Section 194 of Income Tax Act: TDS on Dividends

The Income Tax Act, 1961 contains several provisions to ensure proper collection of taxes at the source itself. Among these, Section 194 of Income Tax Act specifically deals with Tax Deducted at Source (TDS) on dividends paid by Indian companies. This section plays a crucial role in regulating the taxation of income generated through dividends and ensuring compliance with the tax system.

In this detailed guide, we break down Section 194, covering its applicability, provisions, exemptions, rates, procedures, and compliance requirements.

What is Section 194 of the Income Tax Act?

Section 194 of the Income Tax Act lays down the obligation for domestic companies to deduct TDS on dividends before distributing the same to their shareholders. The deduction applies only when the dividend is paid to resident shareholders, as non-resident shareholders are governed by Section 195.

Dividend, for this purpose, includes both:

• Declared dividends as per company law.
• Deemed dividends under Section 2(22) of the Income Tax Act.

The section applies equally to listed companies, unlisted companies, public companies, and private limited companies, provided they distribute dividend income to their resident shareholders.

Key Features of Section 194

• Deductor: Indian company declaring, distributing, or paying dividends.
• Deductee: Resident shareholder receiving dividends.
• Rate of TDS: 10% (20% if PAN not furnished).
• Threshold: ₹10,000 per shareholder per financial year
• Timing: Deduction at the time of credit or payment, whichever is earlier.
• Exemptions: Certain institutions and categories of shareholders are exempt.

Budget 2025 Update to Section 194

The Union Budget 2025 introduced crucial changes:

• Threshold for Dividend TDS Increased – Earlier, TDS was applicable if the dividend exceeded ₹5,000 per shareholder per year. Budget 2025 has raised this limit to ₹10,000.
• This provides relief to small shareholders, particularly retail investors.
• TDS on Rent and Interest Income Thresholds Revised –
• Rent threshold increased from ₹2.4 lakh to ₹6 lakh (u/s 194-I).
• Senior citizen interest income threshold doubled from ₹50,000 to ₹1,00,000 (u/s 194A).

These changes reflect the government’s intent to simplify compliance and reduce the burden of TDS on small taxpayers.

Applicability of Section 194

Section 194 applies under the following conditions:

• The payer must be an Indian company, irrespective of whether it is private, public, listed, or unlisted.
• The recipient must be a resident shareholder.
• The dividend amount must exceed ₹10,000 in a financial year (post-Budget 2025 amendment).
• TDS applies to cash dividends, electronic transfers, and dividend credits.

This section does not apply to dividend payments made to non-resident shareholders, which are covered under Section 195.

Timing of TDS Deduction Under Section 194

TDS must be deducted at the time of credit or payment, whichever is earlier.

1. Credit Basis – When the dividend is credited to the shareholder’s account in the company’s books, even if not actually paid.
2. Payment Basis – When the dividend is actually paid, whether in cash, cheque, demand draft, or electronic transfer.

This ensures that the tax deduction happens at the earliest possible stage.

TDS Rates Under Section 194

The applicable rate of TDS on dividend income under Section 194 is:

• 10% – Standard deduction rate when PAN is provided.
• 20% – If the shareholder fails to furnish PAN.
• 0% / NIL rate – If the shareholder submits Form 15G/15H, subject to eligibility.

Illustration:

If a company declares a dividend of ₹25,000 to a shareholder:

• TDS = ₹25,000 × 10% = ₹2,500
• Net dividend paid = ₹22,500

If PAN is not provided:

• TDS = ₹25,000 × 20% = ₹5,000
• Net dividend paid = ₹20,000

Threshold Limit Under Section 194

The threshold for TDS applicability is crucial:

• Up to FY 2024-25: TDS applied if dividend exceeded ₹5,000 per shareholder.
• From FY 2025-26 (as per Budget 2025): TDS applies only if dividend exceeds ₹10,000 per shareholder per financial year.

This threshold applies per company per shareholder, not on a consolidated basis across multiple companies.

Exemptions Under Section 194

Certain dividend payments are exempt from TDS under Section 194. No TDS is required when:

1. Dividend is paid to LIC, GIC, or other insurance companies where shares are beneficially owned.
2. Dividend is paid to mutual funds specified under Section 10(23D).
3. Dividend is paid to business trusts from special purpose vehicles (SPVs).
4. Dividend paid to an individual shareholder not exceeding ₹2,500, if paid via account payee cheque.
5. Dividend paid to shareholders who have submitted Form 15G (individuals below taxable limit) or Form 15H (senior citizens).
6. Any person or category of persons specifically exempted by CBDT notification.

Compliance Responsibilities of Companies

Every company deducting TDS under Section 194 must comply with the following:

1. Deduction of TDS – Deduct at 10%/20% rate at the time of credit/payment.
2. Deposit of TDS – Deposit the deducted amount with the government by the due dates.
3. Quarterly Filing – File TDS returns in Form 26Q.
4. Issue TDS Certificates – Provide shareholders with Form 16A to claim TDS credit.
5. Maintain Records – Proper documentation of dividend distribution and TDS deduction.

Failure to comply can result in interest, penalties, and disallowance of expenses.

Time Limit to Deposit TDS

• April to February deductions → Deposit by the 7th of the following month.
• March deductions → Deposit by 30th April.

If the due date falls on a public holiday or Sunday, the next working day is considered the last date.

Deemed Dividend Under Section 2(22) of Income Tax Act

The definition of dividend under the Income Tax Act is wider than just declared dividends. Section 2(22) defines deemed dividends, which are also subject to TDS under Section 194.

1. Section 2(22)(a) – Distribution of Assets

• Any distribution of accumulated profits, whether capitalized or not, is considered a dividend.
• Includes distribution of company assets.
• Accumulated profits include current business profits and reserves, but exclude revaluation reserves and depreciation reserves.

2. Section 2(22)(b) – Issue of Debentures/Bonus to Preference Shareholders

• Distribution of debentures, debenture stock, or deposit certificates to shareholders.
• Bonus shares issued to preference shareholders also fall under this category.

3. Section 2(22)(c) – Distribution on Liquidation

• Any distribution on liquidation is considered a dividend to the extent of accumulated profits.
• Profits earned post-liquidation are excluded.
• In case of compulsory government acquisition, profits of the last 3 years before acquisition are not included.

4. Section 2(22)(d) – Reduction of Share Capital

Any distribution to shareholders on reduction of share capital, out of accumulated profits, is deemed dividend.

5. Section 2(22)(e) – Loans and Advances by Closely Held Companies

• Applies to private companies (closely held).
• Deemed dividend if:
• Loan/advance is given to a shareholder holding ≥10% voting power, or
• Loan/advance is given to a concern where such shareholder has ≥20% substantial interest, or
• Loan is given for the benefit of such a shareholder.

This provision prevents tax avoidance through disguised dividend payments.

Forms Under Section 194

• Form 15G – Declaration by individuals below taxable income.
• Form 15H – Declaration by senior citizens above 60 years of age.
• Form 26Q – Quarterly TDS return.
• Form 16A – Certificate of TDS deduction issued to shareholders.

Adjustment of Short or Excess Deduction

The company responsible for deducting TDS can make adjustments for short or excess deduction during the same financial year. This ensures accuracy and compliance without additional penalties.

Penalties and Interest for Non-Compliance

• Interest under Section 201(1A):
• 1% per month for failure to deduct TDS.
• 1.5% per month for failure to deposit deducted TDS.
• Penalty: Equal to the amount of TDS not deducted/deposited.
• Expense Disallowance: Dividend payments may be disallowed as deductible expenses.

Practical Example of TDS Under Section 194

Case Study:

XYZ Pvt Ltd declares dividend of ₹50,000 to Mr. A, a resident shareholder.

• Applicable threshold = ₹10,000
• Dividend exceeds threshold → TDS applicable.
• TDS @10% = ₹5,000
• Net dividend paid = ₹45,000

If Mr. A does not provide PAN, TDS will be deducted at 20% = ₹10,000, and he will receive ₹40,000.

Conclusion

Section 194 of the Income Tax Act is a vital provision ensuring TDS deduction on dividend income. With the abolition of DDT, dividend income is now taxable in the hands of shareholders, and companies bear the responsibility of deducting TDS.

The Budget 2025 increase in threshold from ₹5,000 to ₹10,000 provides relief to small investors, while ensuring larger dividend incomes remain within the tax net. Proper compliance, timely deduction, and accurate filing of returns are essential for companies to avoid penalties. Shareholders, on the other hand, must ensure proper PAN details and filing of returns to claim credit for TDS.

Ensure Hassle-Free Compliance with IndiaFilings

Managing TDS compliance under Section 194 can be complex for companies and confusing for shareholders. At IndiaFilings, we provide expert assistance in:

• Accurate TDS calculation and deduction.
• Timely deposit and return filing (Form 26Q).
• Issuance of Form 16A to shareholders.
• Guidance on Form 15G/15H declarations.
• Complete support for dividend taxation compliance.

Contact IndiaFilings today and make your Section 194 compliance simple, accurate, and stress-free.

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