Deemed Dividend Under India’s Income-Tax Act, 1961

Statutory Design, Scope, Computation, Compliance & Litigation Trends (Updated 2026)

India’s Income-tax Act, 1961 adopts an inclusive and anti-avoidance definition of “dividend” under Section 2(22).

This means that certain corporate payments are taxed as dividends even if they are not dividends under company law. Typical examples include:

• Loans to controlling shareholders

• Distributions on liquidation or capital reduction

• Buy-back consideration (from 1 October 2024 onward)

In practice, Section 2(22)(e) — loans or advances by closely held companies — is the most litigated and controversial provision.

Recent Finance Acts (2018–2025) have significantly reshaped this area, especially with:

• Enhanced historical DDT regime (2018)

• Inclusion of buy-back payments as dividend (2024)

• IFSC inter-group carve-out (2025)

• Increased TDS threshold (₹10,000)

This article explains the law, its structure, computation, compliance strategy, and current litigation landscape.

1. Statutory Framework: Section 2(22)

Section 2(22) defines “dividend” inclusively. The key operative clauses currently applicable (as amended up to Finance Act 2025) are:

Clause	What is Treated as Dividend	Core Trigger
(a)	Distribution of accumulated profits involving release of assets	Profit-backed asset distribution
(b)	Distribution of debentures/deposit certificates or bonus shares to preference shareholders	Limited to accumulated profits
(c)	Distribution on liquidation	Only accumulated profits portion
(d)	Distribution on capital reduction	Limited to accumulated profits
(e)	Loan/advance to ≥10% shareholder or related concern	Capped by accumulated profits
(f)	Buy-back consideration (post 1 Oct 2024)	Entire buy-back payment treated as dividend

There is no current clause (g).

2. Section 2(22)(e) – The Most Litigated Provision

Legislative Intent

Clause (e) prevents closely held companies from distributing accumulated profits to controlling shareholders in the guise of loans instead of formal dividends. It is a legal fiction — courts repeatedly emphasize that it must be applied strictly as drafted.

When Does 2(22)(e) Apply?

Four key conditions must be satisfied:

1️⃣ Payer Company

Must be a company in which the public are not substantially interested (i.e., closely held).

2️⃣ Recipient Nexus

Payment must be:

• To a shareholder holding ≥10% voting power (beneficial owner), OR

• To a “concern” (firm/HUF/AOP/company) in which such shareholder has “substantial interest” (generally ≥20%), OR

• On behalf of or for the individual benefit of such shareholder.

3️⃣ Nature of Payment

Must be a loan or advance.

4️⃣ Accumulated Profits Cap

Taxable only to the extent of accumulated profits.

3. Trade Advances vs Loans – The Critical Boundary

One of the most litigated issues is whether a payment is:

• A genuine commercial/trade advanceOR

• A disguised profit distribution.

CBDT Circular No. 19/2017 clarified:

Trade advances arising from commercial transactions (e.g., purchase orders, job work, supply adjustments) should not be treated as deemed dividend.

The department has been instructed not to litigate settled trade advance cases. However, documentation and substance remain crucial.

4. Buy-Back Now Treated as Dividend (Section 2(22)(f))

From 1 October 2024, Finance (No. 2) Act 2024 inserted Section 2(22)(f). Now:

Any payment by a company for purchase of its own shares under Companies Act, 2013 Section 68 is treated as dividend.

Key Implications:

• Entire consideration is treated as dividend

• No deduction allowed under Section 57

• Shareholder taxed at slab rate

• Capital loss mechanics amended separately This marks a major shift in buy-back taxation.

5. IFSC Inter-Group Exclusion (Section 2(22)(iia))

Finance Act 2025 introduced a carve-out: Certain loans involving IFSC treasury/finance entities may be excluded from deemed dividend. This exclusion applies only if detailed conditions regarding:

• Finance Company/Finance Unit status

• Group entity definition

• Board-specified compliance conditions are satisfied.

6. Tax Consequences & Computation

Example 1: Loan to 10% Shareholder

• Loan: ₹60,00,000

• Accumulated profits: ₹40,00,000

Deemed Dividend = ₹40,00,000

Repayment within same year?❌ Irrelevant. Tax triggered in year of payment.

If shareholder in 30% slab:

Tax = ₹12,00,000Cess @4% = ₹48,000Total ≈ ₹12,48,000

Example 2: Loan to Concern

• Loan to firm: ₹30,00,000

• Accumulated profits: ₹25,00,000

Deemed dividend capped at ₹25,00,000.

Taxability depends on judicial interpretation (see litigation section below).

Example 3: Buy-Back (Post 1 Oct 2024)

• Consideration received: ₹10,00,000

• Entire ₹10,00,000 treated as dividend

• No deduction permitted

7. TDS & Compliance

Section 194 – Dividend TDS

Finance Act 2025 raised threshold:

• Earlier: ₹5,000

• Now: ₹10,000

TDS Rate:

• 10% (resident, with PAN)

• 20% (no PAN)

Company-Side Compliance Checklist

• Maintain accumulated profits computation

• Characterize payment correctly (loan vs trade advance)

• Maintain loan agreements

• Document board approvals

• Review shareholding structure before funding

8. Litigation Landscape

Section 2(22)(e) is among the most litigated provisions.

Supreme Court: Tarulata Shyam

Repayment does not nullify tax charge.

Supreme Court: P. Sarada

Current account withdrawals treated as deemed dividend.

Delhi HC: Ankitech

Amount not assessable in hands of non-shareholder concern.

ITAT Special Bench: Bhaumik Colour

Deemed dividend taxable primarily in hands of shareholder.

Supreme Court: Gopal & Sons (HUF)

Concern can be taxed depending on facts.

National Travel Services

Raised issues regarding registered vs beneficial ownership.

9. Persistent Risk Areas

• Inter-group funding structures

• Layered shareholding arrangements

• Accumulated profits miscalculation

• Director current account withdrawals

• Buy-back structuring post-2024

10. Transition to Income-tax Act, 2025

India has enacted the Income-tax Act, 2025 (effective 1 April 2026). Although policy intent may continue,:

• Section numbering may change

• Buy-back framework may evolve

• Cross-referencing between 1961 Act and 2025 Act will be critical

FY 2026–27 onwards will require careful technical interpretation.

Final Professional Insight

Deemed dividend is an anti-avoidance provision. Any closely held company distributing funds to significant shareholders — whether as loan, advance, or buy-back — must evaluate tax implications before execution. Improper structuring can result in:

• High tax exposure

• TDS defaults

• Interest & penalties

• Long-term litigation