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Income Tax on Dividend Income in India

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Until the Assessment Year 2020-21, shareholders receiving dividends from domestic companies in India were not liable to pay any tax on such dividends. Dividends were exempt from tax under section 10(34) of the Income Tax Act. However, a significant change occurred with the Finance Act of 2020. This act abolished the Dividend Distribution Tax (DDT) and moved to the classical system of taxation. Under this new system, dividends are taxed in the hands of the investors. This means that domestic companies distributing dividends on or after April 1, 2020, are no longer liable to pay DDT, and shareholders are now responsible for paying tax on their dividend income.

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What is Dividend Income?

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Dividend income refers to the distribution of profits by a company to its shareholders. While this is the common understanding of dividends, for tax purposes, the definition is broader. According to Section 2(22) of the Income Tax Act, dividend also includes the following:

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1. Distribution of accumulated profits to shareholders, involving the release of the company’s assets.

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2. Distribution of debentures or deposit certificates to shareholders out of the accumulated profits of the company and the issuance of bonus shares to preference shareholders from accumulated profits.

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3. Distributions made to shareholders of the company on its liquidation from accumulated profits.

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4. Distributions to shareholders from accumulated profits when the company reduces its capital.

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5. Loans or advances made by a closely held company to its shareholders from accumulated profits.

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Taxation of Dividend Income Received on or after April 1, 2020

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The taxability of dividends from Assessment Year 2021-22 onwards is as follows:

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Obligation of Domestic Companies

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Domestic companies are not liable to pay DDT on dividends distributed to shareholders on or after April 1, 2020. However, these companies are required to deduct tax under Section 194. According to Section 194, which applies to dividends distributed, declared, or paid on or after April 1, 2020, Indian companies must deduct tax at a rate of 10% from dividends distributed to resident shareholders if the aggregate amount of dividends distributed or paid during the financial year to a shareholder exceeds Rs. 5,000. No tax deduction is required for dividends paid to Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), or any other insurer with full beneficial interest in the shares.

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Taxation in the Hands of Shareholders

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Section 10(34), which provided an exemption to shareholders in respect of dividend income, has been withdrawn from Assessment Year 2021-22. This means that dividends received during the financial year 2020-21 and onwards are taxable in the hands of shareholders. Consequently, Section 115BBDA, which deals with the taxability of dividends exceeding Rs. 10 lakh, is no longer relevant as the entire amount of dividends is taxable in the hands of the shareholder. The taxability of dividend and the tax rate depend on various factors, including the residential status of the shareholders and the relevant head of income.

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Taxable in the Hands of Resident Shareholders

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The tax treatment of dividend income for resident shareholders depends on whether they deal in securities as traders or investors. If shares are held for trading purposes, dividend income is taxable under the head of business income. If shares are held as investments, dividend income falls under the head of other sources. The method of accounting (mercantile system or cash basis) employed by the assessee does not affect the basis of charge for dividend income. Dividends are taxable in the year in which they are declared, distributed, or paid by the company for final dividends. Interim dividends are taxed on a receipt basis.

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Deductions from Dividend Income

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When dividends are assessable to tax as business income, the assessee can claim deductions for expenses incurred to earn that dividend income, such as collection charges and interest on loans. If dividends are taxable under the head of other sources, the assessee can claim a deduction for interest expenditure incurred to earn that dividend income, up to 20% of the total dividend income. Other expenses, including commission or remuneration paid to a banker or any other person for the purpose of realizing such dividends, are not deductible.

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Tax Rate on Dividend Income

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Dividend income is subject to normal tax rates applicable to an assessee, except in the case of a resident individual who is an employee of an Indian company or its subsidiary engaged in information technology, entertainment, pharmaceutical, or biotechnology industries. In such cases, dividends received in respect of GDRs issued under an Employees’ Stock Option Scheme are taxable at a concessional rate of 10% without any deductions.

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Taxation for Non-Resident Shareholders, Including FPIs

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Non-resident individuals often invest in India as private equity investors or as Foreign Portfolio Investors (FPIs). Non-residents can also be promoters of Indian companies. Non-resident persons typically hold shares of an Indian company as investments, and any income derived from dividends is taxable under the head of other sources. The tax rate on dividend income for non-resident individuals, including FPIs, is 20%, without any deductions. For an investment division of an offshore banking unit, the tax rate is 10%. If dividends are received in respect of GDRs of an Indian company or a Public Sector Company (PSU) purchased in foreign currency, the tax rate is 10%.

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Withholding Tax

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When dividends are distributed to non-resident shareholders, tax is required to be deducted under Section 195 of the Income Tax Act. For dividends paid in respect of GDRs of an Indian company or a Public Sector Company (PSU) purchased in foreign currency or to Foreign Portfolio Investors (FPIs), the tax is deducted under Section 196C and Section 196D, respectively. The withholding tax rate for dividend income can vary based on the relevant section, the nature of income, and the payee’s status.

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Taxability under Double Taxation Avoidance Agreements (DTAA)

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Dividend income is generally taxable in both the source country and the country of residence of the assessee. To prevent double taxation, India has entered into Double Taxation Avoidance Agreements (DTAA) with several foreign countries. The provisions of these DTAA treaties may reduce the tax rate on dividend income for foreign investors. The specific tax rate and conditions may vary based on the agreement between India and the foreign country.nnAdvance Tax Liability on Dividend Income

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If the shortfall in advance tax installment payments or failure to pay on time is due to dividend income, no interest is charged under Section 234C, provided that the assessee has paid the full tax in subsequent advance tax instalments.nnNo Minimum Alternative Tax (MAT) on Dividend Income of Foreign Companies

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nProvisions related to Minimum Alternative Tax

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The provisions related to Minimum Alternative Tax (MAT) apply to foreign companies when they are residents of a country with which India has a DTAA and they conduct business through a Permanent Establishment (PE) in India. However, dividends are not subject to MAT, and certain incomes and expenses are excluded from MAT calculations. These exclusions are applicable to income derived from capital gains on securities, interest, royalties, and fees for technical services (FTS).nnInter-Corporate DividendsnThe Finance Act of 2020 introduced a new Section 80M under the Income Tax Act to prevent cascading effects when a domestic company receives a dividend from another domestic company. However, the Act does not specify tax treatment when a domestic company receives a dividend from a foreign company and further distributes it to shareholders.nnIn conclusion, the taxation of dividend income in India has undergone significant changes with the abolition of DDT. Dividend income is now taxable in the hands of the shareholders, and tax rates vary depending on various factors. Shareholders, both resident and non-resident, should carefully assess their tax liabilities and take advantage of relevant DTAA provisions to optimize their tax position.nnPlease note that tax laws and regulations may change over time, so it is advisable to consult with a tax professional or refer to the latest provisions of the Income Tax Act for the most up-to-date information.

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