Sources of Income
This sub‑topic explains the various sources of income that arise from equity investments, such as dividends and capital gains. Understanding each source is essential because tax rates differ, and the NISM exam tests your ability to identify and compute tax liability correctly. The content links directly to advisory practice, helping you guide clients on tax‑efficient investment choices.
Learning Objectives
- 1Identify all taxable income sources from equity products.
- 2Explain the tax treatment of dividend income.
- 3Distinguish short‑term and long‑term capital gains, including holding periods and rates.
- 4Apply tax formulas to compute liability for dividend and capital‑gain scenarios.
Understanding Sources of Income from Equity
Equity investments generate income primarily in two forms – dividend income and capital gains. Both are recognised under the Income‑Tax Act, 1961, but they are taxed under different provisions and at distinct rates.
Dividend income arises when a listed company distributes a portion of its profits to shareholders. The amount received is credited to the investor’s demat account or paid by cheque, and it is taxable in the hands of the recipient as per the prevailing dividend tax rules.
Capital gains occur when an investor sells equity shares at a price higher than the acquisition cost. The gain is classified as short‑term or long‑term based on the holding period, and each class attracts its own tax rate. The NISM exam frequently asks you to calculate tax on these gains, so mastering the classification criteria is crucial.
- Dividend – cash distribution from profits.
- Capital Gains – profit on sale of shares.
Dividend Income
From FY 2020‑21 onward, dividend received from Indian companies is taxable in the hands of the shareholder at the applicable slab rate. The earlier Dividend Distribution Tax (DDT) paid by the company has been abolished, and the dividend is now treated as ordinary income.
For the purpose of the NISM exam, remember that no tax credit is available against the dividend; the entire amount is added to the investor’s total income and taxed at the marginal rate. However, if the dividend exceeds ₹10,000 in a financial year, the payer must deduct Tax Deducted at Source (TDS) at 10% (subject to the recipient’s PAN). The investor can claim the TDS as a pre‑payment while filing the return.
Exam relevance: Questions often present a dividend amount and ask for the tax payable after considering the investor’s tax slab. A common trap is to still apply the old DDT rate of 15% – the correct approach is to use the individual’s slab rate.
Where:
D= Dividend received (in rupees)R= Applicable tax rate in percent (based on the investor's slab)Worked Example
Given D = 5,000 and R = 10% (assuming the investor is in the 10% slab): Step 1: Tax = (5,000 × 10) / 100 Step 2: Tax = 500 Verification: (5,000 × 10) / 100 = 500.
Many candidates still apply the pre‑FY2020 DDT rate of 15% to dividend income. The correct rule is that dividend is taxed at the investor’s personal slab rate, and DDT no longer exists.
Capital Gains
Capital gains are the profit earned on the sale of equity shares. The Income‑Tax Act classifies them as short‑term capital gains (STCG) if the shares are held for 12 months or less, and as long‑term capital gains (LTCG) if the holding period exceeds 12 months for listed equity.
STCG on listed shares is taxed at a flat rate of 15% irrespective of the investor’s slab. LTCG on listed equity enjoys a concessional rate of 10% on the amount exceeding the annual exemption of ₹1 lakh. The exemption does not apply to unlisted shares, where LTCG is taxed at 20% with indexation.
For the NISM exam, you must quickly identify the holding period, apply the correct rate, and remember the ₹1 lakh exemption for LTCG on listed shares. Forgetting the exemption or mixing up the rates for listed vs. unlisted securities is a frequent source of error.
Where:
SG= Short‑term capital gain (rupees)R_{ST}= STCG tax rate (15%)LG= Long‑term capital gain (rupees)Ex= Exemption amount for LTCG on listed equity (₹100,000)R_{LT}= LTCG tax rate (10%)Worked Example
Scenario: SG = 30,000; LG = 150,000. STCG Tax: (30,000 × 15) / 100 = 4,500. LTCG Tax: ((150,000 - 100,000) × 10) / 100 = 5,000. Verification: STCG = 4,500; LTCG = 5,000.
Comparison of Short‑Term and Long‑Term Capital Gains on Listed Equity
| Aspect | Short‑Term Capital Gains (STCG) | Long‑Term Capital Gains (LTCG) |
|---|---|---|
| Holding Period | ≤ 12 months | > 12 months |
| Tax Rate | 15% flat | 10% on amount above ₹1,00,000 exemption |
| Indexation Benefit | Not allowed | Not allowed for listed equity |
| Applicable to | All listed shares | All listed shares |
Indexation is not permitted for LTCG on listed equity shares. It is only available for LTCG on unlisted shares and immovable property.
Tax Computation Example – Dividend
Scenario
Rohit, an individual taxpayer, receives a dividend of ₹12,000 from XYZ Ltd. He is in the 20% tax slab. XYZ Ltd. deducted TDS of 10% on the dividend.
Solution
Step 1: Gross dividend = ₹12,000. Step 2: TDS already deducted = 10% of 12,000 = ₹1,200. Step 3: Tax payable as per slab = 20% of 12,000 = ₹2,400. Step 4: Net tax to be paid after adjusting TDS = ₹2,400 - ₹1,200 = ₹1,200. Step 5: Final tax liability = ₹1,200 payable while filing the return.
Conclusion
Rohit must pay an additional ₹1,200 as tax on dividend after adjusting the TDS already deducted.
Tax Computation Example – Capital Gains
Scenario
Anita sells two lots of shares in FY 2025‑26. Lot 1: 500 shares bought for ₹150 each, sold after 8 months for ₹180 each. Lot 2: 300 shares bought for ₹200 each, sold after 18 months for ₹260 each.
Solution
Lot 1 – STCG: Purchase cost = 500 × 150 = ₹75,000. Sale proceeds = 500 × 180 = ₹90,000. Gain = ₹15,000. Tax = 15% of 15,000 = ₹2,250.\nLot 2 – LTCG: Purchase cost = 300 × 200 = ₹60,000. Sale proceeds = 300 × 260 = ₹78,000. Gain = ₹18,000. Since LTCG exemption is ₹100,000, the entire ₹18,000 is taxable. Tax = 10% of 18,000 = ₹1,800.\nTotal tax payable = ₹2,250 + ₹1,800 = ₹4,050.
Conclusion
Anita’s combined tax on the two transactions amounts to ₹4,050, illustrating the need to separate STCG and LTCG for correct tax computation.
Other Minor Income Sources from Equity
Besides dividend and capital gains, a few ancillary receipts may arise from equity holdings. These include securities transaction tax (STT) paid on each purchase and sale, which is a cost to the investor but not taxable income.
Historically, companies paid Dividend Distribution Tax (DDT) before FY 2020‑21. Although DDT is no longer applicable, the exam may test your knowledge of the transition and its impact on the investor’s tax liability.
Share buy‑backs and bonus issues generate cash or additional shares but do not create taxable income at the time of receipt. However, they affect the cost base for future capital‑gain calculations, a nuance often examined in scenario‑based questions.
Tax Rates on Different Equity Income Sources (FY 2025‑26)
Impact on Advisory Recommendations
An investment adviser must consider the tax profile of each equity product when constructing a client’s portfolio. For high‑income clients, recommending equities with longer holding periods can convert STCG (15%) into LTCG (10% after ₹1 lakh exemption), improving after‑tax returns.
Advisers should also educate clients about dividend tax implications, especially for those in lower tax slabs where dividend income may be more tax‑efficient than short‑term capital gains.
Finally, documenting the acquisition cost, dates, and any corporate actions (bonus, split, buy‑back) is vital for accurate future capital‑gain calculations, a requirement under SEBI’s advisory compliance norms.
If a client’s investment horizon exceeds 12 months, advise holding listed equity for at least 13 months to benefit from the lower 10% LTCG rate after the ₹1 lakh exemption.
⭐Exam Takeaways
- Dividend income is taxed at the investor’s personal slab rate; DDT is no longer applicable.
- Short‑term capital gains (≤12 months) on listed equity are taxed at a flat 15% rate.
- Long‑term capital gains (>12 months) on listed equity are taxed at 10% on gains exceeding ₹1 lakh; no indexation benefit.
- STT is a transaction cost, not taxable income, but it adjusts the cost base for future capital‑gain calculations.
- Always separate STCG and LTCG in scenario‑based questions to apply the correct tax rate and exemption.
Practice Questions
8 questions on Sources of Income
Which of the following are the two primary sources of income from equity investments?
What is the tax rate applicable to short‑term capital gains on listed equity shares?
An investor in the 10% tax slab receives a dividend of ₹8,000. What is the tax payable on this dividend (ignore TDS)?
A listed‑equity long‑term capital gain of ₹150,000 is realized. What is the tax liability after applying the ₹1 lakh exemption?
Rohit receives a dividend of ₹12,000. The payer deducts TDS at 10% and Rohit is in the 20% tax slab. What is the additional tax Rohit must pay after adjusting TDS?
Anita sells two lots of shares. Lot 1 (held 8 months) yields a short‑term gain of ₹15,000. Lot 2 (held 18 months) yields a long‑term gain of ₹18,000. What is the total tax payable on both lots?
Which statement correctly describes the treatment of indexation for long‑term capital gains on listed equity shares?
If a dividend exceeds ₹10,000 in a financial year and the recipient’s PAN is available, what TDS rate must the payer deduct?