Tax on Dividend Income: Easy-to-Understand Guide

What is Dividend Income?

When a company makes a profit, it can either reinvest it or distribute a portion of it to shareholders. This distributed amount is called a dividend. It can be given in cash, additional shares, or other assets.

Types of Dividend Income

Dividend income is earned when you hold investments like:

• Stocks (dividends from domestic or foreign companies)

• Mutual Funds (equity and debt mutual funds)

• ULIPs (Unit Linked Insurance Plans)

According to Section 2(22) of the Income Tax Act, dividends include:

• Distribution of accumulated profits to shareholders

• Issue of debentures or deposit certificates from profits

• Bonus shares to preference shareholders

• Distributions during company liquidation

• Capital reduction distributions

• Loans or advances by closely held companies to shareholders from profits

Tax on Dividend Income: Key Changes Over Time

Before FY 2020-21

• Tax-Free for Shareholders: Dividends from domestic companies were exempt under Section 10(34).

• Dividend Distribution Tax (DDT): Companies paid a 15% DDT before distributing dividends.

• For High Dividend Earners: If dividend income exceeded Rs. 10 lakh, a 10% tax was charged under Section 115BBDA.

After FY 2020-21 (Current Taxation)

• DDT Abolished: Now, shareholders must pay tax on dividends.

• Tax Based on Income Slab: Dividends are added to your total income and taxed as per your income tax slab.

• No Separate 10% Tax on Large Dividends: The old Section 115BBDA is removed.

How Are Dividends Taxed?

Tax Treatment for Investors vs. Traders

• Traders: If shares are held for trading, dividend income falls under 'Income from Business or Profession'.

• Investors: If shares are held as an investment, dividends are taxed under 'Income from Other Sources'.

Deductions Available

• For Business Income: Traders can deduct expenses like collection charges and loan interest.

• For Other Income: Investors can deduct interest expenses (up to 20% of dividend income). No deductions for commissions or fees.

Tax Rates on Dividend Income

Dividend Tax-Free Limit

• Before April 1, 2020: Up to Rs. 10 lakh was tax-free. Excess was taxed at 10%.

• After April 1, 2020: No tax-free limit. Taxed at slab rates. However, TDS applies only if dividend income exceeds Rs. 5,000.

TDS on Dividend Income

For Resident Shareholders

• TDS at 10% on dividends exceeding Rs. 5,000 in a financial year (Section 194).

• Example: If Mr. Arun receives Rs. 10,000 in dividends, Rs. 1,000 (10%) is deducted as TDS.

• Exceptions: No TDS for LIC, GIC, or insurers holding shares.

For Non-Resident Shareholders

• TDS at 20% under Section 195 (may be reduced under DTAA agreements).

• Documents Required: Form 10F, Tax Residency Certificate, Declaration of Beneficial Ownership.

• No Documents? 20% TDS applies, but can be claimed as a credit while filing an Indian tax return.

Advance Tax and Dividend Income

• Advance tax is payable if total tax liability exceeds Rs. 10,000 per year.

• Exception: If dividend income was unexpected, the taxpayer can pay it in the next advance tax installment to avoid interest under Section 234C.

• No Exception for Deemed Dividends: Interest will apply if not paid on time.

Form 15G and 15H for Dividend Income

• Form 15G: Individuals with total income below the exemption limit can submit this to avoid TDS on dividends.

• Form 15H: Senior citizens with zero tax liability can submit this to prevent TDS deductions.

• Important: These forms must be submitted to the company or mutual fund before the dividend payment.

Final Thoughts

The taxation of dividend income has changed significantly over the years. While earlier, it was largely tax-free for investors, it is now subject to income tax slab rates. If you receive dividends regularly, understanding TDS deductions, advance tax rules, and deduction limits can help you optimize your tax liability. Always report dividend income in your Income Tax Return (ITR) to avoid penalties.