How dividends from shares and mutual funds are taxed in India?

Investing in shares and mutual funds is a popular way to build wealth in India, and dividends form a crucial part of the returns for many investors.

However, understanding the tax implications of these dividends is essential for effective financial planning, as no one wants to face sudden tax surprises. This article provides an overview of how dividends from shares and mutual funds are taxed in India.

1. Dividends from shares.

Dividends received from shares of Indian companies are subject to taxation as per the individual’s income tax slab rates. Prior to the Finance Act 2020, dividends were exempt from tax in the hands of the shareholders as the companies paid a Dividend Distribution Tax (DDT). However, this has changed recently:

Current tax regime:

• Dividend income: Dividends received from domestic companies are now taxed in the hands of the shareholder. The income is added to the total income of the investor and taxed at the applicable income tax slab rate.
• TDS on dividends: As per Section 194 of the Income Tax Act, 1961, companies are required to deduct Tax Deducted at Source (TDS) at the rate of 10% if the dividend payment exceeds ₹5,000 in a financial year. For non-resident shareholders, the TDS rate is 20% (plus applicable surcharge and cess).

2. Dividends from mutual funds.

Dividends from mutual funds, particularly equity-oriented funds, follow similar taxation rules as dividends from shares.

Equity-oriented mutual funds:

• Dividend Income: Dividends from equity-oriented mutual funds are added to the investor’s income and taxed according to the applicable income tax slab rate.
• TDS on Dividends: Mutual fund houses are required to deduct TDS at the rate of 10% on dividend payments if the amount exceeds ₹5,000 in a financial year.

Debt-oriented mutual funds:

• Dividend Income: Dividends from debt-oriented mutual funds are also taxable at the investor’s slab rate.
• TDS on Dividends: Similar to equity-oriented funds, TDS at the rate of 10% is deducted if the dividend exceeds ₹5,000 in a financial year.

3. Tax-advantaged accounts.

Investors can also hold shares and mutual funds in tax-advantaged accounts such as the Public Provident Fund (PPF) and the National Pension System (NPS). These accounts offer different tax benefits:

• PPF: The interest earned, and the maturity amount, are tax-free. However, dividends from shares or mutual funds held within a PPF are not applicable.
• NPS: Contributions are eligible for deductions under Section 80CCD(1), 80CCD(1B), and 80CCD(2). The annuity income from NPS is taxable, but a portion of the corpus withdrawn at maturity is tax-exempt.

4. Foreign dividends.

Dividends received from foreign companies are subject to taxation in India. These are taxed at the investor’s applicable income tax slab rates. Additionally, foreign dividends might also be subject to withholding tax in the country of origin, but relief can be sought under Double Taxation Avoidance Agreements (DTAA).

5. Surcharge and cess.

All taxable dividends are subject to additional surcharges and cess as applicable:

• Surcharge: Applicable at different rates depending on the income level of the taxpayer.
• Health and education cess: Levied at 4% on the income tax (including surcharge).

Conclusion.

Taxation of dividends from shares and mutual funds in India have undergone significant changes, particularly with the shift from DDT to taxing dividends in the hands of shareholders. Understanding these tax implications is essential for optimizing your investment returns and ensuring compliance with tax regulations.

Consulting with a tax advisor or financial planner can help navigate these complexities and make the most of your investment income.