What is investment income?
It is the income generated by buying, selling or investing in any type of company or assets. By using the well-planned strategy and diversification of portfolios, one can turn their savings into huge returns. Interest, dividends through stocks, and capital gain by selling real estate are all considered sources of income.
This income is paid either as a lump sum money or in instalments at regular intervals. Most people earn their income from jobs and employment services, but the right investment can generate extra income for them.
Types of investment income
The three main and basic categories of income through investments are:
Dividends are income paid by the companies to their shareholders. One can pay it on a yearly or quarterly basis. There is no fixed income; it usually depends on the value of the company in the market. The profit made by the company is distributed among all its shareholder based on stock percentage. The capital that is or distributed among the owners is reinvested in the company. It is a way to receive stable income and hence elevate the assurance among shareholders. In the joint-stock company, the payment of the dividend is not seen as an expense. It becomes the division of after-tax revenues amongst stockholders.
The profit earned by selling assets or commodities at a higher price than their purchased price is a capital gain. It includes a variety of things like stocks, cars or real estate. It is an economic concept where the value of the commodity rises over the holding period. A capital gain occurs only when the selling price exceeds the purchased price. If the opposite happens, then on selling the assets, when will go into loss. The capital gain is somehow considered analogous to other significant economic concepts like profit and rate of return. However, it differs from all of them. The distinctive characteristic of capital gain is that individuals can also make capital gains apart from business through buy and hold investment strategy.
Interest is the payment received from a debtor or financial organization to the lender or depositor. It is the money that is paid other than the principal sum that is lend borrowed at a specific rate. Interest differs from a fee that the debtor pays to the lender or third party. It is also different from the dividend. Dividends are paid by the company to their shareholders at no specific rate of interest but on the profit that it makes.
A person earns interest income by the investments on which interest are applicable, like bonds, certificates of deposits, money market instruments, etc. The investors used to be able to withdraw money without worrying about the principal amount invested. But nowadays, it is difficult due to the lower interest rate. One cannot expect to receive the same return by dividends and interest.
Investment income tax
The tax imposed on the three major incomes earned through investing money are:
Tax on dividends
A dividend tax is executed on dividends paid by the companies to their respective shareholders. The companies also have to pay tax on some of the withholding stocks. A dividend tax is levied directly on the profit that a corporation makes. Some authorities do not tax dividends. Some corporation distributes excess funds to shareholders through share buy-back method to avoid dividend tax. Another latent strategy is not to allocate the extra funds to investors, who already benefit from the increased value of their stocks.
In India, the dividend income received by the companies until 31 March 1997 were taxable, but the provision got removed. From April 2002 to March, the authorities eliminated the dividend distribution tax to dodge the double taxation of the dividends for the company and its shareholders. However, the 2008–2009 budget proposed the removal of the double taxation for some particular dividend cases received from the subsidiary. Budget 2020-2021 made the complete abolishment of dividend distribution tax. It eliminated the concept of dividend income being taxed for the investor as per the tax slab rate.
Tax on interest
The federal government levied a tax on most of the interest income. The interest income is taxed in the same way as any normal income is taxed. Interest earned from banks, deposits accounts or any other investment is subject to tax. The investors have to register their income earned to the main office. Under the Income Tax Act, section 80TTA, all savings accounts with interest-earning of up to Rs 10,000 is relieved from tax. This act applies to all types of bank accounts. If this amount exceeds, then the extra amount will be taxable. The bonds that are held for more than one year become subject to tax. The private activity bond and municipal bonds are generally exempted from paying taxes.
Tax on Capital gains
When the investment is sold at some profit, it becomes a taxable income. The tax is not applicable on unsold assets and stocks, no matter how long you hold them. The capital gain tax is valid on the profits gained from the sale of assets apprehended for more than a year. The rate of tax depends on the tax bracket of the investor. The capital gain tax applied through investing in short-term assets is the same as that of ordinary income. To avoid the high-rate taxes, the investors hold their venture for a longer period. The day traders who buy and sell their stocks within a day are taxed at higher rates.
The Income Tax Act keeps on changing from time to time, and this leads to tax fluctuation. One should keep themselves updated with the latest tax rule on dividends, capital gain and interests. These laws are often complicated, so it’s better that one take the guidance of their finance manager to avoid and fallback. While making the investment strategy, one should always keep in mind the applicable tax on every investment. The timely payment of tax is the obligatory duty of each and every citizen.