Understanding that the Dividends paid to you are not "actually" tax free and attract hidden taxes, you can take much more informed decisions when it comes to investing for Dividend based Income.
Let us understand what is Dividend Distribution Tax (DDT) and how does this understanding can help us...Read on..
What is Dividend Distribution Tax?
Section 10(34) of the Income Tax Act, 1961 declares that in addition to the income tax paid by a domestic company against the total income for any assessment year, any amount declared, distributed or paid by such company in form of dividends, is subject to additional tax known as Dividend Distribution Tax (DDT). DDT is not only applicable to company stocks, but also applicable to debt mutual funds and is the tax that debt funds pay on the dividends distributed to retail investors.
Who needs to pay DDT?
Section 10(34) of the Income Tax Act, 1961 declares that in addition to the income tax paid by a domestic company against the total income for any assessment year, any amount declared, distributed or paid by such company in form of dividends, is subject to additional tax known as Dividend Distribution Tax (DDT). DDT is not only applicable to company stocks, but also applicable to debt mutual funds and is the tax that debt funds pay on the dividends distributed to retail investors.
Who needs to pay DDT?
Prior to Apr 2020
DDT was required to be paid by the individual companies (whose Stocks you are holding) or the Fund Houses (whose Mutual Fund units you are holding).
This means that the dividend Income was tax-free in the hands of the investor.
Whats the Catch? : Before the actual payment, stock companies and debt fund houses deduct DDT from the declared dividend and only the remainder is distributed to the investor. Hence, common investor doesn't have any tax liability on the dividend income that he or she finally receives, but the dividend income is actually not tax free since the tax is already deducted from the dividend received.
Post April 2020
Dividend income from shares and MFs will be now be taxable in the hands of the recipient, instead of the company or the MF house, as per the individual applicable tax slab of the individual.
Now, this amount will flow directly into the net asset value (NAV) of mutual funds. So, you get a higher Dividend, though, it becomes taxable as your income now.
How much is the Tax Liability under DDT?
DDT was required to be paid by the individual companies (whose Stocks you are holding) or the Fund Houses (whose Mutual Fund units you are holding).
This means that the dividend Income was tax-free in the hands of the investor.
Whats the Catch? : Before the actual payment, stock companies and debt fund houses deduct DDT from the declared dividend and only the remainder is distributed to the investor. Hence, common investor doesn't have any tax liability on the dividend income that he or she finally receives, but the dividend income is actually not tax free since the tax is already deducted from the dividend received.
Post April 2020
Dividend income from shares and MFs will be now be taxable in the hands of the recipient, instead of the company or the MF house, as per the individual applicable tax slab of the individual.
Now, this amount will flow directly into the net asset value (NAV) of mutual funds. So, you get a higher Dividend, though, it becomes taxable as your income now.
How much is the Tax Liability under DDT?
It's an old and controversial tax. Domestic companies are subject to DDT as per the below tax slabs:
Prior to Apr 2014
DDT was charged at 12.5%
From Apr 2014 to Mar 2020
The dividend distribution tax was increased to 20.35%, from the earlier 12.5%.
Stocks : 20.35% (15% of dividend paid + 12% surcharge + 3% education cess)
Mutual Funds (Equity) : 11.56%
Mutual Funds (Debt) : 29.12%
Post April 2020
The tax rate will now be decided by the tax slab of the individual who receives the dividend - both in case of Stocks and Mutual Funds.
In addition, tax will be deducted at source (TDS) on mutual fund dividends in excess of ₹5,000 per year at the rate of 10%. TDS can, of course, be adjusted at the time of filing your IT Returns.
DDT is a Triple Whammy
The tax on dividends is a triple levy.
1/ Dividend basically means the distribution of a company's after-tax profits. The tax paid on the profits by a company is the first level of tax.
2/ Once the tax is paid on the profits, the after-tax profits can be used to pay dividends. And these dividends attract the next level of tax. So, DDT is the second level.
3/ The recently-introduced Super Rich Dividend Tax — the 10% tax on anyone who earns dividend income of Rs 10 lakh or above in a financial year is the third tax.
Why the change of hands for DDT ?
Dividend distribution tax is a surrogate tax and it has been obstructing the flow of foreign direct investment because it leads to less dividend yield. Therefore, doing away with this tax on the company side can give a big push to foreign investment.
No sense to go for Dividend Option if you are at 15%+ tax bracket
1/ The long term capital gains tax (LTCG) in India which applies for gains in funds held for longer than 1 year is 10% (above a tax free capital gains allowance of ₹1 lakh per year). 2/ The short term capital gains tax (STCG) in India in funds held for shorter periods is 15%. Hence investors in higher tax brackets are better off taking their returns as capital gains rather than dividends which are taxed at slab rate.
Summary
Currently, no other country in the world has a DDT regime. Even in India, it was only in 1997 that DDT was made a part of income tax laws. The tax was scrapped in 2002, but was brought back in the very next year on the pretext of ease of tax administration. And on top of that, the triple whammy makes it quite an unfair tax collection.
The new tax treatment actually increases the tax burden further on investors in higher tax brackets, while lowering it a tad for people in low tax brackets.
But the added complexity, and tax compliance costs are a big deterrent for an individual tax payer.
In nutshell, Dividend Options are a no go for mutual funds of any type. Instead, go for SWP of Mutual Funds if you want a regular flow of income.
Prior to Apr 2014
DDT was charged at 12.5%
From Apr 2014 to Mar 2020
The dividend distribution tax was increased to 20.35%, from the earlier 12.5%.
Stocks : 20.35% (15% of dividend paid + 12% surcharge + 3% education cess)
Mutual Funds (Equity) : 11.56%
Mutual Funds (Debt) : 29.12%
Post April 2020
The tax rate will now be decided by the tax slab of the individual who receives the dividend - both in case of Stocks and Mutual Funds.
In addition, tax will be deducted at source (TDS) on mutual fund dividends in excess of ₹5,000 per year at the rate of 10%. TDS can, of course, be adjusted at the time of filing your IT Returns.
DDT is a Triple Whammy
The tax on dividends is a triple levy.
1/ Dividend basically means the distribution of a company's after-tax profits. The tax paid on the profits by a company is the first level of tax.
2/ Once the tax is paid on the profits, the after-tax profits can be used to pay dividends. And these dividends attract the next level of tax. So, DDT is the second level.
3/ The recently-introduced Super Rich Dividend Tax — the 10% tax on anyone who earns dividend income of Rs 10 lakh or above in a financial year is the third tax.
Why the change of hands for DDT ?
Dividend distribution tax is a surrogate tax and it has been obstructing the flow of foreign direct investment because it leads to less dividend yield. Therefore, doing away with this tax on the company side can give a big push to foreign investment.
No sense to go for Dividend Option if you are at 15%+ tax bracket
1/ The long term capital gains tax (LTCG) in India which applies for gains in funds held for longer than 1 year is 10% (above a tax free capital gains allowance of ₹1 lakh per year). 2/ The short term capital gains tax (STCG) in India in funds held for shorter periods is 15%. Hence investors in higher tax brackets are better off taking their returns as capital gains rather than dividends which are taxed at slab rate.
Summary
Currently, no other country in the world has a DDT regime. Even in India, it was only in 1997 that DDT was made a part of income tax laws. The tax was scrapped in 2002, but was brought back in the very next year on the pretext of ease of tax administration. And on top of that, the triple whammy makes it quite an unfair tax collection.
The new tax treatment actually increases the tax burden further on investors in higher tax brackets, while lowering it a tad for people in low tax brackets.
But the added complexity, and tax compliance costs are a big deterrent for an individual tax payer.
In nutshell, Dividend Options are a no go for mutual funds of any type. Instead, go for SWP of Mutual Funds if you want a regular flow of income.
History
Jan 2014 : Original Version
April 2020 : Budget 2020 changes incorporated, General edits done.
Regards
Jan 2014 : Original Version
April 2020 : Budget 2020 changes incorporated, General edits done.
Regards
Manoj Arora
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