Understanding Taxation of Dividends from Shares and Mutual Funds

Mutual Funds

As the deadline for filing income tax returns approaches, clarity on the taxation of dividends received from investments in shares and mutual funds becomes crucial. The rules surrounding dividend taxation underwent significant changes with the Finance Act, 2020, which abolished the Dividend Distribution Tax (DDT).

Previous Tax Regime vs. Current Scenario

Previously, dividends were exempt from tax in the hands of shareholders and unit holders because companies and mutual funds paid DDT before distributing dividends. However, under the current regime:

  • Dividends received from domestic companies and mutual funds are taxable in the hands of recipients.
  • Dividend income should be reported under the ‘Income from other sources’ in the Income Tax return (ITR).
  • Individuals, Hindu Undivided Families (HUFs), and firms are liable to pay tax on dividends based on their applicable income tax slab rates.

Tax Calculation and Deductions

When calculating tax on dividend income:

  • A deduction of up to 20% of the gross dividend income is allowed for interest expenses incurred to earn such dividends.
  • Other expenses like commission or banker’s remuneration cannot be claimed as deductions.
Mutual Funds

Tax Deducted at Source (TDS)

  • A TDS of 10% applies to dividend income exceeding Rs 5,000 in a financial year.
  • For example, if an individual receives Rs 15,000 in dividends, TDS will be applicable on Rs 10,000 (10% of the amount exceeding Rs 5,000).
  • This TDS can be adjusted against the total tax liability at the time of filing the ITR.

Foreign Dividend Income

  • Dividends received from foreign companies are taxed when received by the investor.
  • Investors have the option to be taxed at a flat rate of 20%, including applicable charges, or at their income tax slab rate.

Mutual Fund Dividends

  • Equity mutual fund dividends are tax-free in the hands of investors, as the mutual fund itself deducts a Dividend Distribution Tax (DDT) before distributing dividends.
  • Debt mutual fund dividends are subject to DDT at a rate of 25%.

Read More: Why You Should Verify Your Income Tax Return Within 30 Days of Filing

Important Considerations

  • Proper disclosure of dividend income in the ITR is crucial to avoid penalties.
  • Investors should stay informed about current tax norms and plan investments accordingly.

Understanding these tax implications ensures that investors can effectively manage their tax liabilities while optimizing their investment returns. For personalized advice, consulting a tax professional is recommended.

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