Income Tax

Taxability of Dividend in Income Tax Returns

As a taxpayer, one may be unclear about the taxability of dividend income and also how to report dividend income on the income tax return for a financial year. A question may also arise whether it is necessary to pay taxes on dividend income or not. The Finance Act of 2020 moved the taxability of dividend income from the dividend-declaring companies to the hands of individual investors.

If an investor receives a dividend from a domestic corporation, he is not required to pay any tax on such dividend until Assessment Year 2020-21 since it is exempt from tax under Section 10(34) of the Act. In such circumstances, though, the domestic firm is required to pay a Dividend Distribution Tax (DDT) which is levied under section 115-O. The DDT was repealed by the Finance Act of 2020, bringing in a more traditional system of taxation in which dividends are taxed in the hands of the shareholders.

As a result, if the dividend is issued on or after 01-04-2020, the provisions of Section 115-O will not apply. As a result, if the dividend is issued on or after 01-04-2020, domestic corporations will not be required to pay DDT, and shareholders will be required to pay tax on such dividend income. Because dividends are again taxable in the hands of the shareholder, several sections of the Act have been resurfaced, including the allowability of costs from dividend income, the deductibility of tax from dividend income, the handling of inter-corporate dividends, and so on.

What is the meaning of dividends?

The distribution of earnings by a firm to its shareholders is commonly referred to as a dividend. However, in accordance with Section 2(22) of the Income Tax Act, the dividend may additionally contain a number of other payments. These could be:

1. Distribution of accumulated earnings to investors, which necessitates the discharge of the corporation’s assets
2. On the reduction of capital by the company, a distribution from accumulated earnings that are made to its investors
3. A loan or advance granted to a shareholder by a closely held corporation from its accumulated earnings
4. The distribution of debentures/ deposit certificates to investors from the corporation’s accumulated profits, as well as the issuance of bonus shares to its preference shareholders from the accumulated earnings
5. On the corporation’s liquidation, a distribution from accumulated earnings that are made to its shareholders

Taxability of dividend that is received on or after 01-04-2020

From Assessment Year 2021-22 onwards, the taxability of dividend income in the hands of both the firm and shareholders would be as follows:

Domestic corporations are exempt from paying DDT on dividends issued or paid to shareholders on or after April 1, 2020. Domestic corporations, on the other hand, will be required to deduct tax (TDS) under Section 194 of the Income Tax Act.

According to Section 194 of the Income Tax Act, which applies to dividends distributed, declared, or paid on or after 01-04-2020, an Indian company must deduct tax (TDS) at a rate of 10% from dividends distributed to resident shareholders or investors if the total amount of dividend distributed or paid to a particular shareholder during the fiscal year exceeds Rs. 5,000. However, as a COVID-19 assistance measure, the government cut the TDS rate for distribution from 14 May 2020 to 31 March 2021 to 7.5 percent.

But no TDS must be deducted out of any dividend amount which is paid, payable, or due to the insurance companies like the Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), or other insurers in connection with any shares held or beneficially owned by them. However, if the dividend is paid to a non-resident or a foreign entity, then, in that case, the tax must be withheld in accordance with the applicable DTAA under Section 195 of the Income Tax Act.

From the Assessment Year 2021-22 and thereafter, Section 10(34), which exempts stockholders from dividend income, stands repealed and is no longer applicable to taxpayers. As a result, dividends paid after the fiscal year 2020-21 and also those paid during the year 2020-21 will be taxable in the hands of shareholders only.

In addition, the applicability of Section 115BBDA of the law which taxes the pay-outs of dividends in excess of rupees 10 lakhs is not relevant. This is so because the full pay-out amount is now taxable in the hands of the investor as per his/ her individual tax rates.

Hence, it can be inferred that the taxability of dividend income and the rate at which they are taxed will be affected by a number of criteria, including the investors’ residential status and the relevant category of income. In addition, the terms and conditions of Double Taxation Avoidance Agreements (DTAAs) and Multilateral Instruments (MLIs) will also apply in the case of a non-resident or foreign shareholder.

Taxability of dividend for the resident shareholders

An individual who deals in securities might do so as a trader or an investor. His income from trading operations is taxed under the heading of business income. As a consequence, if shares are retained for trading purposes, dividend income is taxed under the category of business or profession. In contrast, if shares are kept as an investment, dividend income is taxed under the heading of other sources.

The income, which is taxable under the category of business income, is determined in line with the system of accounting that the assessee uses on a regular basis. A person can use either the mercantile system of accounting or the cash basis of accounting to compute business income. However, the system of accounting followed by the taxpayer has no bearing on the ‘basis of charge’ of dividend income because Section 8 of the Income Tax Act specifies that final dividends, comprising of deemed dividends, are taxed in the year in which they are declared, or distributed, or paid by the firm, whichever is earlier. Interim dividends, on the other hand, are taxable in the previous year in which the amount of such pay-out is unconditionally made available to the shareholder by the corporation. In other words, interim dividends are taxed on the basis of receipt.

When a dividend is taxed under the category of business income, the taxpayer can deduct any of the expenses incurred to obtain that dividend income, such as collection costs, loan interest, and so on. If a dividend is taxable under the category of other sources, the taxpayer can deduct just the interest expense spent to produce that dividend income and that too, up to 20% of the total dividend income. Any additional expenditures, including commission or compensation given to a banker or any other person for the purpose of realizing such dividend, are not deductible.

Other than in the case of a resident individual who is an employee of a corporation or its subsidiary involved in the industry of information technology (IT), entertainment, pharmaceutical, or biotechnology sciences and who receives a dividend in respect of GDRs issued by such company under an ESOP scheme, the dividend income is subject to tax at the normal tax rates applicable to an assessee. In that situation, dividends will be taxed at a reduced rate of 10% without any deductions under the Income-tax Act. The GDRs, though, should be bought in foreign currency by the employee.

Taxability of dividend for non-resident shareholders

Non-residents often engage in India as private equity investors or as Foreign Portfolio Investors (FPIs). A non-resident individual may also be a promoter of an Indian company. A non-resident person normally owns the shares of an Indian firm as an investment, and hence any dividend income is taxed under the category of other sources unless such income is related to the permanent establishment of such non-resident person in India.

Securities held by FPIs are usually recognized as capital assets rather than as stock-in-trade. As a result, the dividend income of FPIs is always taxed under the heading of other sources.

Dividend income is taxed at 20% in the hands of a non-resident person (including FPIs and non-resident Indian citizens (NRIs)) and is not deductible or expensed under any sections of the Income-tax Act. Dividend income from an offshore banking unit’s investment division, on the other hand, is taxed at a rate of 10%. Furthermore, if the dividend is received in respect of GDRs of an Indian company or a Public Sector Undertaking (PSU) acquired in foreign currency, the tax would be levied at a rate of 10% without any deductions.

If the dividend is paid to a non-resident shareholder, the tax must be deducted in accordance with Section 195 of the Income-tax Act. However, when the dividend is issued or paid in respect of GDRs of an Indian Company or a Public Sector Undertaking (PSU) acquired in foreign currency or to Foreign Portfolio Investors (FPIs), the tax must be deducted in accordance with sections 196C and 196D, respectively.

Section 195 states that the withholding tax rate on dividends shall be as established in the Finance Act^[1] of the concerned year or under DTAA, whichever is appropriate in the instance of an assessee. In contrast, the withholding tax rates under sections 196C and 196D are 10% and 20%, respectively.

Disclosure on Income tax return

Dividend payments were formerly reported under the heading of ‘Exempted Income’ when filing income tax return, but it will now be reported under the heading of ‘Income from Other Sources’ as per section 56(2)(i) since it is now taxable. It is worth noting that in the new ITR forms made available by the government, the schedule OS has been updated to contain information about the taxpayers’ dividend income generated during the fiscal year.

If the main source of income of an assessee is salary and dividends, he may continue to disclose income in ITR-1. Disclosure is permitted under the headings of “Salary” and “Other sources.” Notably, TDS would not be deducted from dividends of less than Rs 5,000. However, the assessee may be required to report dividend income in the ITR. If he obtains income from the sale or redemption of shares in the form of capital gains, he will be ineligible to file ITR-1 and must make disclosure in ITR 2.

Conclusion

Dividends paid or distributed by a business concern on or after 01-04-2020 are now chargeable to tax in the hands of the investors, according to the Income Tax Act of 1961. At the time of paying dividends to shareholders, the corporation distributing such dividends must deduct tax at source (TDS) at the relevant rates (including any surcharge or cess). TDS has to be deducted at a pre-determined rate of 10% on the amount of dividend payable to residents in pursuance of Section 194 of the Income Tax Act. TDS is typically deducted at a rate of 20% plus appropriate cess and surcharges for non-resident shareholders. Individuals, on the other hand, are exempted from this TDS deduction provided their total dividend pay-out from a corporation for the fiscal year does not exceed rupees 5,000.

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