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

Section 194K of the Income Tax Act, 1961, introduced by the Finance Act, 2020, and effective from April 1, 2020 (Financial Year 2020-21 onwards), brought a significant change to the taxation of dividend income from mutual funds. Prior to this, dividend income from mutual funds was exempt in the hands of investors, as the Dividend Distribution Tax (DDT) was levied on the mutual fund house itself. With the abolition of DDT, Section 194K was introduced to ensure that dividend income is now taxable in the hands of the investor, subject to Tax Deducted at Source (TDS).

Applicability of Section 194K

Section 194K mandates TDS deduction by any person responsible for paying a resident any income in respect of:

• Units of a mutual fund specified under clause (23D) of Section 10 of the Income Tax Act.
• Units from the Administrator of the Specified Undertaking.
• Units from a specified company.

This primarily covers dividend income distributed by mutual fund houses or Asset Management Companies (AMCs) to their unit holders.

TDS Rate and Threshold Limit

Rate of TDS

The rate of TDS under Section 194K is 10% of the dividend income.

Impact of PAN: If the recipient does not furnish their Permanent Account Number (PAN), the TDS rate will be 20% as per Section 206AA. However, since PAN is generally mandatory for mutual fund investments, instances of 20% TDS under this section are rare.

Threshold Limit

TDS under Section 194K is required only if the aggregate dividend income paid or credited to a resident in a financial year exceeds INR 5,000.

Note: Some proposals in recent budgets have suggested increasing this threshold to INR 10,000. However, the INR 5,000 limit remains widely applicable for the current period unless otherwise specifically notified with an effective date.

When to Deduct TDS

The TDS must be deducted at the earlier of the following:

• At the time of crediting such income to the payee's account.
• At the time of making the payment (in cash, by cheque, draft, or any other mode).

Exceptions and Exclusions from Section 194K

Section 194K does not apply in the following situations:

• If the aggregate dividend income paid or credited to a resident in a financial year is up to INR 5,000.
• Capital Gains: It is crucial to note that Section 194K applies only to dividend income from mutual funds. It specifically does not require TDS on capital gains arising from the redemption of mutual fund units. Capital gains are taxed separately in the hands of the investor based on their holding period and applicable tax rates.
• If the recipient submits Form 15G or Form 15H (declaration for non-deduction of TDS, typically for individuals whose total income falls below the tax threshold).
• For Non-Resident Indian (NRI) investors, TDS on dividend income (or any other income) is governed by Section 195 of the Income Tax Act, not Section 194K.

Compliance Obligations for Deductors

Mutual funds or AMCs, as deductors, must adhere to the following compliance requirements:

• Deduction: Deduct TDS at the prescribed rate (10%) when the dividend income exceeds the threshold.
• Deposit: Deposit the deducted tax to the credit of the Central Government within the specified due dates (usually the 7th of the following month, with an extended date for March).
• TDS Return Filing: File quarterly TDS returns (Form 26Q) accurately and on time.
• TDS Certificate: Issue Form 16A to the deductee, providing details of the tax deducted, which the investor can use to claim credit while filing their Income Tax Return. The deducted TDS will also be reflected in the investor's Form 26AS.

Penalties for Non-Compliance

Non-compliance with the provisions of Section 194K can lead to penalties and interest charges for the deductor:

• Failure to Deduct TDS: Interest at 1% per month or part thereof from the date on which tax was deductible until the date it is actually deducted.
• Failure to Deposit TDS: Interest at 1.5% per month or part thereof from the date on which tax was deducted until the date it is actually paid to the government.
• Penalty under Section 271C: A penalty equal to the amount of TDS that was not deducted or paid.
• Disallowance of Expenses: Under Section 40(a)(ia), if TDS is not deducted or not paid, the expenditure on which TDS was applicable may be disallowed.

Impact on Investors

For investors, the introduction of Section 194K means:

• Dividend income from mutual funds is now taxable in their hands.
• They will receive dividend payments after the deduction of TDS if the amount exceeds the threshold.
• The TDS deducted can be claimed as a credit against their final tax liability when they file their Income Tax Return. If the TDS is more than their actual tax liability, they can claim a refund.
• They should verify the TDS details in their Form 26AS and match it with the Form 16A issued by the mutual fund house.

Conclusion

Section 194K plays a vital role in the current tax regime for mutual fund investments. By shifting the tax burden of dividend income from mutual fund houses to individual investors and mandating TDS, it enhances transparency and streamlines the tax collection process. Investors need to be aware of this provision to accurately report their dividend income and claim appropriate TDS credit when filing their Income Tax Returns, while mutual fund houses must ensure strict adherence to its compliance requirements to avoid penalties.