If you are a high earner, dividend income may be an integral part of your investment portfolio. With these advantages come certain tax obligations, which you need to understand to manage your finances effectively. We will take you through the tax implications of dividend income so that you can optimize your returns while staying compliant with tax regulations. Understanding how dividend income is taxed in India, implementing strategies to minimise tax liabilities, and utilising tax-saving instruments will allow investors to optimise returns while ensuring that their portfolio continues to grow.
How dividends are taxed in India
With the abolition of the Dividend Distribution Tax (DDT) in 2020, dividend taxation in India has undergone a sea change. Earlier, under DDT, companies distributing dividends paid the tax directly, and the dividends were tax-free for shareholders. Now, dividends are taxable for investors based on their applicable income tax slab rates.
Dividend income can be quite substantial in terms of tax liability for individuals already in the highest tax bracket of 30%. If the total dividend income goes over Rs.10 lakh in a financial year, a further surcharge of 10% is applied, which will add more to the tax liability for such individuals.
- TDS is applicable on dividend income: TDS is deducted at 10% by companies and mutual funds if the dividend income exceeds Rs.10,000 in a financial year. This means that high-income earners may have much higher tax liabilities and may have to pay additional amounts while filing their returns.
- Tackling foreign dividend: Dividends received from foreign investments are taxable in the hands of an Indian tax resident under the head ‘Salary and Other Income.’ The applicable slab rate of tax must be paid on the same. Relief could arise depending on the provisions of the Double Taxation Avoidance Agreements (DTAA) if some credit on taxes paid by them in the foreign country is provided.
Alternate tax-smart investment strategies for dividend income
Tax planning is key to maximizing your investment returns. By making smart choices, you can reduce your tax liability while staying compliant with the law. Here are some strategies to help you manage taxes on dividend income more efficiently.
1. Choose the Growth Option instead of income Distribution cum Capital Withdrawal (IDCW)
When investing in mutual funds, opting for the Growth option instead of IDCW can significantly lower your tax burden. In the Growth option, your profits are reinvested, allowing your investment to compound over time. Unlike IDCW, where dividends are taxed at your income tax slab rate, the Growth option ensures that you pay tax only when you sell your units. However, if an investor needs capital inflows periodically, they should opt for IDCW, so it depends on the investor’s needs.
For equity mutual funds, long-term capital gains (LTCG) are taxed at 12.5% if gains exceed Rs.1,25,000 per annum. This is usually more tax-efficient than IDCW payouts, which are taxed as regular income. If you need periodic income, consider setting up a Systematic Withdrawal Plan (SWP) after a minimum of three years to minimize taxes while maintaining cash flow.
2. Invest through family members
If your family members are in a lower tax bracket, you can reduce your overall tax liability by making investments in their names. For instance, investing in the name of your spouse, parent, or child (who has no taxable income) can result in lower taxation on capital gains or dividend income. However, make sure to check the clubbing provisions of the Income Tax Act to avoid unexpected tax consequences.
3. Diversify into international markets
Adding international stocks or funds to your portfolio can provide both diversification and potential tax benefits. Some countries have lower dividend tax rates, allowing you to earn tax-efficient income. Additionally, India has DTAA with several countries, which means you may be able to offset foreign taxes against your Indian tax liability, reducing your overall tax burden.
By using these strategies, you can optimize your taxes, grow your wealth more efficiently, and keep more of your returns working for you.
Balancing out tax efficiency with portfolio growth
While it is important to minimise tax liability, it is equally critical to ensure that the portfolio continues growing. High-income earners must establish a balanced portfolio in harmony with their own risk tolerance and long-term end goals.
- Reinvesting dividends: Instead of taking dividend income out, invest it in high-growth ventures where the beneficiary may compound wealth over time. Some mutual fund schemes and other equity investments offer reinvestment opportunities.
- Monitoring portfolio performance: Regularly reviewing and rebalancing the portfolio ensures that it remains in line with your financial goals. Tax implications of investment decisions should be a consideration, though not the sole factor.
- Diversify portfolio through Index Funds and ETFs: These passive instruments often have lower expense ratios and effectively reinvest dividends. Thus, they serve high-income earners well for tax-efficient diversified exposure.
Dividend income significantly contributes to high-income earners’ investment portfolios by providing a constant cash inflow. However, the tax implications demand substantial planning to ensure that tax liabilities do not diminish returns.
Having an understanding of the intricacies of taxation on dividends, utilising tax-saving instruments, and determining the best investment strategies will help balance between tax efficiency and growth. ELSS funds, growth options within mutual funds, and diversified global opportunities are available to meet your financial goals through different tax laws. Systematic planning enables high-income earners to make the most of their dividend income while reducing their taxes, leading to long-term growth.
Note: The above information is meant only for general information purposes and is not intended as financial advice. Individual circumstances might differ; tax efficiency depends on your specific financial situation and current applicable tax laws.
