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Dividends are a popular source of income for investors. Like most income sources, dividends are subject to tax. Under Section 194 of the Income Tax Act 1961, the company declaring the dividend is required to deduct TDS. In this blog post, we will provide an in-depth explanation of the taxation of dividends in India. If you are a stock market investor, this is a must-read for you!
Dividend income meaning can be explained as funds a company distributes to its shareholders as a portion of its profits. Dividends are typically paid out regularly, often every quarter (i.e., 4 times a year). For the investors, dividends are regarded as a form of income.
Many shareholders expect the companies they invest in to share profits with them, but not all companies pay dividends. Some companies choose to keep their profits as retained earnings and reinvest them in the business to propel growth. This can increase the company's value over time and give investors capital gains instead of direct payouts.
Contrary to the popular belief, it’s not just public companies that pay dividends. Private companies can distribute profits to shareholders as dividends too, though it’s less common and usually handled a bit differently than with public companies.
Dividends can be received from various sources, such as:
Equity Mutual Funds: Dividends distributed from the gains made on equity investments.
Debt Mutual Funds: Dividends generated from interest income on debt securities.
Domestic Company: Dividends paid by companies that are incorporated and operating within India.
Foreign Company: Dividends received from companies abroad.
Dividend tax means tax that a jurisdiction imposes on dividends that you (shareholder) receive from a company’s stocks or mutual funds. It applies to both domestic company’s dividends and foreign company’s dividends.
The tax rate for dividends varies according to the dividend sources. When you file a tax return, you might be required to report the dividend as part of your taxable income.
The dividends are subject to Tax Deducted at Source (TDS). Depending on whether the dividend receiver is a resident shareholder or non-resident shareholder, the dividend rate tax varies.
Section 194 of the Act mandates TDS deduction on dividends distributed, declared or paid by Indian corporations on or after April 1 2020. The TDS deduction rate for this purpose is 10%. This is applicable for resident shareholders when their aggregate dividend crosses Rs. 5000 in a financial year. If the dividend receiver does not file a PAN or provides invalid PAN, the rate will rise to 20%.
For instance: If Mr. Raj received a taxable dividend income of Rs. 10,000 from an Indian company on May 30, 2023, the company would deduct Rs. 1,000 as TDS (10%). This would leave him with Rs. 9,000. Now, when it is time for Mr. Raj to file his income tax return for the financial year, the deducted TDS will be adjusted against his total tax liability.
However, there are some exceptions to this rule. For example, if the dividend is paid to the Life Insurance Corporation of India (LIC), the General Insurance Corporation of India (GIC), or any other insurer that holds the shares or has full beneficial interest in them, no TDS will be deducted.
When dividends are paid to non resident individuals or foreign companies, a tax deduction at source (TDS) of 20% is applied under Section 195. However, this rate can be lower if a double taxation avoidance agreement (DTAA) applies.
To benefit from the reduced rate, non-residents need to submit Form 10F, a declaration that confirms they’re the beneficial owner of the dividends, and a tax residency certificate. If these documents aren’t provided, the 20% TDS will be applied by default. But there is good news that TDS can be claimed back as a tax credit when filing an Indian tax return. Make sure to report all dividend income in your income tax return (ITR).
Let’s see tax on dividend for domestic vs foreign companies:
Dividend Distribution Tax (DDT) was abolished in India w.e.f from 1 April 2020 through the Finance Act 2020. Now, dividend income is taxed in the hands of the shareholders directly rather than at company level. The earlier system where dividend income up to Rs. 10 lakhs was exempt for shareholders, with the company paying DDT, is no longer applicable.
The dividend received from a foreign company is subject to taxation. It is charged under the “Income from Other Sources” head. Dividends from a foreign company will be added to the taxpayer's total income and taxed at the applicable rates.
For example, a dividend will be subject to 30% taxation together with a cess if the taxpayer is in the 30% tax slab rate. Only interest expenses up to 20% of total dividend income may be deducted by the investor, even in the case of a foreign dividend.
Although any dividend an investor receives from a foreign company in which they hold stakes is taxable in India, if it has also been taxed in the country where the foreign company operates, it results in double taxation. In such cases, relief from double taxation can be claimed under the provisions of the Double Tax Avoidance Agreement (DTAA). The DTAA is an agreement between the Indian government and the governments of other countries.
Even if such an agreement is not available, don’t worry. You can still claim relief under Section 91 and avoid payment of double taxes on the same dividend income.
According to most DTAAs India has signed with foreign countries, the dividend is subject to taxation in the source country in the beneficial owner of shares’ hands at a dividend tax rate that ranges from 5% to 15% of the dividends’ gross amount.
When a dividend is payable to a company that owns a certain percentage (which is usually 25%) of the company delivering the dividend, the dividend tax rate is further lowered under DTAA with nations like Canada, Denmark, and Singapore. These DTAAs do not, however, specify a minimum period of time for which the receiving company must retain its shareholding.
As a result, there have been instances where MNCs were frequently caught abusing the laws by expanding their ownership stake in the business, declaring right before the dividend was announced, and selling the shares after receiving the dividend payout.
Dividends are a source of income that a shareholder receives on each company stock he owns. For instance, if a company gives a dividend of Rs. 0.5 per share and the shareholder has 1000 shares of the company, then he’ll get Rs. 0.5 x 1000 shares = Rs. 500 as dividend. Tax Deducted at Source (TDS) is deducted on dividends paid by an Indian company if the total dividend paid to a shareholder during the financial year exceeds Rs. 5,000. If you are an investor who wants to make dividends an income source, then make sure you understand the tax implications of dividends.
Q1. What is income tax on dividends?
A. Income tax on dividends means the tax imposed on the dividend income received by an investor (whether an individual or entity) from investments in stocks/mutual funds.
Q2. Do non residents pay the same TDS as residents on dividend income?
A. No, residents face a 10% TDS on dividend income, while non residents are subject to 20% TDS.
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