Section 194K of Income Tax Act: TDS on Mutual Fund

In the Budget 2020, Finance Minister Nirmala Sitharaman introduced Section 194K to the Finance Act. This section focuses on the tax deduction for amounts paid on mutual fund units, with a specific limit, to any resident individual.

The main goal was to simplify the taxation process and eliminate the double taxation that occurred under the previous laws. Earlier, taxes were imposed both when the company paid the AMC (Asset Management Company) and when the AMC distributed payouts to unit holders.

Now, with Section 194K, this issue has been addressed, making the tax process more straightforward for mutual fund investors.

What Is Section 194K of Income Tax?

Section 194K of the Income Tax Act was introduced in the Budget 2020 and became effective from April 1, 2020, during FY 2020-21. With the removal of Dividend Distribution Tax (DDT), dividends from equity shares and mutual funds, which were previously exempt under Section 10(35), are now taxable at the applicable slab rates in the hands of the shareholder.

Under Section 194K, TDS is required on mutual fund dividends. If a resident shareholder receives more than ₹5,000 in dividends in a fiscal year, a 10% TDS deduction applies to the total amount. This section ensures that TDS is deducted before the dividends are paid out, making the income taxable in the shareholder’s hands.

Types of Income from Mutual Funds

When investing in mutual funds, you can typically earn income in two ways: Dividend Income and Capital Gains Income.

Dividend Income: Previously, dividends paid by fund houses (AMCs) were subject to Dividend Distribution Tax (DDT). However, Budget 2020 removed DDT, making dividend income taxable directly in the hands of the investor starting from FY 2020-21. Under Section 194K of the Income Tax Act, mutual funds must withhold TDS at 10% on dividends exceeding ₹5,000 in a financial year.
Capital Gains Income: Capital gains are taxed based on the investment duration. Long-term capital gains from equity-oriented mutual funds are taxed at 10% if they exceed ₹1 lakh in a year, while short-term gains are taxed at 15%. Importantly, under Section 194K of the Finance Act 2021, there’s no TDS on capital gains from mutual fund redemptions, keeping this income separate from the TDS requirements.

Read More About Types of Mutual Funds

Purpose of Section 194K of the Income Tax Act

Before the introduction of Section 194K, dividends were subject to double taxation. First, when a company paid dividends to an Asset Management Company (AMC), and again when the AMC distributed profits to unitholders.

Investors had the option to reinvest profits or receive dividend income. However, if they chose dividends, the AMC had to pay Dividend Distribution Tax (DDT) again on those dividends.

With Budget 2020, DDT was abolished. Now, AMCs only need to deduct TDS at 10% on dividend distributions, but only if the dividend paid to a recipient exceeds ₹5,000 in a financial year.

A few key points to remember:

If the investor doesn’t provide a PAN, TDS is deducted at 20%.
For NRI investors, TDS is deducted under Section 195.
No TDS is deducted if the recipient submits Form 15G or 15H.

Who is Eligible for Section 194K?

Section 194K applies to anyone responsible for paying a resident income related to:

Mutual fund units
Units of a specific or particular company
Administrator units from a specified undertaking

When making these payments, TDS can be deducted under this section.

Exceptions to Section 194K

TDS under Section 194K doesn’t apply in certain situations:

No TDS is required if the dividend income is less than ₹5,000 in a fiscal year.
Income from capital gains is also exempt from the application of Section 194K.

Rate of Section 194K

Section 194K specifies a TDS rate of 10%. Once deducted, this TDS will appear in Form 26AS. If the final tax liability is lower than the amount deducted, or if there’s no tax due, investors can claim a refund when filing their income tax return.

If you’ve provided your PAN and Aadhaar number, the 10% rate applies. However, if PAN or Aadhaar isn’t provided, the TDS rate jumps to 20%. Fortunately, since a PAN is required to open a mutual fund account, higher TDS rates are rare.

Threshold Limit for TDS Deduction Under Section 194K

There are two key exceptions under Section 194K:

No TDS is deducted if your dividend income is less than ₹5,000.
TDS is not applicable on income from capital gains, whether long-term or short-term.

Calculation of TDS Under Section 194K of the Income Tax Act

For mutual fund dividends exceeding ₹5,000, TDS is withheld at 7.5%. This applies to dividend distribution, reinvestment, and transfer plans. Importantly, TDS does not apply to capital gains for resident investors.

For non-residents, short-term capital gains are taxed at 30% and long-term gains at 20% with indexation. No TDS is deducted if Forms 15G or 15H are submitted.

Due Dates for Depositing TDS

Under Section 194K, TDS on income from mutual funds or specified company shares must be deposited by the 7th of the following month. For TDS deducted in March, the due date is extended to April 30th. Timely deposits are crucial to avoid penalties and ensure compliance.

TDS Considerations for Mutual Fund Income

Under Section 194K of the Income Tax Act, TDS is deducted at 7.5% from mutual fund dividends that exceed ₹5,000. This applies to dividend distribution, dividend reinvestment, and dividend transfer plans. However, capital gains are not subject to TDS for resident investors.

For NRIs, short-term capital gains are taxed at 30%, while long-term capital gains are taxed at 20% with indexation. If the income recipient submits Form 15G or 15H, a TDS deduction is not required.

Penalties for Non-Deposit of TDS Under Section 194K

All dividend payments from mutual fund schemes must comply with Section 194K of the Income Tax Act. Failing to deduct or deposit TDS can lead to interest and penalties.

If TDS isn’t deducted: A 1% interest is charged per month (or part of the month) from when the tax should have been deducted until it is actually deducted.
If TDS is deducted but not paid: A 1.5% interest is levied per month (or part of the month) from the time the tax was deducted until it’s paid to the government.
Penalty under Section 271C: Failure to deduct or pay TDS can result in a penalty equal to the TDS amount not withheld or paid.
Expense Disallowance under Section 40(a): Non-deduction and non-payment of TDS can also result in the disallowance of related expenses.

Wrapping Up

Section 194K of the Income Tax Act governs the taxation of dividend income. It requires TDS on dividends paid out by mutual funds and companies, replacing the previous Dividend Distribution Tax with a more direct approach.

Introduced to simplify the Indian taxation system, this section aligns with the broader tax laws outlined in the Finance Act. This change impacts how dividends are taxed and reported, ensuring compliance with India’s taxation framework.