Last Updated on February 21, 2026

Dividends are one way companies reward shareholders for investing in them. Dividends are typically paid out of the company’s profits and are liable to tax in the hands of the shareholders as “Income From Other Sources. Nonetheless, not all payments of gains obtained by shareholders from a company are regarded as dividends. Even if you don’t know what they are and aren’t listed as dividends paid to shareholders, some transactions or arrangements may still qualify as dividends for tax purposes under the Income Tax Act of 1961. The Income Tax Act defines these types of transactions and arrangements as dividends under Section 2(22)(e).

Among other things, this article discusses the definition of “deemed dividend”, the application of deemed dividends, Section 2(22)(e) provisions for dividends, who pays tax on deemed dividends, exceptions from deemed dividends and what taxpayers should expect when treated as a taxpayer for a deemed dividend.

Overview of Deemed Dividend

Any payment or benefit apart from the sharing of accumulated profits, undertaken by a company to its shareholder who owns over 10% of voting rights or associated parties, whether as an official dividend or otherwise, is known as a deemed dividend.

Deemed dividends apply solely to private limited companies or companies wherein the public is not substantially interested. These are also termed as closely held companies. Deemed dividends do not pertain to public limited companies or firms in which the public is substantially interested.

How does a Deemed Dividend Function?

Deemed dividend crops up when a closely-held company grants a loan or an advance to:

Any of its shareholders who owns over 10% voting power in the company, or
To any undertaking in which such shareholder is significantly interested, or
For the personal benefit of such shareholders, or
In lieu of such a shareholder.

The advance or loan should be doled out of the company’s accumulated profits, or the accumulated profits, including current year profits up to the date of payment. The amount of advance or loan deemed dividends is restricted to the extent of the company’s accumulated profits.

For instance, let us assume that ABC Pvt Ltd is a closely held company, and Hari is one of its shareholders, holding 15% of the shares. The company has amassed profits of Rs. 25 lakhs as on 31 March 2024. The company issues a loan of Rs. 10 lakhs to Hari by way of an account payee cheque. In this instance, the loan amount of Rs. 10 lakhs will be deemed dividends under Section 2(22)(e) with Hari.

Nonetheless, not all payments of gains obtained by shareholders from a company are regarded as dividends. Even if you don’t know what they are and aren’t listed as dividends paid to shareholders, some transactions or arrangements may still qualify as dividends for tax purposes under the Income Tax Act of 1961. The Income Tax Act defines these types of transactions and arrangements as dividends under Section 2(22)(e).

Eligibility for Deemed Dividend Under the Laws of Income Tax in India

The concept of deemed dividend comes under the definition of deemed dividend is defined within Section 2(22), Income Tax Act, 1961, and provides for deemed dividend to be classified within the meaning of ‘dividend’ for purposes of taxation, to also include certain transactions that fall outside of the normal definitions of dividend (and therefore deemed dividends may not necessarily be legally declared dividends).

Main Eligibility Criteria

The primary eligibility requirements for an entity to meet the criteria for deemed dividends are listed below.

Company Type

Only relevant for private companies or closely held companies.
Public companies are usually excluded.

Shareholder Type

Pertains to registered shareholders who own shares bearing voting rights.
Specifically appropriate for closely held companies (I.e., companies not significantly held by the public).

Nature of Transactions (Sections 2(22)(a)-(e))

2(22)(a): Sharing of assets to shareholders leading to a decrease in the company’s assets.
2(22)(b): Sharing on liquidation to the scale of amassed profits.
2(22)(c): Distribution on lowering of capital.
2(22)(d): Distribution of bonus shares out of gathered profits.
2(22)(e): Loans or advances provided to shareholders possessing ≥10% voting power, or to entities in which such shareholders have a considerable interest. This is the most popular deemed dividend scenario.

Accumulated Profits

The company must have gathered profits (exempting capitalised profits).
Transactions are deemed dividends solely to the degree of such amassed profits.

Exclusions

Loans are offered in the normal course of business where lending is a significant part of the company’s business.
Transactions not supported by amassed profits.

Practical Example

If a private company issues a loan to a shareholder who controls over 10% voting rights, and the company has gathered profits, that loan is considered a deemed dividend in the shareholder’s hands.

Tax Treatment

Taxed as “Income from Other Sources” in the hands of the shareholder.
Liable to TDS under Section 194 (for deemed dividend under 2(22)(e)).

Section 2(22) (E) of the Income Tax Act

Section 2(22)e of the Income Tax Act concerns how loans and advances the company makes to shareholders are deemed dividends. The specified payment methods are regarded as deemed dividends under this act.

Payments of loans or lending assets to a shareholder who has a significant interest in the firm are considered a deemed dividend; such amounts must be paid solely from accumulated profits.
Personal payments made by the company to shareholders will also be deemed dividends.

Shareholders’ Problems with Deemed Dividends

In an effort to avoid tax avoidance, Section 2(22) of the Income Tax Act allows for anti-avoidance tax enforcement through the concept of deemed dividend; however, this concept does result in a number of issues for the shareholders and their respective businesses.

Taxation Burden

Deemed dividends are taxed in the hands of the shareholder, not the concern or company obtaining the loan/advance.
This can seem unfair when the shareholder does not directly gain from the funds (e.g., when the loan is granted to an associated concern).

Complex Ownership Frameworks

The law enjoins the recognition of registered and beneficial shareholders with a considerable interest.
In group companies or family-controlled businesses, tracing ownership and deciding who bears the tax can be complex.

Cash Flow Mismatch

In contrast to regular dividends, deemed dividends do not entail a cash payout to shareholders.
Shareholders may incur tax liability without liquid funds to pay it, creating a cash flow strain.

Litigation & Interpretational Issues

Courts and tribunals frequently concern disputes about whether a transaction qualifies as a deemed dividend.
Frequent litigation creates uncertainty and increases compliance costs for taxpayers.

Involuntary Tax Exposure

Shareholders may involuntarily trigger deemed dividend provisions when companies issue loans/advances for genuine business purposes.
Even routine intercompany dealings can be reclassified as deemed dividends, resulting in unanticipated tax exposure.

Effect on Business Decisions

Closely held firms may be reluctant to offer loans or advances to shareholders or associated concerns.
This limits fund management flexibility and can affect growth strategies.

Timeline for Provisions of Deemed Dividend

The triggering event arises the minute a company takes up specific transactions that share accumulated profits indirectly, as under Sections 2(22)(a) to 2(22) (e) of the Act.

Relevant Financial Year

Taxability: A deemed dividend is taxed in the hands of the shareholder in the year in which the transaction occurs.
The date of the loan/distribution/advance is considered the date of the dividend announcement for tax purposes.

Assessment & Filing

During return filing, Shareholders must reveal deemed dividend income under “Income from Other Sources” in their Income Tax Return (ITR) for that assessment year.
Company’s role: The company is not subject to paying Dividend Distribution Tax (DDT) on deemed dividends; rather, the shareholder carries the tax liability.

Timeline for Compliance

Event date: Transaction happens (distribution, loan, etc.).
Same financial year: Income is deemed as a dividend
Assessment year (following year): Shareholder lists and reports the deemed dividend on their ITR.

Tax Rate

The tax rate that applies to the shareholders of a company is the rate that they would pay on their regular income tax, and not the subsidised rate of the dividend specified.
A Deemed Dividend under section 22(e) can be an easy method for avoiding paying taxes on what is essentially the ‘business profit’ generated by a closely held company when there has been no payment of a dividend.

Tax Implications of Deemed Dividends

Tax Liabilities:

Prior to the Finance Act of 2020, Dividends Distributions Tax (DDT) was paid by the company under section 115-O.
Shareholders did not incur tax directly on dividends (including deemed dividends).

After the Finance Act, 2020 (from 1 April 2020 onwards):

DDT scrapped.
A deemed dividend is taxable and is available to the shareholder under the head ‘Income from Other Sources’.
Tax is imposed at the regular slab rates applicable to the shareholder.

Scale of Taxability

Taxable to the degree of the amassed profits of the company.
Applies primarily to closely held companies (not extensively held/public companies).
Section 2(22)(e) relates to loans/advances to:
Shareholders possessing ≥10% voting power, or
Entities in which such shareholders carry ≥20% substantial interest.

Cost to Shareholder

Direct tax cost:

Added to total income and taxed at slab rates (could be as elevated as 30% + surcharge + Cess).

Indirect cost:

No discounted dividend tax rate (unlike normal dividends taxed at 20% for non-residents).
Considered as disguised profit sharing.

Cost of Compliance

Shareholder needs to:

Record deemed dividend in their ITR for the appropriate assessment year.
Keep documentation to verify whether a loan/advance is eligible as a deemed dividend (courts have spelt out that only advances with repayment dues qualify).

How Kanakkupillai Assists?

Get our roadmap on tax implications for companies and shareholders. We help you avoid unwanted tax obligations through our structured options and accurate ITR reporting. With our strategic guidance and compliance support, we add key value in translating complex tax law into actionable compliance measures for businesses and shareholders to optimise tax outcomes and minimise tax penalties.

Contact our tax advisory platform to resolve your deemed dividend issues and maintain foolproof documentation that protects against scrutiny during assessments.

Wrapping Up

The concept of deemed dividend aims to prevent tax evasion by closely held companies and their shareholders, who may resort to transactions equivalent to dividend distributions without paying tax on them. A deemed dividend is regarded as income available to the recipient and is taxed as such. Nevertheless, a few exceptions to the deemed dividend rules should be considered before undertaking any such transaction.

FAQ

1. Is a loan to a shareholder always deemed a dividend?

No. Only if conditions under Section 2(22)(e) are satisfied.

2. Is deemed dividend taxable?

Yes. Taxable under “Income from Other Sources” at the slab rate.

3. Is a deemed dividend applicable to public companies?

No. Applies only to closely held companies.

4. Is a share buyback treated as a deemed dividend?

No. Buyback is governed under Section 115QA (separate tax regime).

What is Deemed Dividend as per Income Tax Act?