Last updated: September 3rd, 2024 4:02 PM

Tax on Dividend Income: Taxation of Dividend Income

Dividends represent a portion of earnings distributed to shareholders if you invest in stocks or mutual funds. Many corporations and mutual fund schemes return profits to their investors through dividends. Given that dividends constitute income, a common question arises: Are dividends taxable when you file your income tax return? Let's delve into the specifics of Tax on Dividend Income.

What is Dividends?

Dividends are payments made by companies to their shareholders out of their profits or retained earnings. A company can reinvest its profits into the business or distribute a portion to its shareholders as dividends. Although dividends are typically paid in cash, they can also be issued as additional stock shares or other types of assets.

What is Dividend Income?

Dividend income typically arises from a company distributing its profits to shareholders. This form of income is common among those who invest in stocks, ULIPs (Unit Linked Insurance Plans), or mutual funds. However, according to Section 2(22) of the Income-tax Act, the concept of a dividend is broad and includes several other forms of distributions:

• The distribution of accumulated profits to shareholders involves the release of the company's assets.
• The issuance of debentures or deposit certificates to shareholders from the company’s accumulated profits, along with the allocation of bonus shares to preference shareholders from these profits.
• Distributions made to shareholders during the company’s liquidation are derived from accumulated profits.
• Distributions to shareholders from accumulated profits when the company reduces its capital.
• Loans or advances a closely held company makes to its shareholders from its accumulated profits.

Sources of Dividend Income and Their Tax Implications

Dividends can be received from various sources, each with its tax implications. Here’s where you might earn dividend income:

• Domestic Company: Dividends received from a domestic company in which you hold shares.
• Foreign Company: Dividends from a foreign company in which you have invested.
• Equity Mutual Funds: If you have opted for the dividend payout option in your equity mutual fund investments.
• Debt Mutual Funds: If you have chosen the dividend payout option in your debt mutual fund investments.

Also, read Statement of Financial Transactions (SFT) for Dividend income

Overview of Changes in Tax on Dividend Income

Taxation Before the Assessment Year 2020-21

Before the Assessment Year 2020-21, dividends received from domestic companies were exempt from income tax under Section 10(34) of the Income Tax Act, except for dividends exceeding Rs. 10 lakh, which were taxed under Section 115BBDA. During this period, the tax burden was primarily on the company distributing the dividends, which was required to pay Dividend Distribution Tax (DDT) at a rate of 15% (plus applicable surcharges and cess) under Section 115-O before paying out dividends to shareholders. This system effectively exempted shareholders from paying tax on most of the dividend income they received. Also, read Highlights of Budget 2021

Changes Introduced in FY 2020-21

The Finance Act of 2020 brought significant changes to how dividends are taxed in India, starting from the Assessment Year 2021-22:

• Abolition of DDT: The Finance Act abolished DDT, shifting the tax liability from companies to shareholders. As a result, dividends are now taxed directly by the recipients, including individuals, Hindu Undivided Families (HUFs), and firms.
• Taxation of Dividend Income: Under the new system, individual investors can receive dividend income up to Rs. 5,000 without any tax liability. Any amount above this threshold is taxed according to the recipient's applicable income tax slab rates. This change effectively increased the tax burden on recipients, particularly those receiving substantial dividends.
• Removal of the 10% Tax on Large Dividend Receipts: The previous provision under Section 115BBDA, which imposed a 10% tax on dividend income exceeding Rs. 10 lakh, was abolished. All dividend income is subject to taxation based on the recipient’s income tax slab rate, regardless of the amount.

Classification and Tax Treatment

The tax treatment of dividends depends on whether the recipient is a trader or an investor:

• Trading Purposes: If shares are held for trading, dividend income is taxed under the head 'Income from Business or Profession.'
• Investment Purposes: If shares are held as investments, dividends are taxed under 'Income from Other Sources.'

Deductions and Allowances

• For Business Income: Investors who receive dividends as business income can deduct all related expenses incurred in earning that income, such as collection charges and interest on loans.
• For Income from Other Sources: If dividends are classified as 'Income from Other Sources,' only interest expenses incurred to earn the dividend income can be deducted, up to 20% of the total dividend income. No other deductions, such as commissions or fees paid for dividend collection, are allowed.

Dividend Tax Rate

The tax rates on dividend income vary based on the type of assessee receiving the dividend and the instrument from which the dividend is distributed. The table below outlines these variations effectively:

Category of Assessee	Dividend Nature	Rate of Tax
Resident	Dividend received from a domestic company	The normal rate of tax applicable to the assessee
Non-Resident Indian (NRI)	Dividend on GDR of Indian company/PSU (purchased in foreign currency)	10%
NRI	Dividend on shares of Indian company (purchased in foreign currency)	20%
NRI	Any other Dividend income	20%
Foreign Portfolio Investor (FPI)	Dividends on securities other than those under section 115AB	20%
Investment Division of Offshore Banking Unit	Dividends on securities other than those under section 115AB	10%

Key Points

• Residents: Dividends received from domestic companies are taxed at the normal income tax rates applicable to the resident assessee.
• NRIs: Tax rates for NRIs vary depending on the type of investment. Dividends from Global Depository Receipts (GDRs) of Indian companies or Public Sector Undertakings (PSUs) purchased in foreign currency are taxed at a reduced rate of 10%. In contrast, dividends from shares of Indian companies purchased in foreign currency are taxed at 20%.
• FPIs and Offshore Units: Foreign Portfolio Investors and the investment divisions of offshore banking units face a 20% tax rate on dividends from securities not covered under section 115AB, except that investment divisions of offshore banking units are taxed at 10%.

Dividend Tax-Free Limit

Before April 1, 2020

Previously, dividends from domestic companies were tax-free for shareholders if the total dividend income was up to Rs. 10 lakh in a year. The excess was taxed at 10% if the dividends exceeded this amount. This allowed many investors to receive dividends without paying additional tax.

After April 1, 2020

The rules changed significantly in 2020. The tax-free limit was removed, and now all dividends are taxable based on your income tax slab rate. There's no longer a specific tax-free amount for dividends. However, companies only deduct tax at source (TDS) if your total dividend income exceeds Rs. 5,000 in a year. Below this amount, no TDS is applied.

Taxation Timing for Final and Interim Dividends Under Section 8

Section 8 of the Act stipulates that the taxation of final dividends, including deemed dividends, occurs in the year they are declared, distributed, or paid by the company—whichever event happens first. In contrast, an interim dividend is taxable in the tax year in which the company unconditionally makes the dividend amount available to the shareholder. This means that interim dividends are taxed on a receipt basis, aligning the tax obligation with the shareholder's actual access to the funds.

TDS on Dividend Income 

TDS for Resident Shareholders

As mandated by Section 194, TDS on dividends distributed, declared, or paid by Indian companies on or after April 1, 2020, must be deducted at a rate of 10%. This applies to resident shareholders when the aggregate dividend exceeds Rs. 5,000 during the financial year. For example, if Mr Arun received a dividend of Rs 10,000 from an Indian company on May 30, 2023, the company would deduct Rs 1,000 as TDS (10%), leaving Mr Arun with Rs 9,000. The deducted TDS will be adjusted against his total tax liability when filing the FY 23-24 income tax return. Exceptions to this rule include dividends paid to the Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), or any other insurer that owns shares or has a full beneficial interest in them. In such cases, no TDS is deducted.

TDS for Non-Resident Shareholders

TDS is deducted at 20% under Section 195 for dividends payable to non-resident individuals or foreign companies. This rate may be reduced under applicable double taxation avoidance agreements (DTAAs). Non-residents must provide Form 10F, a declaration of beneficial ownership, and a certificate of tax residency to avail of the reduced rates. If these documents are not provided, the standard 20% TDS applies, though it can be claimed back as a credit when filing an Indian tax return. Note: You must report all dividend income in your income tax return (ITR).  

Tax Collected at Source (TCS) on Dividend Income

Tax Collected at Source (TCS) is a tax levying method used by the Indian government, where taxes are collected directly at the income's source. This system plays a critical role in tax collection, particularly in the context of dividend income. Both investors and businesses must be aware of how TCS impacts dividend income and other financial transactions.

Key Updates for Fiscal Year 2023-24

• Increased TCS Rate for LRS: One significant update for the fiscal year 2023-24 is the increase in the TCS rate applicable to international remittances under the Liberalised Remittance Scheme (LRS). The TCS rate has been increased from 5% to 20%, and notably, there is no minimum threshold for applying this increased rate.
• Scope of Application: The updated TCS rate under LRS covers a broad range of remittances, including those for medical expenses, education fees, and other purposes such as overseas investments.

Advance Tax Provisions Related to Dividend Income

Advance tax is applicable when an individual's total tax liability for the financial year is Rs. 10,000 or more. Taxpayers are required to pay this tax in instalments as per the due dates provided by the Income Tax Department. Failure to pay advance tax or delays in payment can lead to interest charges and penalties.

Dividend Income and Advance Tax Adjustments

• Exemption from Interest under Section 234C: Normally, any shortfall in payment of advance tax instalments attracts an interest penalty under Section 234C. However, if the shortfall is due to dividend income received, the interest penalty can be waived. This exemption is conditional upon the taxpayer paying the full tax due on the dividend income in subsequent advance tax instalments.
• Exception for Deemed Dividends: It's important to note that this benefit does not extend to deemed dividends as specified under Section 2(22)(e) of the Income Tax Act. In cases involving deemed dividends, interest under section 234C will still be charged if there is a shortfall in the advance tax payment related to this income.

Submission of Form 15G and 15H for Dividend Income

Resident individuals anticipating an annual income below the exemption limit can utilize Form 15G to inform the mutual fund or company distributing dividends of their eligibility for tax exemption. This form is useful for ensuring no tax is withheld on their dividend income. Similarly, senior citizens who expect a zero annual tax liability can submit Form 15H to the distributing company. This allows them to receive dividends without the deduction of tax at source. Upon declaring dividends, the mutual fund or company typically informs shareholders through registered mail. To benefit from receiving dividends without tax withholding, eligible shareholders must proactively submit Form 15G or Form 15H to the distributing entity.

Taxation of Dividends from Domestic Companies

Dividend income from Indian companies, up to ten lakhs in a fiscal year, is exempt from income tax for the shareholder. However, these dividends are subject to taxation through the Dividend Distribution Tax (DDT) mechanism. Under DDT, the company distributing the dividends pays the tax directly to the government before disbursing the remaining amount to shareholders.

Additional Tax on Dividends Exceeding ?10 Lakhs

According to the Finance Act 2016, if a shareholder's dividend income exceeds ten lakhs in a fiscal year, the excess amount is subject to an additional 10% income tax. This tax applies to all shareholders, including firms, resident individuals, and Hindu Undivided Families (HUFs). Importantly, this 10% tax is in addition to the DDT already paid by the company. Example: For instance, Mr Sharma received ?15 lakhs in dividend income from various domestic companies after those companies had paid DDT. Since this amount exceeds the ?10 lakh exemption threshold, Mr Sharma is required to pay a 10% income tax on the excess ?5 lakhs. As a result, he owes ?50,000 (10% of ?5 lakhs) in income tax on his dividend earnings for the fiscal year.

Taxation of Dividends from Foreign Companies

Dividends received from foreign corporations are classified under "income from other sources" in the Indian tax framework. These dividends are included in the taxpayer's total income and are subject to tax at their applicable slab rates. For instance, if a taxpayer is in the 30% tax bracket, the dividend income would be taxed at 30% plus any applicable cess.

Deductions for Interest Expenses

Investors receiving foreign dividends can deduct interest expenses related to the earning of this dividend income. The allowable deduction is up to 20% of the gross dividend income. This helps reduce the net taxable income from dividends, making it slightly more favourable for investors who finance their foreign investments through borrowings.

Withholding Tax (TDS) Provisions

Under Section 194 of the Income-tax Act of 1961, any firm declaring the dividend must deduct tax at source (TDS). For dividends paid to individuals exceeding Rs. 5,000 in a financial year, the TDS rate is 10%. However, if the recipient does not furnish their Permanent Account Number (PAN) to the payer, the TDS rate increases to 20%. This higher rate is meant to enforce compliance with tax identification norms. Click here to learn more about Dividend Income from Foreign Company

Relief from Double Taxation on Dividends from Foreign Companies

When dividends from a foreign company are taxed in both the country of origin and the recipient's country (India), this results in double taxation. To alleviate this, the Indian government provides mechanisms for tax relief to ensure that taxpayers do not pay tax twice on the same income.

Double Taxation Avoidance Agreements (DTAA)

India has established Double Taxation Avoidance Agreements with various countries to simplify tax obligations for taxpayers who earn income across borders. Under most DTAAs, the tax rate on dividends paid to the beneficial owner of the shares ranges from 5% to 15% of the gross dividend amount. These agreements often include provisions to reduce the tax rate further for dividends paid to a company that holds a significant percentage of the issuing company's shares—commonly 25%—as seen in DTAAs with countries like Canada, Denmark, and Singapore.

No Minimum Holding Period

Notably, these DTAAs do not specify a minimum period that the shares must be held to qualify for the reduced tax rate. This absence has historically allowed multinational corporations (MNCs) to temporarily increase their shareholdings immediately before dividends are declared to benefit from lower tax rates and then reduce their shareholdings after receiving the dividends.

Claiming Relief Under Section 91

If no specific DTAA exists between India and the country from which the dividend is received, taxpayers can still claim relief under Section 91 of the Indian Income Tax Act. This provision allows for a deduction from the Indian tax payable the amount of foreign tax paid on the income, thereby preventing double taxation.

Procedural Steps to Claim Relief

To claim relief under DTAA or Section 91:

• Documentation: Gather and prepare necessary documents such as proof of tax paid in the foreign country and the tax residency certificate.
• Filing Tax Returns: Declare the foreign dividend income and the foreign tax credit on your Indian tax return.
• Claiming the Relief: Apply for tax relief as per the applicable DTAA or under Section 91, ensuring all criteria are met and the proper forms are submitted.

Inter-Corporate Dividend Taxation  

With the shift of dividend taxability from companies to shareholders starting from the Assessment Year (AY) 2020-21, the Indian government introduced Section 80M in the Income Tax Act. This provision aims to mitigate the cascading effect of taxes when a domestic company receives a dividend from another domestic company and then distributes it further to its shareholders.

Key Provisions Under Section 80M

• Dividend from Domestic Companies: When a domestic company receives dividends from another domestic company, Section 80M allows the recipient company to reduce such dividend income from its total income if the same is distributed to its shareholders one month prior to the due date of filing the income tax return. This effectively prevents the double taxation of the same income at the corporate level.

Taxation of Dividends from Foreign Companies

• High Equity Shareholding (26% or more): Dividends received by a domestic company from a foreign company, where the domestic company holds 26% or more in equity, are taxed at a concessional rate of 15% plus applicable surcharge and Health and Education Cess under Section 115BBD. This tax is computed on a gross basis, meaning no deductions for any related expenditure are allowed.
• Lower Equity Shareholding (less than 26%): Conversely, if the equity shareholding is less than 26%, dividends are taxed at the normal corporate tax rate. However, in this scenario, the domestic company can claim deductions for expenses incurred in earning the dividend income.

Implications for Corporate Tax Planning

These distinctions in tax treatment based on the source of dividends and the shareholding percentage necessitate careful planning and documentation for corporations to ensure compliance and optimal tax treatment.

Expert Assistance for Dividend Taxation and E-Filing with IndiaFilings

Navigating the complexities of dividend income and its tax implications can be challenging. For precise and efficient management of these matters, consider consulting with experts at IndiaFilings. Our tax professionals can assist with e-filing your Income Tax Return (ITR), ensuring compliance and helping you maximize your tax benefits. [shortcode_102]