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2020

Frequently Asked Questions on Section 194K of Income Tax Act, 1961

Frequently Asked Questions on Section 194K of Income Tax Act 1961

Q1: What does section 194K of the Income Tax Act says?

Any person responsible for paying to a resident any income in respect of:

  • Units of a mutual fund specified under Clause (23D) of Section 10; or
  • Units from the Administrator of the specified undertaking; or
  • Units from the specified company.

shall, at the time of credit of such income to the account of the payee or at the time of payment thereof by any mode, whichever is earlier, deduct income tax thereon at the rate of 10 per cent.

Q2: Who is the payee for the purpose of attracting the provisions of section 194K?

  • According to Section 194K, any ‘resident’ deriving an ‘income’ from mutual funds specified under Section 10 Clause (23D) will be subject to have a 10 per cent TDS. Before the clause was introduced, TDS on mutual funds was deducted for NRI investors and not residents.

Q3. What is the limit for non-deduction of TDS?

  • No TDS is required to be deducted if the income to a Resident from units of a mutual fund specified under Section 10(23D) or units from the specified company does not exceed ₹5,000 in a financial year.

Q4. When will the provisions of section 194K be applicable?

  • As per the Budget 2020 tax proposal, dividends distributed by mutual funds would become subject to 10% tax deduction at source (TDS) from the next financial year i.e. 2020-21.

Q5. Which incomes will be covered under section 194K?

  • No clarification has been issued in this regard. However, prima facie it appears that not only dividend income but capital gains from mutual fund units will also become subject to 10% TDS unless the government issues a clarification to the contrary.
  • Hence, TDS levy would be applicable to capital gains from mutual funds also and needs a suitable clarification from the government in case this is not the intention.
  • Also, the definition of “income” under Section 2(24) also includes capital gains. Therefore, if the provisions of the new Section 194K are not clarified, then TDS shall also become applicable on capital gains (including long term and short term capital gains) from mutual fund units.

Q6. What will be the effect of levy of TDS on capital gains under section 194K?

  • Levy of TDS on capital gains from mutual fund units would particularly impact those earning income from Mutual Funds via systematic withdrawal plans.
  • How TDS on long term capital gains from equity Mutual Funds will integrate into the taxation system is also not clear as long term capital gains from equity mutual funds and equity are exempt from tax up to₹1 lakh in a financial year for each individual.

Q7. What is the current system of taxation of capital gains from mutual funds?

Currently, capital gains from mutual funds are taxed as follows:

Taxation of Equity Mutual Funds:

  • Short-term Capital Gains: Short term capital gains (if the units are sold before one year) from equity funds are taxed at the rate of 15% plus 4% cess.
  • Long-term Capital Gains: Long term capital gains tax in equity funds are taxed at 10% + 4% cess provided the gain in a financial year is over ₹1 Lakh. Long term capital gains up to ₹1 lakh are exempt from tax for an individual in one financial year.

Taxation of Debt Mutual Funds:

  • Short-term Capital Gains: Short term capital gains (if the units are sold before three years) from debt mutual funds are taxed as per applicable tax slab rate of the investor. Therefore, if you are in the 30% tax slab then short term capital gains tax on debt fund is 30% + 4% cess.
  • Long-term Capital Gains: Long term capital gains from debt funds are taxed at 20% with indexation. To calculate capital gains with indexation, you should index your purchasing cost by multiplying the purchasing cost with the ratio of the cost of inflation index of the year of sale and cost of inflation index of the year of purchase, and then subtract the indexed purchasing cost from sale value.

Q8. What is the intention of the Government to introduce Section 194K?

  • In the Union Budget, the finance minister proposed to remove the deeply unpopular dividend distribution tax (DDT).Dividend income from shares and MFs will be now be taxable in the hands of the recipient — instead of the company of MF house — at applicable income tax rates.
  • Hence,accordingly a proposal has been included in Clause 80 of the Finance Bill 2020, in which the Ministry has proposed to insert a new section, 194K, below 194J of the existing Income Tax Act, proposing to tax income earned from mutual funds at 10 per cent.

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