Dividend Distribution Tax (DDT) is a tax paid by companies when they pay dividends to shareholders. It is also paid by mutual funds when they declare dividends to unit holders. In both cases, DDT is deducted at source and only the net dividend (after deducting tax) is paid to investors.
DDT Paid by Companies
DDT is deducted by companies at 15% of the dividend declared. The calculation of DDT is done through a complex gross payment method. Thus if a company has declared a dividend of Rs 10 per share, it will have to pay DDT of ((100*0.15/(1-0.15)) = Rs 1.1765 per share).
In addition, those investors who receive more than Rs 10 lakh in stock dividends per year, have to pay tax at 10% on the excess amount.
DDT Paid by Mutual Funds
Dividends paid by equity mutual funds are subject to DDT at 10%. This amount is also deducted by the fund at source and only the net amount is paid to you. Hence dividends are tax-free in the hands of investors, because the tax has already been deducted by the fund.
Note that this rate is the same as the long term capital gains tax rate on mutual funds (10%). However you also get an annual tax exemption on long term capital gains up to Rs 1 lakh. This is not available for mutual funds.
This makes capital gains in mutual funds a more tax efficient way of booking your profits than getting dividends in mutual funds.
Dividends paid by debt mutual funds are subject to DDT at 25%. After you add health and education cess and surcharge, the rate is approximately 29%. This is very close to the highest tax bracket in India at 30%.
However there is no additional tax on mutual fund dividends even if you receive more than Rs 10 lakh in dividends. This provision only applies to dividends from stocks.