InvestorQ : Can you explain how dividends are taxed in case of direct equities and equity mutual funds?
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Can you explain how dividends are taxed in case of direct equities and equity mutual funds?

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2 years ago
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When you own equities, you are paid dividends on an annual basis out of the profits made by the company. Nowadays most companies pay interim dividends during the year too. Normally, the average dividend yield on the index is around 1.5%, although this can go down to below 1% or even above 2% in case the pricing goes to extremes. In the Indian context, in case of equity mutual funds, you will get dividends only if you opt for the dividend option. If you opt for the growth option of the mutual fund then you will only see the NAV appreciating. But how are dividends treated in both the cases?

How are dividends taxed in the hands of the investor? In case of investors in equities and equity funds, the dividend received is tax-free in the hands of the investors. However, effective the Union Budget 2016, a new additional tax has been introduced on equity dividend. Now shareholders will have to pay a tax of 10% if the total dividend received by them during a financial year exceeds Rs.10 lakh. This includes dividends from all equity holdings. However, in case of equity funds there is no such upper restriction and it is entirely tax-free in the hands of the investors. This is one area where the dividends paid out by equity funds score over the direct equity.

Another aspect to look at is the Dividend Distribution Tax (DDT). In case of direct equities, the company declaring and paying the dividend has to deduct 15% DDT before paying the dividend. Effectively, this reduces the amount of dividend in the hands of the investors. When an equity fund pays out dividends, there was no such thing as DDT till March 2018. However, from April 2019, as announced in the Union Budget 2018, all dividends paid out by equity funds will now be subject to DDT at 10%. This becomes a kind of a double taxation for equity funds because they have already paid DDT when the company has deducted the DDT and only paid the net amount of dividends to the mutual fund in the first place.

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