Holding shares in a company offers you the opportunity to generate income. When these shares are appreciated, you can receive a profit after you sell them. Companies also share the profits they make by way of dividends, which is called dividend income. Dividends denote payments that are disbursed to shareholders from their earnings or earned surplus. They are generally given as cash payments or allocated as surplus stock shares or various kinds of assets.
What Does Dividend Income Mean?
If you are one of those who buy stocks, mutual funds, or ULIPs, you will earn a dividend. As per Section 2 (22) of the Income-tax Act, the definition of a dividend is extensive and constitutes the following:
- The allocation of retained earnings to shareholders involves the distribution of the company’s assets of the company;
- The allotment of debentures or deposit certificates to shareholders from their income reserves and the allocation of bonus shares among preference shareholders.
- The distribution of accumulated profits among shareholders and creditors upon liquidation is viewed as deemed dividend income for tax purposes.
- Returning cash to shareholders through capital reduction means distributing profits to them.
- Advances or loans that a closely held company offers to its shareholders out of their accumulated profits.
How Dividends Originate?
Dividends originate from the following ways:
- The domestic company where you have bought shares
- The foreign company where you have bought shares
- Equity mutual funds, where you have opted for the dividend alternative
- Debt mutual funds, where you have opted for the dividend alternative
- Based on the origins of dividend income, the division of tax burden on the stakeholders can be implemented.
Let’s look at the consequences of the tax on dividend earnings on the sources of income mentioned above.
Taxation Prior to the Beginning of the Assessment Year 2020 -2021
Prior to the Assessment Year 2020-2021, dividends acquired from domestic companies did not incur any tax liability by virtue of Section 10(34) of the Income Tax Act. As an exception, dividends exceeding Rs 10 lakhs are taxed under Section 115BBDA. During that interval, the tax liability was the primary responsibility of the company involved in dividend distribution, which had to pay a 15% Dividend Distribution Tax (DDT) under Section 115-O before distributing dividends to shareholders. Such an arrangement virtually exempted shareholders from paying tax on the significant portion of dividend income they received.
New Features Initiated in FY 2020-2021
The Finance Act 2020 initiated substantial changes in the way taxation of dividends takes place across India, commencing from the Assessment Year 2021-22:
- Cancellation of DDT: The Finance Act brought about the cancellation of DDT, which led to a transference of the tax burden to the shareholders, which the company initially withstood. Due to this, dividends now come under the direct taxation of recipients, which involves individuals, HUFs, and businesses.
- Assessment of Dividend Income: With the new rules, individuals who invest privately can receive up to Rs. 5000 in dividend income without paying taxes. If the amount of dividend income is higher than Rs. 5000, the extra income will be taxed according to the normal income tax rates for that person. These changes might mean that people who earn a lot from dividends could end up paying more in taxes.
- Elimination of 10% Tax on Substantial Dividend Receipts: The earlier provision in effect under Section 115BBDA, which levied a 10% tax on income resulting from dividends above Rs.10 lakh, was canceled. Every dividend income is taxable, depending on the standard rates for various income brackets of the dividend recipient, regardless of the amount.
Categorization and Tax Regime
The applicability of tax on dividends rests on whether an investor or a business dealer receives it.
- Trading and Commercial Activities: If shares are owned for trading, dividend income is taxed under the category of “Income from Business or Profession.”
- Investment Activities: If shares are owned for investment, dividend taxation falls under the “Income from Other Sources” category.
Tax Reductions and Allowances
- Business Earnings: Stakeholders who receive dividends in the form of business profits can deduct all expenses included in the proceeds from that income, such as interest rates and collection charges.
- Income from Other Sources: Dividends classified as “Income from Other Sources” require a deduction for the interest expenses incurred to receive the dividend income, which is 20% of the total dividend payments. No further deductions related to commissions or charges paid towards the payout of dividends are permitted.
Tax Liability On Dividend
The tax burden on dividend income varies, depending on the class of the assessees who earn the dividend and the source of the dividend distribution.
The given table presents a summary of the variations in dividend income.
| Class of Assessee | Dividend Payout Structure | Rate of Tax |
| Resident | Dividend income from a domestic company | The standard tax rate is appropriate for the assessee |
| NRI | Dividend on the GDR of an Indian company/PSU (receiving in foreign currency) | 10% |
| NRI | Dividend on Indian company shares (earned in foreign currency) | 20% |
| NRI | Additional Dividend Income | 20% |
| FPI | Dividend on securities distinct from 115AB | 20% |
| Investment Division of Offshore Banking Unit | Dividend on securities excluding 115AB | 10% |
No Tax-Free Dividend Limit After April 1, 2020
The tax-free threshold on dividends from national companies for shareholders was abolished as of April 1, 2020. Currently, all dividends are subject to taxation, depending on your income tax rate bracket. Now, no specific amount exists for tax-free dividends. Yet, TDS deductions are made by companies if your total dividend payments exceed Rs. 5000 annually. Lower than this amount, no TDS is employed.
Taxation Schedules for Final and Interim Dividends
Section 8 outlines the taxation provisions for final dividends, which include deemed dividends whose assessment occurs in the year of declaration, payment, or distribution by the company, whichever comes first. On the contrary, an interim dividend is subject to tax in the year the company pays the dividend amount to the shareholder without any qualification. This indicates that interim dividends are taxable in the previous year, whereby you have received them and are a payout of the last year of the company from reserves or net income of the company. This helps align the tax liability with the actual funds available to the shareholder.
TDS on Dividend Income
1. Representing Resident Shareholders
Section 194 states the applicability of TDS on dividends that are declared, paid, or distributed on or after April 1, 2020, at a 10% rate by an Indian company on dividend distribution to the resident shareholders. Such TDS deduction can be applied if the total dividend distribution or payment during the financial year to a shareholder surpasses Rs 10,000. Previously, till FY 2024-25, the threshold was Rs. 5000.
This rule does not extend to dividend payments to the Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), or any insurer owning shares or having a beneficial interest in holding them.
2. Representing Non-Resident Shareholders
TDS deduction at 20% is applicable for dividend payments to non-resident individuals or foreign companies, as per Section 195 of the Income Tax Act, 1961. This section outlines provisions that prevent double taxation and reduce the rate under valid double taxation avoidance agreements (DTAAs). Non-residents need to furnish Form 10F, a claim of beneficial ownership, and a tax residency certificate to take advantage of the reduced rates. If these related documents are not supplied, then the normal TDS rate of 20% applies, which can be refunded as a credit upon submission of an Indian tax return.
3. Tax Collected at Source on Dividend Income
This method of levying tax collects taxes directly at the source of income and is crucial for tax collection, specifically in the matter of dividend income. Both shareholders and businesses must know the impact of TCS on dividend income and various financial dealings.
4. Advance Tax Provisions Regarding Dividend Income
If a person has incurred a tax liability for the specified financial year that exceeds or is equal to Rs. 10,000, the advance tax provisions will apply. Where such an advance tax obligation is not remitted either partially or wholly, in such a condition, it can draw a penalty or interest.
Suppose there is an arrear in the earned or advance tax installments or a discrepancy in its timely payment due to dividend income. In that case, no interest is to be levied under section 234C if the assessee has remitted full tax in successive advance tax installments. However, this benefit does not accrue with regard to deemed dividends, as is mentioned under Section 2 (22) (e).
5. Form 15G/15H Submission Regarding Dividend Income
Resident individuals who earn dividends and anticipate annual income that falls short of the exemption limit can file Form 15-G to inform the company of their qualification for tax exemption.
Likewise, a senior citizen whose yearly income is less than the threshold and who has nil tax obligation can file Form 15H with the entity distributing the dividend.
6. Tax on Dividend Income from Domestic Companies
Dividend payments from Indian companies of up to ten lakhs within a fiscal year are income-tax-free for the shareholder. However, such dividends are taxable income due to the operation of Dividend Distribution Tax (DDT). According to the DDT mechanism, the company paying out dividends contributes to tax payments to the government before remitting the rest to investors and shareholders.
7. Surplus tax on Dividends Above ₹10 Lakhs
The Finance Act 2016 imposes a 10% Income tax surplus on shareholders if their dividend income exceeds ten lakhs within a fiscal year. This tax is imposed on every shareholder, firm, HUF, and resident individual. Notably, this 10% tax is levied on top of the DDT paid by the company.
8. Taxation on Dividend Income from Foreign Companies
Returns received from overseas corporations are grouped as “income from other sources” within the Indian tax regime. Such dividends are part of the taxpayer’s total income and are taxable under the relevant slab rates. For example, if a taxpayer figures in the 30% income tax bracket, the dividend income levied would be 30% plus any imposed tax.
9. Writing off Interest Expenses
Investors obtaining returns through foreign dividends can write off interest expenses pertaining to earnings from stock investments. The deduction permissible is up to 20% of the gross revenues from the dividend. This helps lower the net taxable income from dividends, making it beneficial for investors who fund their overseas investments through borrowings.
10. Withholding Tax Provisions
Section 194 of the Income Tax Act 1961 states that any firm announcing a dividend must deduct TDS. The tax deduction rate is 10% for dividend payments to individuals beyond Rs. 5,000 covering a fiscal year. Suppose the recipient does not present their PAN (Permanent Account Number) to the remitter. In that case, the TDS charge rises to 20%, which implements tax compliance and tax identification regulations.
The Bottomline
Taxation of dividend income is central to retaining fair revenue systems while adapting to the well-being of shareholders and governments. On the one hand, it guarantees that revenues generated from investment promote public finance. Conversely, a mismanaged dividend tax structure can impede financing and growth within the capital market. A well-framed tax regimen on dividends can boost economic stability, raise investor confidence, and uphold lasting fiscal sustainability.
At Kanakkupillai, we deliver definitive tax solutions that integrate with varied corporate and regulatory practices. This results in a more solution-driven approach in a dynamic tax environment.
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