Indian tax laws for equity mutual funds (funds that invest > 65% of their corpus on common stock) specify that
- Short term ( less than one year) capital gains tax is 10%
- Long term capital gains is 0%
- Dividends paid are non-taxable
- Security transaction tax (STT) of 0.1% has to be paid on all SELL transactions
Indian tax laws for debt mutual funds specify
- Short term capital gains is treated as income (basically added to salary and taxed at the tax bracket you belong to)
- Long term capital gains is 10%
- Dividends paid are non-taxable in the hands of the investor but they undergo a tax called dividend distribution tax (DDT) (12.5% + surcharge + education cess) that the fund has to pay before declaring dividend. This effectively reduces the quantum of the dividend in your hands
- There is no STT.
So if you are in the highest tax bracket, it might make sense to opt for the dividend option when you are buying debt mutual funds since effectively you pay onl 13.xx% as tax on the dividend as DDT as compared to growth option.
For equity mutual funds, the verdict is very clear folks - growth is the direction in which you should be going.