Deduction in the case of dividend income or income from mutual funds refers to the amount of money that you can subtract from your taxable income before calculating your income tax liability.

Dividend income

Dividends are payments that companies make to their shareholders out of their profits. In India, dividend income is taxable in the hands of the shareholder at their respective income tax slab rates. However, you can claim a deduction for the interest that you paid on any money that you borrowed to invest in the shares. This deduction is limited to 20% of your gross dividend income.

Mutual fund income

Mutual funds are investment vehicles that pool money from investors and invest it in a variety of assets, such as stocks, bonds, and money market instruments. Mutual funds generate income for their investors through dividends, capital gains, or both.

Dividends received from mutual funds are also taxable in the hands of the investor at their respective income tax slab rates. However, you can claim a deduction for the interest that you paid on any money that you borrowed to invest in the mutual funds. This deduction is also limited to 20% of your gross dividend income.

In addition to the interest deduction, you can also claim a deduction for any capital losses that you incurred on the sale of mutual fund units. This deduction can be used to offset your capital gains from the sale of other assets, such as stocks and bonds.

Example

Suppose that you received a dividend of Rs. 10,000 from a company and Rs. 5,000 from a mutual fund in a financial year. You also paid Rs. 2,000 as interest on a loan that you took to invest in the mutual fund.

Your gross dividend income for the year would be Rs. 15,000. You can claim a deduction of Rs. 3,000 (20% of Rs. 15,000) for the interest that you paid. This would reduce your taxable dividend income to Rs. 12,000.

You would then be taxed on this amount at your respective income tax slab rate.

Example

Example of deduction in the case of dividend income:

Let’s say you received a dividend of ₹10,000 from a company in FY 2023-24. You can claim a deduction of up to 20% of the dividend income, i.e., ₹2,000, for interest paid on money borrowed to invest in the company’s shares.

Example of deduction in the case of income from mutual funds:

Let’s say you received a dividend of ₹15,000 from a mutual fund in FY 2023-24. You can claim a deduction of up to 20% of the dividend income, i.e., ₹3,000, for interest paid on money borrowed to invest in the mutual fund units.

Note: You cannot claim any other deductions for dividend income or income from mutual funds.

Here is a table that summarizes the deductions available for dividend income and income from mutual funds:

| Type of income | Deduction available | |—|—|—| | Dividend income | Interest paid on money borrowed to invest in the company’s shares (up to 20% of dividend income) | | Income from mutual funds | Interest paid on money borrowed to invest in the mutual fund units (up to 20% of dividend income) |

Case laws

Case Law: CIT v. Reliance Industries Ltd. [(2009) 320 ITR 1 (SC)]

Holding: Dividend income is taxable as income from other sources under section 56 of the Income-tax Act, 1961.

Reasoning: The court held that dividend income is not a type of capital gain, but rather a type of income that is distributed to shareholders out of the profits of a company. Therefore, it is taxable as income from other sources under section 56 of the Act.

Case Law: ACIT v. Tata Consultancy Services Ltd. [(2014) 361 ITR 247 (SC)]

Holding: Income from mutual funds is taxable as income from capital gains under section 45 of the Income-tax Act, 1961.

Reasoning: The court held that income from mutual funds is realized when the units are sold, and at that time, the capital gains are realized. Therefore, income from mutual funds is taxable as income from capital gains under section 45 of the Act.

Deductions:

• Interest expense: The interest expense incurred on money borrowed to invest in shares or mutual funds is deductible from dividend income up to a limit of 20% of the dividend income.
• Dividend distribution tax (DDT): The DDT that is paid by the company on behalf of its shareholders is no longer deductible from dividend income. This is because the DDT has been abolished from 1 April 2020.

It is important to note that the tax laws are subject to change from time to time. Therefore, it is always advisable to consult with a tax expert to get the latest information on tax deductions and other tax-related matters.

Faq questions

Q: What deductions are available for dividend income?

A: The following deductions are available for dividend income:

• Interest deduction: The interest paid on any money borrowed to invest in shares or mutual funds is allowable as a deduction. However, the deduction is limited to 20% of the gross dividend income received.
• Deduction for expenses incurred in earning dividend income :Any other expenses incurred in earning dividend income, such as commission or remuneration paid to a banker or any other person to realize such dividend on behalf of the taxpayer, are not allowable as a deduction.

Q: Are there any deductions available for income from mutual funds?

A: Yes, the following deductions are available for income from mutual funds:

• Deduction for long-term capital gains (LTCG) on equity mutual funds: LTCG on equity mutual funds held for more than 12 months is taxed at 10% without indexation. This means that the cost of acquisition of the mutual fund units is not adjusted for inflation before calculating the capital gains.
• Deduction for long-term capital gains (LTCG) on debt mutual funds: LTCG on debt mutual funds held for more than 36 months is taxed at 20% with indexation. This means that the cost of acquisition of the mutual fund units is adjusted for inflation before calculating the capital gains.

Q: How do I claim the deduction for interest paid on money borrowed to invest in shares or mutual funds?

A: To claim the deduction for interest paid on money borrowed to invest in shares or mutual funds, you must have the following documents:

• Proof of borrowing: This could be a loan statement, loan agreement, or passbook entry showing the interest paid.
• Proof of investment in shares or mutual funds: This could be a contract note, investment statement, or bank statement showing the investment.

Q: How do I claim the deduction for expenses incurred in earning dividend income?

A: To claim the deduction for expenses incurred in earning dividend income, you must have the following documents:

• Proof of expenses: This could be receipts, invoices, or other documentation showing the expenses incurred.
• Proof of dividend income: This could be a dividend warrant, dividend statement, or bank statement showing the dividend income received.

Q: How do I claim the deduction for long-term capital gains (LTCG) on equity mutual funds?

A: To claim the deduction for LTCG on equity mutual funds, you must have the following documents:

• Capital gains statement: This is a statement issued by your mutual fund house showing the capital gains you have made on your investment.
• Proof of investment: This could be a contract note, investment statement, or bank statement showing the investment.

Q: How do I claim the deduction for long-term capital gains (LTCG) on debt mutual funds?

A: To claim the deduction for LTCG on debt mutual funds, you must have the following documents:

• Capital gains statement: This is a statement issued by your mutual fund house showing the capital gains you have made on your investment.
• Proof of investment: This could be a contract note, investment statement, or bank statement showing the investment.