There are two ways to earn through investments. These are capital appreciation and dividends. Earnings through capital appreciation can be easier to calculate and tax. However, an applicable tax on dividend income can be complex to compute.
Before we learn about income tax on dividends, lets learn about the sources of dividends.
You get dividends when you invest in listed stocks of a company or mutual fund. These dividends are declared over specific periods. They can be either interim or final. They can also be in the form of cash per share or bonus shares in equity holdings.
In mutual funds, you can earn regular dividends only if you invest in a dividend mutual fund. These are mutual funds that invest in the assets of dividend-distributing companies. When the underlying assets of the mutual fund earn dividends, the asset management companies add them to the Net Asset Value (NAV) of the fund. How these dividends impact the scheme’s returns depends on its fund manager. This applies to both equity and debt mutual funds in India.
Now, let’s discuss the applicable tax on dividend income from them.
Earlier, the companies distributing dividends were liable to pay a Dividend Distribution Tax (DDT). This tax was abolished during the Union Budget 2020, with the introduction of the Finance Act 2020. Now, these tax implications are moved to the hands of investors.
The dividends earned on investments are now added to your income and taxed as per your income tax slab. Let’s understand this with the help of an example.
Suppose your annual income is greater than ₹15 lakh, and your income through dividends is ₹20,000 for the same year. You will be taxed 30 per cent on your dividend income. Therefore, your tax on dividends will be ₹6,000 (30 percent of ₹20,000).
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The tax rate for dividends also depends on whether you are a trader or a direct investor. Let’s look at both of them separately.
If you are an investor investing in shares or mutual funds through a broker, your dividends will be added to your income. The dividends will be treated as your ‘income from other sources’. This income will be taxed as per your income tax slab. However, you can still claim deductions for your interest expenditure not exceeding 20 percent of your dividend amount.
Similarly, if you are a trader, your dividend income will be considered your business income. Therefore, your dividends will be treated as your business or professional earnings and taxed accordingly. In this case, you can claim deductions on your income by considering business expenses over the period. These expenses can be loans, management expenses, collection charges and more.
Suppose you invested in the shares of an Indian company. You earned a dividend of ₹5000 on your investment in a particular year. However, to invest in this asset, you had taken a loan for which you paid interest of ₹2000 for the same period.
You can consider the interest on your loan for investment as a deductible. But you can only consider it to the extent of 20 percent of your dividend amount. Therefore, your deductible on this dividend will be ₹1,000 (20 percent of ₹5000).
Another way to get tax rebates on your earnings is by making tax-saving investments. You can invest in tax saving instruments like Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF), five-year fixed deposits or National Savings Certificate (NSC). These investments can help you save taxes up to ₹1.5 lakh per financial year, as per Section 80C of the Income Tax Act.
Investing in these instruments can reduce your final tax burden on income while giving you some long-term returns.
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The 2020 finance act also imposed TDS on dividend earnings through stocks and mutual funds. The TDS on dividend income was 10 per cent for any dividend amount of more than ₹5000. However, during the Covid-19 pandemic in 2020-21, this rate was reduced to 7.5 per cent. Since 21 April 2021, this tax liability has been reversed to 10 per cent. These rates are lower than the US tax dividends. These rates can be as high as 37 per cent of your dividend income in the US.
The amount of dividend income deducted through TDS is available for credit while filing your income tax returns. They can be refunded as your tax slab and tax liability permits.
Just like short-term capital gains tax and long-term capital gains tax apply to your investments, your dividends are taxed too. Your dividends are taxed as TDS before being added to your income. And, since they become a part of your income, you incur taxes on them per your income tax slab. That’s why it is important to consider taxes on dividends and returns to calculate the real returns on your investments.
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Yes, dividends are subject to income tax. When you get dividends by investing in stocks or mutual funds, it gets added to your income. Therefore, they are taxed as per your income tax slab.
You won't be taxed if your income after dividends comes under the tax-free income tax slab. However, a 10 per cent TDS would be applicable if your dividend amount is greater than ₹5000. This deduction is available for credit while filing your income tax returns.
If you have purchased the stock through a loan, your interest amount is deductible up to 20 percent of your dividend value.
No, earnings from dividends are added to your income as ‘income from other sources’ and are taxed according to your income tax slab.