Section 194K - TDS on Mutual Funds

This section of the Income Tax Act brought a significant change in the taxation regime concerned with the dividends earned through mutual funds investment. The previous tax laws posed challenges for both parties, the beneficiaries and the distribution companies. Thus, 194K TDS was added to sort out the complexities involved in the dividend income and the existing tax laws.

The sole purpose of introducing this section to the Income Tax Act was to avoid double taxation, which was the result of the previous tax laws. This section eliminates Section 10(35) of the previous tax laws and outlines the TDS rules for earning through mutual fund (MF) dividends.

Under the sec 194K of the Income Tax Act, the earnings through the MF dividends are taxable in the shareholder's hands. A 10% deduction is applicable when a resident individual receives more than ₹5000 in dividends in a fiscal year. Thus, this law compels the mutual funds to deduct TDS while distributing dividends more than ₹5000.

Mutual Fund investments result in two types of income for the shareholders:

Capital Gains: Capital gains are generated when an investor sells mutual fund units at a profit. Whereas, if the investor sells the MF units at a price lower than the purchase price, it is called Capital Loss.

These gains are taxable based on the period of their holdings. Long-term capital gains above ₹1 lakh are taxed at 10%. While, short-term capital gains are subject to Securities Transaction Tax (STT) and are taxed at 15%. However, according to the 194K section, the mutual fund is not required to deduct TDS on mutual fund redemption of these capital gains.

Dividend: Dividends are profits issued by mutual funds to their shareholders and must be declared in the ITR under the "Income from other sources." According to the existing law, this type of income from MF is taxable in the shareholder's hands.

How to Report Mutual Fund Dividend Income in ITR?

Any resident investor who avails capital gains from the selling of MF during a fiscal year needs to either fill ITR1 or ITR2. However, the dividend earned from MF needs to be reported in a separate section of the ITR.

Steps to report MF dividend income:

• The dividend income needs to be reported quarterly.

• While filling up the ITR form, report your dividend income under the section: “Schedule of Other Sources."

• You will need to provide details for each quarter, starting with dividend earnings up to 15th June. Next, 16th June to 15th September, 16th September to 15th March and so on.

Understanding whether your income earned through your mutual fund investments falls under the bracket of section 194K is crucial to staying on track and avoiding delays. Not all your gains come under the same umbrella of tax-paying, as mentioned above.

Only the income earned through dividend payouts by mutual fund companies is subject to the 194K laws. However, not all dividends are subject to tax deductions.

There are two exceptions to this:

Dividend income limit: This means that unless the dividend income is less than ₹5000, no TDS is applicable. The TDS deductions are done by the fund house or the AMC.

Capital gain income: Since both types of income gains are taxed differently, it is important to remember that capital gains are not liable for 194K TDS. Regardless of whether your capital gains are long-term or short-term, they are not applicable for TDS deductions.

Failure to comply with the rules of the Section 194K or delayed payment can result in penalties and interest. Thus, it is important that you fill the ITR within the stipulated time and under the correct sections.

Non-compliance with the taxation rules may attract the following penalties:

• Non-deduction and non-compliance will result in disallowance of the expenditure as per Section 40(a)(ia).

• If there is a failure to deduct TDS as per sec 194K, you will be liable to pay a penal interest of 1% from the deductible date to the date it is actually deducted.

• If you fail to pay the deduction as per the section, you will be charged with 1.5% interest from the payable date to the day you complete the payment.

• Additionally, a penalty will also be charged as per Section 271C, which is equal to the TDS amount, in case there is a failure in deduction or payment of TDS.

Mutual funds have been recognised as a great investment option by many investors. Young and experienced investors have been choosing MF for several years to save taxes and earn great returns. However, understanding the tax implications of the same is crucial to save yourself from paying penalties.

After the addition of Section 194K, earnings made through dividend payouts of mutual funds are subject to taxation. According to the section, every dividend earning above ₹5000 in a fiscal year will be liable to a 10% TDS deduction at the hands of the shareholders. The capital gains earned from the selling of mutual fund units in the fiscal year are not applicable for TDS deductions.

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