📌 Introduction
Dividend income is one of the most common forms of passive income for investors. Under the Income Tax Act, dividend is taxable under the head “Income from Other Sources” as per Section 56(2)(i).
However, the definition of dividend under the Act is much wider than its general meaning. It includes not only normal dividends but also several “deemed dividends” under Section 2(22).
In this blog, we will break down the concept in a simple and practical manner.
📖 What is Dividend as per Income Tax?
As per Section 2(22), dividend includes:
(a) Distribution of Accumulated Profits
- Any distribution by a company to shareholders
- Whether profits are capitalised or not
- If it involves release of company assets → treated as dividend
👉 Example:
If a company distributes assets instead of cash, the market value is treated as dividend.
(b) Distribution of Debentures / Bonus to Preference Shareholders
- Distribution of:
- Debentures
- Deposit certificates
- Bonus shares to preference shareholders
👉 Important:
- Bonus shares to equity shareholders = NOT dividend
- Value considered = Market value
(c) Distribution on Liquidation
- Amount received during liquidation
- To the extent of accumulated profits → taxable as dividend
👉 Note:
- Post-liquidation payments = Capital receipt (not dividend)
(d) Distribution on Reduction of Capital
- If capital is reduced and shareholders receive money
- It is treated as dividend to the extent of accumulated profits
⚠️ (e) Deemed Dividend – Loans & Advances
This is the most important.
When is Loan treated as Dividend?
If:
- Company is closely held (not public company)
- Loan/advance is given to:
- Shareholder holding ≥10% voting power, OR
- A concern where such shareholder has ≥20% interest
👉 Then:
➡️ Loan is treated as dividend (to the extent of accumulated profits)
💡 Key Points:
- Applies only to closely held companies
- Taxable in hands of shareholder
- Limited to accumulated profits
❌ Exceptions to Deemed Dividend
The following are NOT treated as dividend:
✔️ (i) Loan in Ordinary Course of Business
- If lending is a substantial business activity
- Then loan is NOT dividend
✔️ (ii) Inter-group Loans (Specific Conditions)
- Between group entities under prescribed conditions
✔️ (iii) Set-off of Dividend
- If loan is later adjusted against dividend → no double taxation
🧾 CBDT Clarification
As per CBDT Circular No. 19/2017:
👉 Trade advances (commercial transactions) are NOT treated as deemed dividend
Examples:
- Advance for job work
- Business-related payments
- Security deposits in business transactions
➡️ If transaction is commercial in nature, Section 2(22)(e) does NOT apply.
❌ Transactions NOT Treated as Dividend
- Distribution on demerger
- Shares issued for full cash consideration
- Certain non-participating shares
📊 Meaning of “Accumulated Profits”
Accumulated profits include:
- All profits up to the date of distribution
Special Points:
- Includes capitalised profits
- Excludes depreciation reserves (as per case law)
- In amalgamation → includes profits of amalgamating company
📅 Basis of Taxation (Section 8)
Dividend is taxable in the year:
- When declared OR
- Distributed OR
- Paid
👉 Whichever is applicable
⚡ Tax Rate on Dividend
- Taxable at normal slab rates
- Applicable for both:
- Domestic dividend
- Foreign dividend
📘 Practical Illustrations
✅ Illustration 1 (Trade Advance Case)
- Dhaval holds 65% shares in a company
- Company gives advance for job work
👉 Since it is a business transaction,
➡️ NOT treated as deemed dividend
✅ Illustration 2 (Loan Case)
- Shareholder holds 15% shares
- Loan received = ₹1,00,000
- Accumulated profits = ₹10,00,000
👉 Entire ₹1,00,000 is:
➡️ Taxable as deemed dividend
👉 Even if loan is repaid later:
➡️ Still taxable
🧠 Key Takeaways
✔ Dividend is taxable under Income from Other Sources
✔ Definition is very wide under Section 2(22)
✔ Loans to major shareholders = deemed dividend
✔ Trade advances = NOT dividend
✔ Taxable at normal slab rates
🔍 Conclusion
Understanding dividend taxation is crucial for:
- Investors
- Business owners
The concept of deemed dividend under Section 2(22)(e) is particularly important as it prevents tax avoidance through loans instead of dividend distribution.
Proper classification of transactions (loan vs business advance) can significantly impact tax liability.
👉 If you also earn income from property, make sure to read our guide on Income Tax on Rental Income in India to understand its tax implications.
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