What is IDCW in Mutual Fund ?

Introduction

A stock or mutual fund investor needs to know many techniques and terminologies to trade efficiently. Mutual funds are very different from stocks, and knowing the terminologies plays a vital role. 
As a mutual fund investor, you must know terms like direct, regular, growth, and dividend to invest efficiently. While regular and direct are modes of investment, growth and dividend are the modes of profit distribution.

In essence, growth and dividend plans are two sides of the same coin because a mutual fund scheme's growth and dividend plans invest in the same financial instruments. However, while growth plans reinvest all profits made by the scheme, dividend schemes disburse the profits to investors.
A dividend scheme delivers returns based on the number of units you hold. For example, if a scheme declares a dividend of ₹10 and you hold 1,000 units, you will get ₹10,000 as the dividend.

However, since April 2021, the term ‘Dividend’ has become history as the Securities and Exchange Board of India, SEBI, has changed the nomenclature of ‘Dividend’ to ‘IDCW.’ This article explains the meaning of IDCW in mutual funds, its methodology, advantages, disadvantages, etc.

What is IDCW in a Mutual Fund?

The full form of IDCW in mutual funds is Income Distribution cum Capital Withdrawal. SEBI changed the name of dividend schemes vide Circular no. SEBI/HO/IMD/DF3/CIR/P/2020/194 dated 5th October 2020 to IDCW to make such schemes’ objectives more pronounced. The new rule was implemented on and from 1st April 2021.
Besides IDCW, SEBI also changed the nomenclature of ‘Dividend Reinvestment’ to ‘Reinvestment of Income Distribution’ and ‘Dividend Transfer’ to ‘Transfer of Income Distribution and Capital Withdrawal.’ So, all mutual fund houses having the three aforementioned schemes changed the scheme names on 1st April 2021. Hence, if you want to invest in a dividend mutual fund scheme today, you have to invest in an IDCW scheme instead. 

In simple terms, IDCW means that a portion of the investor’s capital can be disbursed and distributed as a dividend. Generally, mutual fund houses declare dividends depending on the surplus cash generated by the scheme. While, in a Growth scheme, the surplus cash is used to increase the NAV (Net Asset Value), the NAV witnesses little change in an IDCW mutual fund since the dividend gets distributed. This is why the NAVs of IDCW mutual fund schemes move a lot less aggressively than Growth scheme NAVs. 

The frequency of dividend payments in IDCW schemes may be daily, weekly, monthly, quarterly, or annually. Daily and weekly dividend payments are usually made by liquid and income schemes. According to SEBI (Mutual Funds) Regulations 1996, mutual fund houses, also known as Asset Management Companies (AMCs), need to dispatch the dividend to unitholders before the end of 15 days from the declaration of the dividend or record date.
 
An IDCW mutual fund investor can choose from dividend payout or dividend reinvest. If you opt for the dividend payout option, the AMC will transfer the dividend amount to your bank account within 15 days of the dividend declaration date. This mode is preferred by investors willing to get a regular income from mutual fund investments. However, if you want to increase the number of units, you may opt for the dividend reinvest mode. In this case, the mutual fund house reinvests the dividend to buy more units. So, every time the AMC declares a dividend, you can see a healthy jump in your folio's total number of units.  

What Prompted SEBI to Change the Nomenclature of Dividend to IDCW?

SEBI is the regulatory agency monitoring and governing mutual fund schemes in India, including IDCW schemes. The agency adopts various steps to make the capital and secondary markets more transparent and investor-friendly. The name change of dividend to IDCW is one such investor-friendly initiative.   

Due to SEBI’s changing of rules regarding IDCW in mutual funds, it became mandatory for India’s top-100 listed companies with high market capitalization to frame a dividend distribution policy. Further, other companies may also disclose their dividend distribution policy and publish it on their websites. SEBI amended the LODR or Listing of Obligations and Disclosure Requirements and laid clear guidelines for framing the Risk Management Committee. 

Earlier, dividend payouts were inversely proportional to NAVs. So, every time a mutual fund house declared and disbursed dividends, the scheme's NAV dropped proportionately to the dividend value. This meant the investor did not earn any extra amount since a drop in the capital facilitated the withdrawals. However, in essence, dividends are supposed to be extra income generated on the investors’ capital. This prompted SEBI to reclassify dividends schemes as IDCW or Income Distribution and Capital Withdrawal schemes.

While the name change hasn’t changed the operational methodology of such schemes, it has made the investors more aware of the pattern of these schemes. In IDCW, Income Distribution means NAV appreciation, and Capital Withdrawal means the investor’s capital or the equalization reserve amount. Whenever a mutual fund manager sells units at a higher price than face value, they transfer the realized gain to the equalization reserve account and pay dividends from this account.

The name change is aimed to promote transparency and help investors make informed decisions. Presently, AMCs declare the investment objective and methodology of IDCW schemes in the offer documents of all mutual fund schemes offering such schemes.      

Taxability of IDCW Schemes in Mutual Fund

Earlier, companies were required to pay a Dividend Distribution Tax of 15% before disbursing dividends. But, the Finance Act 2020 made it mandatory for investors to pay taxes on dividend income from IDCW schemes in mutual funds. However, if your dividend income does not exceed INR 1 lakh a financial year, you need not pay taxes. If, however, your dividend income is more than ₹1 lakh in a financial year, you must show the extra income under ‘Income from Other Sources’ and pay appropriate taxes as per your income tax slab.  

It is also wise to note that AMCs deduct a TDS (Tax Deducted at Source) on dividends. But, TDS is deducted only when your dividend income is above  ₹5,000 a financial year. 

IDCW in Mutual Funds - The Methodology

Before understanding the methodology of IDCW, it is wise to recollect the meaning of IDCW in mutual funds. Whenever an investor receives a dividend, it is nothing but a withdrawal of the investor’s capital with or without appreciation.

Let’s understand this with an example.
Imagine you invested ₹1 lakh in a mutual fund scheme whose NAV is 10. So, you get 10,000 units. Now, the mutual fund house declares a dividend of ₹5 per unit. This makes you eligible to receive a dividend or IDCW of ₹50,000. The ₹50,000 will be credited to the fund’s equalization reserve or your capital account. Now, if you redeem the IDCW amount, the NAV (excluding dividends) becomes 5. So, your total investment reduces to ₹50,000 since you have already withdrawn ₹50,000 as IDCW.The aforementioned scenario does not factor in any growth or degrowth in the mutual fund scheme you have invested in. The amount would change depending on the scheme’s performance. So, if the NAV increases between the time of purchase and the time of redemption, your fund value will be more. Conversely, your fund value will decline substantially if the NAV decreases due to negative market conditions. This is because every mutual fund house levies an expense fee for managing its operations. Unless specified, the expense fee is on all mutual fund schemes, irrespective of whether the fund is profit-making or loss-making. In fact, the higher the expense fee, the lower the profits will be.   
 

Dividends Declared by Companies and Mutual Funds - The Differences

Stock market investors often invest in dividend-paying companies like ITC, Coal India, Hexaware, TCS, Infosys, etc. In contrast, mutual fund investors seeking dividends invest in IDCW schemes. But are dividends distributed by companies similar to mutual funds? No, they are not. 

Unlike mutual funds, companies are not obligated to declare and distribute dividends. Generally, companies declare dividends only when their profits beat their expectations. Companies have to abide by the Companies Act 2013 while declaring dividends.   

Mutual funds must declare dividends based on what they mentioned in the IDCW scheme’s offer document. Generally, mutual fund houses must declare and distribute dividends for IDCW schemes at least once every financial year.  

Also, a company’s dividend payment may or may not affect its price. But, when an IDCW mutual fund disburses dividends, its NAV declines proportionately. Moreover, a company has higher authority over the dividend amount or rate. In contrast, a mutual fund house can only decide the dividend rate and nothing more since all capital and profits belong to the investors. 

Which Mutual Fund Schemes are Better? IDCW or Growth?

Mutual fund investors can invest in growth or IDCW schemes in India. You may opt for the ‘Growth’ option if you are a long-term investor or wish to fulfill a cherished dream. Since growth funds do not witness frequent withdrawals, the fund managers are at liberty to utilize the funds in the investors’ best interests. However, if you want regular income, it is better to choose IDCW schemes, but you may have to forego compounding interest.  
In terms of taxation, growth investors have to pay two types of taxes - Long-Term Capital Gains (LTCG) Tax and Short-Term Capital Gains (STCG). In contrast, IDCW scheme investors may have to pay three types of taxes - dividend, LTCG, and STCG. 
So, before investing in a mutual fund scheme, analyze your investment objective and spending habits. It is advisable that you must not withdraw the investment amount after investing since early withdrawals may defeat the primary purpose of investing. However, this doesn’t mean you should stay put in non-performing schemes. 

Conclusion

Investing in IDCW mutual fund schemes might be a viable alternative to conventional instruments like fixed deposits or sovereign savings schemes. 5paisa provides a ready reckoner of the top IDCW schemes in India and offers easy access to the schemes. You can browse the list of top-performing schemes, upload documents like PAN and Aadhar Card, and create an account. Ensure to read the scheme documents diligently before investing.