This article is written by Palak Shah, pursuing a Certificate Course in Advanced Corporate Taxation from lawsikho.com.
Table of Contents
Introduction
There are numerous ways in which an investor invests its money and one of that is by the way of buying shares of the company. When a person buys shares of the company, he becomes the shareholder of the company and in return of the investment made by him in the company he is entitled to earn some incentive which is called as a dividend.
The investment made in shares by the shareholder is an asset for him and when he sells those shares, they are entitled to capital gains from it.
Therefore, both capital gains and dividend income are sources of profit for shareholders and create tax liabilities for the shareholders.
Difference between capital gains and dividend
When individuals choose to purchase shares or any other capital asset like shares, they do so in the hope of availing returns from these investments. Capital is the initial sum invested by the person. Therefore, a capital gain is a benefit that happens when an investment is sold at a price greater than the purchase price initially. Investors do not make capital gains until the investment is sold and profits are taken.
Capital gains can be of two types –short term capital gains and long-term capital gains on shares.
Whereas the dividend income is paid to the shareholders out of a corporation’s earnings. This is considered income rather than a capital gain for the tax year. The dividend income was taxed earlier at the hands of the company but after the Finance Act 2020, various amendments have been carried out in the income tax act by the way of which now the dividend income is taxed at the hands of shareholders.
Capital gains
Meaning
A capital gain is an increase in a capital asset’s value here shares that gives it a value higher than the price at which it was purchase. An investor has no capital gain until it sells an investment for a profit. By comparison, a capital loss happens when the capital asset value decreases below the selling price of an asset.
Taxation of income earned from selling shares
Equity shares gains
- Capital gains on short term
If shareholdings listed on a stock exchange are sold within 12 months of purchase, the seller may make short-term capital gains. Short-term capital gain accrues to the seller when shares are sold at a higher price than the purchase price.
Short term capital gain calculation = Sale price(less) Sale expenses (less) Purchase price
- Long-term capital gains
If equity shares listed on a stock exchange are sold after 12 months of purchase, the seller may make long-term capital gains. Long-term capital gains made on the selling of equity shares were excluded from tax under Section 10(38) before Budget 2018 was implemented.
Under the Financial Budget 2018 rules, if a seller makes a long-term capital gain of exceeding Rs. 1 lakh on the selling of equity shares, the gain made would trigger a capital gains tax of 10 per cent long-term capital gains tax. Such requirements shall refer to transactions made since or on 1 April 2018.
Taxation of gains from shares
- Tax on short-term capital gains
Short-term capital gains, regardless of tax rates, are subject to a special tax rate of 15 per cent. Where the total taxable income minus short-term gains are therefore lower than taxable income, i.e. You will balance the Rs 2.5 lakh-this deficit to your short-term gains. Thereafter, the remaining short-term gains i.e. the amount left after adjusting the short-term capital gains with the total taxable income the tax on such remaining amount will be imposed on it at 15 per cent + 4 per cent cess on it.
- Tax on long-term capital gains
Long-term capital gains on a stock exchange-listed shareholding are not taxable up to the Rs 1 lakh limit.
According to the amendments in Budget 2018, the long-term capital gain of more than Rs 1 lakh on the selling of equity shares would result in a capital gains tax of 10 percent. Such requirements apply to transactions carried out since or on 1 April 2018.
Dividend income
A dividend is a compensation paid to shareholders who have invested in the equity of a business, typically extracted from the net income of the company. Industries hold most income as retained earnings, which reflects capital to be used for current and future business. The remainder, however, is sometimes paid out as a dividend to shareholders. The board of directors of a corporation may pay dividends at a scheduled pace, for example monthly, quarterly, semi-annually, or annually. Alternatively, companies may issue individual or in addition to a scheduled dividend non-recurring special dividend.
As an example, consider company XYZ. The investor who purchased 1000 stock shares for Rs.2,600 at Rs.10 per share benefited as the stock price rose. Regardless of the move in the stock price, if company XYX announces a special dividend of Rs.0.10 per share the investor benefits. In this case, the investor has Rs.50 (500 x Rs.0.10) dividend income.
Earlier the dividend income was taxed at the hands of the company and it was called as the Dividend Distribution Tax which has been abolished by the Finance act 2020 and now the shareholders are liable to pay the tax on the income earned through a dividend.
Let us compare the two tax regimes and understand how the income of shareholders of the company is taxed:
Existing regime under which the income of shareholders was taxed under the Income Tax Act before Budget 2020
- Tax implication in the hands of the company: Under the existing laws, although the dividend made up income in the hands of the shareholders, the tax on such dividend was payable by the company which declared a dividend, @ 15% of the gross dividend under section 115-O (plus surcharge and cessation) which essentially amounts to an effective Dividend Distribution Tax (‘DDT’) of 20.56%.
The tax so charged by the company (DDT) shall be considered as the final payment of tax for sums distributed or charged by the dividend.
- Tax implications in shareholder’s hands: Under the Income Tax Act, the dividend received by the shareholder and protected under section 115O has been removed from their possession under section 10(34). However, Budget 2016 introduced a new section 115BBDA which stated that if a shareholder (other than the Indian Company / Trust covered under section 12A or 12AA, among others) received a dividend exceeding Rs. 10 lakhs, that shareholder would be liable to pay tax @ 10 percent (plus the related surcharge and cessation) irrespective of the slab rate applicable to him, in addition to the company’s DDT payable. Even in the case of non-resident shareholders, there is no tax liability for Indian dividends received in India. Therefore, the Indian company which declared a dividend was not liable for deducting TDS from those dividends.
However, in cases, where such dividend was liable to tax in the hands of a non-resident in their country of residence, there was generally no credit available for the dividend distribution tax paid by the Indian Company.
Post-budget scenario
In the case of dividends, the burden of tax is usually on the payer business and not on the receiver, as it would normally be. The Finance Bill, 2020 has indicated that the dividend is profited in the shareholders’ hands and not in the company’s pockets. Therefore, the burden of the tax will be on the receiver.
The Finance Act, 2020 modified the dividend provisions and provided that the dividends are taxable in the hands of shareholders at the prevailing (slab-wise) rates and the domestic business is not allowed to pay any DDT.
Thus, the amendment repealed DDT as provided for in Section 115-O w.e.f. 1 April 2020. The dividends earned are now to be treated as shareholder profits, in line with their respective individual slab rates.
Beginning 1 April 2020, any dividend earned shall be taxable in the hands of shareholders other than the dividend in respect of which tax has been paid under section 115-O and section 115BBDA, where appropriate.
Person –
The dividend shall be taxed on an individual shareholder according to the relevant slab rates.
In addition, the government has removed 10 per cent additional tax on dividend income above Rs 10 lakh per year for non-corporate resident taxpayers (section 115BBDA of the Act).
Companies –
For corporate owners, dividends are paid according to marginal tax rates, ranging from 25.17% to 34.94% (including surcharge and cessation).
Certain sections of the Income Tax Act have been amended which dealt with taxability of the dividend income of the shareholder and which are as follows:
Section 10(34) which earlier exempted dividend in the hands of shareholders from being considered as income is no longer applicable and the dividends will be considered as the income of the shareholders if received on or after 1st April 2020.
Section 115-O of the Income Tax Act (Domestic Company Distributed Profits Tax) – Overriding the provisions of the Income Tax Act where any dividend declared, distributed or paid up to 31 March 2020 (Amendment by Finance Act 2020) is charged income tax at a rate of 15 percent. Although in the case of a dividend referred to in section 2(22)(e), a premium of 30 percent would be charged.
Section 115BBDA which taxes dividends in excess of Rs. 10 Lakh @10% in the hands of shareholder was amended and the effect is that it is applicable to dividends which are declared, distributed or paid by a domestic company on or before 31st March 2020 only.
Let’s understand the current regime of how income of various shareholders is taxed after the recent amendments with the help of following examples:
- When the shareholder is an individual and has 50 shares of company X and the company has declared dividend @Rs. 10 on each share. Therefore, the individual is entitled to Rs. 500 dividends. The taxability in the hands of the company is NIL because DDT has been abolished and further no TDS has to be deducted on the dividend as the amount of dividend is less that Rs. 5000 (as per S.194).
The tax implication will be in the hands of the shareholder and the amount of Rs. 500 will be included in the shareholders total income and will be chargeable to tax as per the slab rate applicable to him in the head of income from other sources.
- If the dividend declared by the company is more than Rs. 5000 then the company will have to deduct TDS @10 percent from the dividend paid to the individual shareholder.
For eg; Dividend of Rs. 1000 per share has been declared by the company. Mr. A holds 1200 shares of the company and is therefore liable to Rs.12,00,000 dividend. The company will deduct TDS @10% which is Rs. 1,20,000 and then pay the dividend to Mr. A and Mr. A will include that amount in his total income minus the TDS i.e. Rs. 10,80,000 and this shall be chargeable to tax as per the slab rate applicable as income under other sources.
- If an individual owns shares in more than one company then the total of the dividends received by the person form various companies is to be added to his total income under the head of income from other sources and is subject to tax as per the applicable tax rates. And if the dividend is received in excess of Rs. 5000 then the companies will deduct the TDS and pay accordingly to the individual.
Special considerations
Whether taxes are made on capital gains and dividends vary. Differentiations of Capital gains are made depending on whether the asset was owned for a short or long period of time. Dividends are either graded as ordinary or qualified and are taxed accordingly.
Capital gains are paid differently depending on whether they are deposits in the short or the long term. Capital gains are short-term when an investor sells the asset after less than a year of owning it. In this situation, short-term capital gains for the year are taxed as ordinary income. Assets kept for more than a year before being sold are deemed on sale to be long-term capital gains.
Dividends are generally paid out as cash, but may also be in the form of property or stock. Dividends may be ordinary or qualified, and ordinary dividends are taxable as income. A qualified dividend is a dividend that falls under capital gains tax rates which are lower than the income tax rates on ordinary dividends whereas Ordinary dividends are a share of a company’s profits passed on to the shareholders periodically. Qualified dividends are taxed at the rate of capital gains and not at the rate of common income as ordinary dividends. Qualified dividends are capital gains for tax purposes.
Conclusion
Therefore, if the shareholders sell their investment held by them in a company then they are taxed as per the provisions applicable to the Capital Gains, and if they receive yearly or quarterly or monthly dividend income on the shares held by them then that would be considered as the ordinary income of the shareholders and taxed accordingly in their hands. The shareholders are made responsible for paying taxes according to their respective slab rates and the company are made exempt from the legislative obligation to pay DDT.
References
- The Income Tax Act, 1961
- The Finance Act, 2020
- https://www.investopedia.com/terms/o/ordinary-dividends.asp
- https://www.investopedia.com/terms/q/qualifieddividend.asp
- https://cleartax.in/s/capital-gains-income
- https://taxguru.in/income-tax/taxability-dividend-income-tax-act.html
- https://taxguru.in/income-tax/taxation-dividends-change-hands.html
- https://taxguru.in/income-tax/income-tax-dividend-received-company.html
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