Introducing Section 194K during the Budget 2020 brought a key update for mutual fund investors in India. This section ensures tax deducted at source (TDS) on dividends, streamlining the taxation process and addressing earlier inefficiencies. Let’s break it down to understand its implications and how it works.
What is Section 194K?
Section 194K of the Income Tax Act mandates a 10% TDS on dividend income from mutual funds. The payer of this income deducts TDS before crediting it to the investor’s account. This deducted amount can be claimed as a tax refund for the taxpayer when filing the annual income tax return.
Types of Income From Mutual Funds
Investing in mutual funds can generate two types of income:
Dividend Income: Dividends are taxable in the hands of the investor. Since discontinuing the Dividend Distribution Tax (DDT) in FY 2020-21, dividends from mutual funds are now subject to TDS if the income exceeds ₹5,000 in a financial year.
Capital Gains Income: Capital gains are categorized as long-term or short-term based on the holding period. Gains exceeding ₹1 lakh from equity-oriented mutual funds are taxed at 10% for long-term capital gains (LTCG), and short-term gains are taxed at 15%. Importantly, TDS does not apply to capital gains under Section 194K.
Applicability of Section 194K
Section 194K applies to:
Mutual fund units as defined under Section 10(23D).
Units managed by specified undertakings or enterprises.
TDS must be deducted either when the income is credited to the investor’s account or when the payment is made, whichever occurs first.
Exceptions to Section 194K
There are a few notable exceptions where TDS is not applicable:
Dividend income below ₹5,000 in a financial year.
Income derived from capital gains, whether short-term or long-term.
Purpose of Section 194K
The primary objective of Section 194K is to eliminate the double taxation issue faced earlier. Previously, tax was levied twice—once when the company paid dividends to the asset management company (AMC) and again when AMCs distributed profits to unit holders.
The introduction of TDS under Section 194K simplifies this by directly deducting tax at the distribution stage. This ensures:
Transparency in dividend taxation.
A streamlined process for investors claiming TDS refunds.
TDS Rules for Mutual Fund Income
Here are the key rules investors need to keep in mind:
TDS Rate: 10% on dividend income exceeding ₹5,000 in a financial year.
Scope: Applies to dividend distributions, reinvestments, and transfers.
Exclusions: No TDS is deducted on capital gains for resident investors. For NRIs, the rate is 30% for short-term gains and 20% (with indexation) for long-term gains.
Form Submission: Submitting Form 15G or 15H can exempt eligible individuals from TDS deductions.
Key Considerations
Threshold for Dividend Income: Only dividends exceeding ₹5,000 in a financial year are subject to TDS.
Capital Gains Exclusion: Section 194K explicitly excludes capital gains from TDS deductions, providing clarity for mutual fund investors.
Tax Rate Differences: Dividends are taxed at a 10% TDS rate, whereas capital gains are subject to different rates based on holding periods and investor categories.
Conclusion
Section 194K simplifies the taxation of mutual fund dividends while eliminating inefficiencies like double taxation. For investors, understanding its scope and implications is crucial for effective tax planning. While dividend income is directly subject to TDS, capital gains remain outside its purview, providing flexibility to investors.
By staying informed about these changes, you can optimize your investment returns while ensuring compliance with tax laws.
Comments