Before you learn about the dividend distribution tax, think about why you invest in shares? You invest in shares today because you feel their value will grow in the future. Today, you tend to look at the potential value of a share as the primary incentive for investing in them. 

Similarly, when you invest in a mutual fund, you pay the price per unit in terms of its Net Asset Value (NAV). You invest in mutual funds with the expectation that their NAV during redemption will be higher than when you bought them.

However, there is one more incentive which primarily drives investment decisions. 

This incentive is the dividend paid out by the company to its shareholders. Companies may choose to distribute a part of the profit earned amongst their shareholders from time to time. This distribution is in the form of a dividend paid per share of the company. This dividend distribution attracted a dividend distribution tax (DDT) earlier. This tax used to be paid by companies until 2020, when the government abolished DDT.

Before you learn about the now abolished DDT, let us look at taxation on dividends. 

What is the Dividend Distribution Tax that now stands cancelled?

According to the then-existing DDT, a company issuing a dividend was required to pay the government a tax of 15% on the gross dividend amount. As per section 115O of the Income Tax Act. 

With the DDT in place, the income through dividends was exempted from taxes in the hands of the individual investors or shareholders. 

Therefore, the total burden of tax fell on the dividend-paying company. 

This tax burden was then passed to the individual investors. 

The DDT tax was deducted at the source by the dividend distributing company. Then, these companies used to pass the remaining amount to the investors. 

After the abolition of DDT, the applicable TDS on dividends is 10% if the dividend income of the shareholder exceeds ₹5000 for the financial year.

Are individual investors required to pay tax on dividend income?

Yes. Dividend income which was earlier exempt up to ₹10 lakh, has now become taxable for the investor. When you earn a dividend, it adds to your income and is taxable according to your income tax slab. 

As the dividend income is now taxable, Tax Deducted at Source (TDS) becomes applicable on such income. Therefore, companies are now required to deduct tax at the rate of 10% from dividends distributed to the resident shareholders if the total amount of dividend paid during the financial year to a shareholder is more than ₹5,000.

What is Dividend Distribution Tax for Mutual Funds? 

The dividend distribution tax was applicable on both equity and debt-based mutual funds. 

• For equity mutual funds, the dividend distribution tax was 25% (29% when surcharge and cess are added). 
• For debt mutual funds, the dividend distribution tax was 10% (11.64% with cess and surcharge). 

What are the benefits of DDT abolition? 

• The abolition of DDT ensured that the tax burden indirectly shifted to the shareholders is now direct and easily computable. 
• With the abolition of DDT, shareholders falling in the lower tax brackets get the entire dividend added to their income without tax being deducted at the source. 
• Shareholders whose income falls below the taxable bracket do not have to pay any income tax on the dividends received. This depends on their income staying below the taxable level after receiving dividends for the financial year.

What are the drawbacks of DDT abolition? 

• The DDT abolition creates inequality in terms of taxation on dividends. Some shareholders have to pay more tax, while others pay lesser or no tax on the same amount of dividend received. 
• The current tax norms on dividends favour shareholders with a lower tax bracket. 

For example, if your income falls under the 30% income tax slab, you will have to pay 30% taxes on the dividend received. 

To conclude

Taxes can be complex and become even more complicated when they apply differently to different individuals. 

Due to recent changes in dividend tax laws, dividend income is now taxable for you as an individual investor. As for any amendments, they have their own pros and cons.

Frequently asked questions

1) Is there a dividend/distribution tax in India?

Not any more. There used to be a Dividend Distribution Tax rate in India. 

However, the government abolished the Dividend Distribution Tax during the 2020 union budget. 

Therefore, companies are no longer required to pay Dividend Distribution Tax. 

2) How is dividend distribution tax calculated?

This used to be how the dividend distribution tax was calculated. 

Suppose a company ABC declared a dividend of, say, ₹5,00,000 on 10th April 2019. Let’s calculate the Dividend Distribution Tax that the company was required to pay. 

Now, the company’s gross dividend is its net dividend added to its DDT. 

Its net dividend is 85% , and DDT is 15%. Both of these are proportions of the gross dividend. 

To get all the figures for calculating the DDT, we first need to calculate the gross dividend.

Gross Dividend (100%) = Net Dividend (85%) + Dividend Distribution Tax (15%)

Gross Dividend = ₹5,00,000 * 100/85 = ₹5,88,235.29

Now that we have calculated the gross dividend, let’s calculate Dividend Distribution Tax on the Gross Dividend:

DDT is 15% of the Gross Dividend 

Therefore, Dividend Distribution Tax = ₹5,88,235 * 15% = ₹88,235

₹88,235 is 17.65% of ₹5,00,000

Therefore, the effective Dividend Distribution Tax rate was 17.65%. However, this did not include cess and surcharge. After calculating cess and surcharge, the effective rate was 20.56%. Since the Dividend Distribution Tax has been abolished, India's effective Dividend Distribution Tax rate is now zero.

3) How much dividend is exempted from income tax?

Dividend isn't exempted from income tax and all the dividend you earn will be counted in your income. The income tax slab that you fall into including your dividend will decide the tax percentage you'll pay.