What is Equity Income?
Equity investment can provide a return in two ways - capital appreciation and dividend income. While capital appreciation refers to an increase in the market value of equity shares, a dividend refers to the distribution of profits by a company to its shareholders. Equity income is also known as dividend income. This blog post is a detailed explanation of equity income.
Equity Income
Profit-making companies can either reinvest their profits or distribute them amongst their shareholders. Companies in their growth phase tend to plough back their profits. However, mature companies with limited investment opportunities usually pay dividends as a way of reward to their investors for investing in their business. It is worth noting that dividends on equity shares are never guaranteed, but are paid at the discretion of the company.
Companies paying equity income are usually well-established with have a history of paying dividends. This creates a constructive obligation on them to continue distributing profits. The stocks of dividend income paying companies tend to be value stocks which trade at levels below their fundamentals.
For example, say Company N made a net profit of INR 25 lacs in the previous financial year. It plans to increase its marketing efforts and hence, chooses to reinvest INR 20 lacs of that money in the business. It had sufficient funds in cash and decided to distribute the balance of INR 5 lacs to its shareholders by way of equity income.
Unlike interest to debt holders, dividends to equity holders are not an expense to a company. They are simply a distribution of the company’s excess profits to its investors. Hence, paying dividends does not reduce a company’s taxable income.
Equity Income Investing
Equity income is one of the sources through which one can make passive income. Investors buying equity income stocks tend to hold them for a longer-term, mainly because it provides them with a constant cash income.
Also, dividends are usually paid out by well-established companies. Hence, equity income investing is ideal for moderately conservative investors.
Investors wanting to earn a regular income can also consider putting their money in a dividend yield fund’. It is a type of mutual fund which invests heavily in equity shares that provide regular dividends. However, the dividends are not guaranteed and are subject to market risk.
Example
ITC Ltd., the Indian conglomerate with a diversified business presence across sectors like FMCG, hospitality, software and packaging has paid dividends 23 times since 2001. For the financial year ending March 2021, ITC declared an equity dividend of 1075.00% amounting to INR 10.75 per share.
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Frequently Asked Questions
Yes, equity income is subject to income tax in the hands of the investor. Dividends are taxable as per the applicable slab rate of the shareholder. A tax @ 10% is deductible at source (TDS) in case the dividend receivable is greater than INR 5,000. For non-individual shareholders (Company, Firm, HUF, etc.), equity income is subject to TDS without any limit.
For eg: Mr X received a dividend amounting to INR 15,000 from Company T. Since his dividend income exceeds INR 5,000, Company T deducts a TDS @ 10% which amounts to INR 1,500. Mr X receives the balance amount of INR 13,500. Further, the equity income is taxable in the hands of Mr X at the applicable slab rates. Mr X can claim the TDS of INR 1,500 as credit from his total tax liability while filing his annual income tax return.
Dividend can be expressed as a percentage (on face value) or in absolute terms as dividend per share (DPS). It is pertinent to note that only the equity holders holding shares on the record date receive dividend income. The record date is when the investors must be listed in the company's register of members to be eligible to receive dividend income.
For instance, a company has 10,000 outstanding equity shares with a face value of INR 100 each. It declares a dividend of 2%. The record date is 28 March 2022. This implies that the company will payout INR 2 (100*2%) on each share. This will be paid to those investors who hold shares on 28 March.