r2i forum

I *think* I found the hard way the answer to this question -
If I have an NRE account, should I invest in growth or dividend option in any MF.

when my distributor (bank relationship manager) messed up my investments as a single holder instead of joint holder - the bank informed me, *incorrectly*, that since the liquid fund has no exit load - I can redeem it and they will re-invest it in my existing joint holder portfolio.

When I redeemed the fund, they deducted 33% tax on the income earned since it was a growth option. when I questioned, they said thats the rule - and I verified the websites and indeed, thats what all the AMCs have declared.

which means, when one invests via the NRE account, one should do so always in the dividend option - to avoid the TDS.

NOw the question to the experts is - what happens if you choose the dividend reinvestment option - how is TDS calculated then ?

TDS is deducted on the capital gains. Since mutual funds know your cost basis and selling value, they deduct TDS. TDS is not your final tax liability, you can file your tax return and get the money back refunded.

Taxation on Dividend option or dividend reinvestment option are the same. Reinvestment is your idea of putting the money back in the fund as a new purchase. So, it does not affect the taxation.

Fund manager pays the dividend distribution tax of 25% or 15% for liquid funds and debt funds ( add cess and other taxes). So, it works out to be better for those in higher tax bracket. Usually the fund manager try to pay as much dividend possible, but there could be situation where even with dividend option, one may end up paying capital gain taxes and related TDS deducted.

For example, if your debt fund distribute dividends monthly on 3rd of every month, your NAV goes up every day ( accrual) until 3rd. And after the distribution the NAV goes back to normal value. So, if you sell the fund during the accrual phase, for example on 1st or 31st, you will end up with small capital gains.

But note growth scheme is helpful if you have stayed in the fund for about 1 year, then the capital gains becomes long term and you end up paying only 10% taxes. For stock mutual funds and individual stocks, the long term capital gains tax is 0%.

In this case, it was a HDFC liquid fund - and they deducted 33% TDS since the money was linked to my repatriable amount.
I understand that I have to file tax returns and get the refund back based on income earned in India - NRE accounts and NRO accounts put together - all accounts using the same PAN, in fact.

when you talk about dividend distribution tax of 25% for liquid funds, can you elaborate on that ? how does that affect me in this case ?

From Kotak's website, I found the following
TDS rate for Short Term NRI investor's under Equity Scheme(s) = 15% (A)
Surcharge = A x 10% = 1.5% (B)
Education Cess = A + B x 3% = 0.495% (C)
TDS to be deducted = A + B + C = 16.99%

TDS rate for Short Term NRI investor's under Non - Equity Scheme(s) = 30% (A)
Surcharge = A x 10% = 3% (B)
Education Cess = A + B x 3% = 0.99% (C)
TDS to be deducted = A + B + C = 33.99%

TDS rate for Long Term NRI investor's under Equity Scheme(s) = NIL

TDS rate for Long Term NRI investor's under Non-Equity Scheme(s) = 20% with indexation benefit. (A)
Surcharge = A x 10% = 2% (B)
Education Cess = A + B x 3% = 0.66% (C)
TDS to be deducted = A + B + C = 22.66%


Based on the above, and your own advice, it looks like the best returns is to to be achieved if one does long term investments via equity schemes since no TDS is involved. is that correct ? (obviously we have to pick the right funds...etc.etc)

Does PFIC rules come into the picture at all ?
I was under the impression that due to PFIC - I should not be investing in equity schemes.. but everyone - including my financial planner says - nobody knows about PFIC except in this forum - and just ignore that you heard about it - and invest in equity schemes as there is no way you can find the paperwork to take care of PFIC even if you wanted to.
comments?