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Equity markets are one of the most attractive investment avenues for modern-day investors. The capital gains, driven by the demand-supply forces in the market, are the main earnings for traders. However, the extra incomes earned with the equity are the main gains for the investors. Dividends are the income generated periodically with the market gains.
The equity shareholders are paid the last in times of liquidation due to their ownership status. However, this payment of dividends is at the sole discretion of the company. As per the profit levels, the company decides whether to pay dividends to the shareholders or invest that profit back into the company.
So, the frequency of rollout of dividends stands as one of the most attractive factors while investing in the equity shares of any company. However, before April 2020, there was no motivation for the companies to pay dividends due to the dividend distribution tax (DDT). Some amendments, provisions and taxation rules changed this story. Read the article to understand more.
All about DDT
Dividends are given to shareholders from the profit/ reserves of the company and are distributed according to their feasibility. Also, it is a major income for many shareholders. A ‘record date’ is decided by the management, and the dividend is distributed among the shareholders as on the record date. Mainly two types of dividends are distributed:
- Interim dividend – It is paid during the financial year. Usually, quarterly or half-yearly.
- Final dividend – It is paid after the completion of the financial year.
Before April 2020, the dividends distributed among the shareholders were taxable under Section 115O of the Income Tax Act 1961. The Indian domestic companies rolling out dividends to their shareholders were paying a 15% tax on the gross dividend. However, due to this, income in dividends for shareholders was tax-free.
Let us understand how companies paid dividend distribution tax rate calculation was done in India with an example:
Net dividend distributed to shareholders= ₹ 34 lakh (85% of gross dividend)
So, gross dividend = ₹40 lakh
Dividend Distribution Tax (15%) = ₹6 lakh.
Must read: How Dividend Income Enhances Your Investment Portfolio.
The special provision
A special provision was passed in the Finance Act of 2020, suggested to shift this tax payment liability on dividends to the shareholders. Some key pointers of this provision are:
- Domestic companies paying dividends would not pay any tax on it.
- The shareholders would pay tax on the dividend income, as per their income tax slab rates. The tax would be levied as below:
- For investors: income from other sources
- For traders: profit and gains from the business or profession
- The companies would deduct tax deducted at source (TDS) at 10% on the dividends paid above the threshold of ₹5000/-.
For example: If dividend income = ₹7500/- The TDS @10%.
TDS on the dividends paid = 7500 * 10% = ₹750/-.
- The previous exemption of no tax on dividends worth ₹10 lakh was removed with this provision.
An interesting read: Top 5 high-yield investment opportunities and risks.
The impact of special provisions
The dividend distribution tax in India was abolished at the end of FY 2019-2020. This change had some pros and cons:
| Pros | Cons |
| If the shareholders receiving dividends have taxable incomes below their income tax limits, then no tax is levied. | Shareholders were discouraged to a certain level from receiving the dividends as tax was imposed on their income. |
| The calculation of tax burden and overall dividend taxation is made simpler with this change. | The dividend distribution tax rate as per the individual slab rate creates inequality in the tax paid on the dividends. |
DDT in mutual funds
The dividend distribution tax on mutual funds is taxable as per the following rates:
- The dividend distribution tax on equity mutual funds was paid at 25%. Moreover, surcharges and cess are added.
- The debt mutual funds, with equity exposures, were taxed at 10%. Moreover, surcharges and cess are added.
Read about: A comprehensive guide to dividend yield mutual funds in 2024.
Bottomline
The amendment in the tax on dividends is crucial to understand the liability of tax payment. The shift in tax burden had both – advantages and disadvantages for the dividend distribution. The DDT implication is now solely on the shareholders while companies enjoy the relief from it.
FAQ
The dividend income received after April 2020 is charged to their income tax slab. The categorisation for such dividend income would be as they receive. It would be under the head ‘income from other sources’ for investors. It would be under ‘Profit and gains from the business or profession’ for the traders. Moreover, if the dividend income exceeds the threshold of 5000/-, then 10% TDS would also be deducted from this income.
Yes. The dividend distribution tax (DDT) was abolished by the Finance Act of 2020. Previously, this tax rate was 15% and was paid by the company. However, they shifted this tax burden to the shareholders of the company. Now, the shareholders pay the tax on dividends earned according to their income tax slabs. The companies only deduct TDS at 10% on this dividend if it exceeds the limit of 5000/-.
The domestic companies paying dividends to shareholders were liable to pay dividend distribution tax (DDT). This tax was charged at 15% on the gross dividend income. However, the shareholders earning dividends less than 10 lakh were not liable for any tax payment. Then, the tax calculation was as follows:
Assume the net dividend distributed to shareholders ₹17 lakh (which would be 85% of the gross dividend- 15% tax).
So, Gross dividend = ₹20 lakh. DDT (15%) = ₹3 lakh.
This tax was paid by the domestic company previously, which was paying dividends to shareholders before April 2020 at 15%. Then, shareholders had a tax burden only above ₹10 lakh. However, due to a special provision passed in the Finance Act of 2020, the tax on dividends paid after April 2020 is now the responsibility of shareholders. This tax was paid as per the income tax slab rates of the individual.
After April 2020, the tax payment on the dividends was done by the shareholders. The domestic companies rolling out these dividends are not liable for any payment. However, if the dividend paid to any individual shareholders exceeds the mark of ₹5000/- then companies have to deduct TDS of 10% on the total amount of this dividend. For example: The dividend = ₹9000 and TDS is 10%.
So, TDS = 9000 * 10% = ₹900.