Guide on Section 194 of Income Tax Act: TDS on Payment of Dividend

Introduction

We always have our taxes circling in mind when the due date is close. But have you ever wondered how your dividend income impacts your taxes? When dealing with Section 194 of the Income Tax, knowing its nuances keeps you on the right side. 

Tax Deducted at Source (TDS) holds significant importance within the Indian tax system, as it facilitates the direct collection of taxes at the source of income. Section 194 of the Income Tax Act, 1961, is the go-to for understanding TDS on dividends paid by Indian companies to their shareholders. 

And if we’re talking about mutual funds dishing out dividends, that’s where Section 194K comes in. Both sections ensure that tax is taken out at the source, which is a big part of the government’s plan to make tax collection more efficient. It’s crucial for companies and shareholders to get the hang of Section 194 to stay on top of tax requirements and avoid any penalties.

Before diving into the specific details, it’s important to have a clear overview of how TDS operates under Section 194. This section provides the foundational understanding of the obligations placed on domestic companies concerning dividend payments, setting the stage for the more detailed discussions that follow.

Also Read: Understanding Section 193: TDS on Interest on Securities in Income Tax Act

Overview of TDS under Section 194

Per the stipulations of Section 194 of the Income Tax Act, the principal officer of a domestic company must withhold TDS on dividend payments. This provision was established to facilitate a more streamlined tax collection process and ensure the efficient collection of taxes on dividend income. Section 194 pertains to TDS on dividends issued by domestic companies, while Section 194K pertains to TDS on dividends disbursed by mutual funds and specified companies.

Presently, both Section 194 and Section 194K have a threshold of ₹5,000 for TDS applicability on dividends. Should the aggregate dividend payment to an individual surpass this amount within a financial year, the company must deduct TDS at a rate of 10% on the entire dividend sum. This threshold has remained unchanged in recent years, and the tax must be withheld at the time of payment or credit, whichever occurs earlier.

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The Finance Act of 2020 introduced sizeable changes that altered the landscape of dividend taxation. This section explains the major shift in tax responsibility from companies to shareholders and how these changes affect the application of TDS on dividends.

Changes Implemented by the Finance Act, 2020

The Finance Act of 2020 brought about significant changes in the taxation of dividends, notably the abolition of the Dividend Distribution Tax (DDT). This shift transferred the tax burden on dividends from the company to the shareholders, making dividend income taxable in the hands of the shareholders. Consequently, the responsibility for Tax Deducted at Source (TDS) on dividends was reinstated. After the Finance Act of 2020, the responsibility for TDS lies with the company paying the dividend, with shareholders bearing the tax on the dividend income at their applicable income tax rates. Domestic companies and mutual funds were categorized under Section 194 and Section 194K, respectively.

Also Read: Tax Benefits Under Section 24(b) of Income Tax Act

Having established the basic framework, it’s essential to understand who is responsible for TDS under Section 194 and the conditions under which it is applicable. This section breaks down the responsibilities of the principal officer and the conditions that trigger TDS deduction.

Applicability of TDS Under Section 194

Understanding the applicability of TDS under Section 194 of the Income Tax Act is crucial for companies to ensure compliance with tax regulations.

Responsibility of the Principal Officer

The principal officer of a domestic company is responsible for ensuring that TDS on dividend payments is deducted and deposited with the government. The term ‘principal officer’ encompasses individuals managing the company or overseeing its affairs. It comprises of the managing director, director, manager, or any other person designated by the company for this purpose. Compliance with TDS provisions is essential to avoid potential penalties for non-compliance.

Conditions for TDS Deduction

TDS under Section 194 of the Income Tax Act is applicable when the dividend amount paid or credited to a shareholder exceeds ₹5,000 in a financial year. This threshold ensures that small shareholders with minimal dividend income are not subject to TDS, offering relief to lower-income individuals. The TDS deduction must occur at the earliest of the two events: when the dividend is credited to the shareholder’s account or paid out.

Also Read: Navigating TDS on Fixed Deposits

After covering the applicability, the next logical step is to delve into the tax rates. This section outlines the standard and higher TDS rates based on the availability of the Permanent Account Number (PAN) and highlights the importance of PAN in tax deductions.

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Tax Rates Under Section 194

The tax rate for TDS under Section 194 of the Income Tax Act may vary based on whether the payee has provided their Permanent Account Number (PAN).

PAN Status	TDS Rate
Furnished	10%
Not Furnished	20%

Also Read: Income Tax Act Section 89A: Relief for Foreign Retirement Benefits

To ensure complete understanding, it is also crucial to discuss the various modes of payment that require TDS deduction. This section emphasizes the uniformity in TDS application across different payment methods.

Modes of Payment Requiring TDS Deduction

TDS Sections 194 and 194K apply universally to all modes of payment including cheque, draft, electronic transfer, and any other method. Under these sections, the company deducts TDS before making the payment to the recipient. This consistent application of TDS across different payment methods upholds uniformity, fairness in tax collection, and compliance with tax regulations. 

By mandating TDS deductions irrespective of the payment method, these sections prevent discrepancies and ascertain that tax liabilities are met expeditiously and equitably. 

Not all payments are subject to TDS under Section 194 of the Income Tax Act. This section explores the exceptions that provide relief under specific circumstances, offering clarity on when TDS is not required.

Exceptions to TDS Under Section 194

Specific exceptions to the TDS requirement under Section 194 or Section 194K are tailored to offer relief in particular circumstances. 

Also Read: Understanding Section 193: TDS on Interest on Securities in Income Tax Act

This section revisits a significant exemption that was in place before the Finance Act 2020. Understanding this historical context helps clarify the current TDS requirements after the abolition of the Dividend Distribution Tax (DDT).

Exemption for Payments Under Section 115-O

As mentioned earlier, prior to the Finance Act 2020, dividends subject to Dividend Distribution Tax (DDT) under Section 115-O were exempt from TDS under Section 194. However, with the abolition of DDT, this exemption is no longer applicable. 

Under current regulations, TDS is deducted from dividend payments when the total dividend paid to a shareholder exceeds ₹5,000 in a financial year. The company deducts TDS at 10% on the entire dividend amount, provided the shareholder has furnished their PAN. The TDS rate increases to 20% if the PAN is not provided.

Entities like LIC and GIC enjoy specific exemptions under Section 194 of the Income Tax Act. This section details these exemptions and explains the conditions under which they apply.

Exemption for Dividends Received by LIC, GIC, and Subsidiaries

As per the latest Income Tax guidelines, entities such as the Life Insurance Corporation of India (LIC), General Insurance Corporation (GIC), and their subsidiaries are eligible for an exemption from TDS for dividends received, subject to specific conditions. 

This exemption is applicable when these entities have complete beneficial ownership of the shares from which the dividend is paid. Additionally, other insurance companies in similar circumstances can benefit from this exemption.

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Entities such as LIC, GIC, and their subsidiaries are exempt from TDS on dividends under specific conditions, as per Sections 194 and 194K, respectively. This exemption is intended to recognize the significant contributions and key roles played by these institutions in the financial and insurance sectors. It provides them with relief from the administrative burden of TDS compliance.

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Individual shareholders can use certain forms to mitigate TDS obligations. This section discusses how Forms 15G and 15H can be utilized to claim exemptions from TDS on dividends, providing practical guidance on their application.

Also Read: Form 16: Everything You Need to Know

Understanding the definitions of various distributions deemed as dividends is key to applying TDS correctly. This section provides detailed explanations of the relevant sections under the Income Tax Act, which categorize different types of dividend distributions.

Detailed Definitions Under Section 2(22)

Below is a summary of the pertinent sections of the Income Tax Act that delineate various types of distributions considered dividends. These sections play a key role in determining the applicability of TDS under Section 194 of the Income Tax Act:

Specified Section	Type of Dividend	Description
Section 2(22)(a)	Distribution of Accumulated Profits	Cash, property, or other assets distributed to shareholders as dividends.
Section 2(22)(b)	Distribution of Debentures	Distribution of debentures, debenture stock, or deposit certificates to shareholders treated as dividends.
Section 2(22)(c)	Distribution of Assets on Liquidation	Distribution of company assets during liquidation considered as dividends.
Section 2(22)(d)	Distribution on Reduction of Share Capital	Distribution of assets due to share capital reduction treated as dividends.
Section 2(22)(e)	Loans and Advances	Loans or advances from a closely held company to shareholders treated as dividends.

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Proper compliance with TDS regulations is critical to avoid penalties. This section outlines the deadlines for TDS deposit and the penalties for non-compliance, emphasizing the importance of timely action. Investing with Tap Invest can offer clarity on how and where to invest your hard-earned money.

Compliance and Time Limits for TDS Deposit

Adhering to the TDS deposit deadlines is essential to avoid penalties and ensure efficient tax administration.

General Rule for TDS Deposit

As a standard procedure, TDS deducted under Section 194 must be remitted to the government by the 7th of the subsequent month following the deduction. For example, TDS deducted in April should be deposited by the 7th of May. Timely remittance of TDS ensures the expeditious receipt of funds by the tax authorities, facilitating streamlined tax administration.

Also Read: Navigating TDS on Fixed Deposits

Exception for TDS Deducted in March

An exception to the general rule is applicable for TDS deducted in March, with the deposit deadline extended to the 30th of April. This extension allows companies additional time to fulfil their year-end tax compliance obligations, particularly during the finalization of financial statements.

Penalties for Non-Compliance

Non-compliance with the TDS provisions under Section 194 can lead to substantial penalties.

• Interest on Late Payment of TDS

In case TDS is not deposited within the prescribed time, interest is charged at a rate of 1.5% per month or part of a month from the date the tax was deducted to the date on which it is deposited. This interest is charged from the date the tax was deducted until the date it is deposited to the government. This interest is intended to compensate the government for the delayed receipt of tax funds.

Also Read: TDS on NRI FD Interest: Informative Guide

• Penalty for Failure to Deduct TDS

Failure to deduct TDS can result in a penalty equal to the amount of TDS that was not deducted. This penalty is imposed in addition to the interest on late payment, emphasizing the importance of adhering to TDS provisions promptly.

This section revisits the forms and exemptions available to shareholders, providing a more detailed look at how these tools can help ease the TDS burden under Section 194 of the Income Tax Act.

Forms and Exemptions for Shareholders

Various forms and exemptions are accessible to shareholders to alleviate their TDS obligations under Section 194.

Form 15H for Senior Citizens

For senior citizens aged 60 or above, Form 15H can be submitted to claim exemption from TDS on dividend income under Section 194. This avenue is particularly advantageous for retired individuals reliant on dividend income, whose total income falls below the taxable limit.

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Form 15G for Non-Senior Individuals

Non-senior individuals can utilize Form 15G to request exemption from TDS under Section 194 of the Income Tax Act if their total income remains below the taxable threshold. 

Although primarily intended for interest income covered under Section 197A, Form 15G can also be employed for TDS on dividends under Sections 194 and 194K for individuals with restricted income. This form safeguards individuals with lower income from TDS, thereby preserving their disposable income.

Finally, to bring all the concepts together, this section presents practical scenarios that illustrate how TDS under Section 194 of the Income Tax Act operates in real-life situations, making the theoretical concepts more tangible.

Practical Implications and Examples

Section 194’s pragmatic implications become more apparent when examining the following scenarios:

• Scenario 1: In the event that a company issues a dividend of ₹10,000 to a shareholder who has furnished their PAN, the company will levy a 10% TDS, totalling ₹1,000, with the shareholder receiving ₹9,000.
• Scenario 2: Should a company declare a dividend of ₹4,000 to shareholders, and the dividend amount does not exceed ₹5,000, no TDS will be deducted, and the shareholder will receive the entire ₹4,000.
• Scenario 3: If a shareholder submits Form 15G, indicating a total income below the taxable limit, the company will refrain from deducting TDS upon due verification of the form.

Conclusion

Mastering “194 section in income tax,” “section 194 income tax,” “sec 194 of income tax,” and “194 of income tax act” empowers you to handle your tax obligations and liabilities smoothly. Section 194 of the Income Tax Act of 1961 is an apex provision facilitating the effective collection of taxes on dividend income. It requires TDS on dividend payments, which makes it easier for taxpayers and ensures taxes are collected at the source of income.

The amendments ushered in by the Finance Act 2020 have brought about changes to the provisions of Section 194. These changes include the primary objective of enhancing the efficiency of tax collection and furthering compliance with tax regulations for both companies and shareholders. It’s vital for companies and shareholders to fully understand the scope, tax rates, exemptions, and compliance requirements of Section 194 to navigate tax compliance effectively.Tap Invest takes care of the complexities of investments, such as high-return invoice discounting and asset leasing to unlisted bonds and P2P investments for you, making sure your finances are accurate and fully compliant with regulations.