Income while you hold

Capital gains arise only when you sell. But holding investments earns you money in the meantime too, dividends on your shares and interest on your deposits and bonds, and that income is taxed as it arrives, whether or not you ever sell a single share. Many beginners believe dividends are tax-free, a belief that used to be partly true and is now wrong, and the surprise usually turns up at filing time. This short chapter clears it up.

Dividends are taxed in your hands

A dividend is a share of profit a company pays its shareholders. For years these were effectively tax-free in the investor's hands because the company paid a separate dividend distribution tax before handing them out. That system was abolished, and the rule is now the simpler and, for most people, less favourable one: dividends are taxable in the hands of the investor who receives them, added to your total income and taxed at your normal slab rate, under the head Income from Other Sources.

There is a collection mechanism attached. When a company pays you a dividend above a small annual threshold, it deducts tax at source, or TDS, illustratively 10%, and pays that straight to the government on your behalf, handing you the rest. That TDS is not an extra tax; it is a part-payment of the tax you owe, credited to you.

Follow it through. Suppose you receive 50,000 rupees of dividends in the year and you are in a 30% slab. The tax on that dividend income is about 15,000. The company already deducted TDS of about 5,000, so that much is paid, and you settle the remaining 10,000 when you file. The TDS the company deducted appears in the tax department's records against your name, in Form 26AS and the Annual Information Statement, which a later chapter shows you how to reconcile. The practical lesson is plain: dividends add to your taxable income, and TDS is only a down payment on the tax, not the whole of it.

Interest is taxed the same way

Interest income follows the same logic. The interest from bank fixed deposits, savings accounts beyond a small limit, bonds, and similar holdings is taxable at your slab rate, also under Income from Other Sources. Banks likewise deduct TDS on interest above a threshold, illustratively at 10%, which again is a part-payment credited to you, not a final tax. So a saver in a high slab who assumed the bank's TDS settled everything can owe more at filing, exactly as with dividends.

Why this shapes an investor's choices

This has a quiet consequence worth carrying into how you invest. Because dividends are taxed at your slab as they arrive, a company that pays out large dividends creates a yearly tax bill for a taxed investor, while a company that instead reinvests its profits to grow, paying little or no dividend, defers the tax into a future capital gain that is often taxed more gently. This does not mean dividends are bad, but it does mean that for an investor in a high slab, a high dividend is not the pure benefit it appears, a point the Fundamental Analysis course touched on and the tax-aware chapter returns to. As always, the right choice depends on your own situation, not on tax alone.

What to carry forward

Holding investments earns dividends and interest, and both are taxable in your hands at your slab rate under Income from Other Sources, with TDS acting only as a part-payment credited to you, not a final tax. Dividends are no longer tax-free, so they add a yearly tax bill that a high-slab investor should weigh, one reason a low-dividend, reinvesting company can be more tax-efficient.

Everything so far, gains and income alike, has centred on equity. The moment you invest outside equity, into debt funds, gold, or property, the rules change, and several changed recently. The next chapter surveys how other assets are taxed, and why you must always check the specific rule.