TDS Section 194K: TDS on Mutual Fund

What is Section 194K?

The recent inclusion of Section 194K TDS marks a significant shift in the taxation of dividend income from the mutual fund, as it revokes the previous exemption related to income from mutual fund units by eliminating Section 10(35). According to the newly introduced Section 194K, any individual accountable for remunerating a resident concerning:

• Units of a mutual fund in accordance with Section 10(23D),
• Units from the administrator, or
• Units from a specified company,

The deductor must deduct TDS (Tax Deducted at Source) of 10% when crediting such income to the payee's account if it exceeds ₹5,000. Alternatively, the deduction should be made at the time of payment, whichever comes first. This step underscores a definitive move by the authorities to streamline and regulate the tax implications associated with these financial transactions.

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Types of Income from Mutual Fund Units and Their Taxability

• Dividend: The existing income tax law previously imposed a tax on the dividend (DDT) paid by fund houses (Asset Management Companies) on behalf of investors. However, the Budget 2020 abolished the DDT. Since the fiscal year 2020-21, dividend income has become taxable for the recipient/investor. Despite this change, the recently inserted Section 194K TDS in the Finance Act 2021 necessitates mutual funds to deduct TDS on dividends exceeding ₹5,000 for unitholders. This provision demonstrates the authorities' commitment to streamlining and regulating the taxation process for dividend income in mutual funds.
• Capital Gains: Under the existing income tax law, capital gains are taxable in the hands of the taxpayer. Long-term capital gains from equity-oriented mutual funds incur a tax rate of 10% if the gains exceed ₹1 lakh within a year. On the other hand, short-term capital gains from equity-oriented mutual funds, which are subject to Securities Transaction Tax (STT), are taxed at 15%.

However, the recent addition of Section 194K TDS in the Finance Act of 2021 does not mandate mutual funds to deduct TDS on capital gains arising from the redemption of units by unitholders. This provision marks a calculated decision by the authorities to maintain a streamlined approach to the taxation of capital gains from mutual funds, ensuring clarity and consistency in the tax framework.

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Analysis of Section 194K

• Deductor: Mutual funds distributing dividends to equity mutual fund investors are required to deduct TDS on these dividends. The deductor is responsible for depositing the TDS with the government.
• Deductee: Indian resident shareholders earning dividend income from equity mutual funds will receive the amount after TDS deduction under Section 194K of the Income Tax Act. Similarly, Indian resident shareholders earning dividend income from equity shares will receive the amount post-TDS deduction under Section 194. On the other hand, Non-Resident Indian (NRI) investors/shareholders earning dividend income will receive the amount after the deduction of TDS under Section 195.
• Payments Covered U/S 194K: Section 194K TDS especially addresses the payment of dividends on equity mutual funds to a resident shareholder that exceeds ₹5000 within a financial year.

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Section 194K Exceptions

TDS under Section 194K is exempt in certain cases, including:

• No TDS is required if the annual dividend income is up to Rs. 5,000.
• Capital gains income is not subject to Section 194K.
• Payments under a contract do not require TDS if the amount is Rs. 30,000 or less.

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TDS on Mutual Fund Redemption

Mutual fund redemptions come with specific tax considerations. Under Section 194K of the Income Tax Act, capital gains from redeeming mutual fund units are exempt from TDS, meaning your capital gains aren’t subject to TDS upon redemption.

However, if you earn dividends from these investments, TDS applies. For resident investors, a 10% TDS will be deducted if annual dividend income exceeds ₹5,000.

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How Budget 2020 Changed the Taxation of Dividends for Mutual Fund Investors

Previously, the income tax laws entailed a double taxation of dividends. Initially, companies were taxed when paying Asset Management Companies (AMCs) dividends. Subsequently, a second tax was levied when the AMCs distributed profits to the unitholders.

Investors could reinvest their profits into the fund or receive dividend income. Opting for the latter would lead the AMC to once again pay the Dividend Distribution Tax (DDT) on the dividend distribution.

However, the Budget of 2020 brought a significant change, abolishing the DDT. Currently, AMCs are only obligated to deduct TDS at 10% on the dividend distribution, provided the dividend payment per recipient exceeds Rs 5,000 within a fiscal year.

Note: TDS should be deducted at 20% if the investor does not provide PAN. Additionally, for Non-Resident Indian (NRI) investors, TDS should be deducted as per the regulations specified in Section 195. This alteration signifies a concerted effort to streamline and rationalize the taxation structure pertaining to dividends in the domain of mutual funds.

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