Everything about Tax Free Dividends: Tax Rates, TDS Rates & Limits

In India, investing in the securities market is one of the best options to earn higher returns. You can invest in various companies by buying their equities and becoming a shareholder. When you become a shareholder, you are liable to get a dividend from the company.

The dividend given to you is taxable under income from other sources, but there is a tax-free limit that you can avail of.

In this article, we will discuss the tax-free limit of dividend income. But before that, you should know what a dividend is, what tax-free dividends are, when you can tax dividend income and many more.

A company may sell equity to raise funds for running its business. When you buy a company's equities, you will be a shareholder of that particular company. So when the company performs well, it distributes some of its earnings to its shareholders. These funds are called dividends.

There are two main types of dividends that you can receive while being a company's shareholder:

• Interim Dividend: This type of dividend is paid to the shareholders during a financial year before releasing a company's final financial statement.
• Final Dividend: It is a type of dividend that a company pays after the end of a particular financial year, 31st March. This dividend is declared at the company’s annual general meeting for that financial year.

Dividends received by an individual in India are tax-free up to a certain limit. The tax-free limit of dividend income is ₹5,000, so if you have an income up to this amount, it is not taxable. 

However, if you earn more than ₹5,000 income on dividends, you must pay tax at the applicable rate.

Paying tax on dividend income depends if you are trading shares for business or investment purposes. If you hold the shares for trading purposes, any income on dividends earned in the interim is taxable based on business income rules. Under this, you are entitled to claim deductions for your expenses.

However, if you bought the shares as an investment, the dividend income you will earn will be taxable based on rules for income from other sources. Under this, you can only claim a deduction on the interest expenses incurred while earning the dividend income.

You might wonder what amount of dividend is tax-free? The answer to this question is a maximum of ₹ 5000. If you are earning more, it is taxable in the year of payment done by the company, distribution, or declaration, whichever is earlier. Final dividends and deemed dividends fall under this category.

In the case of interim dividends, they are taxable in the preceding year in which the dividend is given to you by the company. The tax that is charged on interim dividends is on a receipt basis. In addition, dividend income taxation depends on the account from which it is received and its type.

The mutual fund organisation or company you have invested in is liable to deduct Tax Deducted at Source (TDS). It is to be deducted before the dividend is paid to you. However, TDS rates on dividends vary depending on your residential status.

• TDS for Resident Individuals: If you are earning a dividend income of more than ₹5000, the rate of TDS deduction will be 10%. However, the TDS rate will be 20% if you fail to provide your PAN. You can claim the deducted TDS while filing Income Tax Return (ITR) from the total tax liability as a credit.
• TDS for Non-Resident Individuals (NRIs): For any dividend paid, the TDS rate for NRIs is 20%. However, it is subject to the Double Taxation Avoidance Agreement (DTSS) provisions. The NRI can opt for the lower tax benefits due to any favourable agreement with the country they reside.

You might need to pay an advance tax if you receive any dividends when you sell a stock. The government imposes a fixed rate of 15% or 20% on dividend income as an additional tax.

However, the rate varies on the type of dividend you receive. If you pay less advance tax instalment or delay the payment, you will not be charged any interest under Section 234C of the Income Tax Act, 1961. This is valid only if you pay the full tax in the following advance tax instalments. Further, this exemption is invalid for deemed dividends according to Section 2(22)(e).

If you are an NRI, you will have to pay 20% of your dividend income as taxes for investing in the shares of Indian companies. However, the taxation of dividend income will depend on the relevant provision of DTAA with the country where you reside. This will benefit you as you will not have to pay tax on the same dividend income abroad and vice versa.

You can claim tax relief twice if your dividend income is taxed twice. In addition, you are liable to pay an additional surcharge based on different slab rates and an education and health cess of 4%.

Therefore, dividends are paid to you for being the shareholder and investing in the company. You can avoid TDS on dividend incomes now that you know what tax-free dividends are. You will be charged according to the applicable rate if you earn more than the tax-free limitations.