Section 194 K- Tax deduction on mutual fund unit income

Finance minister Nirmala Sitharaman recommended the inclusion of section 194K in the Finance Act in the financial year 2020. This section covers tax deductions on the paid amounts on mutual fund units, without limitation, to all residents. Let us consider Section 194K in terms of:

• Current income tax law levies tax on the dividend (DDT) paid by the fund houses (Asset Management Company) and in name of investors.

Dividend-DDT was abolished as per the 2020 budget

From the Financial year 2020-21, the Income of dividends will be taxable in the hands of the Receiver/Investor.

Although, the new TDS section 194K put in the Finance Act 2021 needs mutual funds to deduct TDS when they distribute dividends of more than Rs 5,000 to shareholders.

Capital gains-As per the recent provision of Income Tax

In the hands of the taxpayer long-term capital gains received from equity-oriented mutual funds will be taxed at a 10% rate if the gains are more than Rs 1 lakh in a year.

As with that, even any type of short-term capital gains received from the equity-oriented mutual funds, subject to STT, is also taxed at a rate of 15%.

Although, New TDS Section 194K put in Finance Act 2021 does not need a mutual fund to deduct TDS on capital gains occurring on redemption of units by unit holders.

Section 194 K

The new provision, Section 194K, removes the financial exemption from mutual fund units by removing section 10(35). According to section 194K, every resident is responsible for paying:

• Distribution of mutual funds in terms of section 10(23D).
• Units from the official administrator.
• Units from specialized companies.

TDS will be deducted at 10% at the time of credit of this type of income in the payer’s account above Rs 5,000 or at the time of payment, whichever is earlier.

The objective of Section 194 K –

As per previous income tax laws, the dividend was taxed twice. Earlier, the tax was levied if the company paid dividends to the asset management company (AMC). The second tax liability is if the AMC has to allot its profits to the unit holders.

An investor can either select to invest the money back into the fund or get a dividend income. If the investor selects to receive the income of the dividend, the AMC will also need to pay DDT on the dividend distribution.

In Budget 2020, DDT has been removed, only AMC is needed to deduct TDS at 10% on dividend distributions if distributions are paid to recipients of more than Rs 5,000 per FY.

Note

• TDS should be deducted at 20% if the depositor does not provide PAN.
• In the case of NRI investors, TDS will be deducted as per section 195.

Exceptions

TDS as per Section 194K is not needed to be deducted in these below-mentioned cases:

• Tax at the rate of 10% is not needed to be deducted at source when the dividend earned income is up to Rs 5,000 in an F.Y.
• Even capital gain income will also be exempted from the pertinence of this Section 194K.

Laws of Income Tax before Section 194K –

As per the recent regime, the duty of outlining income from dividends and capital gains was on sole investors. Earned Dividend income from mutual funds was exempt as per Section 10(35). Whereas, there was no law related to TDS deduction on any income received from mutual funds. In this, Only Non-residents (NRIs) were subject to TDS. DDT was applied to the company distributing dividends, but the similar was tax-free in the hands of taxpayers.

Conclusion

In short, the new laws bring in by Budget 2020 have transferred the load of tax payment on dividend earned income from the company distributing dividends to the recipient of such dividend earned income.