Tax on Dividend Income: A Complete Guide

Introduction

Earning dividends helps you in many different ways. But worrying if you have to pay up the taxes on it? Don’t worry if you earn dividends, staying updated makes you ahead of the race. The tax rules have changed throughout the years, and now individuals are responsible for paying the tax on dividend income and not the companies.

The Finance Act 2020 completely transformed how dividends are taxed in India. Previously, companies paid Dividend Distribution Tax (DDT). Now, you pay the tax directly. This shift impacts your investment returns immediately.

Every investor must understand these new rules. Your tax liability might have increased substantially. Don’t worry, though. With proper knowledge, you can still optimise your dividend earnings effectively.

What is Dividend Income?

Dividend income flows directly from a company’s profits into your pocket. Companies share their success with you through these payments. You earn these dividends simply by holding shares in the company.

The Income Tax Act defines dividends quite broadly under Section 2(22). Moreover, dividends include various distributions beyond just profit sharing. These include accumulated profits released as assets, bonus shares to preference shareholders, and even certain loans to major shareholders.

Companies typically distribute dividends quarterly or annually. You might receive dividends from several sources, including Indian companies, mutual funds, or foreign corporations. Each source now comes with its tax implications, and you must consider them carefully.

Current Tax Rate on Dividend Income in India

Everything changed on April 1, 2020. Before this date, companies paid Dividend Distribution Tax (DDT) at 20.56%. You received tax-free dividends. Now, you pay the tax directly through your income tax return.

The Finance Act 2020 abolished DDT completely. This shifted the entire tax burden from companies to you, the investor. Your dividend income now gets added to your total taxable income. Consequently, you pay tax according to your income slab rate.

1. For Individuals and HUFs

The impact on individual investors has been significant. Your effective tax rate on dividends can now reach up to 35.88%, including surcharge and cess. This represents a substantial increase from the previous DDT rate of 20.56%.

Your dividend income gets taxed at these slab rates:

• First ₹2.5 lakhs: No tax
• ₹2.5 lakhs to ₹5 lakhs: 5%
• ₹5 lakhs to ₹10 lakhs: 20%
• Above ₹10 lakhs: 30%

Furthermore, you face surcharges on your tax amount if your total income exceeds ₹50 lakhs. These surcharges range from 10% to 37%. Additionally, everyone pays a 4% health and education cess on the tax amount.

2. For Partnership Firms

Partnership firms now face tax rates up to 34.94% on dividend income. This includes applicable surcharge and cess. Previously, they received tax-free dividends after companies paid the DDT.

3. For Domestic Companies

Domestic companies receiving dividends face variable tax rates based on several factors. These include annual turnover and tax regime selection. The effective tax rates range from 17.16% to 34.94%.

Company Category	Effective Rate (Income > ₹10 Cr)	Effective Rate (Income < ₹10 Cr)
Standard regime (turnover ≥ ₹400 Cr)	34.94%	33.38%
Standard regime (turnover < ₹400 Cr)	29.12%	27.82%
Section 115BA regime	29.12%	27.82%
Section 115BAA regime	25.17%	25.17%
Section 115BAB regime	17.16%	17.16%

4. For Foreign Investors

Non-resident investors face a flat 20% tax on dividends from Indian companies. The company must withhold this tax before making the payment. With surcharge and cess, the effective rate may reach 28.49% for individuals and 21.84% for foreign companies.

Tax on Dividend Income Above 10 Lakhs

When your dividend income exceeds ₹10 lakhs annually, you enter the highest tax bracket for individuals, which carries a 30% tax rate. This is significantly higher than the previous DDT regime and requires careful tax planning.

For dividend income exceeding ₹10 lakhs, you should be aware of these additional considerations:

1. Surcharge Impact: If your total income (including dividends) exceeds ₹50 lakhs, a surcharge applies on the tax amount:
   • Income between ₹50 lakhs and ₹1 crore: 10% surcharge
   • Income between ₹1 crore and ₹2 crores: 15% surcharge
   • Income between ₹2 crores and ₹5 crores: 25% surcharge
   • Income above ₹5 crores: 37% surcharge
2. Health and Education Cess: A 4% cess applies on the tax amount plus surcharge.
3. Advance Tax Obligations: With substantial dividend income, you may need to pay advance tax in quarterly instalments to avoid interest penalties.

7 Different Strategies to Optimise Tax on Dividend Income

Don’t just accept higher dividend taxes! Smart strategies can significantly reduce your tax burden. Act now to implement these approaches before your next dividend payout.

1. Use Family HUF Structure: Create a Hindu Undivided Family and transfer dividend-paying investments. This splits income across family members and utilises multiple basic exemption limits.
   
2. Leverage Corporate Holding Structure: For substantial dividend portfolios, consider a holding company. The Section 80M deduction provides significant tax advantages for corporate structures.
   
3. Opt for Growth over Dividend: With mutual funds, choose growth options instead of dividend options. This defers taxation until redemption and potentially qualifies for lower LTCG rates.
   
4. Strategic Timing of Dividends: If you control a closely-held company, distribute dividends strategically across financial years. This helps shareholders maintain lower tax brackets.
   
5. Maximise Interest Deduction: Document loans taken for dividend-generating investments properly. Claim the full 20% interest deduction under Section 57.
   
6. Consider Tax-Efficient Structures: For businesses, evaluate REITs, InvITs, and business trusts that offer special dividend tax treatment. These vehicles often provide more favourable tax outcomes.
   
7. NRI Investment Planning: Non-residents should carefully select between NRO, NRE, and FCNR accounts. Each offers different dividend tax implications depending on your situation.

Different Tax Exemptions You Get on Dividend Income

Don’t panic about the new tax regime! Some relief options still exist. You can reduce your dividend tax burden through these available exemptions and deductions.

1. Section 80M Deduction for Companies

Domestic companies enjoy a special benefit. The tax on dividend income for companies can be claimed under Section 80M for dividends they receive and redistribute for deductions. This prevents double taxation across corporate structures.

For example, if Company A receives ₹10 lakhs as dividends and distributes ₹8 lakhs to its shareholders, it can claim an ₹8 lakh deduction. This provision significantly reduces the tax burden for holding companies and investment companies.

2. Interest Expense Deduction

Did you take a loan to invest in dividend-paying stocks? You can claim tax relief. Section 57 allows the deduction of interest paid on such loans. However, this benefit comes with a cap of 20% of your dividend income.

3. Special Provisions for Alternative Investment Funds

Category I and Category II AIFs enjoy pass-through status. The dividend income remains exempt in their hands under Section 10(23FBA). Instead, unitholders pay the tax. No TDS applies to payments to these AIFs.

Tax You Need to Pay on Foreign Dividend Income

Investing in international markets has become increasingly popular among Indian investors. However, dividends from foreign companies come with their own set of tax implications:

1. Global Income Taxation: For resident Indians, foreign dividend income is taxable in India as per their applicable tax slab rates.
   
2. Foreign Tax Credit: If tax has already been deducted in the source country, you can claim relief under the Double Taxation Avoidance Agreement (DTAA) if one exists between India and that country.
   
3. Foreign Tax Reporting: Foreign dividend income must be reported in the Schedule FA (Foreign Assets) of your income tax return.
   
4. DTAA Benefits: India has DTAAs with over 85 countries, which can help reduce the effective tax rate on foreign dividends by providing credit for taxes paid abroad.

To claim these benefits, proper documentation is essential, including tax residency certificates and proof of foreign tax payment.

Income Tax on Mutual Fund Dividends

Mutual fund dividends face full taxation after the DDT abolition. You must act strategically to manage this tax burden effectively.

1. Equity Mutual Funds

Dividends from equity-oriented funds now hit your pocket directly. These dividends get added to your total income. You pay tax at your applicable slab rate, which could reach 30% plus surcharge and cess.

Previously, equity fund dividends enjoyed tax-free status in your hands. The fund house paid DDT at 11.648%. This change represents a significant tax increase for most investors.

2. Debt Mutual Funds

Debt fund dividends also follow the same taxation pattern now. They get added to your total taxable income. The fund houses deduct 10% TDS on dividend payments exceeding ₹5,000.

3. Growth vs. Dividend Option

Financial experts strongly recommend choosing the growth option over the dividend option. This strategy offers three key advantages:

• Defers tax liability until redemption
• Potentially qualifies for lower LTCG tax rates (10% above ₹1 lakh)
• Enhances returns through the power of compounding

Business Trusts and Special Purpose Vehicles

Business trusts offer unique dividend tax treatment. Dividends received by business trusts from Special Purpose Vehicles (SPVs) enjoy exemption under Section 10(23FC). However, the tax treatment for unitholders varies based on the SPV’s tax regime choice.

If the SPV opts for the Concessional Tax Regime (CTR), unitholders pay tax on dividends. Resident unit holders pay tax under Section 115UA at their applicable rates. Non-resident unitholders face a flat 20% tax under Section 115A.

However, if the SPV hasn’t opted for CTR, unitholders receive tax-free dividends under Section 10(23FD). This applies to both resident and non-resident unitholders equally.

The business trust must withhold tax appropriately. They withhold 10% when SPV has opted for CTR. No withholding applies when SPV hasn’t opted for CTR, as specified under Section 194LBA(2A).

Income Tax on Equity Dividend

Equity dividends constitute a major income source for many investors. The tax treatment has changed dramatically after DDT abolition. You must understand these changes immediately.

1. TDS on Dividend Payments

Companies must deduct TDS at 10% when paying dividends exceeding ₹5,000. This applies to all resident shareholders. For non-residents, companies deduct TDS at 20%, subject to DTAA benefits.

You can avoid TDS by submitting Form 15G/15H if your total income falls below the taxable limits. Submit these forms before the dividend declaration to prevent TDS deduction.

2. Section 194 Requirements

The TDS obligation under Section 194A applies to all companies paying dividends. However, individual shareholders receiving less than ₹5,000 in a financial year enjoy exemption from TDS.

3. Dividend Stripping Provisions

Beware of dividend stripping rules under Section 94(7). These anti-abuse provisions prevent tax avoidance through buy-sell transactions around dividend dates. You cannot claim losses if you purchase shares within 3 months before the record date and sell within 3 months after receiving dividends.

Foreign Institutional Investors and Non-Residents

Foreign Institutional Investors (FIIs) need immediate attention to their dividend taxation. Section 115AD specifically addresses FII dividend income. It imposes a flat 20% tax rate on dividends received by FIIs.

Indian companies must withhold tax at 20% when paying dividends to FIIs. This requirement comes from Section 196D. With surcharge and cess, the effective TDS rate can reach 28.49% for individuals and 21.84% for foreign companies.

The Supreme Court ruling in PILCOM v. CIT [2020] creates additional complexity. The court established that withholding tax obligations follow Indian tax laws, not DTAA provisions. Therefore, companies must withhold at Indian statutory rates regardless of DTAA benefits.

Non-resident individuals face similar treatment. Section 115A imposes a flat 20% tax on their dividend income. With surcharge and cess, the effective tax rate can reach 23.92% for individuals and 21.84% for foreign companies.

Challenges and Compliance Requirements

The DDT abolition brings serious compliance challenges. Both companies and shareholders face new responsibilities. Act quickly to ensure compliance and avoid penalties.

Challenges for Companies

Companies distributing dividends face multiple compliance hurdles. They must determine the correct withholding rates for each shareholder category. This task becomes particularly complex with international shareholders.

Companies must now consider:

• Applicable tax treaty provisions for each country
• Multilateral Instrument implications effective from April 2020
• Most Favoured Nation clauses in various treaties
• Filing Form 15CA and 15CB for each foreign remittance

For companies with numerous international shareholders, these requirements create a significant administrative burden. Expert assistance becomes essential to navigate these complexities effectively.

Challenges for Non-resident Shareholders

Non-resident shareholders face their hurdles. They must complete several steps to claim treaty benefits:

• Obtain a Tax Residency Certificate from their home country
• Apply for a Permanent Account Number (PAN) in India
• File Indian income tax returns to claim refunds
• Establish beneficial ownership of dividend income

For fiscally transparent entities like partnerships and LLCs, proving beneficial ownership presents special challenges. Contradictory judicial precedents further complicate this area.

How to Calculate Tax on Dividend Income

Calculate your dividend tax liability correctly to avoid issues with tax authorities. Follow these steps for accurate calculation:

1. Identify Your Dividend Sources: Gather information about all dividend income. Include domestic companies, foreign companies, and mutual funds.
   
2. Check TDS Already Deducted: Companies deduct 10% TDS on dividend payments exceeding ₹5,000. This appears in your Form 26as.
   
3. Apply Available Deductions: Subtract permissible deductions like interest expense (up to 20% of dividend income) under Section 57.
   
4. Add to Total Income: Combine your net dividend income with other income sources. This determines your tax slab.
   
5. Calculate Tax Liability: Apply your income tax slab rate to the total taxable income. Add applicable surcharge and 4% health education cess.

Example Calculation for FY 2024-25

Let’s see this in action using the following steps. Assume Mrs. Verma has:

• Salary income: ₹9 lakhs
• Dividend income: ₹3 lakhs
• Interest paid on loan for investments: ₹40,000

1. Maximum deduction for interest = 20% of ₹3 lakhs = ₹60,000 Therefore, eligible deduction = ₹40,000 (actual interest paid)
2. Taxable dividend income = ₹3 lakhs – ₹40,000 = ₹2.6 lakhs
3. Total taxable income = ₹9 lakhs + ₹2.6 lakhs = ₹11.6 lakhs
4. Basic tax = ₹1,60,500 Health and education cess (4%) = ₹6,420 Total tax liability = ₹1,66,920

How to Report Dividend Income in ITR

You must report dividend income correctly on your tax return. Mistakes can trigger notices from tax authorities. Follow these steps for proper reporting:

1. Choose the Right ITR Form: For dividend income, use ITR-2 or higher forms. ITR-1 (Sahaj) cannot be used if you have dividend income exceeding ₹10,000.
   
2. Report in Schedule OS: Declare all dividend income under “Income from Other Sources” in Schedule OS. Enter domestic dividends in the appropriate row for “Dividend Income.”
   
3. Claim Section 57 Deduction: Deduct eligible interest expenses (up to 20% of dividend income) in the designated field within Schedule OS.

Contact us now to avoid dividend tax non-compliance and ensure timely filing. Act early to prevent heavy penalties and legal complications. RegisterKaro’s experts are ready to assist you every step of the way.

Frequently Asked Questions (FAQs)

1. How much is tax on dividend income in India?

Dividend income is now taxed at the recipient’s applicable income tax slab rate, which ranges from 5% to 30% depending on their total income, plus applicable surcharge and cess.

2. How has dividend taxation changed in recent years?

Since April 1, 2020, the Dividend Distribution Tax (DDT) previously paid by companies was abolished, and the tax burden shifted to recipients who now pay tax on dividends at their applicable income tax slab rates.

3. Is there any tax exemption available on dividend income?

Currently, there is no blanket exemption for dividend income. However, individuals can claim a deduction for interest expense (up to 20% of dividend income) incurred for earning dividend income under Section 57.

4. How is tax calculated on dividend income above 10 lakhs?

Dividend income above ₹10 lakhs is taxed at 30% plus applicable surcharge (ranging from 10% to 37% depending on total income) and a 4% health and education cess.

5. What is the TDS rate on dividend payments in India?

Companies deduct TDS at 10% on dividend payments exceeding ₹5,000 to resident Indians. For non-residents, the TDS rate is generally 20%, subject to DTAA benefits.

6. Do I need to pay advance tax on my dividend income?

Yes, if your total tax liability (including tax on dividend income) exceeds ₹10,000 in a financial year, you need to pay advance tax in quarterly instalments to avoid interest penalties.

7. How are foreign dividends taxed for Indian residents?

Foreign dividends received by resident Indians are taxable at their applicable income tax slab rates. However, they can claim foreign tax credit for taxes already paid in the source country under applicable DTAAs.