While investing in mutual fund (MF) schemes, many people opt for the dividend payout option to get regular income while staying invested.
Till the financial year (FY) 2019-20, companies and fund houses used to pay Dividend Distribution Tax (DDT) before distributing the dividend.
While investing in mutual fund (MF) schemes, many people opt for the dividend payout option to get regular income while staying invested. People investing in direct equities also enjoy dividend income, depending on the quantum of profit earned by the companies.
Change in tax treatment of dividend income
Till the financial year (FY) 2019-20, companies and fund houses used to pay Dividend Distribution Tax (DDT) before distributing the dividend, while the dividend amounts received were tax-free in the hands of investors.
So, irrespective of their tax bracket, investors used to enjoy the same tax treatment.
However, things have changed now after the abolition of DDT, making dividend income taxable in the hands of investors.
“Finance Act, 2020 amended the provisions relating to taxation of dividend income under the Income Tax Act, 1961 (“the Act”). Prior to the amendment, dividend was taxed in the hands of the company paying the dividend. The company paying dividend was liable to pay Dividend Distribution Tax (DDT) u/s 115-O of the Act. Also, such dividend received was exempt in the hands of shareholders u/s 10(34) of the Act,” said Dr. Suresh Surana, Founder, RSM India.
So, the investors in higher tax brackets need to pay more tax on dividend income, compared to the investors in lower brackets.
“The Finance Act 2020 has abolished the concept of DDT and made dividends taxable in the hands of shareholders in accordance with the classical system of taxing dividends. This amendment came into force from April 1, 2020. Thus, in case of dividends distributed on or after April 1, 2020, the company paying dividend is not liable to pay Dividend Distribution Tax (DDT) and the dividends are taxable in the hands of shareholders, at the slab rates applicable to them,” said Dr. Surana.
Talking on the rate of tax on dividend income, Dr. Surna said, “As per section 56(2)(i) of the Act, dividends would generally be taxable under the head “Income From Other Sources” unless the shares are held for trading purposes wherein the same would be subject to tax as Business income. They will be taxed at normal rates of tax applicable to the taxpayer. Also, as per section 57, the taxpayer cannot claim deduction of any expense against dividend income except interest expense on money borrowed for the purpose of investment. The deduction of interest expense will also be subject to a maximum limit of 20 per cent of amount of gross dividends.
With the dividend income becoming taxable, tax is now deducted at source (TDS) by the companies and the fund houses.
“Section 194 of the Act contains TDS provisions in relation to dividends paid to residents. According to this section, the company paying dividends shall deduct 10 per cent tax at the time of payment or distribution of dividend. TDS shall not be deducted when the amount of dividend does not exceed Rs 5,000 and it is paid to resident individuals by any mode other than cash. In case of dividend paid to non-residents, TDS provisions u/s 195 shall be applicable and for which the rate prescribed under the Act is 20 per cent. However, it is notable that the non-resident shareholders can avail of the withholding rates prescribed under the Tax treaty provisions entered into by their country with India, if it is more beneficial to them and subject to certain conditions,” said Dr. Surana.
So, if your income is not taxable or in case you are in the 5 per cent tax bracket, you may claim the excess TDS amount back. Otherwise, you have to pay more tax over and above the TDS rate, depending on your income level.
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