Deemed Dividend- Section 2(22)(e) of Income Tax Act: Detailed Analysis

Dividend refers to the return(s) received by a shareholder as a result of investment in a company by way of share capital. Dividend is a part of the earning of the company which is distributed to the shareholder. Such dividend is tax-free for the recipient as companies are required to pay DDT (Dividend Distribution Tax) at the time of distribution of dividends.

In Income tax Act 1956, Dividend also includes ‘Deemed Dividend under section 2(22)(e) and this article covers the taxability of deemed dividends under the Income Tax Act in detail.

What is deemed dividend under section 2(22) of the income tax act

As per section 2(22)(e) of income tax act, Any payment made by a company, not being a company in which public is substantially interested (ie. closely held company or unlisted company) of any sum by way of advance or loan to:

  • Any of its shareholders who hold more than 10% of voting power in the company or
  • To any concern in which such shareholder (shareholders holding more than 10% of voting power) is substantially interested or
  • On behalf of such shareholder or
  • For the individual benefit of such shareholder

-to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22)(e).

What are the exception to section 2(22)(e) of income tax Act

Following Payments are not to be treated as deemed dividend-

  • The loan is given by a company involved in money lending, where lending loans is an ordinary course of business of the company.
  • Loan extended to shareholders, subsequently adjusted against dividend declared and distributed later

Whether Dividend under Section 2(22)(e) is taxable in the hand of shareholders or company?

As per section 10(34) of income tax act, dividend received by individual/HUF from an Indian company is exempt from income tax in the hand of shareholders as the company has already paid Dividend distribution tax on the distribution of such dividends.

But prior to 01-April-2018, Companies paying deemed dividends were not required to pay DDT on such payments. However, Budget 2018 introduced an amendment in Section 115-O of the income tax act. This amendment mandated such companies to pay DDT on deemed dividends on or after 1 April 2018. It sought to levy this tax on closely-held companies (Unlisted companies/Privately held company) as they generally hide dividends by making them look like loans or advances.

As a result, Deemed dividend u/s 2(22)(e) shall be exempt in the hands of shareholders and the company needs to pay Dividend distribution tax on the deemed dividend.

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