Taxability of Dividend under Income Tax Act

1. What is Dividend ? – As an investor when you invest in an entity, you expect something in return on the value of investment. The amount invested in an entity is used by the entity to expand and grow their business and earn more profits. The profits earned by the entity is distributed to the investors who had invested their money in the entity. Dividend is one of the forms of return on investment.

2. Section 2(22) of the Income Tax Act (Dividend) – As per sec 2(22), dividend “includes” [It means definition of dividend is inclusive not exhaustive] :-

a. any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company. [It means distribution of profits out of the profits earned by the company whether it is in the form of reserves or it is current year profit which is not capitalised] ;

b. any distribution to its shareholders by a company of debentures, debenture-stock, or deposit certificates in any form, whether with or without interest, and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalised or not. [It means distribution of debentures, debenture stock etc and shares by way of bonus to preference shareholders to the extent company has accumulated profits in the form of reserves] ;

c. any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not. [It means at the time of liquidation, any distribution made by the company to shareholders out of the accumulated profits] ;

d. any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933, whether such accumulated profits have been capitalised or not. [It means when capital of the company is reduced, any distribution to the shareholders. In current scenario, there is no relevance of this clause as it relates to period ending before 1st April 1933] ;

e. any payment by a company, not being a company in which the public are substantially interested [Unlisted Company], of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) [preference shares are excluded] holding not less than ten percent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits. [It means you are giving loan or advance to a shareholder holding 10% or more voting power, or to any concern in which such shareholder who is a beneficial owner of shares and holding not less than 10% of voting power is a member or partner of the concern and in which he has substantial interest (substantial interest means at any time during the previous year, beneficially entitled to not less than 20% of the income of such concern), or any payment made by the company for the benefit of such shareholder. This clause is also called as deemed dividend because directly you are not paying anything to the shareholder out of the profits but you are paying by window dressing in the form of loan or advance or indirectly benefiting the shareholder] ;

But dividend does not include –

(i) a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ;

(ia) a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964, and before the 1st day of April, 1965            ;

(ii) any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company [Banks, NBFC’s] ;

(iii) any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off. [It means dividend earlier treated as deemed dividend under sec 2(22)(e), to offset such dividend it is now paid again, so it will not be treated as dividend] ;

(iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956) [Any payment to shareholders on buyback of shares of the company is not to be treated as dividend] ;

(v) any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company.

3. Section 8 of the Income Tax Act (Dividend Income) – As per sec 8(a), any dividend declared or distributed or paid within the meaning of sub-clauses (a), (b), (c ), (d), (e) of sec 2(22) is deemed to be the income of the previous year in which such dividend is declared, distributed or paid as the case may be. As per sec 8(b), any interim dividend declared by the company shall be deemed to be the income in the previous year in which it is unconditionally made available to the member who is entitled there to.

4. Section 10 of the Income Tax Act (Dividend Exempt from Tax) – Following are some dividends which are exempt from tax :-

a. Sec 10(23F) – any income by way of dividends or long-term capital gains of a venture capital fund or a venture capital company from investments made by way of equity shares in a venture capital undertaking.

b. Sec 10(23FA) – any income by way of dividends, other than dividends referred to in section 115-O, or long-term capital gains of a venture capital fund or a venture capital company from investments made by way of equity shares in a venture capital undertaking.

c. Sec 10(23FC) – any income of a business trust by way of—

(i) interest received or receivable from a special purpose vehicle; or

(ii) dividend [referred to in sub-section (7) of section 115-O].

d. Sec 10(23FE) (Introduced by Finance Act, 2020 w.e.f. 01-04-2021 – any income of a specified person in the nature of dividend, interest or long-term capital gains arising from an investment made by it in India, whether in the form of debt or share capital or unit, if the investment—

i. is made on or after the 1st day of April, 2020 but on or before the 31st day of March, 2024;

ii. is held for at least three years; and

iii. is in –

a) a business trust referred to in sub-clause (i) of clause (13A) of section 2;

b) a company or enterprise or an entity carrying on the business of developing, or operating and maintaining, or developing, operating and maintaining any infrastructure facility as defined in the Explanation to clause (i) of sub-section (4) of section 80-IA or such other business as the Central Government may, by notification in the Official Gazette, specify in this behalf; or

c) a Category-I or Category-II Alternative Investment Fund regulated under the Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992 (15 of 1992), having hundred per cent investment in one or more of the company or enterprise or entity referred to in item (b).

e. Sec 10(26AAA) – in case of an individual, being a Sikkimese, any income which accrues or arises to him-

(a) from any source in the State of Sikkim; or

(b) by way of dividend or interest on securities.

Provided that nothing contained in this clause shall apply to a Sikkimese woman who, on or after the 1st day of April, 2008, marries an individual who is not a Sikkimese.

f. Sec 10(34) – any income by way of dividends referred to in section 115-O :

Provided that nothing in this clause shall apply to any income by way of dividend chargeable to tax in accordance with the provisions of section 115BBDA;

Amendment by Finance Act, 2020 :

From 1st April 2020, any dividend received is taxable in the hands of shareholder other than the dividend on which tax under section 115-O and section 115BBDA, wherever applicable, has been paid;

Sec 10(35) – any income received upto 31st March 2020 from Mutual Funds is exempt from tax. (Amendment by Finance Act 2020) Such income from 1st April 2020 is taxable and TDS will be deducted at the rate of 10 percent (rate of 7.50 percent for the period 14th May 2020 to 31st March 2021) under sec 194K if the total amount of income in a financial year exceeds Rs. 5,000. No TDS will be deducted if income is in the nature of capital gains.

5. Section 115BBDA of the Income Tax Act (Tax on certain dividends received from domestic companies) – Overriding the provisions of Income tax act, where the total income of the specified assessee (means a person other than domestic company, fund or institution or any university or other educational institution or any hospital or other medical institution referred in sec 10(23C) or a trust or institution registered under sec 12A or sec 12AA) being resident in India includes any income exceeding Rs. 10 lakhs by way of dividend (on or before 31st March 2020), the dividend exceeding Rs. 10 lakhs is chargeable at 10 percent.

6. Section 115-O of the Income Tax Act (Tax on distributed profits of domestic companies) – Overriding the provisions of Income tax act, where any dividend declared, distributed or paid upto 31st March 2020 (Amendment by Finance Act 2020), the income tax shall be charged at the rate of 15 percent. But in case of dividend referred to in sec 2(22)(e), rate of 30 percent is chargeable.

7. Section 194 of the Income Tax Act (TDS on Dividend) – As per amendment made by Finance Act, 2020, where dividend is paid to a shareholder who is resident of India, as referred to in sec 2(22)(a), (b), ( c), (d), (e), TDS at the rate of 10 percent (rate of 7.50 percent for the period 14th May 2020 to 31st March 2021) is deducted provided in case of an individual where dividend does not exceed Rs. 5,000 in a financial year to an individual and dividend is paid by any mode other than cash, then No TDS will be deducted.

Note :

1. Dividend is taxable in the hands of investors as per slab rate applicable as normal income irrespective of whether TDS has been deducted on such dividend or not from FY 2020-21 onwards.

2. Taxability of Dividend paid to Non-Resident is determined under sec 195 as well as provisions contained under Tax Treaties entered with various countries upon availability of pre-requisite documents (Tax Residency Certificate, Form 10F and No PE Declaration) for availment of benefits of Tax Treaty.