW is not available in all mutual fund schemes.