Tax on Dividend Income

Tax on dividend income is a tax that investors should pay under section 194 of the Income Tax Act of 1961 on the income they generate from dividends. Investing has become one of the most important factors in an effective financial plan. You can save as much as you can, but keeping the whole saved amount in your savings account will only grow slowly, resulting in an inadequate final amount.

On the other hand, the Indian stock market has the potential to grow your invested amount by a hefty margin, provided you invest after extensive research. One of the best parts of investing, especially in stocks, is their dual benefit. Stocks provide dividends, which can become an alternate source of income and also appreciate in price, further increasing your profits.

However, if you are earning from dividends, you may be liable to pay taxes. In this article, you will understand tax on dividend income and better understand your tax liability if your stock investments have announced dividends.

What is dividend income?

Companies offer their shares for the first time to the general public through a process called Initial Public Offering (IPO). Once they go public, the investors who buy the shares using their demat accounts become the shareholders and part owners of these companies. Companies reward their shareholders for buying and holding the shares of the company through dividends.

Dividends are the payouts by public companies to their shareholders, commonly done by distributing the profits generated in a financial year. The company distributes a portion of the profits to the shareholders based on the number of shares they hold. Dividends are announced per share by the companies. For example, if a company has announced a dividend of Rs. 2 per share and you hold 200 shares. You will receive Rs. 400 as dividend income.

However, as per section 2(22) of the Income Tax Act, 1961, dividend income can also be received from the following situations:

Distribution of accumulated profits due to the release of company assets.

Distribution of accumulated profits at the time of company liquidation.

Distribution of deposit certificates or debentures from accumulated profits.

Issue of bonus shares to preference shares from accumulated profits.

Distribution of accumulated profits due to capital reduction of the company.

Loan or advance given from accumulated profits.

What is tax on dividend income?

Under the Income Tax Act, 1961, the Indian government and the income tax authority require every Indian citizen to pay taxes on the income they earn in a financial year. Dividend income is also taken as income for the investor as the company credits the dividend income directly into the investor’s bank account. Hence, as dividends are termed income, the government levies tax on dividend income to be paid by the investor at the time of filing the Income Tax Return (ITR) as per the applicable tax rates.

The tax on dividend income depends on whether you are a trader or an investor. If you are a trader, the dividend income falls under the business income head while filing an ITR. On the other hand, if you are an investor, the dividend income falls under the head of income from other sources.

Tax rate on dividend income

Here is a detailed table on dividend income tax rate:

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When do I need to pay tax on dividend income?

As per section 8 of the Income Tax Act, the investor must pay tax on dividend income in the year in which it has been announced, distributed, or actually paid by the company, whichever is earlier. Here, the dividend income includes the deemed or the financial dividend amount. However, if the dividend amount is interim (interim dividend), the dividend amount is taxable in the previous year in which the company has provided the dividend amount. Hence, interim dividend is taxable on a receipt basis.

How are dividends taxed?

Prior to April 1, 2020, companies were required to pay a Dividend Distribution Tax (DDT) before distributing dividends to shareholders. The rate was around 17.65% (including surcharge and cess). However, the Finance Act 2020 abolished the DDT, shifting the tax liability on dividends to the shareholders. This means that dividends are now taxed at the hands of the shareholders as per their applicable income tax slab rates.

Here is how the dividend is taxed:

1. Resident individuals and HUFs

Dividends are added to the total income and taxed according to the applicable income tax slab rates.

2. Domestic companies

Dividends received by domestic companies are taxed at the applicable corporate tax rates.

3. NRIs and foreign companies

Dividends are subject to a tax rate of 20% (plus applicable surcharge and cess) under Section 115A of the Income Tax Act.

4. Tax deducted at source (TDS)

The companies are required to deduct TDS at 10% TDS if the dividend exceeds Rs. 5,000 in a financial year for resident shareholders and 20% for NRIs.

How to calculate tax on dividend income?

Here are the steps to calculate tax on dividend income:

1. Identify the source

Identify if the dividend has been paid by a domestic or an international company.

2. Classify the taxpayer

Classify the taxpayer category you fall into, including resident Indians, HUFs, NRIs, foreign companies, FPIs, or domestic companies.

3. Apply the applicable tax rate

Add the income to your total income generated in the financial year. Once done, apply the applicable tax rate as per your taxpayer category to determine your tax on dividend income.

4. Minus deductions

You can subtract all the eligible deductions as per your taxpayer type to lower the tax on dividend income.

How much tax is paid on dividend income?

The tax paid on dividends in India depends on the type of taxpayer and the total income. Here are all the factors involved in dividend tax:

1. Resident Indians and HUFs

Dividend income is added to total income, and tax is paid according to the applicable income tax slab. However, the company deducts TDS at 10% if the total dividend amount exceeds Rs. 5,000.

2. NRIs and foreign companies

Dividends are taxed at a flat rate of 20% (plus surcharge and cess). However, in the case of a foreign country, if India and the country have a Double Taxation Avoidance Agreement (DTAA) provision, the tax rate of dividends may be lower.

3. Domestic companies

Dividends received by domestic companies are taxed at the applicable corporate tax rates applicable to the company. This means the dividends are treated as part of the company’s income and taxed at the corporate tax rate.

TDS on dividend income

After April 1, 2020, the Finance Act imposed a requirement on companies to deduct tax deducted at source (TDS) from the dividend income of investors. Here are its provisions:

Companies are liable to deduct TDS at 10% from the total dividend payout of resident investors if the dividend amount is higher than Rs. 5,000.

Investors can get a TDS refund as a credit against their total tax liability when filing their income tax return. However, the investor must be an Indian resident.

Companies are required to deduct TDS at 20% from the total dividend payout if the shareholder is a non-resident Indian (NRI). However, they can avail of a lower tax on dividend income by utilising the DTAA provisions. For this, they must submit relevant documents such as Form 10F, tax residency certificate, beneficial ownership declaration, etc. In case of failure to submit these documents, a higher TDS is applicable, which the NRIs can claim as a refund at the time of filing ITRs.

Old vs. New provision for taxability of dividend income

Here is a detailed explanation of old vs. new provisions for the taxability of dividend income:

1. Exemption until March 31, 2020 (FY 2019-20):

Until March 31, 2020, Indian resident investors were not liable to pay income tax on dividends received from Indian companies. This was because of the Dividend Distribution Tax (DDT) provisions, which required companies to pay DDT to the government to declare dividends.

2. Change in dividend taxation (effective April 1, 2020):

The Finance Act 2020 removed the DDT provisions and required investors to pay income tax on dividends received from domestic companies as per their applicable tax slabs, effective from 1st April 2020. Hence, the dividends were made taxable at the hands of the investors.

3. Withdrawal of DDT liability on companies and mutual funds:

After the removal of DDT provisions, companies are no longer required to pay DDT. Now, the tax liability falls on the shareholders receiving dividend income.

4. Withdrawal of 10% tax on dividend receipts in excess of Rs. 10 lakh

The Finance Act 2020 also removed the provision of additional dividend tax, which investors had to pay at the rate of 10% if the total dividend amount exceeded Rs. 10 lakh. No, whatever the dividend income is, it is taxed at the applicable income tax slab rate of the shareholder.

Advance tax on dividend income

Advance tax is a taxation process where individuals and entities pay tax in installments throughout the financial year rather than waiting until the end of the year. Shareholders are also required to pay advance tax on dividend income if the total tax liability is equal to or more than Rs. 10,000 in a specific financial year. The government applies penalties and interest in case of failure of advanced tax on dividend income or if the tax amount is short of the actual tax liability amount.

Double taxation relief

A dividend income received from a foreign country may already have been taxed in the country of origin, creating double taxation. In such a case, a shareholder can claim tax relief under the Double Tax Avoidance Agreement (DTAA) provisions. India has entered into DTAAs with several countries to provide relief from double taxation. Under the DTAA method, dividend income is taxed in only one of the two countries. For example, suppose a resident of India earns income in a country with which India has a DTAA. In that case, the income may be taxed only in that foreign country and exempted in India.

Furthermore, if the tax has been deducted in both countries, the shareholders can claim a refund for the tax paid in India if the tax has been deducted in the foreign countries. However, if India does not have a DTAA provision with a country, a shareholder can still claim tax relief under section 91 of the Income Tax Act 1961 to avoid paying tax in both countries.

Deduction on expenses from dividend income

The Finance Act 2020 allows shareholders to deduct expenses that were incurred to earn the dividend income from the tax on dividend income liability to lower the tax amount. Traders who file the dividend income under the income from a business or profession head can claim deductions of all the expenses they incurred to earn the dividend income, such as interest on loans, collection charges, etc. Similarly, investors can also claim deductions on the dividend income for interest expenses incurred to earn the dividend up to 20% of the total dividend income.

For example, if an investor borrowed money to buy stocks and paid Rs. 3,000 in interest on the loan, and the final dividend amount is Rs. 5,000, only 20% of Rs. 5,000, i.e., Rs. 1,000 can be claimed as deduction for the loan interest.

Conclusion

Dividends are ideal for investors who want to invest in low-risk stocks, called dividend growth stocks, that do not witness high volatility but offer regular dividends. Such stocks can provide steady returns to investors by offering regular dividends but require them to pay dividend tax based on the tax rate on dividends, shareholder type, and total dividend payout. Since DDT has been removed, you are now liable to pay tax on dividend income as per your income tax slab rates to ensure effective tax compliance.

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