What is Section 194K of Income Tax Act?, Types of Income from Mutual fund Units and Motive behind Section 194K of Income Tax Act

Introduction

During Budget 2020, Nirmala Sitharaman recommended the addition of Section 194K to the Finance Act. This clause allows any resident individual to deduct the amount paid on mutual fund units, up to a certain limit. In this article information on “What is Section 194K of Income Tax Act?” And information on TDS Section 194K (Tax Deducted at Source) is mentioned.

What is Section 194K of the Income Tax Act?

Dividend Distribution Tax (DDT) was repealed on April 1, 2020, and dividend income will henceforth be taxable in the hands of the receiver. The dividends paid on equity shares and mutual funds were previously exempted under Section 10 (35). This income is now taxed at slab rates by the government.

If you pay mutual fund dividends, you must deduct TDS as required by section 194K of the Income Tax Act. If your entire and full dividend in a financial year exceeds INR 5,000, you must compute this deduction at a rate of 10 percent on the number of dividends received. Hence from April 1, 2020, TDS Section 194K (Tax Deducted at Source) is applicable by the IT Department.

Types of Income from the Mutual Fund Units

• Income earned as a form of Capital Gain

1. 1. Capital gains are taxed in the hands of the taxpayer under current income tax law. If long-term capital gains from equity-oriented mutual funds reach INR 1 lakh in a year, the profits will be taxed at a rate of 10%.

   2. Similarly, any short-term capital gains made through STT-eligible equity-oriented mutual funds will be taxed at a 15% rate.

   3. However, under the new Section 194K of the Finance Act of 2021, a mutual fund is not required to deduct TDS (Tax Deducted at Source) on capital gains deriving from unit holder redemptions.

• Income earned as a form of Dividend

1. 1. The existing income tax law imposes a tax on the dividends (DDT) paid on behalf of investors by fund houses (Asset Management Companies).

   2. According to Budget 2020, DDT has been phased out.

   3. Dividend income will be taxable in the hands of the receiver/investor beginning in FY 2020-21.

   4. However, the new TDS Section 194K of the Finance Act of 2021 compels mutual funds to withhold TDS when issuing dividends to unitholders in excess of Rs 5,000.

The motive behind Section 194K of Income Tax Act

Dividends were taxed twice under earlier income tax regulations. When a corporation paid a dividend to an Asset Management Company, a tax was charged at first (AMC). The second time the tax was imposed was when the AMC distributed its profits to unitholders.

An investor has the option of reinvesting gains in the fund or receiving dividend income. If the investor elects to receive dividend income, the AMC will be obligated to pay DDT on the dividend payout.

DDT (Dividend Distribution Tax) is repealed in Budget 2020, and AMCs (Asset Management Companies) are only liable to deduct TDS at a rate of 10% on dividend distributions if the total dividend paid per recipient exceeds Rs 5,000 in a fiscal year.

Points to keep in Mind:

• If the investor does not furnish a PAN, TDS should be deducted at a rate of 20%.

• TDS should be deducted as per Section 195 in the case of NRI investors.

Exceptions Under Section 194K of Income Tax Act

TDS is not needed to be deducted under Section 194K in the following circumstances:

• If the dividend income is less than Rs 5,000 in a financial year, no tax is required to be deducted at the source.

• Capital gain income is likewise exempt from Section 194K’s application.

An eligible entity to deduct TDS as per Section 194K

Any person who is responsible for paying a resident any of the following income can deduct TDS when crediting the income to the payee’s account or making the payment by any method.

• Units of administration from a certain undertaking.

• Mutual Fund Units.

• Units of a certain corporation or a group of companies.

Conclusion

The new provisions of the Income Tax Act, Section 194K, have transferred the responsibility of tax payment to dividend income on investors. Previously, the distribution firm was responsible for paying the tax, but now the burden has been passed to the beneficiary of the dividend income, avoiding double taxation.