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Tax on Corporate Dividends: Which Ones are Mandatory?

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Tax on Corporate Dividends: Which Ones are Mandatory?

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Definition of a Corporate Dividend

A dividend is a distribution of profits by a corporation to its shareholders. When a corporation, or company, earns a profit it can disburse a percentage of the profit as a dividend to shareholders.

A number of Indian corporations pay out dividends to their shareholders every year. Here's a list of all the Indian companies that have been paying the highest dividends consistently over the last 10 years.

Source of dividend

A dividend could come from profit across a number of sources such asL

  • Investment in a domestic company
  • Investment in a foreign company
  • Equity mutual funds
  • Debt mutual funds

Corporate Dividend Tax

The tax you pay on dividends depends on whether you are a trader or an investor. This means: if you're a stock trader, you will be taxed on your corporate dividends as part of your profession. If you're not a trader, which means you're either a student or have regular job, then your corporate dividends are taxed as income from 'other sources'.

Distribution Tax on dividends

Dividends declared by companies were subject to dividend distribution tax until 30th March, 2020. But with effect from April 1, 2020, dividend payout tax has been removed, and taxable in the shareholders' assessment. In other words, it's now taxable on your gains.

Dividends up to ₹2.5 lakh are tax-free as of the financial year 2020-21

Streamlining Corporate Dividend Tax

You didn’t have to pay any tax on a dividend earned from a company based in India till FY '20-21. However, in such cases, the domestic company is liable to pay a Dividend Distribution Tax (DDT) under section 115-O.

Further, the Finance Act’ 20 abolished the DDT and taxed dividends at the investor level, irrespective of the amount received at applicable income tax slab rates.

Tax rates on Dividend Income

Dividend tax rates vary based on the type of assessee getting the dividend and the method used to distribute it. This table below can help you understand this better:

Category of Assessee

Dividend nature

Rate of Tax

Resident

Dividend from domestic company

A normal rate of tax applicable to the assessee

NRI

Dividend on GDR of Indian co./PSU (purchased in foreign currency)

10%

NRI

Dividend on shares of Indian co.(purchased in foreign currency)

20%

NRI

Any other Dividend income

20%

FPI

Dividend on securities other than 115AB

20%

Investment Division of offshore banking unit

Dividend on securities other than 115AB

10%

To remember

Final dividends are taxable the very year in which they are declared, dispersed, or handed over by the corporation, whichever comes first.

Interim dividends, on the other hand, are taxable when the amount of the dividend is categorically dispersed by the corporation upon receipt of claims. 

TDS on Dividend Income

Since 1st April ’20, TDS was introduced to dividends. A base tax of 10% would be knocked off from the dividend if it exceeds ₹5,000 during that financial year.

However, no tax is cut back from any dividend paid or due to the Life Insurance Corporation of India (LIC), the General Insurance Corporation of India (GIC), or any other insurer if they own shares or have any rewarding interests. When a dividend is paid to a non-resident or a foreign corporation, however, the tax is withheld in line with the relevant DTAA (Double Taxation Avoidance Agreements) under Section 195.

Double Taxation Relief

A lot of Indian investors also have portfolios of foreign stocks by investing directly in the markets of foreign countries. As a result, a disbursement from a foreign company is taxable in India; double taxation would occur if tax is being levied at the country of origin as well. To avoid this double taxation, India has an agreement with several countries where relief can be claimed according to DTAAs, as well as under Section 91 of the Income Tax Act.

More about Section 91 of the IT Act

As mentioned above, you can claim a tax relief for dividend income earned from another country, if India and that other country share a DTAA or Double Taxation Avoidance Agreements. If there's no DTAA between India and the other country, then the relief can be claimed from the country of residence, which in this case could be India, if you're living here.

Inter-corporate Dividend

The Government has added a new section 80M to the IT Act, which came into place in 2020-21, to prevent the major impact whenever a domestic firm gets a dividend from another domestic company. 

1. Corporates earning dividends from a domestic company

Section 80M states that inter-corporate dividend shall be subtracted from the total income of the company, if the dividend is further distributed to shareholders one month before the due date of filing of return.

2. Corporates earning dividends from a foreign company

A dividend received by a domestic company (having 26% or more equity shareholding) in a foreign company - is taxable at a rate of 15% plus Surcharge and Health and Education Cess under Section 115BBD. A domestic company having less than 26% equity shareholding is taxable at the normal tax rate.

How a domestic firm receives a dividend from a foreign corporation and distributes it to its shareholders, however, is still not clear.

An afterthought

Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding.

On payment, however, individual shareholders in many countries pay double taxation on those dividends:

  1. The company pays income tax to the government when it earns any income
  2. When the dividend is paid, the individual shareholder pays income tax on the dividend payment.

Frequently Asked Questions

1. What is the frequency of dividend payments?

The frequency with which a dividend can be paid is - daily, weekly, monthly, quarterly, half-yearly, or annual basis, relative to the company or mutual fund house paying the dividend.

2. Is corporate dividends tax deductible?

A dividend from a domestic firm earned during Assessment Year 2020-21 is non-taxable, since it is exempt from tax under section 10(34) of the Act. The domestic corporation, however, is obligated to pay a Dividend Distribution Tax (DDT) under section 115-O in such instances.

However, the DDT was repealed by the Finance Act of 2020, reverting to the traditional method of taxes, where profits are taxed in the hands of the investors. In other words, if you're earning income from dividends, then you pay tax on them as part of your income.

3. Are dividends considered income?

Yes, dividends are considered 'income from other sources' under the Income Tax Act.

4. What does DDT mean?

DDT, or Dividend Distribution Tax, is a tax that companies must pay on dividends they pay out. There is no Dividend Distribution Tax (DDT) with effect from FY 2020-21.

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