Deemed Dividends: Meaning, Types and Taxation

Dividends are the returns that a shareholder earns for investing in a company. In other words, dividend is the distribution of profit by the company to its shareholders. This dividend is taxed in the hands of the shareholders as “Income From Other Sources.” 

In certain cases, amounts received by the shareholders from the company, even though not as a dividend, will be deemed as a dividend and will be taxed accordingly. This article will cover the concept of deemed dividend and the taxability associated with it. 

What is Deemed Dividend?

Any benefit or payment other than the distribution of accumulated profits, made by a company to its shareholder who holds more than 10% of voting rights or related parties, whether as an official dividend or not, is known as a deemed dividend. These payments can be in the form of an advance or transfer of an asset other than cash.

The concept of deemed dividend only applies to private companies or companies where public participation is minimal.

What is Considered As Deemed Dividend?

The following cases of receipts are deemed to be dividends as per the Income-tax Act, 1961:

Distribution of Assets

As per Section 2(22)(a), any distribution of accumulated profits by the company to its shareholders will be a dividend if it includes the release of its assets, such as shares, etc., as a whole or in part. In this case, where the dividend is paid in kind as part of the company’s assets, the market value of such asset as on the date of such distribution is deemed as a dividend in the hands of the shareholder. 

Distribution of debentures, deposit certificates to shareholders and bonus shares to preference shareholders

As per Section 2(22)(b), any distribution of debentures or deposit certificates by the company to its shareholders will be deemed dividend. The market rate of such debentures or deposit certificates will be taxed in the hands of the shareholder.

Further, bonus shares given to preference shareholders to the extent of the company’s accumulated profits will also be deemed dividend. In this case, the market value of such bonus shares will be taxed in the hands of the preferred shareholders.

Distribution of Assets on Liquidation

As per Section 2(22)(c), any distribution made to the shareholders at the time of liquidation of the company, to the extent of the accumulated profits before liquidation is deemed to be a dividend. However, the distribution made after the date of liquidation is not a dividend. 

Distribution on Reduction of Share Capital

As per Section 2(22)(d), any distribution to the extent of accumulated profits of the company to its shareholders shall be deemed to be a dividend. 

Advance or Loan by a company to its shareholders.

As per Section 2(22)(e), any advance or loan to the extent of accumulated profits, given to a shareholder who has a beneficial interest, by a private company. Here a beneficial shareholder means one who holds 10% or more of the equity capital of the company.

Amount received on buy-back of shares by a domestic company

As per Section 2(22)(f), any amount received on the buy-back of shares by the company before 01.10.2024 will be taxed in the hands of the company and is exempt in the hands of the shareholder. 

Such amount received on or after 01.10.2024 will be deemed dividend and will be taxed in the hands of the shareholders at applicable slab rates.

The following table gives the taxability of the amount received on buy-back:

Exceptions To Deemed Dividend

The following are not considered as dividends:

Distribution in respect of shares issued for full cash consideration

Any shares issued for full cash consideration during liquidation or reduction of capital to a shareholder who is not entitled to part of the surplus asset are not dividends.

Payment on Buy-Back of shares

The amount received on the buy-back of shares before 01.10.2024 will not be treated as a dividend and is exempt.

Distribution of Shares on Demerger

The distribution of shares to the shareholders on account of demerger by the new company will not be treated as a dividend. 

Taxation Of Deemed Dividend

The following table summarises the tax treatment of deemed dividends: 

Calculation Of Deemed Dividend

Let us understand the calculation of deemed dividend with an example,

Example: Mr. Anban, a resident Indian, holding 30% of equity shares in RVP Pvt. Ltd, took a loan of Rs. 5,00,000 from the same company. The company had accumulated profits of Rs. 4,00,000. 

In this case,  as it is a private company, and Mr. Anban holds substantial interest i.e., more than 10% of equity shares, as per section 2(22)(e) the loan granted will be treated as a deemed dividend but only upto the extent of accumulated profits. Therefore, the deemed dividend taxable in the hands of Mr. Anban will be Rs. 4,00,000 and not the entire loan amount of Rs. 5,00,000.

However, if RVP was a public company, the provisions of deemed dividend would not be applicable.

Note: If an asset is transferred, its FMV will be treated as deemed divided.

Conclusion

Understanding deemed dividends is essential for both shareholders and companies to ensure compliance with tax provisions. This article provides clarity on the concept of deemed dividends and their taxation.