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Deemed Dividend under Section 2(22)(e)

Updated on:  

08 min read

The term ‘Dividend’, as generally understood, refers to the return(s) earned by a shareholder for investing in a company by buying its shares. Such dividend was tax-free for the recipient as companies paying dividends already pay Dividend Distribution Tax when they pay out the dividend.

Interestingly, for the purpose of Indian tax laws, a dividend also included ‘Deemed Dividend’ in its ambit. This article throws light on the taxability of deemed dividend.

Latest Update

In Budget 2020, the Finance Minister has abolished Dividend Distribution Tax (DDT). Now the incidence of dividend income taxation is shifted to investors from the companies.

Update from budget 2021:

  1. Exemption from ITR filing to senior citizens aged 75 years and above, earning only pension and interest income.
  2. The income tax department launched pre-filled ITRs with additional details to simplify the return filing process.
  3. The due date for filing belated and revised returns is reduced by 3 months. This also means that the IT department will have to process the returns and send a notice under section 143(1) by 31st December.

Deemed Dividend under Section 2(22)(e)

According to Section 2(22)(e), when a company in which the public are not substantially interested*, extends a loan or an advance to:

a. any of its shareholders who has more than 10% voting power in the company or
b. to any concern in which such shareholder is substantially interested or
c. for the individual benefit of such shareholder or
d. on behalf of such shareholder to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22)
*a company in which public is not substantially interested is otherwise called a closely held company.

Exceptions

Payment under circumstances specified below will not be treated as a deemed dividend:
a. Loan given by a company involved in money lending, where loans have been extended in the ordinary course of business
b. Loan extended to shareholders, subsequently adjusted against dividend declared and distributed later

Illustration

Here is a simple illustration to explain the provisions of deemed dividends.

ABC Pvt Ltd. is a company, the public is not substantially interested in. Hari is one of the company shareholders, who hold 15% shares. The company has accumulated profits of Rs.25 lakhs as on 31 March 2018. The company granted a loan of Rs.100,000 to Hari, by way of an account payee cheque. He repaid the amount on 5 May 2018.

In this case, even if the loan has been repaid by Hari, the loan amount granted to the extent of accumulated profits are treated as deemed dividend.

Income tax implications

Earlier (prior to 1st April 2018), companies that pay out deemed dividends would not pay DDT on such payments.
Budget 2018 introduced an amendment to Section 115-O that addresses this.
It mandated such companies to pay DDT at the rate of 30% plus applicable surcharge and cess on transactions carried out on or after 1 April 2018. 

This amendment has been introduced because the taxability of deemed dividend in the hands of recipient made tax collection on it from the shareholder difficult. As a result, the shareholder doesn’t have to pay any taxes on such receipts.

In Budget 2021, the burden of paying tax on dividend is transferred to the shareholders. Now the companies are not liable to pay Dividend Distribution Tax (DDT) while distributing dividends to the shareholders, i.e. DDT is abolished.
These amendment has put all this to rest.

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