India’s dividend tax shift makes mutual fund growth options more attractive

Dividends and mutual fund IDCW payouts are taxed at investors’ slab rates, while the removal of interest deductions further strengthens the case for growth options among higher-rate taxpayers.

Dividend income in India is taxed in the hands of the investor, not the company, and the treatment now applies equally to cash payouts from shares and to the dividend, or income distribution cum capital withdrawal, option in mutual funds. Under the current regime, those receipts are added to total income and taxed at the investor’s slab rate, while companies and fund houses must deduct tax at source when annual dividend payments from a single company or scheme cross ₹10,000.

That arrangement reflects a major shift in India’s tax policy. Dividend distribution tax, which was once paid by companies before profits reached shareholders, was abolished from 1 April 2020. The result was to move the tax burden on dividends directly on to investors. More recently, the threshold for tax deducted at source was lifted from ₹5,000 to ₹10,000 from 1 April 2025, while the deduction for interest on borrowings used to buy shares or fund units was removed from 1 April 2026, according to the material supplied and tax commentary on the post-2025 framework.

For resident investors, the default rate is the individual’s income-tax slab, with 10% deducted at source once dividend receipts from one company or scheme exceed ₹10,000 in a year. If a resident investor has not provided a Permanent Account Number, the deduction rises to 20%. Non-resident Indians are generally taxed at 20%, plus surcharge and cess, although a lower rate may apply under a tax treaty. The surcharge on dividend income is capped at 15%, regardless of the investor’s overall income.

The mechanics can be significant. An investor who receives ₹16,000 in dividends from one company in a year will have ₹1,600 withheld as tax deducted at source, leaving ₹14,400 in hand. But the full ₹16,000 is still treated as income for the year and taxed at the investor’s slab rate, with the withheld amount credited against the final bill. Someone in the 30% band would pay the balance when filing, while a taxpayer whose income falls below the taxable limit could claim a refund.

For mutual fund investors, the difference between the dividend and growth routes matters. Under the IDCW option, payouts are taxed when they are received, often at a higher rate than long-term capital gains on equities. Under the growth option, no tax arises until redemption, when capital gains rules apply. For equity funds held for more than 12 months, gains above ₹1.25 lakh a year are taxed at 12.5%, which can leave more money after tax than repeated dividend payouts for higher-rate taxpayers.

Filing also matters. Investors are expected to match annual statements from their broker or fund platform with Form 26AS and the Annual Information Statement, then report the gross dividend in the schedule for income from other sources in the income tax return. Tax already deducted can be claimed as credit, and any balance must be paid through advance tax or at filing. Taxpayers whose total income is below the limit can submit a nil-tax declaration to the company or fund house to prevent deduction at source; under the current system, that declaration is Form 121, which replaced Forms 15G and 15H.

The broader lesson is simple: the absence of tax deducted at source does not mean the absence of tax. Even dividends below the withholding threshold remain taxable and must be reported. For many investors, particularly those in higher slabs, the growth option in mutual funds may be more tax-efficient than receiving regular dividend payouts, especially now that interest expenses can no longer be offset against dividend income.