Taxability of dividend income

“The beauty of Dividends is that you get paid, whether or not the market is up”

Dividend Investing is one of best investing strategy. Dividend stocks have outperformed with less volatility. Dividend stocks provide two sources of returns one is regular income from dividend payments and other is capital appreciation of the stock price. This total returns can increase over a period of time. Because of the lower volatility, stocks with dividend often attracts investors who has lower risk taking capacity.

But are the incomes received through dividends taxable?

Before we discuss this topic Let us understand which is dividend?

MEANING OF DIVIDEND

Dividend is either a portion of a company’s profits or it is taken from the reserves as part of an agreement which is between company and shareholders. The word Dividend comes from the word “dividendum” which means total divisible sum.  Dividend is declared by the company’s board of directors and after the approval from the shareholder. Dividends are often distributed on quarterly basis and it can be paid out in the form of cash or in the form of reinvestment in additional stocks.

NOW LET US UNDERSTAND THE SOURCES OF DIVIDEND

1. Current Year Profit
2. Past Profit remaining undistributed
3. Money provided by Government

LET US UNDERSTAND EACH SOURCE IN DETAIL

1. Dividends out of current year profits: Any company who declares dividend out of current year profits has to meet all the below mentioned requirements:

• Depreciation: Depreciation should be deducted from the depreciable assets as per the prescribed rates or its useful life before declaring the dividend.
• Reserve: No Company can declare or pay a dividend unless it transfers a certain percentage of profit to reserves
• Set off previous year loss: Company must always remember to set off the carried forwarded previous year’s loss from the current year’s profit before declaring the dividend.
• Free Reserve:Company shall not declare its dividend out of any reserve other than what it has in Free Reserve.

2. Past Profit Remaining Undistributed: Dividend can be paid out of the profits of current year or previous year or both. Let say if company incurred losses in the current financial year, even then it can distribute dividend if it has profit remaining undistributed in previous years. Now if the company has negative balance in the profit and loss account in the beginning of current year and earns some profit at the end of the current year but that profit is not sufficient to cover the losses of previous year even then the dividend  can be distributed out of the profit earned during current year. So in short if the company earned profit in any year then they can distribute dividend out of the profit earned during current year, or the year preceding the current year. This can be done irrespective of the losses incurred by the company. However the profit must be kept intact in the profit and loss account.
3. Money provided by Government: Where the Central Government or the State Government has guaranteed the payment of dividend of the company, dividend may be paid out of the money provided by such Government.

 Now there are situations where the company does not Earn Profits, in that case dividend can be declared subject to conditions as stated below

1. Rate of Dividend: The rate of dividend declared shall not exceed the average of the rates at which dividend was declared by it in the three years immediately preceding that year Provided that this sub-rule shall not apply to a company, which has not declared any dividend in each of the three preceding financial years. 
2. Amount of Dividend: The total amount to be drawn from such accumulated profits shall not exceed one-tenth of the sum of its paid-up share capital and free reserves as appearing in the latest audited financial statements.
3. Set off of Losses: The amount so drawn shall first be utilized to set off the losses incurred in the financial year in which dividend is declared.

WHAT IS THE TIMELINE FOR PAYMENT OF DIVIDEND?

• The amount of dividend including interim dividend shall be deposited in a separate account with a scheduled bank within 5 days of its declaration
• Dividend declared shall be paid within thirty days of declaration and in case any dividend which is been transferred but remains unpaid or unclaimed for seven days from the expiry off 30days, then the same shall be credited to unpaid or unclaimed dividend account opened with a scheduled bank.
• The company shall within a period of ninety days of making any transfer of an amount to the unpaid dividend or unclaimed dividend account, prepare a statement containing the names, their last known addresses and the unpaid dividend to be paid to each person and after that it should be placed it on the website of the company if any.
• Any amount remaining unclaimed for specified number of years in such account, shall be transferred along with interest accrued, if any, thereon to Investor Protection and Education Fund account under section 125 of the Act.

TYPES OF DIVIDEND :

There are 5 types of Dividend

1. Cash Dividend

• Cash dividends are the most commonly used dividend type. In this type of dividend, the dividend amount is paid by transferring a sum of money. The money can be transferred electronically or through cash and check.

2. Stock Dividend

• Stock dividends refer to the dividend which is paid by allotting a certain number of shares to the existing shareholders without taking any kind of consideration.
• The stock dividend is treated differently in two different cases where; the first case is when the company issues less than 25 % of the outstanding shares, then it is treated as a stock dividend, but if the issue is more than 25% of the outstanding number of share, then the same is treated as stock split and nit stock dividend.

3. Scrip Dividend

A scrip dividend is the type of dividend issued by the company in which the company gives transferrable promissory notes which promise to pay the shareholders the amount of dividend on some later date. The notice issued may or may not be interest-bearing.

4. Property Dividend

Property dividend is paid using non-monetary items such as assets, inventories, etc., rather than directly paying cash. The company pays this dividend when the company does not have enough cash reserves to pay off dividends.

5. Liquidating Dividend

The liquidating dividend is the dividend declared by the company usually when the company is in liquidation and the directors decide to pay back to the shareholders their original contribution towards the capital of the company.

So till now we have understood the meaning of dividend, its sources and what is the timeline for payment of Dividend, but one question that comes to an investor’s mind is whether the income earned through dividend is taxable?

LET US UNDERSTAND  TAXABILITY OF DIVIDENDS

DIVIDEND DISTRIBUTION TAX

Taxability of dividend income has seen changes over the years. Up to Assessment Year 2020-21, if a shareholder gets a dividend from a domestic company, it is exempt from tax for the shareholders. In this case, Companies had to pay dividend distribution tax. However after the Finance Act 2020, Dividend Distribution Tax concept is abolished and now the Dividends have become taxable in the hands of investors.

The dividend income is taxed in the hands of the investors only if dividend is distributed on or after 01-04-2020. In this case, the entire amount will be taxable in the hands of the investors and they will be liable to pay tax on dividends. The companies will not be required to pay DDT.

DIVIDEND INCOME IS TAXABLE OR NOT?

Any Dividend received in either from direct equity investment or from equity mutual funds, it is taxable. The onus of paying tax is now shifted to dividend receiver from the dividend payer. The company or the mutual fund house that pays dividend is responsible for deducting TDS on the dividend amount before pay out. The TDS rates also differs according to the residential address.

DIVIDEND TAX RATES IN INDIA

Dividend Tax depends on the receiver’s occupation.  If the shareholder is involved in trading business of stocks, the dividend income received by him are taxed under business income.

If the shareholder is simply an investor then the dividend income are earned through Indian companies or foreign companies is taxed under income from other sources. The rate of tax will be the income tax slab rate applicable to the shareholder.

DIVIDEND TAX RATE FOR NON RESIDENT INDIANS (NRI) IN INDIA

For NRI’s who have invested in Indian companies the Tax Rate if flat 20% on the income. The taxation of Dividends for NRI’s is subject to the provisions of India’s Double Taxation Avoidance Agreement which ensures the same income is not taxed twice. This Means NRI’s need not pay the tax for the income earned through dividends abroad or vice versa also. In case if the amount is taxed twice , the investor can claim double taxation relief.

TDS ON DIVIDEND INCOME IN INDIA

Any company who is paying dividend to Resident Individual in India should deduct 10% as TDS on the amount of dividend. This rule is applicable only when the dividend amount is exceeding ₹ 5000.  For any dividend income received by NRI, TDS will be deducted at flat rate of 20% subject to the provisions of Double Taxation Avoidance Agreement.

WHAT IS INTERCORPORATE DIVIDEND?

The Government of India has introduced a new section 80M under the Act to remove the cascading effect where a domestic company receives a dividend from another domestic company

These companies receive dividend and declare dividend at the same time. A deduction is allowed for dividends received if they are distributed as dividends one month before the filing date. This section is applicable to dividends distributed on or after April 1, 2020.

Inter-corporate dividends are a type of dividend paid between companies. Inter-corporate dividends occur when a firm receives a dividend as a result of its ownership of shares in another company. Inter-corporate dividends are a type of dividend paid between companies. Inter-corporate dividends occur when a firm receives a dividend as a result of its ownership of shares in another company. 

PURPOSE

Section 80M is applicable with regard to dividend provided on or after April 1, 2020. The aim of this section is to confirm that the company has comprised dividends from  a domestic company and has also  distributed to its shareholders , some benefits  is provided to the company by assuming that such distribution is made out of the dividends acknowledged and thus allowing deductions to the company with reference to such distributions.

LAW BEFORE SECTION 80M

It is to be noted that section 80M did exist in some kind in the earlier tax law, but the same got discontinued after the introduction of Dividend Distribution Tax. It was easier with DDT to gather tax at one point which the corporates used to declare since the technology infrastructure at that point had made tracking the dividend incomes difficult once it has been distributed to the shareholders.   

REINTRODUCTION OF SECTION 80M

The Finance Bill 2020 proposed amendments within the tax Act, 1961 on different aspects, One among these changes were to relieve the corporates from Dividend Distribution Tax and hence make dividend taxable for the investors.