Dividend-paying stocks, mutual funds, and ULIPs are popular ways for investors to generate a stream of regular income. Before 2020, dividend income was tax-free in the hands of investors because companies and mutual funds were required to pay Dividend Distribution Tax before paying out dividends. However, with the abolition of DDT in 2020, dividends are now added to the investor’s income and taxed according to their tax slab rate.
Here we’ll explore the past and present taxation of dividend income by tackling concepts like what is DDT, current dividend taxation rules, tax rates, dividend TDS, and exemptions in tax on dividend income India offers.
What is Dividend Distribution Tax (DDT)?
Before 31 March 2020, the Indian government levied a special tax on companies and mutual fund houses called the Dividend Distribution Tax. According to this law, companies had to pay a certain percentage of the declared dividend amount as DDT before distributing any dividends to investors. Due to this provision, dividend income was completely tax-free in the hands of investors. However, the Finance Act of 2020 changed how dividends are taxed.
Along with DDT, another special provision was withdrawn. Under Section 115BBDA, tax on dividend income of more than Rs. 10 lakh per financial year was levied at 10% in the hands of individual taxpayers, Hindu Undivided Families, and firms, however, the income is now taxed as per the taxpayer’s slab rate.
Taxation of Dividend Income in India
Due to the recent changes, investors may get confused about whether or not dividend income is taxable. The answer is yes. With the abolition of DDT, dividend income is taxed fully in the hands of investors. This income is added to the investor’s taxable income under the head ‘Income From Other Sources’ and taxed according to their tax slab rate.
Thus there is no uniform dividend tax rate but rather a variable one depending on the investor’s total income. Under Section 57 of the Income Tax Act, the only deduction applicable when income has this classification is on the interest expenses incurred to earn such an income, which is capped at 20% of the total dividend income.
In case a company’s shares are held for trading purposes as part of a business, dividend income is taxed under ‘Income from Business or Profession’. The tax rates under this income classification are also the same as the classification above, however, it does allow taxpayers to claim certain extra deductions on expenses like not only the loan interest but also brokerage and collection charges, which can bring their tax liability down more.
A tax consultant can help you get into the specifics of the difference between dividend taxation under ‘Income from Other Sources’ and ‘Income from Business or Profession’.
Income earned from dividends is also subject to TDS (Tax Deducted at Source). If a taxpayer’s dividend income in a financial year exceeds Rs. 5,000, companies and AMCs are required to deduct a TDS of 10% before paying out the dividends under Section 194. This provision also came into effect on 1 April 2020. We’ll take a deeper dive into TDS rules and exemptions on dividend income in the following sections.
Dividend Tax Rate for Different Investors
The dividend tax rate differs based on the taxpayer’s residential status (Resident or NRI) and the type of investment which pays the dividend.
For Resident Individuals
Dividend income earned by residents investing in any domestic company is taxed according to applicable income tax slab rates. A 10% TDS is also deducted in case their annual income from dividends exceeds Rs. 5,000 per year. This amount can be claimed as a refund or adjusted with the final tax liability at the time of filing returns.
For Non-Resident Individuals (NRIs)
For NRIs, the rules of tax on dividend income are a bit more complex. Investing in GDR (Global Depository Receipt) of Indian companies and PSUs using foreign currency attracts a tax rate of 10% on dividend income. NRIs earning dividend income taxable in India by investing in domestic companies using foreign currency also attract tax but at a higher tax rate of 20%. Any other dividend income earned by NRIs is also charged at the 20% tax rate.
As far as TDS is concerned, NRIs are taxed at a higher rate compared to resident Indians, at 20%.
For Corporates and FPIs (Foreign Portfolio Investors)
The dividend income earned on securities other than the ones listed under 115AB is subject to 20% tax.
TDS on Dividend Income
In addition to abolishing the DDT, the Finance Act of 2020 also introduced TDS taxation of dividend income. According to this new system, companies or mutual fund houses distributing dividends have to deduct TDS before making the payment to their investors. The exact rate of TDS depends on the investor’s residential status. For residents, these rules are mentioned under Section 194, which states that dividend income is subject to a 10% TDS if the investor’s dividend income exceeds Rs. 5,000 per financial year. This rate increases to 20% if they fail to provide their PAN details.
For example, if an individual earns Rs. 9,000 dividend income from a company, TDS at 10% will be deducted before the remaining amount is distributed to the shareholder as it exceeds Rs. 5,000. Thus Rs. 9,000 – Rs. 900 = Rs. 8,100 will be credited to the individual.
On the other hand, TDS rules on dividend income for NRIs are stated under Section 195. When an Indian company distributes dividends to a non-resident investor, it must deduct TDS at 20%. This rate can be reduced if the NRI’s country has a Double Taxation Avoidance Agreement with India.
Ways to Reduce TDS
In case a resident investor’s total income in a financial year is below the basic exemption limit, they can submit Form 15G (or Form 15H if they are a senior citizen) to the dividend-paying company or mutual fund house to prevent TDS deduction. Even if any TDS is deducted, it can be claimed as a refund at the time of filing income tax returns.
To get the DTAA benefit, NRIs need documents such as Form 10F, a Tax Residency Certificate (TRC), and a declaration of beneficial ownership. These will help them claim their dividends at much reduced TDS rates.
When is Dividend Income Taxable?
Section 8 of the Income Tax Act answers when dividends are taxable. The final (and deemed) dividend is taxable in the year it is declared, distributed, or paid – whichever occurs first. An interim dividend, on the other hand, is taxable in the financial year when it is unconditionally made available to the shareholder.
Dividend Income Exemptions and Deductions
Most of the benefits that allowed tax relief on dividend income were abolished alongside DDT, however, a few remain. Some provisions in the Income Tax Act make dividend income exempt from tax under specific conditions. For example, dividends received from agricultural cooperatives are exempt, as are dividends received by registered charitable trusts.
Investors can also claim deductions on expenses incurred to earn dividends. For example, traders whose dividend income is classified as ‘Income from Business or Profession’ can enjoy deductions on various expenses related to their trading activity like interest on loans taken to purchase dividend-paying stocks, brokerage fees associated with trading, and collection charges for realising dividend payments. Investors whose dividend income is taxed under ‘Income from Other Sources’ can only claim a deduction on interest expenses incurred to earn dividends, which is capped at 20% of the total dividend income.
Old vs. New Provision for Taxability of Dividend Income
Up to 31 March 2020, dividend income was tax-free in the hands of investors. Companies and AMCs paid the Dividend Distribution Tax before paying out dividends. However, the Finance Act of 2020 changed this provision by abolishing DDT. Under the new rules, dividends are added to the investor’s taxable income and taxed according to their slab rates. Thus the biggest difference between the old and the new provision is that instead of the company distributing the dividends, it’s the investors who pay the tax.
Other than this, the Section 115BBDA provision was withdrawn. It stated that dividends in excess of Rs. 10 lakh received by resident individuals, HUFs, and firms would be taxed at a flat rate of 10%. Now, the tax on dividend income for individuals or entities depends on their slab rates.
Inter-Corporate Dividend Taxation
So far we’ve discussed tax on dividend income for individuals, but what happens when one company receives dividends from another company? Earlier this kind of income was also subject to DDT, but ever since it was abolished, a new provision was introduced. When a domestic company receives dividends from another domestic company, it is taxed as per the corporate tax rate applicable to it. The Government also introduced Section 80M to provide relief from double taxation on inter-corporate dividends. This section allows a domestic company to claim a deduction on the amount of dividends it receives from another domestic company, but only if it redistributes the same dividends to its shareholders within one month of the due date for filing returns.
In case a domestic company receives dividends from a foreign company, the dividends are taxed differently based on shareholding. Under Section 115BBD, if the domestic company holds at least 26% equity in the foreign company, the dividend income is taxed at a dividend tax rate of 15% with no deductions allowed for expenses incurred to earn the dividend. In case the shareholding is below 26%, the dividend is taxed at the normal corporate tax rate applicable to the domestic company which depends on the turnover. Deductions can also be claimed for expenses related to earning this income.
How to Reduce Tax on Dividend Income?
Ever since the DDT along with its special provisions was abolished, the scope for tax-efficient dividend planning has changed. With dividends now being taxed at individual slab rates, high-income earners face a heavier tax burden. For example, dividend income over Rs. 10 lakh was taxed at 10% pre-2020, but now it can go up to 30%. To save as much of your hard-earned money as possible, you should consider getting help from tax consulting services, who can guide you through the intricate ways of minimising tax liability while ensuring compliance with ever-changing rules and regulations. Here are some strategies one can consider to reduce their tax liability.
1. Holding Dividend Stocks in Tax-Efficient Accounts
Choosing options like growth mutual funds over dividend-paying funds can help save some tax as the income is taxed as capital gains and not as dividend income. Equity funds like ELSS (Equity Linked Savings Schemes) also offer tax deductions up to Rs. 1.5 lakh per year under Section 80C and also make long-term capital gains up to Rs. 1.25 lakh exempt from tax which can lead to further tax savings.
2. Using DTAA for Foreign Dividend Tax Relief
DTAAs are also called tax treaties, and they help prevent double taxation for individuals earning income in two or more countries. These treaties can be used by NRIs to significantly lower their dividend tax rate. For example, the standard TDS rate on dividend income is 20% for NRIs. If an investor can claim DTAA benefits, they can get a reduced TDS rate by providing Tax Residency Certificates and other required documents to the relevant authorities.
3. Timing Dividend Withdrawals for Tax Optimization
Another popular strategy for minimising taxation of dividend income is by spreading it across family members who fall under the basic exemption limit or lower tax slabs. Using Form 15G or 15H can even make TDS on dividend income exempt if the individual’s total annual income isn’t taxable.
Conclusion
Before 31 March 2020, the government levied a Dividend Distribution Tax on companies. Before distributing dividends to their investors, companies paid tax on their declared dividends. The tax on dividend income India changed with the Finance Act of 2020, which abolished DDT and its special provisions, making dividend income taxable in the hands of taxpayers at their applicable slab rates. It also introduced TDS provisions, which state that 10% must be deducted if an investor’s dividend income exceeds Rs. 5,000 per year.
