What is section 194K? If you have no idea about the same, read this blog to know everything related to it.
Overview:
Nirmala Sitharaman has advocated enforcing 194K of the Finance Act in Budget 2020. The purchase of mutual fund units is wholly or partially deductible for any citizen or permanent resident of the United States who uses this provision. Questions like “What is Section 194K of the Income Tax Act?” can be answered here. Section 194K of the Internal Revenue Code deals with taxes withheld during employment.
What is Section 194K?
Section 194K refers to a provision of the Income Tax Act that deals with TDS (Tax Deducted at Source) on income from mutual funds. It requires the deduction of TDS by the mutual fund houses when distributing dividends or income to unit holders.
Who is Eligible for Section 194K
Any individual or Hindu Undivided Family (HUF) who receives income from mutual funds is eligible for Section 194K. The TDS is deducted by the mutual fund before distributing the income to the unit holders.
Rate of Section 194K
The rate of TDS under Section 194K is 10% for resident individuals and HUFs. For non-resident individuals and foreign entities, the rate can be higher depending on tax treaties.
What Are the Types of Income From Mutual Funds?
Income from mutual funds includes dividends and capital gains. Dividends are distributions of profits by the mutual fund, while capital gains arise from selling mutual fund units for a profit.
Applicability of Section 194K
Section 194K applies when mutual funds distribute income to unit holders through dividends or capital gains.
Exceptions to Section 194K
In the following circumstances, TDS under Section 194K is not required to be withheld: If the dividend income is less than Rs 5,000 in a fiscal year, 10% of the tax must not be withheld at the source. Income from capital gains is likewise excluded from Section 194K’s application.
The Purpose of Section 194K TDS Deduction on Income
The purpose of TDS deduction under Section 194K is to ensure that the government receives its due share of tax on the income earned from mutual fund units. It also helps in reducing tax evasion and increasing tax compliance among taxpayers.
- TDS Considerations for Income From Mutual Fund Units (Rules 83 and 84)
- Capital Gains are not subject to TDS in the case of resident or domestic investors.
- If the person receiving the income submits Form 15G and/or 15H then no deduction of TDS.
To know about Rule 83 and Rule 84, request a callback from our experts right away!
Mutual Fund Shares as a Revenue Source
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Capital Gains
- Capital gains are taxed in the hands of the taxpayer under existing income tax laws. If your long-term capital gains from equity-focused mutual funds for the year are more than INR 1 lakh, you will be taxed at 10%.
- The STT results in a 15% tax rate on short-term capital gains if you invest in an equity-focused mutual fund.
- Capital gains distributed by mutual funds in response to redemption requests from unitholders are no longer subject to TDS (Tax Deducted at Source) under the provisions of new Section 194K of the Finance Act of 2021.
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Dividend Income, Monetary
- Under current income tax return, fund companies must pay a tax (DDT) on dividends distributed to shareholders (Asset Management Companies).
- The use of DDT will be outlawed entirely by 2020.
- This dividend income will be subject to taxation by the receiver/investor beginning in the fiscal year 2020-21.
- When paying out dividends to unitholders of more than Rs 5,000, mutual funds must comply with the new tax withholding provision outlined in Section 194K of the Finance Act of 2021.
Background on Section 194K of the Income Tax Act
Dividends were double-taxed when I was a kid. Initially, a tax was applied whenever a company paid a premium to an asset management firm (AMC). The tax was levied again when the AMC distributed its profits to unitholders.
Gains can be reinvested in the fund or taken as dividends at the investor’s discretion. If the investor chooses to take a dividend payment, the AMC is responsible for remitting DDT on the dividend payment.
The Dividend Distribution Tax (DDT) will be abolished in Budget 2020. Asset Management Companies (AMCs) would only be required to withhold 10% TDS from dividend payouts if the total dividends paid to any recipient in a fiscal year exceed Rs 5,000.
Noteworthy Factors:
- Investors must provide their PAN or face a 20% TDS to avoid paying taxes.
- Those who are non-resident aliens (NRIs) who invest must account for Section 195 TDS deductions.
IRC 194K’s Exceptions
If either of the following applies, then no TDS is required to be withheld per Section 194K:
- You don’t have to pay taxes if your annual dividend income is less than Rs 5,000.
- A sale’s proceeds are also exempt from the restrictions of Section 194K.
Organization Eligible for Subsidy Deduction Under Section 194K
They are crediting the following income to a resident’s account or making the subsequent payments may be subject to TDS deductions at the payer’s discretion.
- The departments within an organization that are in charge of a given project’s administration.
- Comparable Units from Other Mutual Funds
- In the form of shares in a corporation or business conglomerate.
In what circumstances can a taxpayer claim a TDS exemption under Section 194K?
Section 194K additionally specifies the rate at which AMCs must deduct such TDS and the conditions under which they must do so. Under section 194K, TDS must be withheld from the source of any income paid to a resident Indian in connection with the following.
- Mutual fund shares
- Project-specific units that the Administrator has allocated
- Shares in the selected corporation
Tax Withholding and Collection Procedures Act, Section 194K Rate
Section 194K of the Internal Revenue Code establishes 10% as the base deduction rate. Form 26AS will be updated to reflect the final TDS amount. The investor is still required to file a tax return even if they have no tax liability or if the amount of tax payable is less than the amount withheld.
The rate is 10% if the investor has provided the PAN and the Aadhar Number to the deductor. If the deductor does not have the taxpayer’s PAN or Aadhaar number, the TDS rate is 20%. Due to the necessity of a PAN when starting a mutual fund, a high TDS: https://incometaxindia.gov.in/Pages/Deposit_TDS_TCS.aspx is unusual.
Investment Consequences
Investors now have to pay taxes on dividend income due to the implementation of Section 194K. Investors’ tax burdens have increased as a direct result of this. It’s possible that small investors (those who don’t receive dividends worth more than Rs. 5,000 in a fiscal year) won’t be much impacted (especially those who do not have dividend income of more than Rs. 5,000 in any financial year).
But this field can be a game-changer for people with a substantial portion of their investments in dividend programs that generate significant annual income.
If Section 194K is made law again, they will have less dividend income and have to pay more taxes. This is a massive shift because the top tax bracket must now tax dividend income at the maximum rate. Investors may look elsewhere if dividend funds can no longer provide profitable returns.
Whether the profits are short-term or long-term, equity or debt funds investors will benefit more from receiving capital gains as part of the growth plan. Payments from equity mutual funds held for less than a year would be subject to taxation at 15% rather than the maximum rate of 30%, while gains held for more than a year would be subject to taxation at 10% after the income tax exemption of Rs. 1,00,000.
Slab rates will be applied to debt funds for the short term, while long-term funds would be taxed at 20% after indexation.
Conclusion
Section 194K of the Income Tax Act imposes new obligations on investors regarding the taxation of dividend income. The burden of paying dividend taxes has shifted from the distributor to the dividend receiver. You can contact Vakilsearch in case you need assistance.
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