Section 194K: TDS on Mutual Fund Distributions Demystified
Mutual fund investors often receive income in the form of dividends or capital gains. While capital gains are taxed at the time of redemption, dividend income is now subject to Tax Deducted at Source (TDS) under Section 194K of the Income Tax Act.
Introduced by the Finance Act 2020, this section ensures tax collection on mutual fund income before distribution, creating greater transparency in investment taxation. Let’s understand the scope, rates, exemptions, and compliance requirements of Section 194K TDS in detail.
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What is Section 194K of the Income Tax Act?
Section 194K mandates that any person responsible for paying income to a resident individual from mutual fund units must deduct TDS before crediting the income.
- It applies to dividends distributed by mutual funds, not capital gains.
- TDS is deducted when the amount exceeds the prescribed threshold.
The provision applies to resident investors only (non-residents are covered under Section 195).
Types of Mutual Fund Income Covered Under Section 194K
| Type of Income | TDS Applicability | Section Applicable |
|---|---|---|
| Dividend from Mutual Funds | ✅ Applicable under Section 194K | 194K |
| Capital Gains on Redemption / Sale | ❌ Not covered under Section 194K | Taxable as STCG/LTCG |
| Bonus / Reinvestment Income | ✅ TDS applies if treated as dividend distribution | 194K |
| Dividend from Equity / Debt Mutual Funds | ✅ Applicable | 194K |
Thus, only dividend distributions (periodic or reinvested) are covered under Section 194K, while redemption proceeds fall under capital gains taxation.
Purpose of Section 194K in Mutual Fund Taxation
Before FY 2020-21, mutual funds paid a Dividend Distribution Tax (DDT) before distributing dividends, and investors received the post-tax amount. Budget 2020 abolished DDT and shifted the tax liability to investors, introducing Section 194K to ensure TDS at source on dividend income.
Objectives of Introducing Section 194K
- Prevent revenue leakage due to underreporting of dividend income.
- Simplify tax collection through the TDS mechanism.
- Bring parity between dividend income from companies and mutual funds.
- Reduce the compliance burden on small investors by setting a threshold limit.
TDS Rate and Threshold Limits Under Section 194K
| Particulars | Details |
|---|---|
| Applicable From | 1 April 2020 |
| Applicable To | Resident individuals receiving mutual fund income |
| Nature of Income | Dividend distribution or reinvestment |
| Threshold Limit | ₹5,000 per financial year (per fund house) |
| TDS Rate | 10% on the dividend amount |
| If PAN not furnished | 20% |
| When to Deduct TDS | At the time of credit or payment, whichever is earlier |
Example: If you receive ₹6,000 as dividend from a mutual fund in a financial year, TDS @ 10 % = ₹600 will be deducted, and you’ll receive ₹5,400.
Exceptions and Exemptions Under Section 194K
| Exemption Scenario | Description |
|---|---|
| Dividend ≤ ₹5,000/year | No TDS deduction if total dividend from a mutual fund house is ≤ ₹5,000 in a year. |
| Income credited to NPS/EPF | Dividends credited directly to NPS/EPF accounts are exempt. |
| Non-Resident Investors | Covered under Section 195, not Section 194K. |
| Form 15G / 15H Submission | Investors with low income can submit these forms to avoid TDS deduction. |
TDS on Mutual Fund Redemption vs Dividends
| Basis | Dividend Income | Redemption / Sale Income |
|---|---|---|
| Nature of Income | Dividend Distribution | Capital Gains |
| TDS Applicability | Yes, under Section 194K | No |
| Tax Treatment | Added to total income and taxed as per slab | Taxed as STCG/LTCG based on holding period |
| Applicable Rate | 10% (20% if no PAN) | Nil TDS (tax payable during return filing) |
| Reporting | Shown under “Income from Other Sources” | Shown under “Capital Gains” |
This distinction is crucial because investors often mistake redemption proceeds for dividend income.
How Budget 2020 Changed Mutual Fund Taxation
Budget 2020 brought a paradigm shift in how mutual fund income is taxed.
Before Budget 2020
- Dividend Distribution Tax (DDT) was paid by mutual funds.
- Investors received dividend income tax-free.
- No TDS was applicable.
After Budget 2020
- DDT abolished.
- Dividend income became taxable in the hands of investors.
TDS under Section 194K introduced at 10 %.
| Taxation Aspect | Before Budget 2020 | After Budget 2020 |
|---|---|---|
| Tax Paid By | Mutual Fund House | Investor |
| TDS Deducted | No | Yes (u/s 194K) |
| Dividend Income Taxability | Exempt | Taxed as per income slab |
| DDT Rate | 11.648% to 29.12% | Abolished |
This reform aimed at making mutual fund taxation fairer and more transparent, especially for high-income investors
Consequences of Non-Compliance With Section 194K
Non-compliance can result in penalties, interest, and disallowance of expenses for mutual fund houses or distributors.
| Nature of Default | Penalty / Interest Applicable |
|---|---|
| Failure to deduct TDS | Interest @ 1% per month (from due date of deduction to actual deduction) |
| Failure to deposit TDS | Interest @ 1.5% per month (from deduction date to payment date) |
| Late filing of TDS return (Form 26Q) | ₹200 per day u/s 234E (up to total TDS amount) |
| Incorrect filing / mismatch | Penalty ₹10,000 – ₹1 lakh u/s 271H |
Mutual fund houses must ensure accurate deduction, deposit, and quarterly filing to avoid scrutiny.
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Conclusion
Section 194K ensures a fair and traceable system of tax collection on mutual fund dividend income. While investors now bear the tax liability, the TDS mechanism ensures early compliance and reduces chances of underreporting.
To summarize:
- TDS @ 10 % applies on dividend income above ₹5,000 per mutual fund house per year.
- No TDS applies on capital gains from redemption.
- Non-residents are covered separately under Section 195.
Investors should monitor Form 26AS , verify TDS credits, and declare dividend income accurately during ITR filing to avoid mismatches and scrutiny.
