What is IDCW in a Mutual Fund?

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.

What is IDCW in a Mutual Fund?

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.

IDCW in Mutual Funds – The Methodology

Let’s consider an example to illustrate how returns differ between IDCW (Income Distribution cum Capital Withdrawal) and Growth Plans in mutual funds. Suppose you invest ₹1 lakh in both the IDCW and Growth plans of a mutual fund scheme when its NAV is ₹12.

Investment Details:

Note: This is a simplified calculation. The actual tax liability might vary based on factors like your overall income and applicable tax deductions.

Analysis:

The above example highlights that the Growth Plan outperformed due to uninterrupted compounding. In the IDCW plan, dividends are distributed periodically, reducing the NAV, and are subject to taxation based on your income tax slab. In contrast, Growth Plans benefit from compounding without interim distributions, resulting in significantly higher returns, especially when dividends are taxed.

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 ₹1 lakh a financial year, then you need not pay taxes. If your dividend income is more than ₹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 ₹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.

Wrapping Up!

IDCW (Income Distribution cum Capital Withdrawal) in mutual funds is a strategic option for investors seeking both regular income and capital appreciation from their investments. SEBI’s change to this nomenclature from the traditional “dividend” aims to clarify that these payouts include both income earnings and returns on capital, ensuring more transparent and informed investing. 

Remember, while IDCW can boost regular income, it’s crucial to understand its tax implications to optimize your investment returns effectively. Ready to enhance your investment portfolio? Consider mutual funds and open a Demat account with Angel One to start investing now.

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