Use Code: ITR40
File ITR Today
Dividend refers to the returns a shareholder receives for investing in a company. Dividends are usually paid out of the company's profits and are subject to tax in the hands of the shareholders.
For example, let us say that Company ‘A’ is making sound amounts of net profit and wants to distribute the profits with its shareholders, The board of the company decides to give 3% returns per share to every shareholder. Each share unit costs Rs. 100, so for every share, the shareholder receives Rs. 30; this amount is called a ‘Dividend’.
Whereas the deemed dividend is a particular amount or asset loaned to a shareholder who has a substantial share in that company, for the purpose of taxation, the loaned amount is considered to be a ‘deemed dividend.’ The loan or advancement amount should only be provided from the company's accumulated profits. It is to be noted that only private limited companies whose activities are not of public substantial interest are eligible for a Deemed Dividend.
"Substantial interest" in a company generally refers to a significant ownership stake or financial interest held by an individual or entity in a particular business. When a shareholder holds at least 10% of shares and 10% of the voting interest in a company, he is said to have a substantial interest in that company.
In many cases, substantial interest is determined by the percentage of ownership or control an individual or entity holds in a company. For instance:
The concept of substantial interest often plays a crucial role in tax laws, especially concerning matters such as:
Let us say that Mr. X is a shareholder of company ’Z’, He holds shares worth 20%. As of April 10, 2020, Company Z has an accumulated profit of Rs. 5,00,000. Now, Mr.’X’ approaches the board to request a loan of Rs. 1,00,000. Mr.’X’ being a shareholder having substantial interest in company Z, the board agrees to loan him Rs. 1,00,000, after a month i.e, on May 10th. Mr. X returns the loaned amount back (which is before the end of the current financial year), although Mr. X has returned the amount, Rs. 1,00,000 made from the accumulated profits, the loaned amount will be treated as ‘Deemed Dividend’.
Section 2(22)e of the Income Tax Act deals with how the types of loans and advances the company makes for the shareholder are deemed dividends. The following are the payment methods that are considered to be deemed dividends under this act,
From 1 April 2020, the way dividends are taxed has changed.
Earlier, companies had to pay Dividend Distribution Tax (DDT) before giving dividends to shareholders. Because of this, dividends were mostly tax-free for shareholders.
Now, DDT has been completely abolished.
When a closely held company gives a loan or advance to a major shareholder, it is treated as deemed dividend under Section 2(22)(e).
Yes.
| Recipient | Transaction | Tax Treatment |
|---|---|---|
| Individual shareholder | Loan or advance from a closely held company | Deemed dividend is taxable as income from other sources at the applicable slab rates |
| Concern in which shareholder has a substantial interest | Loan or advance from a closely held company | Deemed dividend is taxable as income from other sources at the applicable slab rates |
| Individual shareholder | Payment for individual benefits from a closely held company | Deemed dividend is taxable as income from other sources at the applicable slab rates |
| Closely-held company | Loan or advance from another closely held company | Deemed dividend is taxable as income from other sources at the rate of 30% (plus surcharge and cess) |
| Public limited company | Loan or advance from a closely held company | Deemed dividend is not taxable, as Section 2(22)(e) is not applicable to public limited companies |
The following are some key exceptions where loans or advances are not treated as deemed dividends:
Here’s an improved version of the content on exceptions to deemed dividends and the difference between deemed dividends and actual dividends:
| Category | Deemed Dividend | Actual Dividend |
|---|---|---|
| Applicable to | Closely held companies | Public companies |
| Nature of transaction | Loans and advances distributed to shareholders | Dividends distributed to shareholders |
| Shareholder requirement | Shareholders with more than 10% voting power | All shareholders |
| Tax Rate | 30% + cess and surcharge | 15% + cess and surcharge (if dividend > ₹5,000) |
Dealing with deemed dividends and their exceptions can be tricky for shareholders and directors, especially under Section 2(22)(e) of the Income Tax Act. Misunderstanding these provisions can lead to unintended tax liabilities, higher rates, and compliance issues.Our experts help you structure transactions efficiently, leveraging exceptions where applicable, so you pay only what you owe. Connect with the experts.
Section 2(22)(e) defines certain transactions or payments made by a company to its shareholders or their associates as deemed dividends for taxation purposes, even if they aren't officially categorized as dividends.
Transactions that might be considered deemed dividends include distributions of accumulated profits, loans, advances, or assets provided to shareholders or their associates by the company.
Deemed dividends are typically subject to taxation at the hands of the recipient shareholders or associates as per the income tax rates applicable in their jurisdiction.
Exceptions might exist, such as loans given in the ordinary course of business, or transactions that are specifically exempted or not covered by the provisions of the Act. Specific provisions can vary across different jurisdictions.
It's essential to maintain clear records and documentation regarding transactions between a company and its shareholders or associates. Seeking advice from tax professionals or legal experts is advisable before engaging in transactions that might fall under the purview of deemed dividends.
This section prevents companies from distributing profits to shareholders in the form of loans, advances, or assets without categorizing them as dividends to avoid taxation. By deeming certain transactions as dividends, it ensures proper taxation of these distributed profits.
For detailed and specific guidance, individuals and companies should refer directly to the Income Tax Act of their respective jurisdiction or consult with tax professionals well-versed in local tax laws.
