What is Dividend Income?
Dividend income is the amount paid by a company to its shareholders out of the profits made during a specific quarter or financial year. Dividends are typically paid out on a per share basis, hence, larger the number of shares held, greater is the dividend earned by the shareholder. Dividend pay-out occurs only at the discretion of the company management thus it is not guaranteed even if the company makes a profit.
What are the Different Types of Dividend Payouts?
Dividend income received by shareholders in India can be classified into the following three types:
- Dividend income from any domestic company
- Dividend income from any foreign company
- Dividend income from equity or debt mutual funds
Is Tax Payable on Dividend Income?
In most cases, dividend income received by the shareholder or holder of mutual fund units is not taxable. However, there may be other considerations when estimating the tax payable on dividend income. The following are the different dividend taxation rules for shareholders/mutual fund unit holders based on the source of the dividend received.
What are the Key Types of Taxes Applicable to Dividend Income?
The two key types of taxes on dividend income are:
- Dividend Distribution Tax (DDT) – The effective rate of DDT in India is 17.65% which is calculated based on the 15% DDT on gross dividend amount under Section 115O of the Income Tax Act, 1961. DDT is paid by the company distributing dividends and the deduction occurs before the actual pay-out to the shareholder is completed. DDT is applicable only to dividends distributed by domestic companies and not on dividends distributed by foreign companies.
Tax on Dividend Income – This is the tax payable by the shareholder/mutual fund unit holder on dividends received during a specific financial year. The rate of tax on dividend in this case varies based on the source from which the dividend income is received. The applicable rates are 10% on dividends in excess of Rs. 10 lakh received from domestic companies and as per the income tax slab rate of the assessee on dividends received from foreign companies. In case of mutual funds, all dividends are exempt from income tax thus only DDT is applicable.
Tax on Dividends Received from a Domestic Company
Dividend Income received from any Indian company (equal to or less than Rs. 10 lakh in a fiscal) is exempt from income tax once in the hands of the shareholder. These dividends are however taxed using the Dividend Distribution Tax (DDT) mechanism. In case of DDT, the company declaring dividends pays tax at the applicable rate to the government before paying out the money to shareholders.
However, as per the Finance Act, 2016, the dividend income received by the shareholder is chargeable to income tax at the rate of 10% (on the incremental amount) if annual dividend pay-out exceeds Rs. 10 lakh. This taxation rule is applicable in the case of firms, resident individual and Hindu Undivided Family (HUF). It is noteworthy that this 10% tax on dividends is payable in addition to the DDT that has already been charged.
The following is an illustrative example:
Let’s assume Mr. Sharma received dividend income of Rs. 15 lakh from different domestic companies during the year after DDT has already been paid. Since this amount exceeds the tax free dividend limit of Rs. 10 lakh, he has to pay the income tax at the rate of 10% on the amount in excess of Rs. 10 lakh i.e. Rs. 5 lakh. Hence, he has to pay Rs. 50,000 (10% of the Rs. 5 lakh) as income tax on his dividend earnings for the fiscal.
Tax on Dividends Received from a Foreign Company
Dividend Income received from any foreign company is taxable in the hands of the shareholders. Earnings from dividends will be charged to income tax as per the slab rate under the head ‘income from other sources’. No DDT is payable by the foreign company to the government of India at the time of distributing dividends to its shareholders in India.
For instance, if the individual comes under the 20% tax slab (net taxable income over Rs. 5 lakh but less than Rs. 10 lakh), then the dividend income received will also be taxable at the rate of 20% plus applicable cess.
Dividend Income or Income Distributed by Mutual Funds
Any amount or income received by an individual or taxpayer with respect to total number of units from the Administrator of a specified company or a specified undertaking or Mutual Fund under the Clause 23D will be exempted from Income Tax.
Any dividend income received from a mutual fund scheme that is registered under the Securities and Exchange Board of India (SEBI) Act, 1992 will be exempted from income tax under Section 10 (23D) of the Income Tax Act, 1961. Therefore, any income received from mutual fund investment (short-term or long-term) in the form of interest or dividend is exempt from income tax.
Double Taxation Relief on Dividend Income
Dividend income received from any foreign company may be taxed twice – once in the foreign company’s country of origin and a second time in India after its reaches the shareholder. However, if the income tax on the foreign company’s dividend income has been paid twice i.e. paid in India as well as in the home country of the company, then the taxpayer or individual can claim for the double taxation relief.
This double taxation relief can be claimed in two ways:
- On the basis of a Double Taxation Avoidance Agreement (DTAA) entered into by the Indian government with the country to which that company belongs.
Or
- Under Section 91 of the Income Tax Act, if no DTAA exists between India and the foreign company’s country of origin.
In either case, this double taxation relief on dividends mechanism ensures that the taxpayer does not have to pay any tax on the same dividend income twice.