BackDYK: Dividend reinvested in ELSS tax deductible
You can claim the amount reinvested for deduction under section 80C of the Income-tax Act
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With the equity market doing well, mutual funds (MFs) are also making the most of it. Those who have opted for dividend option may have heard of dividend declaration by the fund house. But under the dividend option, you have two sub-options: first, you can opt for a payout of the dividend, and in the second it can be reinvested into the scheme. If you have opted for the dividend reinvest option under an equity-linked saving scheme (ELSS), you can claim the amount reinvested for deduction under section 80C of the Income-tax Act.
Options available
When you invest in an MF scheme, you need to choose among growth, dividend payout and dividend reinvestment options. If you don’t mention any of these options, the fund house will go with the default option for that scheme as mentioned in the form. However, an investor is free to alter the default or selected option later. Under the growth option, the scheme does not pay any dividend, but continues to grow. Whatever gains are made by selling any fund holdings are ploughed back into the same scheme. This gain is reflected in the net asset value (NAV) of the scheme, which rises over time.
Under the dividend option, dividends are announced out of the realized gains by the scheme time to time. Further, under payout option, the fund pays dividend as and when the dividend is declared. Under dividend reinvestment option, the declared dividends get reinvested into the scheme itself. Hence, instead of receiving dividend, the unitholders receive units. The number of units allotted under the plan would be the dividend declared divided by the ex-dividend NAV.
Investments made in ELSS funds, which are also known as tax-saving MF schemes, qualify for tax deduction for amounts up to 1.5 lakh under section 80C. There is also a lock-in period of three years. In case you choose dividend reinvestment option under ELSS, the dividend is automatically reinvested and gets eligible for further tax deduction under section 80C (as dividend reinvested is treated as fresh investment) in the relevant financial year in which it gets reinvested, irrespective of when the initial investment was made.
What should you do?
Although you can claim the dividend reinvested for tax deductions, ideally one should not choose dividend reinvestment option under an ELSS fund, as the amount reinvested as dividend gets locked for three years from the date of investment. It is possible that the amount reinvested as dividend further earns a dividend that also gets reinvested—you get into a cycle and may not be able to withdraw the entire amount in future. Therefore, it’s better to opt for the growth or dividend payout option, particularly under ELSS funds.
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