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FM Nirmala Sitharaman proposed the addition 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, without a limit, to any resident individual. Let’s discuss Section 194K in terms of:

  1. Different types of income from mutual fund units
  2. Scope of Section 194K
  3. Purpose of Section 194K
  4. Exceptions to the section, if any
  5. Income tax provision before Section 194K
  6. Conclusion

1. Different types of income from mutual fund units

In general, an individual can earn 2 types of income by investing in mutual fund units. They are:

Sl.No.

Income Type

Chargeability to Tax

1.

Capital Gains:

Current Regime: Capital gains are taxable in the hands of the taxpayer. Any long-term capital gains earned from the 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 mutual funds, subject to STT, will be taxed at the rate of 15%. 

New Regime: A clarification is yet to be issued if the capital gains are taxable in the hands of the taxpayer. Otherwise, the mutual fund company needs to deduct TDS on such income.

2.

Dividend

Current Regime: Tax on the dividend (DDT) which is paid by the Fund Houses (Asset Management Company) on behalf of the investors.

New Regime: 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.

2. Scope of Section 194K

A new provision, Section 194K, was introduced in the Finance Bill 2020, effective from 1 April 2020. This new section withdraws the exemption in respect of income from units of mutual funds by abolishing Section 10(35).

As per Section 194K, any person responsible for paying an income to a resident with respect to:

1. Units of a Mutual Fund as per Section 10(23D)

2. Units from the Administrator

3. Units from a specified company

at the time of credit of such income to the payee’s account exceeding Rs 5000 or at the time of making payment, whichever is earlier, shall deduct TDS @10%.

3. Purpose of Section 194K

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

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

When it comes to the new tax regime, DDT is abolished and only AMC is required to deduct TDS @ 10% on the distribution of dividend, provided that the dividend paid per recipient exceeds Rs 5,000 in an FY.

4. Exceptions to the section, if any

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

1. Tax @ 10% is not required to be deducted at source if the dividend income is up to Rs 5,000 in a financial year.

2. Capital gain income is also exempted from the applicability of Section 194K (subject to further notification).

5. 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 deduction of TDS 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 hands of the taxpayer.

6. Conclusion

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