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Section 194K—Tax deduction on income from mutual fund units

Updated on: Apr 24th, 2024

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5 min read

FM Nirmala Sitharaman proposed the insertion of Section 194K in the Finance Act during the Budget 2020. This section includes a tax deduction on the amount paid on the units of mutual funds, with a limit, to any resident individual. Let’s discuss Section 194K in detail. This resulted in the elimination of double taxation, which happened due to previous tax laws. Under the previous laws, tax on mutual fund payout was levied when the company distributed to the AMC(Asset Management Company) and when the AMC distributed the same to the unit holders.

Different types of income from mutual fund units

In general, an individual can earn two types of income by investing in mutual fund units. They are:

Sl.No.Income TypeChargeability to Tax
1.DividendExisting income tax law levies tax on the dividend (DDT) paid by the fund houses (Asset Management Company) on behalf of the investors. 

DDT has been abolished as per the Budget 2020. 
From FY 2020-21, dividend income will be taxable in the hands of the receiver/investor.
However, the new Section 194K inserted in Finance Act 2021 requires the mutual fund to deduct TDS while distributing dividends exceeding Rs 5,000 to unitholders. 
 
2.Capital GainsExisting income tax law: Capital gains are taxable in the hands of the taxpayer. Any long-term capital gains earned from equity-oriented mutual funds will be taxed at the rate of 10% if the gains exceed Rs 1 lakh in a year. 
Similarly, any short-term capital gains earned from the equity-oriented mutual funds, subject to STT, will be taxed at the rate of 15%.  
However, the new Section 194K inserted in Finance Act 2021 does not require a mutual fund to deduct TDS on capital gains arising on redemption of units by unitholders.

Section 194K

This new provision, Section 194K, withdraws the exemption regarding income from units of mutual funds by abolishing Section 10(35). As per Section 194K, any person responsible for paying a resident with respect to:

  • Units of a mutual fund as per Section 10(23D)
  • Units from the administrator
  • Units from a specified company

Shall deduct TDS at the time of credit of such income to the payee’s account or at the time of making payment, whichever is earlier.

Purpose of Section 194K

Under the previous income tax laws, dividends were taxed twice. Initially, a tax was imposed when a company would pay a dividend to an Asset Management Company (AMC). The second imposition of the tax was when the AMC would distribute its profits to the unitholders.

An investor can either choose to invest the profits back into the fund or earn dividend income. If the investor chooses to earn dividend income, the AMC will again be required to pay DDT on the distribution of dividends.

In Budget 2020, DDT is abolished, and AMC is only required to deduct TDS at 10% on the distribution of dividends, provided that the dividend paid per recipient exceeds Rs 5,000 in an FY.

Please note-

  • TDS should be deducted at 20% if the investor does not provide PAN.
  • In the case of NRI investors, TDS should be deducted as per Section 195

What is the rate of TDS?

The rate of TDS is 10%. The rate of TDS will be 20% in all cases if PAN is not quoted by the deductee.

Exceptions to the section if any

TDS under Section 194K is not required to be deducted in the following cases:

  • Tax under section 194K is not required to be deducted at source if the dividend income is up to Rs 5,000 in a financial year.
  • Capital gain income is also exempted from the applicability of Section 194K.
  • on will be required to be made if the payment for the contract does not exceed Rs.30,000. 

Income tax provision before Section 194K

Under the current regime, the onus of reporting dividend income and capital gains was on individual investors. Dividend income from mutual funds was exempt under Section 10(35). On the other hand, there was no provision regarding TDS deduction on any income earned from mutual funds. Only NRIs were subject to TDS. DDT was charged on the company distributing dividends, but the same was tax-free in the taxpayer’s hands.

Conclusion

To sum up, the new provisions introduced by Budget 2020 have shifted the burden of tax payment on dividend income from the company distributing dividends to the recipient of such dividend income.

Related Articles

TDS rate chart
Dividends – Meaning, Advantages & Tax Implications
Taxation of Capital Gains of Equity Funds

Frequently Asked Questions

Who Deducts TDS Under Section 194K of the Income Tax?

The introduction of Section 194K of the Income Tax Act shifted the onus of reporting dividends and deducting the applicable tax from companies to the recipients of the dividend.   

In simple terms, the AMC or fund houses now have to deduct TDS while transferring the income to the payee’s account. Income from the following units is subject to deduction under the Section 194K of the Income Tax:

  • Mutual Fund units as per section 10(23D).
  • Units from a specified company.
  • Units from the administrator of specified undertakings.
When is Section 194K levied?

For the purpose of TDS, Section 194K is applicable when such income as specified in this section in a financial year exceeds ₹5,000.

Can TDS on dividend be refunded?

It is important to note that even if TDS is deducted on your dividend income, you can claim a refund by filing your income tax return. Therefore, it is advisable to declare your dividend income in your income tax return and claim the refund if applicable.

What is the threshold limit under section 194K?

The threshold limit under section 194K is Rs. 5,000.

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Quick Summary

FM Sitharaman proposed Section 194K in Budget 2020, eliminating double taxation on mutual fund incomes. It includes tax deduction on dividend exceeding Rs 5,000. TDS rate is 10% or 20% without PAN. Exceptions exist for incomes up to Rs 5,000 and capital gains. Previous laws required individual reporting of incomes, but now TDS shifts to the recipient. NRI taxation under Section 195.

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