Tax on Dividend Income: Tax Implications on Dividend Earnings
Updated: Nov 16
Dividend income has long been a popular source of passive earnings for investors in stocks and mutual funds. While it provides a steady stream of income, it is important to understand the tax implications associated with such earnings. In India, the taxation of dividend income has undergone significant changes in recent years, and keeping up with the current tax regulations is essential for effective financial planning.
Prior to April 2020, dividends were subject to the Dividend Distribution Tax (DDT), which was paid by companies before distributing dividends to shareholders. However, with the introduction of the Finance Act, 2020, the DDT was abolished, and now, dividends are taxed in the hands of the investors. This shift has made it crucial for individuals to understand how dividends are taxed based on their income slab and what exemptions or deductions are available to reduce their tax burden.
In this article, we will explore various aspects of taxation on dividend income, covering topics such as tax rates, applicable exemptions, filing requirements, and how to manage your tax liability.
Table of Contents
Understanding Dividend Income
A dividend is often the amount that a business distributes to its shareholders from its profits. You will get paid a dividend if you invest in mutual funds, ULIPs, or stocks. Nevertheless, in accordance with Income-tax Act Section 2(22), the dividend must additionally comprise the following:
The release of the company's assets in exchange for the distribution of accrued profits to shareholders
The issuance of bonus shares to preference shareholders and the distribution of debentures or deposit certificates to shareholders from the company's cumulative profits
Distribution of accumulated earnings to shareholders upon the company's dissolution; Distribution of accumulated profits to shareholders upon the company's reduction of capital
Advance or loan given by a company to its shareholders out of its accumulated profits
Sources of Dividend
Dividends are available to you from the following sources:
From a domestic business that you have invested in using shares
From a foreign business that you have invested in with shares
If you have selected the dividend option, from equity mutual funds
If you have selected the dividend option, from debt mutual funds
Relevant tax incidence would be applicable based on the dividend income source. Now let's examine the tax implications for each of the aforementioned revenue streams separately.
Tax on Dividend Income
Prior to Assessment Year 2020–21, a shareholder receiving a dividend from a domestic company would not be required to pay tax on it because it was exempt from tax under Section 10(34) of the Act, subject to Section 115BBDA, which provides that dividends exceeding Rs. 10 lakh are subject to taxation. Under section 115-O, the domestic firm is required to pay a Dividend Distribution Tax (DDT) in these circumstances.
The DDT was eliminated by the Finance Act of 2020, and investors are now subject to dividend taxes under the traditional tax system. Therefore, regardless of the amount received at the applicable income tax slab rates, dividend income will now be taxable in the hands of taxpayers.
Whether or not the dividend recipient trades or invests in securities will determine whether the payout is taxable. The individual's trade activity-related income is subject to taxation under the heading "business income." Therefore, dividend income from shares held for trading purposes will be subject to taxation under the heading of income from business or profession. Conversely, dividend income that arises from shares held as investments is subject to taxation under the heading of income from other sources.
In cases where the dividend is liable to be taxed as business income, the assessee is entitled to deduct any costs incurred in order to generate the dividend income, including interest paid on loans and collection fees. In contrast, the assessee may deduct up to 20% of the total dividend income from solely interest expenses spent in order to obtain the dividend income if the payout is taxable under the head of income from other sources. Any additional costs, such as commission or compensation paid to a banker or another individual in order to realise such dividend, are not eligible for deduction.
Taxability of Dividend Income: Old & New Provisions
Up to March 31, 2020 (FY 2019–20), the dividend received from an Indian corporation was exempt. The reason for this was that the dividend distribution tax (DDT) had already been paid by the corporation prior to payment when it declared the dividend.
The Finance Act of 2020, however, modified the dividend taxation scheme. All dividends paid on or after April 1, 2020, are subject to taxation at the investor's or shareholder's expense.
Companies and mutual funds are no longer liable for DDT. In the same vein, Section 115BBDA's 10% tax on resident persons', HUFs', and businesses' dividend receipts exceeding Rs 10 lakh is also removed.
Tax Rates for Dividend Income
The type of taxpayer receiving the dividend and the medium on which it is delivered determines the tax rate on dividends. The following table makes this simply understandable:
TDS on Dividend Income
According to Section 194, an Indian company must deduct tax at the rate of 10% from dividends distributed to resident shareholders if the total amount of dividends distributed or paid to a shareholder during the financial year goes above and beyond Rs. 5,000. TDS will be applicable to dividends distributed, declared, or paid on or after April 1, 2020. Nonetheless, with regard to any shares it owns or in which it has a full beneficial interest, no tax shall be withheld from the dividend paid or due to General Insurance Corporation of India (GIC), Life Insurance Corporation of India (LIC), or any other insurance provider. Nonetheless, in Section 195 in the event that the dividend is payable to a non-resident or a foreign corporation, the tax will be subtracted.
Let us consider an example in this context. On June 15, 2020, for example, Mr. X got a dividend of Rs 6,000 from an Indian company. The corporation will deduct a TDS @7.5% on the dividend income, or Rs 450 since the individual's dividend income is above Rs 5,000. Mr.X will be given the remaining Rs. 5,550. Additionally, Mr. X's taxable income from the dividends is subject to taxation at the slab rates in effect for FY 2020–21 (AY 2021-22).
TDS must be withheld from non-resident individuals at the rate of 20%, subject to any applicable double taxation avoidance agreements (DTAAs). The non-resident must provide documentary verification, such as Form 10F, a declaration of beneficial ownership, a certificate of tax residency, etc., in order to be eligible for the reduced deduction owing to the beneficial treaty rate with the nation of residence. Higher TDS would be deducted in the absence of certain documents, which might be claimed when filing an ITR.
Deduction of Expenses from Dividend Income
The Finance Act of 2020 allows for the deduction of interest expenses paid against dividends. 20% of the dividend income received should be the maximum amount deducted. You cannot, however, deduct any additional costs, such as commissions or wages, which you paid in order to get the dividend income. In the aforementioned scenario, only Rs 1,200 can be deducted for interest if Mr. Ravi borrowed money to purchase equity shares and paid interest totaling Rs 2,700 during FY 2020–21.
Advance Tax on Dividend Income
If a taxpayer's total tax liability for a given financial year is equal to or greater than Rs. 10,000, advance tax provisions will be applicable. If the advance tax liability is not paid in full or in part, interest and a penalty are assessed.
Form 15G/15H Submission
A resident individual who is receiving dividends and whose projected annual income is less than the exemption threshold may send form 15G to the mutual fund or firm that is providing the dividend. Similarly, the corporation distributing the dividend can get Form 15H from a senior citizen whose projected annual tax liability is zero. The mutual fund or firm notifies the shareholder via registered mail about the dividend declaration, and in order to collect dividend income without paying tax withholding, the shareholder must submit form 15G or form 15H.
Dividend from a Foreign Company
A foreign corporation's dividend is taxable. It will be taxable under the "income from other sources" heading. Dividends from foreign corporations are included in the taxpayer's total income and are subject to tax at the taxpayer's applicable rates. For example, if the taxpayer is subject to the 30% tax slab rate, the dividend will likewise be subject to 30% taxation in addition to the cess. The investor may only deduct interest expenses up to 20% of gross dividend income, even in the event of a foreign dividend. However, under section 194 of the Income-tax Act of 1961, the firm declaring the dividend will have to deduct TDS. According to this provision, dividend income beyond Rs. 5000 for an individual is subject to 10% TDS; if the beneficiary of the dividend does not submit a PAN, this rate will increase to 20%.
Relief from Double Taxation
A foreign company's dividend is subject to taxation in both India and the foreign company's country of origin. Nonetheless, the taxpayer may be eligible for double taxation relief if the tax on an international company's dividend was paid twice, that is, in both countries. The relief sought may be in accordance with the terms of a double taxation avoidance agreement signed by the Indian government and the nation to which the foreign firm belongs, or it may be made in accordance with Section 91 (in the absence of such an agreement). In other words, the taxpayer is spared from paying tax on the same income more than once.
Conclusion
Tax on dividend income can be confusing to handle, so you must get your facts right. The best option is to consult an expert and seek their guidance on this matter. The last thing you want to do is pay more taxes or get penalties for missing out on your liability. An expert makes sure that neither of these happens.
Frequently Asked Questions
Q1. How often do dividends get paid out?
Dividend payments may be made on a daily, monthly, quarterly, half-yearly, or annual basis, contingent upon the mutual fund firm or business paying the dividend.
Q2. Do dividends require tax payment?
A shareholder who receives a dividend from a domestic firm up until Assessment Year 2020–21 will not be required to pay tax on the dividend since it is free from tax under section 10(34) of the Act. However, under Section 115-O, the domestic business is required to pay a Dividend Distribution Tax (DDT) in certain circumstances. However, the Finance Act of 2020 eliminated DDT and replaced it with a traditional tax system in which investors pay income taxes. Therefore, the assessee is required to pay dividend income tax.
Q3. Are dividends taxable in India?
Yes, dividends are taxable in India because they are considered a form of income.
Q4. What is dividend distribution tax (DDT)?
A 15% dividend distribution tax is due by any Indian corporation that has declared, distributed, or paid any kind of dividend. DDT regulations were first implemented by the Finance Act of 1997. The only business subject to the tax is a residential one. Even if they are not required to pay taxes on their income, domestic businesses are nonetheless required to pay the tax. DDT is no longer in use as of April 1, 2020.
Q5. What are the tax implications for shareholders receiving dividends?
Shareholders are subject to tax on dividend income, which is included in their total income for the year.
The dividend income is taxed at the applicable income tax slab rates, depending on the individual's total income.
Q6. How can investors optimize tax outcomes on dividend earnings?
Investors can explore tax-efficient investment strategies, such as holding dividend-paying stocks in tax-saving accounts like a Tax-Free Savings Account (TFSA) or equivalent.
Q7. Are there specific tax considerations for foreign investors receiving dividends in India?
Foreign investors may be subject to withholding tax on dividends, and the rates may vary based on tax treaties between India and the investor's home country.
Q8. Are any expenses allowed as a deduction from dividend income under “income from other sources”?
In the event of dividends, the interest paid on any loans made to purchase shares or mutual funds is, indeed, deductible. A maximum of 20% of the total dividend income may be deducted for interest. Nevertheless, no deduction is available for any other costs, such as commission or payment to a banker or any individual who realises the income on the taxpayer's behalf. Dividend receipts from both domestic and foreign corporations are subject to the restrictions.
Q9. Is TDS applicable on dividend income?
Yes, Tax Deducted at Source (TDS) is applicable on dividend income. If the dividend paid by a company exceeds Rs. 5,000 in a financial year, TDS at the rate of 10% is deducted. For non-resident shareholders, the TDS rate may be higher and is subject to tax treaties between India and the shareholder's country of residence.
Q10. How should dividend income be reported in the income tax return (ITR)?
Dividend income should be reported under the head "Income from Other Sources" in the ITR. You must declare the total dividend income received during the financial year and pay taxes on it based on your applicable tax slab.
Q11. Are dividends from foreign companies taxed differently?
Yes, dividends received from foreign companies are treated as foreign income and are taxable in India at the applicable slab rates. Unlike dividends from domestic companies, no TDS is deducted by foreign companies. However, any tax paid in the foreign country may be claimed as a tax credit under Section 90 or Section 91 if applicable.
Q12. Is advance tax applicable on dividend income?
Yes, if the total tax liability on your dividend income exceeds Rs. 10,000 in a financial year, you are required to pay advance tax. Failure to pay advance tax can result in interest penalties under Sections 234B and 234C of the Income Tax Act.
Q13. Are dividends received from mutual funds taxable?
Yes, dividends received from mutual funds are taxable in the hands of the investor. Post the Finance Act 2020, mutual fund dividends are taxed as per the individual's income tax slab rates, and TDS is applicable if the total dividend exceeds Rs. 5,000.
Q14. Can dividend income be set off against capital losses?
No, dividend income cannot be set off against capital losses. Dividend income is classified under "Income from Other Sources," while capital gains or losses fall under capital gains. Therefore, they are treated separately for tax purposes.
Q15. Can I claim any exemption on dividend income?
There is no specific exemption available for dividend income post the Finance Act 2020. Previously, dividends up to Rs. 10 lakh were exempt under Section 10(34), but this exemption has been removed, and dividends are now fully taxable.
Q16. Is there any special tax rate for dividend income for senior citizens?
No, there is no special tax rate for dividend income for senior citizens. The dividend income is taxed at the individual's applicable income tax slab rate, regardless of age.
Q17. What happens if a company declares dividends, but the payment is deferred to the next financial year?
Dividend income is taxable in the year when it is actually received by the shareholder. Therefore, if a company declares a dividend in one financial year but pays it in the next, it will be taxed in the year of receipt.
Q18. How do tax treaties impact the taxation of dividends for foreign investors?
Tax treaties between India and other countries may provide relief to foreign investors by lowering the withholding tax rate on dividends. The specific tax rate and relief provisions vary depending on the tax treaty between India and the investor's country of residence.
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