Income Tax on Dividends: How dividends are taxed?

Source of dividend

You can receive dividends from the following sources –

• From a domestic company in whose shares you have invested
• From a foreign company in whose shares you have invested
• From equity mutual funds if you have chosen the dividend option
• From debt mutual funds if you have chosen the dividend option

Depending on the source of dividend income, relevant tax incidence would be applicable. So, let’s understand the tax implication on the above-mentioned sources of income independently –

Dividend received from a domestic company

If you receive dividends on the shares of a domestic company, the amount of dividend received would be tax-free in your hands under Section 10(34) of the Income Tax Act. The reason the dividend income would be tax-free is because the company distributing the dividend has already paid a Dividend Distribution Tax (DDT) on before distributing the dividend. The dividend income has been, therefore, taxed earlier and is not subject to another tax in the hands of the investor. The exemption on dividend income under Section 10(34) of the Income Tax Act can be claimed by individual investors and HUFs.

However, there is a corollary of the above exemption. If the total income from dividends exceeds INR 10 lakhs in a financial year, you would have to pay a tax under Section 115BBDA of the Income Tax Act. A tax of 10% would be levied on the income which exceeds INR 10 lakhs.

Example So, suppose you receive a dividend income from two domestic companies amounting to INR 3 lakhs and INR 5 lakhs each. In both the cases you would not have to pay any tax on the dividend income. Now, if you receive dividend from another domestic company and the amount of dividend is INR 4 lakhs, the aggregate dividend earned in the financial year would amount to INR 12 lakhs. Since the tax-free limit of INR 10 lakhs is crossed, you would have to pay a tax of 10% on the excess which is INR 2 lakhs. In this case, therefore, your tax liability on dividend income would be INR 20,000.

Dividend received from a foreign company

If you have invested in an international company, the dividends paid by that company would be considered as a taxable income under Section 115BBD of the Income Tax Act. The dividend income would be listed under ‘income from other sources’ and added to your total income. Thereafter, it would be taxed at your income tax slab rates.

Example If you have a gross total income of INR 10 lakhs and receive INR 1 lakh as dividends from a foreign company, your gross total income would become INR 11 lakhs. Thereafter, your tax liability would be calculated as follows –

Double Taxation Relief on dividends received from foreign companies

Though dividend received from foreign company is taxable in India, if it has also been taxed in the country where the foreign company operates, there is a case of double taxation. In these cases you can claim a relief on double taxation. You can claim the relief as per the provisions of the Double Tax Avoidance Agreement (DTAA) which the Indian Government has with the Government of other countries. If the agreement is not available, you can also claim a relief under Section 91 of the Income Tax Act and avoid paying double taxes on the same income.

Dividend received from equity or debt mutual funds

Dividends received from both equity and debt mutual funds would be completely tax-free in your hands under Section 10(35) of the Income Tax Act. This is because both equity and debt funds would have paid a Dividend Distribution Tax on the dividends which have been distributed. The dividend that you have received is, therefore, already taxed and would not be taxed further. Furthermore, unlike in case of dividends from domestic companies, there is no upper limit on the tax-free dividend. Any amount of dividend that you would receive would be totally exempted from tax.

Dividend Distribution Tax

As mentioned earlier, a Dividend Distribution Tax is deducted by domestic companies and dividend mutual funds before the dividend is paid. The rate of this Dividend Distribution Tax, however, differs. The applicable rates are as follows –

Foreign companies are not required to pay the Dividend Distribution Tax and that is why the dividend paid by them is taxed at your income tax slab rates.

Recording dividend income in the income tax return

Whenever you receive a dividend income in a financial year the same should be recorded in your income tax return whether the dividend is taxable or not. The dividend income should be mentioned under the head ‘income from other sources’. Once it is recorded, its taxability would be determined based on the above-mentioned rules.

So, now you know how dividend income is taxed in your hands. The next time you receive any dividend income, ascertain its source. If it is paid by a domestic company or a mutual fund scheme, the income received would be tax-free. If, however, a foreign company pays the dividend the same would be taxed. Know the tax implications properly so that you can file your returns correctly.