Impact of income tax on dividend income.

Is dividend income still a better option when compared to FD returns

What is dividend income?

A dividend is a reward that a firm pays to its shareholders in cash, shares, or other assets in the business world. The board of directors decides on a company’s dividend, which the shareholders must approve. A dividend is often a portion of a company’s profit that is distributed to its shareholders.

They are a method of generating income from the ownership of stock. The dividend is only subject to taxation if it is received in cash by the shareholder. The return of capital and dividends issued in the form of stock is not included in the calculation of taxable income.

Tax treatment of dividend income

According to the Finance Act 2020, dividend income is now taxable in individual investors’ hands rather than the hands of the dividend declaring company. As a result, beginning in the fiscal year 2021-22, dividend income will be taxable in the hands of shareholders, and the responsibility of tax payment will be moved from the company to the shareholders. This income is taxed at the shareholder’s appropriate income tax slab rate.

Until March 31, 2020, a dividend from an Indian company was exempted from income tax. Because the firm reporting the dividend had already paid the dividend distribution tax (DDT) before making the payment.

Shareholders are responsible for paying tax on any, and all dividends declared by a company and disbursed starting on April 1, 2020. If the amount received in dividends exceeds Rs 5,000 in a financial year, the amount is liable to 10% TDS. Due to the pandemic epidemic, the rate has been reduced from 10% to 7.5 percent. The lower rate is effective until March 2021.

You must report the total amount of any dividend income generated in the fiscal year when completing your ITR. TDS deducted (as shown on Form 26AS) will be applied as a credit against the final tax owed. Generally, Form 26AS is used to aggregate a taxpayer’s yearly income tax return. It includes information on taxes deducted at source, taxes collected at source, and advance tax paid by the taxpayer.

An example:

On July 20, 2020, Ganesh received a dividend of Rs. 7,000 from an Indian company. The firm would deduct a TDS of 7.5% from his dividend income, which is Rs 525 because his dividend income exceeds Rs. 5,000. Ganesh will be transferred the remaining Rs. 6475 in his bank account. Additionally, dividend income will be added to Ganesh’s taxable income for FY 2020-21, which is then taxed at the slab rates for that year (AY 2021-22).

When PAN is not available, TDS rates are different.

If the resident shareholder’s PAN is not available, TDS will be deducted at a rate of 20% by the domestic business.

Dividend income classification for a resident shareholder

Anyone can participate in the securities market, either as a trader or as an investor, depending on their financial circumstances.

Suppose an individual owns shares solely for the purpose of trading. In that case, the dividend income earned on such shares will be subject to taxation as “Business Income” under the heading “Income from Business or Profession.”

In contrast, if the shares are held as an investment, the dividend income will be subject to income tax under the heading “Income from other

Deductions if dividend income is considered as business income

In the case of dividends being taxed as business income, the taxpayer can deduct any costs related to earning the dividends, such as loan fees and any other charges. There are no limitations on the amount of deduction that may be taken.

Deductions if dividend income is treated as other sources of income

In the case of dividends being classified as ‘Other Income’ for tax purposes, the taxpayer can claim a deduction solely for interest expenses spent in order to generate the dividend income. More importantly, the deduction allowed on dividends is limited to no more than 20% of dividend income. Other expenditures like commissions, collection fees, and bank charges are not deductible.

According to the preceding example, if Ganesh had borrowed money to invest in equity shares of the company and paid interest of Rs 3000 during the fiscal year 2020-21, only Rs 1,400 (20% of Rs.7000) is deductible as an interest expense on loan.

Should you choose dividend income when compared to an FD?

Returns on Fixed Deposits:

Fixed deposit accounts, as the name suggests, pay a fixed interest rate on your principal investment. Almost every scheduled bank in India offers this investment opportunity. An investor makes a principal investment that generates interest (around 5 % now) for the deposit duration. The investor receives both the principal and accumulated interest upon maturity.

Unfortunately, fixed deposits do not produce high returns when measured against inflation (roughly around 4.5 %). In reality, inflation eats up all the returns of fixed deposits. They are good investment that provides security in a low-risk scenario.

Returns on stocks/ dividend yield:

Dividend yield refers to the dividend payments made to shareholders expressed as a percentage of the stock’s current price. Given the current price of a company and the assumption that the dividend remains constant, this figure shows you how much future income you may anticipate from it.

Although dividend yield varies between companies, the typical range is 3 to 10 percent. Furthermore, this may fluctuate significantly based on various circumstances such as the success of the firm, market mood, economic development, and so on.

Why is dividend income still a better option when compared to FD returns

FDs are the safest type of investment you can make. Your money grows at a constant rate, providing you with guaranteed returns at a predetermined rate with no fluctuation in the value.

On the other hand, a stock’s total return comprises both dividends and share price movements. Suppose a stock valued at 200 rupees increases in value to 220 rupees over a year, giving you a 10% return on your investment. If a firm declares a 5% dividend on its shares, the result is a total return of 15% on the investment. This rate of return significantly outperforms inflation.

Be careful to evaluate a stock’s overall return potential in addition to its yield when making a long-term investment decision. In the long run, high dividend-yielding companies provide both passive income and consistent growth for investors who are comfortable with the volatility and risk of equities.

Summary:

Both FD and equity have benefits and drawbacks. To make this decision, you must pick what’s best for you. An FD is an excellent choice if you want a reliable, risk-free investment that you don’t have to worry about. However, if you are seeking substantial growth in your wealth and are willing to take a calculated risk, investing in equities may be the ideal option for you to consider.