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Section 194K of the Income Tax Act: A Detailed Overview of TDS on Mutual Funds

Section 194K of the Income Tax Act: A Detailed Overview of TDS on Mutual Funds

Finance Minister Nirmala Sitharaman added Section 194K to the Finance Act in the 2020 Budget. The mutual fund industry's dividend tax environment has undergone a substantial change with the passage of TDS (Tax Deducted at Source) Section 194K. Before this provision was introduced, businesses that distributed dividends and the individuals who received them faced unique issues due to the way the tax code treated dividends. A review of rules was required to provide a clear and straightforward taxing process due to the intricate relationship between dividend income and the current tax system. A revolutionary approach to TDS on mutual fund dividends has been made possible by the addition of Section 194K, which has significantly changed the dynamics of dividend taxation by providing more clarity and compliance. In this article, we will explain this section and related facts.

 

Table of Contents

 

What is Section 194K of the Income Tax Act?

The tax code has undergone a major change with the addition of Section 194K, which eliminates Section 10(35) and thereby revokes the prior exemption for income from mutual fund units. According to the recently implemented Section 194K, it applies to any person responsible for compensating a resident with respect to: 

  • Units from the administrator

  • Units of a mutual fund as defined by Section 10(23D)

  • Units from a company

If such revenue exceeds ₹5,000, the deductor is required to deduct 10% TDS (Tax Deducted at Source) before crediting the payee's account. Alternatively, whichever occurs first, the deduction has to be made at the time of payment. This measure highlights a decisive step taken by the government to simplify and control the tax ramifications of these financial transactions.


Mutual Fund Investment Income Types

  • Capital Gains: The government's income tax code would impose taxes on capital gains in the hands of the taxpayer. Profits from equity-oriented mutual funds are subject to 10% taxation if they represent long-term capital gains of more than one lakh within a calendar year. Any short-term capital gains from equity-oriented mutual funds that qualify for STT are probably subject to a 15% tax rate. Nonetheless, a mutual fund is not required to deduct the TDS on capital gains from the holder's redemptions under Section 194K.

  • Dividends: The dividends that fund houses or AMCs pay on an investor's behalf are subject to taxation under the current income tax legislation. According to the 2020 budget, DDT is not legal any more. The recipient would be liable for taxes on dividend income. Mutual funds are required by the Finance Act's new TDS Section to withhold TDS when paying dividends to unit holders that exceed Rs. 5,000.


Objective of Section 194K

Dividends were subject to two separate taxes under the prior income tax legislation. When a business paid a dividend to an Asset Management Company (AMC), a tax was once levied. When the AMC would divide its profits to the unitholders, it was the second time the tax was imposed. Investors have the option of receiving dividend income or reinvesting the earnings back into the fund. The AMC will once more have to pay DDT on dividend distributions if the investor decides to receive dividend income. DDT is eliminated in Budget 2020, and AMC is only obligated to deduct 10% of TDS from dividend distributions if each beneficiary receives more than Rs 5,000 in dividend payments during a fiscal year.


Applicability and Exceptions to Section 194K

It's critical to know if the income you get from your mutual fund assets is subject to section 194K to stay on schedule and prevent delays. As was already established, not all of your gains are subject to taxation. The 194K laws only apply to income received from mutual fund companies' dividend payouts. But not every payout qualifies for a tax deduction. Here are the exceptions:

  • Dividend income limit: This indicates that there is no TDS unless the dividend income is less than ₹5000. The fund house or the AMC is responsible for deducting TDS.

  • Income from capital gains: It's crucial to keep in mind that capital gains are not subject to 194K TDS since they are taxed differently from other types of income gains. Your capital gains are not deductible under TDS, regardless of how long-term or short-term they are.


Tax Rate under Section 194K

According to section 194K, the applicable rate of deduction is 10%. After it is made, the TDS deduction will show up in Form 26AS. Investors may file their income tax return if the final tax owed is less than what was actually deducted or if there is no overall tax burden. The 10% rate is imposed if the investor has provided the deductor with their PAN and Aadhar number. If the deductor does not provide a PAN or Aadhaar number, the applicable rate of TDS is 20%. Higher TDS incidents are rare because opening a mutual fund requires providing a PAN.


Penalties for Not Depositing TDS

Mutual fund schemes are required to comply with section 194K regulations for all dividend payments. If the TDS is not deducted or paid, interest will be charged on the investment along with a penalty. These details are enumerated here.

  • Interest is charged at the rate of 1% if TDS is not deducted. This interest is charged for each month or a portion thereof, starting on the day the tax was deductible and continuing until the tax is really deductible.

  • 1.5% interest is charged if TDS is not paid after the tax is dedicated. This interest is assessed on a monthly or partial monthly basis, starting from the date the tax was withheld and continuing until the tax is paid to the government.

  • In addition to the interest amount, a penalty under section 271C is also due for failing to pay or deduct TDS. The penalties will be the same as the TDS that was neither paid to the government nor withheld. 

  • The failure to deduct and pay TDS will also result in the disallowance of the expenses under section 40(a) (ia).


Conclusion

Many investors agree that mutual funds are an excellent choice for investments. For many years, investors of all ages have chosen mutual funds (MF) as a way to reduce taxes and increase earnings. However, in order to avoid incurring penalties, it is imperative that you comprehend the tax ramifications of the same. Income received from mutual fund dividend payouts after the adoption of Section 194K is taxable. As per the clause, shareholders would be required to deduct 10% of any payout that exceeds ₹5000 throughout a fiscal year. TDS deductions are not available for capital gains made during the fiscal year from the sale of mutual fund units.


FAQ

Q1. When is Section 194K levied?

When the income mentioned in this section exceeds ₹5,000 in a financial year, Section 194K becomes relevant for TDS purposes.


 Q2. Who deducts TDS under Section 194K?

The Income Tax Act's Section 194K was introduced, and it made companies responsible for declaring dividends and withholding the relevant tax on behalf of dividend receivers. To put it simply, TDS must now be subtracted by AMCs or fund houses when transferring funds to payee accounts. Under Section 194K of the Income Tax, income from the following units is deductible: 

  • Mutual Fund units in accordance with Section 10(23D)

  • Units from a certain business

  • Units from the designated undertakings' administrator.


 Q3. Can TDS on dividends be refunded?

You can request a refund by filing your income tax return, even if TDS is withheld from your dividend income. As a result, it is wise to report dividend income on your income tax return and, if necessary, request a refund.


 Q4. What is the rate of TDS under Section 194K?

For mutual funds, the appropriate TDS rate under Section 194K is 10%, provided that the dividend payment surpasses Rs 5,000 in a given fiscal year.


 Q5. Are there any exemptions under Section 194K?

In some circumstances, such as those involving Non-Resident Indian (NRI) investors and under certain rules mentioned in Section 195 of the Income Tax Act, TDS may be deducted at a different rate or not at all. 


 Q6. Can investors claim TDS deducted under Section 194K as a tax credit?

Yes, when filing their income tax returns, investors can claim the TDS deducted under Section 194K as a tax credit, which will lower their overall tax burden.


 Q7. What was the income tax provision regarding mutual fund dividends before Section 194K?

Individual investors were responsible for reporting capital gains and dividend income under the existing system. Mutual fund dividend income was excluded under Section 10(35). However, there was no clause addressing the TDS deduction for any income received from mutual funds. TDS applied only to NRIs. Dividends were tax-free in the hands of the taxpayer, but the firm that distributed them was charged DDT.


 Q8. What is TDS on mutual fund redemption?

If long-term capital gains from equity-oriented mutual funds surpass ₹1 lakh in a single year, they are subject to a 10% tax rate. Conversely, short-term capital gains from mutual funds focused on stock are taxed at a rate of 15% and are subject to the Securities Transaction Tax (STT).


 Q9. Under which head of income do I show Section 194K?

Fund firms that declare dividends before paying them to mutual fund clients withhold Dividend Distribution Tax (DDT). The entire dividend income is subject to taxation by the investor according to the income tax bracket found under "Income from Other Sources."


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