How does dividend distribution tax affect an investor? If you are an investor in the stock market, you probably own some stock of certain companies which pay high dividends. This is one of the most appealing aspects of investment for particular investors who enjoy payments from companies they invest in. In the hands of shareholders, those who invest in companies, a dividend payout comprises an income earned. Ideally, this should incur tax, but does it? The answer is a resounding “yes”.

Know the Basics - What is a dividend?

For some investors who open a demat account, the prospect of investing in companies that yield high regular dividends is exciting. Any return which is generated by a company to the shareholders of that company, out of profits that the company earns, constitutes a dividend. This is typically given out to shareholders once annually. Since this is a kind of earning for a shareholder, it should, for the most part, be subjected to income tax.

According to regulations passed in April 2020, dividends are taxed in shareholders’ hands. In India, companies hand out two dividends - an interim dividend and a final dividend. The interim dividend is paid out to shareholders during the financial year. If a company pays a dividend at the close of the financial year, it is called the final dividend. Before April 2020, the tax liability for the distribution was in the hands of the company (domestic company) handing out the dividend. However, in terms of dividend distribution tax, if you can call it that, it is now payable by shareholders only.

What is a dividend distribution tax?

Investors find investing in an upcoming IPO compelling as this means they may get dividends out of the invested company as it grows and expands. This is all very well for investors as they can earn capital out of the value of the stock as well as out of dividend payouts. This is probably the main aspect of stock investment that potential shareholders find enticing. They may not think of the taxability of such earnings when investing.

Before April 2020, Indian companies which generated dividend payouts had to pay a tax on these payouts. This tax amounted to a 15% tax liability on the dividend’s gross amount. Therefore, this dividend distribution tax turned out to be hefty, depending on the dividend yield by any company, and shareholders walked to the bank happily. The DDT applied to stock dividends as well as dividends which arose out of mutual fund investment. So what is dividend distribution tax now? Now, DDT is no longer a liability in the company’s hand which pays out the dividend.

Dividend Distribution Tax in India

It is important to know how dividends and taxability are treated under the Income Tax Act, under Section 194. Domestic corporations may not be liable to pay dividend distribution tax anymore, but they are liable for deducting tax as per Section 194. The deduction of tax from any dividend payout after April 2020 is done at 10% of the dividends which may be distributed to Indian shareholders. This is only deducted in the case where the dividend payout during the financial year is above Rs. 5,000. However, concerning the dividend distribution tax, a point to note is that any dividend paid out by the LIC, or Life Insurance Corporation of India, the GIC or the General Insurance Corporation of India, and other insurers concerning shares in their possession, are not subjected to a deduction of tax on dividends.

Why has the dividend distribution tax been abolished in India?

The Indian government, in a bid to make taxation a fair practice for large and small investors, and to encourage small investors, abolished the dividend distribution tax. Here are some reasons for the removal of such a tax:

• To benefit smaller investors who may receive small amounts in terms of dividend payouts, and encourage them to invest in the markets more
• To remove any preferential treatment given to large investors, earning large amounts as dividends for the sake of tax exemption
• To encourage companies to share more profit with shareholders

Tax Liability of Shareholders

Is the tax liability of shareholders receiving dividends known as the dividend distribution tax in India? The simple answer to this is “no”. The DDT which existed before it was abolished in 2020 was the only “dividend distribution tax” and it was the onus of companies to pay it. So, what is the tax liability on the part of shareholders receiving dividends now? Consider the following:

• In case you are a resident Indian, you are not liable to pay any tax on dividends received if the amount of your dividends is up to Rs. 5,000.
• In case the dividends you receive amount to more than this amount, your dividend is taxed according to your income earned, that is, the tax slab that you fall within. Dividend income is taxed under the purview of “income from other sources”. According to this calculation, say, if you fall within the 30% bracket of income tax, your dividend amount will be added to your income and your total income is taxed at 30%.

Stock Investment - Know Certain Aspects

Let’s say you open a demat account and hope to make big gains in the stock market. You should do some homework about the companies you invest in, not just to know about their historical returns, but also about their yield of dividends. This is the case with any upcoming IPO too. You may invest in an IPO, but as the company grows, it may give you great capital returns (on which you also have to pay tax) and dividends on which you, the shareholder, are likely to pay tax. It is important to pay your taxes, but it is equally vital that you, the investor, should make gains with investment, and not just have to see it all diminish with tax payments. Dividends are great reasons to invest in stocks, but these cannot be the sole basis on which you make your investment decisions.