This article talks about the tax treatment of dividends received by domestic companies for residents and non-residents.
Investors receive dividends on making investments in companies through their shares. This dividend is an income source for the investor and thus is subject to income tax. The tax treatment of dividends received from companies was changed owing to the tax regime under the Finance Act, 2023. Prior to Finance Act, 2023, the tax on dividends was levied on the issuing company as Dividend Distribution Tax (DDT), but now the liability of tax on dividends falls upon the investor. Let us understand the tax treatment on dividends under the old and new regimes.
Tax Treatment of Dividend Before 01-04-2023
If shareholders receive dividends from the domestic company, they shall not be liable to pay tax on such dividend as it is exempt from tax under Section 10(34) of the Income Tax Act, 1961. The shareholders are exempted from paying tax on dividends as the dividend distributing company has already paid the Dividend Distribution Tax (DDT) under Section 115O before distributing the dividend to the shareholders. This exemption was allowed to both individual investors and HUFs. However, as per the old laws, the exemption to shareholders was provided only to the limit of Rs. 10 lakhs. If the total income from dividends for an individual exceeds Rs. 10 lakhs in a financial year, then income tax would be applicable at 10% under Section 115BBDA of the Income Tax Act, 1961. However, this system of taxing dividends has been abolished with effect from April 01, 2023. The Finance Act, 2023 has reintroduced the classical system of taxation wherein dividends are taxed in the hands of the shareholders.
Tax Treatment of Dividend After 01-04-2023
Owing to the Finance Act, 2020, the tax treatment of dividend for domestic companies, resident shareholders, and non-resident (including NRIs) shareholders have changed significantly.
The obligation of the Domestic Companies
The domestic companies are no longer required to deduct DDT on dividends distributed to shareholders on or after April 01, 2020. However, domestic companies shall be liable to deduct Tax at Source (TDS) under Section 194 of the IT Act. Under this section, domestic companies are required to deduct tax at the rate of 10% from dividends distributed to resident shareholders, if and only if the aggregate dividend paid to a shareholder during the financial year exceeds Rs. 5,000. Where the dividend is payable to a non-resident or a foreign company, the tax shall be deducted under Section 195.
Tax Obligation on Dividend for Resident Shareholders
The exemption under Section 10(34) in respect of dividend income is withdrawn from the Assessment Year (AY) 2021-22. Thus, the entire amount of dividend shall be taxable in the hands of the shareholder. Any person can deal in shares either as an investor or as a trader. If the shares are held by the individual as an investment, then income arising from them is taxed under the head ‘income from other sources’. But if the shares are held for trading purposes, then the dividend earned on them is taxed under the head ‘PGBP’. Let us understand the specific tax treatment of dividend income under the respective heads.
- Income from other sources: Dividend income from stocks held as an investment is taxable under other income at the applicable tax slab rate of the shareholder. The shareholders can only claim a deduction of interest expenditure incurred to earn dividends to the extent of 20% of the total dividend income. No other deductions are allowed.
- PGBP: Dividend income from stocks held for trading purposes is treated as business income and hence is taxed accordingly. Under this head, shareholders can also claim the deductions of all expenditures which are incurred to earn the dividend like collection charges, interest on the loan, etc.
Tax Obligation on Dividend for Non-Resident Shareholders
Any non-resident may invest in Indian shares either directly as private equity investors or as Foreign Portfolio Investors (FPIs). A non-resident usually holds shares in an Indian company as an investment and thus the dividend income is taxable under the head ‘income from other sources’. The dividend income in the hands of a non-resident is taxable at the rate of 20% without providing for any kind of deductions. However, there may be certain exceptions to this rate such as dividend income of an investment division of an offshore banking unit shall be taxable at the rate of 10%. Also, where a dividend is distributed to non-residents, tax shall be required to be deducted as per the provisions of Section 195, 196C & 196D. A lower tax rate may be applicable to non-residents if they are eligible for the Double Tax Avoidance Agreement (DTAA). However, DTAA is not applicable to FII or FPI as per Section 196C & 196D of the IT Act, and the tax shall be withheld at 20% of the dividend.
Taxability on Interim Dividend
Interim Dividends are taxed in a similar manner as the Final Dividend. The only difference is the time when the tax liability arises. As per Section 8 of the IT Act, the final dividend shall be taxable in the year in which it is declared, distributed, or paid by the company, whichever is earlier, whereas interim dividend is taxable in the previous year in which the amount of dividend is paid by the company to the shareholder. Thus, interim dividend is chargeable to tax on a receipt basis.
Summary
| Assessee | Particulars | Deductions Allowed | Tax Rate | TDS applicable
|
| Resident | Shares held as Investment: Other Sources | Only interest expenditures up to 20% of the dividend received | As per the slab rate of the individual | S. 194:
10% if dividend exceeds Rs. 5,000 |
| Resident | Shares held for trading purposes: PGBP | All expenditures which are incurred to earn the dividend | As per the slab rate of the individual | S. 194:
10% if dividend exceeds Rs. 5,000 |
| Non-Resident | Under normal circumstances | No deductions allowed | 20% | S. 195:
10% |
| Non-Resident | Dividend on GDRs of an Indian Company or
Public Sector Company (PSU) purchased in foreign currency |
No deductions allowed | 10% | S.196C:
10% |
| Investment
division of an offshore banking unit |
Dividend income from securities | No deductions allowed | 10% | S.196D:
10% |
| FPI | Dividend income from securities | No deductions allowed | 20% | S.196D:
20% |