Even though over the years we have seen a shift in taxation of dividends, it still remains an attractive stream of income for most taxpayers.
With the soaring cost of living, it has become imperative for the common man to look for alternate sources of income. One of the commonly preferred source is investment in stocks and mutual funds as it provides lucrative returns in the form of dividend, as compared to other investment sources such as bank deposits and fixed deposits.
From an income-tax perspective, dividend received from an Indian company is exempt from tax. However, with effect from the financial year 2016-17, dividend is chargeable to tax at the rate of 10% plus applicable surcharge and cess, for a resident individual/ HUF/ firm, if the aggregate amount of dividend received from a domestic company during a financial year exceeds Rs 1,000,000. In contrast, any income received by an individual/HUF as dividend from a debt mutual fund or an equity mutual fund is fully exempt from tax.
Dividend received from a foreign company is taxable under the head “Income from Other Sources” and charged to tax at the rates applicable to the taxpayer. If the dividend received is taxed in India and in the country of the foreign company declaring the dividend, relief from double taxation on such dividend can be claimed by resident taxpayers under the provisions of the relevant tax treaty, subject to conditions. If there is no tax treaty with the foreign country, then the taxpayer can claim relief under the provisions of the domestic tax law.
Besides taxation of dividend income in the hands of investors, domestic companies declaring the dividend are also required to pay Dividend Distribution Tax (DDT). The tax rate, however, depends upon the type of entity declaring the dividend.
As per the provisions of the Income tax Act, 1961 (the Act), domestic companies declaring dividends are liable to pay DDT on grossed-up dividend amount and not the net declared dividend. A domestic company has to pay the DDT at the rate of 15% plus 12% surcharge and 4% education cess, thereby aggregating the effective rate to 20.56%.
On the contrary, a debt mutual fund has to pay DDT at the rate of 25% plus 12% surcharge and 4% education cess, on the grossed-up dividend declared. Hence, the effective tax rate on the net declared income comes to 38.83%.
With effect from financial year 2018-18, an equity mutual fund is also required to pay DDT at the rate of 10% plus 12% surcharge and 4% education cess, on the grossed-up dividend declared, resulting in an effective tax rate of 12.94%.
With the application of DDT, the government indirectly collects the required taxes at the source from the domestic company/ mutual funds. However, the levy of DDT and the taxation in the hands of resident taxpayers earning dividend above Rs 1,000,000 from domestic companies has resulted in double taxation of the excess amount of dividend income. The issue of double taxation needs to be addressed by the government.
Even though over the years we have seen a shift in taxation of dividends, it still remains an attractive stream of income for most taxpayers, primarily due to limited sources of lucrative investment avenues available today.
(By Divya Baweja, Partner, Deloitte India, and Preeti Gupta, Senior Manager with Deloitte Haskins and Sells LLP)