Taxation of Dividend and Interest

Income from other sources is a residuary head of income and sweeps in all such incomes which fall outside the other four heads of income. However, certain incomes will always be taxable under the head income from other sources, such as winning from lotteries, gifts, interest on enhanced compensation, etc.

Rules for Taxability of Income

Any income, which is not exempt from tax and has to be included in the total income, shall be chargeable to tax under the head 'Income from Other Sources' if it is not chargeable to income tax under any of the following heads:

1. Salaries
2. Income from house property
3. Profits and gains from business or profession
4. Capital gains

However, certain incomes are always taxable under the head 'income from other sources'.

Computation of Income

Income taxable under the head 'income from other sources' shall be an aggregate of certain incomes specifically taxed under this head and other incomes that are not chargeable under any other head, hence, chargeable under this head. Income taxable under the head 'income from other sources' shall be computed in the following manner:

Dividends usually refer to the distribution of profits by a company to its shareholders. However, certain receipts are also deemed as dividend. The deemed dividend, as defined in Section 2(22) of the Income-tax Act, includes following:

1. Distribution entailing the release of company's assets;
2. Distribution of debentures, or deposit certificates;
3. Distribution of bonus shares to preference shareholders;
4. Distribution on liquidation;
5. Distribution by the company on reduction of its capital; and
6. Loan or advance to shareholders.
7. Payment by a Company on purchase of its own shares from a shareholder [subject to certain exception]

Dividend declared, distributed, or paid on or after 01-04-2020 is taxable in the hands of the shareholders. Where the dividend was declared, distributed, or paid before 01-04-2020, shareholders were exempt from paying tax on the dividend as per section 10(34) as the company was liable to pay Dividend Distribution Tax (DDT) on such dividend.

A shareholder can deduct only the interest expenditure from dividend income subject to a limit of 20% of total dividend income. No further deduction is allowed for any other expenses, including commission or remuneration paid to a banker or any other person to realize such dividend.

Tax on dividends from various securities

Dividend income is taxable at the applicable tax rate or at a special rate which depends on two factors which are the residential status of the recipient and the nature of security. The dividend can be classified into the following:

(a)   Dividend from shares

• If the recipient is a resident – taxable at the applicable tax rate and interest expenditure incurred to earn such dividend income shall be allowed up to 20% of total dividend income.
• If the recipient is a non-resident – taxable at a special rate of 20% subject to provisions of DTAA and no expenditure shall be allowed.

(b)   Dividends from mutual funds

• If the recipient is a resident – taxable at the applicable tax rate and interest expenditure incurred to earn such dividend income shall be allowed up to 20% of total dividend income.
• If the recipient is a non-resident – taxable at a special rate of 20% subject to provisions of DTAA and no expenditure shall be allowed. However, if the dividend is received by an FPI in respect of units purchased in foreign currency, the tax rate shall be 10%.

(c)   Dividends from GDRs

• If the dividend is taxable under section 115AC – taxable at 10% and no deduction is allowed.
• If the dividend is taxable under section 115ACA – taxable at 10% and no deduction is allowed.
• In other cases – taxable at the applicable tax rate and interest expenditure incurred to earn such dividend income shall be allowed up to 20% of total dividend income.

(d)  Dividends from REITs/InVITs

• If the recipient is a resident – taxable at the applicable tax rate and interest expenditure incurred to earn such dividend income shall be allowed up to 20% of total dividend income.
• If the recipient is a non-resident – taxable at a special rate of 20% subject to provisions of DTAA and no expenditure shall be allowed.

Interest on securities is taxable under the head income from other sources if the same is not chargeable to income tax under the head "Business or Profession".

If books of account in respect of such income are maintained on a" cash basis", then the interest is taxable on a "receipt basis". If, however, books of account are not maintained or are maintained on the basis of the mercantile system of accounting, then interest on securities is taxable on an "accrual" basis.

'Interest on securities' means

• Interest on any security of the central government or a state government;
• Interest on debentures or other securities for money issued by or on behalf of a local authority or a company or a corporation, established by a Central or State or Provincial Act.

The interest shall be chargeable as per tax rates applicable to the assessee. However, certain specified interest income of a non-resident or foreign company is chargeable to tax on a gross basis at special rates which are as follows:

Here, it is to be noted that if the interest income is not chargeable to tax or chargeable to tax at lower rates as per provisions of the Double Taxation Avoidance Agreement (DTAA), then provisions of DTAA shall apply and tax shall be charged accordingly.

Interest Exempt from tax -

(a)  Interest on notified securities [Section 10(4)(i)]

(b)  Interest on NRE Account [Section 10(4)(ii)]

(c)  Interest on rupee-denominated bonds [Section 10(4C)]

(d)  Interest from the leasing of aircraft or a ship to a unit of an IFSC [Section 10(4F)]

(e)  Interest on certain securities [Section 10(15)]

• Interest or premium on notified securities or deposits [Section 10(15)(i)]
• Interest payable to Bank of Ceylon [Section 10(15)(iii)]
• Interest payable to foreign central banks [Section 10(15)(iiia)]
• Interest payable to Nordic Investment Bank [Section 10(15)(iiib)]
• Interest payable to European Investment Bank [Section 10(15)(iiic)]
• Interest payable on foreign currency deposit [Section 10(15)(iv)(fa)]
• Interest payable on notified bonds or debentures [Section 10(15)(iv)(h)]
• Interest on Gold Deposit Bonds [Section 10(15)(vi)]
• Interest on bonds issued by local authority [Section 10(15)(vii)]
• Interest on deposits with offshore banking unit [Section 10(15)(viii)]
• Interest payable by a unit located in IFSC [Section 10(15)(ix)]

(f)  Income of European Economic Community [Section 10(23BBB)]

(g)  Income from specified fund located in IFSC [Section 10(23FBC)]

(h)  Interest income of wholly owned subsidiary of ADIA or Sovereign wealth fund or pension fund[Section 10(23FE)]

(i)  Interest income earned by certain persons - Interest earned by the entities or persons specified in Section 10, charitable or religious trust specified in Section 11 and political parties specified in Section 13A shall be exempt from tax.

Interest on compensation or enhanced compensation

Income received by way of interest on compensation or on enhanced compensation is taxable under the Income from other sources.

A deduction of 50% of such interest income shall be allowed under Section 57.

Further, in view of Section 145B, such interest shall be taxable in the previous year in which it is received. The interest on compensation or enhanced compensation shall be chargeable to tax only if the original or enhanced compensation is taxable. Thus, if compensation is exempt from tax, the interest payable on such compensation shall also be exempt from tax.

Section 57 specifically provides the list of expenditures which are allowed to be deducted from the income taxable under the head of other sources. It also provides that the expenditure incurred wholly and exclusively to earn the income is allowed to be deducted from income taxable under this head, provided the following conditions are satisfied:

• The expenditure must not be in the nature of the personal expenditure of the assessee;
• It must not be in the nature of capital expenditure; and

It must be laid out or expended in the relevant previous year and not in any prior or subsequent year.