Why investing in dividend-paying companies help in better tax planning? Know what analyst says

- By Raghvendra Nath, Managing Director, Ladderup Wealth Management

Equity investors purchase shares of a company with the expectation that their investments will increase in the form of capital gains or get dividend benefits. Often investors get confused if they should chase the latest high-flyer in the stock market or should consider companies that are consistently profitable and are committed to paying dividends for the foreseeable future.

People invest in stocks to generate wealth in form of capital appreciation and by getting dividends. Thus, those companies which are cash rich and earn good profits distribute their profits to shareholders in terms of dividends. It’s a type of reward that the company pays to their shareholders when they earn profits. A few companies might offer dividends multiple times in a year. Dividends provide not only income but also accelerate the payback on investments. Numerous sizable businesses have routinely paid out big dividends over the years, including Vedanta Ltd., Coal India, Infosys, Reliance Industries, Britannia Industries, Sail, and many others.

Because they offer more lucrative returns than low bank fixed deposit rates, these dividend-paying equities are more alluring than cautious investment strategies. Even when the market is under a tight bear grip, high dividend yield stocks are better as they generate regular income as well as protect portfolio from the downside. If we look at historical data, we can find that dividend-yielding equities typically outperform other stocks over the long term.

Stock dividend payments are directly credited to your bank account. One needs to take into consideration two aspects. First, one needs to remember that companies pay a dividend based on the company’s earnings. If for some reason earnings were to decline, then these high dividends will not be there. Consideration of the taxation implications is an additional factor. Let's examine this in more detail.

Prior to April 1, 2020, the dividends received by shareholders from an Indian company were exempted. Thus, before disbursing payment to the shareholders, the dividend-paying company used to already pay the dividend distribution tax (DDT). But it wasn't really tax-free in the genuine sense of the word. Irrespective of their tax bracket, investors used to enjoy the same tax treatment. Small investors were paying the tax, which was much more than what they would have paid otherwise.

Dividends were rendered taxable in the hands of the investor according to their tax bracket in the 2020–2021 Union Budget. Investors in low tax brackets benefit from this, while those in higher tax brackets suffer the most. The tax burden on dividend income is higher for investors in high tax brackets. One should also be aware that the government now deducts tax from dividends at source (TDS). Dividend income that exceeds Rs. 5000 is subject to a 10% tax deduction.

Investing in dividend yielding aids in the investor's ability to generate consistent income flows. This sum may also be utilised to make additional lower-level stock investments. As a result, one will have more opportunities for money to grow and produce better returns, which will aid in wealth building.