Deemed Dividend under Section 2(22)(e) of Income Tax

A dividend is the return(s) that a shareholder receives after purchasing a company’s shares. Tax is not levied on dividends for the recipient, as companies pay dividend distribution tax in the initial stage. However, 'dividend' also includes 'deemed dividend' under its confines.

A deemed dividend is an income that is referred to as a dividend, though it is not distributed by a closely-held company. Deemed dividend tax falls under the Income Tax Act’s Section 2(22)e. As per Section 2(22)e, when a closely held company gives a loan or extends an advance to the respective personnel:

• A shareholder who holds a minimum of 10 per cent of the voting rights and is the beneficial owner of shares. However, the shares held mustn't be entitled to a dividend rate’s fixed rate.
• When such a shareholder is substantially interested in any business concern.
• For such a shareholder's individual benefit.
• To a specific extent on behalf of such shareholder.

Till the company earns profits, payments like these are deemed dividends under Section 2(22)e. However, other than the above-mentioned points, loans handed out by a subsidiary company to its parent company are also subject to this section.

Tax is levied on dividend income in the declaration/payment/distribution year. Recipients are not taxed on dividends, as they receive an income tax exemption. However, deemed dividends don’t receive that exemption. Shareholders do have to pay a nominal tax rate.

DDT was abolished economy-wide from 1 April 2020. Since then, dividend income (including deemed dividend) is taxed directly in the recipient’s hands at their slab rate, not via a 30% company-level DDT. Verified against the Income Tax Department’s official page on the taxation of dividends and interest.

There are a few conditions that apply when determining the tax on a deemed dividend. Here they are:

• The paying company can’t be a company in which the public isn’t substantially interested, while the receiving company can be listed or public.
• The company loans or advances should not be in the business’ ordinary course.
• The company has to be assigned by the shareholder as their creditor.
• The accumulated profits of the company are the only consideration for a deemed dividend. All the commercial profits of a company till the distribution/payment/liquidation date are considered as accumulated profits.

Most people only hear about the “losses deemed dividends” section – 2(22)(e) – because it is the one that catches directors and shareholders off guard. But the Income Tax Act actually lists five different situations under Section 2(22) where a payment is treated as a dividend even though the company never formally declared one. Here is the full picture, explained simply, before we go deep into 2(22)(e).

Sec 2(22)(a) – Distribution of accumulated profits releasing company assets

If a closely held company gives a shareholder an asset (instead of cash) out of its accumulated profits – say, a company car or property – the market value of that asset on the date of distribution is treated as a dividend in the shareholder’s hands.

Sec 2(22)(b) – Issue of debentures, deposits, or bonus shares to preference shareholders from accumulated profits

If the company issues debentures or deposit certificates to shareholders or gives bonus shares to preference shareholders, funded out of accumulated profits, this too counts as a deemed dividend, valued at the market rate.

Sec 2(22)(c) – Distribution on company liquidation

When a company winds up and distributes its accumulated profits to shareholders, the amount distributed (up to the level of accumulated profits before liquidation) is a deemed dividend. Anything distributed after the liquidation date does not count.

Sec 2(22)(d) – Distribution on capital reduction (to the extent of accumulated profits)

If a company reduces its share capital and pays out money or assets to shareholders, the portion that comes from accumulated profits is treated as a deemed dividend.

Sec 2(22)(e) – Loans/advances to a substantial shareholder or a connected concern

This is the most commonly triggered clause for small and family-run private companies. It applies when a closely held company gives a loan or advance to:

• A shareholder who holds more than 10% of the company’s voting power (a “substantial shareholder”), or
• A company or concern in which such a shareholder also has a substantial interest.

This provision is the clause that most small private companies encounter, usually when a director borrows money from their own company, so the rest of this article focuses on it in detail.

The term “dividend” describes the returns on an investor’s investment in a corporation.

Let's take an example where a firm is producing a good net profit and wishes to distribute the earnings to its shareholders. The board of the company chooses to pay each shareholder a 3% return on their investment. Each share unit costs Rs. 100. Therefore, the shareholder receives Rs. 30 for each share, which is known as a "dividend."

While the “deemed dividend” is actually a specific sum of money or asset lent to a shareholder with a sizeable stake in the company, for tax purposes, the sum qualifies as a “deemed dividend". Only the company's accumulated profits should be used to fund any debt or advancement.

The Income Tax Act, Section 2(22)e, explains how some loans and advances made by a firm to a shareholder are recognised as deemed dividends. The payment types listed below are those that this statute considers to be deemed dividends:

• Payments of loans or lending of assets to a shareholder who owns a significant stake in the company are deemed dividends and must come only from earnings that have been accumulated.
• Loans from accumulated profits given to a parent business by a subsidiary company.
• Advances given to shareholders by the company to help them install equipment and plant that would allow them to execute an export order.
• The corporation will also count any personal payments given to shareholders as declared dividends

This term decides whether the section applies to you at all, so it is worth getting right. In plain terms:

• You are a “substantial shareholder” of a company if you hold 10% or more of its equity shares and voting power.
• If you also control (directly or through family) 20% or more of a separate firm, HUF, or company, a loan from your company to that separate entity can also be taxed as a deemed dividend in your hands – not the entity’s.
• Preference shares with a fixed dividend rate are excluded; only ordinary voting shares count towards the 10% test.

Think of it this way: the law isn’t worried about a random small shareholder taking a loan from the company – that’s normal business. It’s worried about someone who effectively controls the company and uses that control to pull money out tax-free, disguised as a loan. The 10% threshold is the law’s way of identifying “people with real control", much like how a landlord only worries about a tenant who could realistically decide to stop paying rent, versus one who has no say at all.

1.Closely held company: The company loaned to must be one in which the public is not substantially interested (i.e., a private limited company, not a listed public company).

2.Accumulated profits exist: The company must have accumulated profits on the date the loan is given. No accumulated profits means no deemed dividend, regardless of the loan amount.

3.Substantial shareholder: The recipient must hold 10% or more of the voting equity in the company (or be a concern where such a shareholder holds 20%+ interest).

4.It is a loan or advance, not a genuine business transaction: trade advances, security deposits for a genuine commercial arrangement, or payments in the ordinary course of business are not covered.

Here is a second, simpler worked example using round numbers, useful for a quick mental check:

Why ₹8,00,000 and not less? Because the full loan amount is within the company’s accumulated profits of ₹10,00,000. If the loan had instead been ₹12,00,000, only ₹10,00,000 (the accumulated profits figure) would be taxed as a deemed dividend – the remaining ₹2,00,000 stays as a plain loan, not a dividend.

The Dividend Distribution Tax (DDT) was abolished economy-wide, effective 1 April 2020. From that date onwards, all dividend income – including deemed dividends under Section 2(22)(e) – is taxed directly in the hands of the recipient shareholder at their regular income tax rate, under the head “Income from Other Sources". There is no flat 30% company-level tax and no DDT on this type of transaction anymore.

Important correction – TDS under Section 194 does NOT apply to 2(22)(e)

A common claim online is that companies must deduct 10% TDS under Section 194 on deemed dividends, just as they do for regular dividends. This is incorrect for Section 2(22)(e) specifically. Section 194 TDS applies to dividends under clauses 2(22)(a) to (d) and to dividends generally – but a deemed dividend arising from a loan/advance under 2(22)(e) is excluded from Section 194 TDS. This has been confirmed in recent rulings, including the ITAT Ahmedabad decision in Mateshwari Bus Operations Pvt. Ltd v. ITO (TDS) (order dated 29 September 2025), which held that TDS under Section 194 is attracted only where the payment is a dividend paid to a shareholder under the standard provisions – not on a deemed-dividend loan where no actual cash dividend was declared.

Practical effect: the company does not withhold tax when it gives the loan. The shareholder is responsible for including the deemed dividend amount in their own return and paying tax on it directly (via advance tax or self-assessment tax) at their slab rate. If your accountant tells you otherwise for a 2(22)(e) case, ask them to double-check – this is a frequently confused point.

Two situations are specifically carved out of Section 2(22)(e), and they come up often enough in small-business practice to call out separately:

• Loans in the ordinary course of business: If lending money is a substantial part of the company’s actual business (e.g., an NBFC or a money-lending company), a loan to a shareholder made on the same commercial terms as it offers everyone else is not deemed a dividend.
• Genuine inter-corporate loans between holding and subsidiary companies: Where the loan is a bona fide commercial transaction between group companies – for working capital, margin money, or business necessity – and not a disguised way of pulling out a shareholder’s profits, tribunals have repeatedly held it falls outside 2(22)(e), especially where the recipient company is not itself a shareholder in the lending company.

• Misclassifying a director’s current account loan: Many small companies let directors draw money informally through a running “current account” without realising that each draw beyond accumulated profits can be deemed a dividend the moment it is paid, not when it is eventually settled.
• Assuming repayment cancels the tax: Repaying the loan within the same year does not undo the deemed dividend – the tax event happens at the point the loan is given.
• Deducting TDS under Section 194 anyway (or failing to disclose the loan): As covered above, 2(22)(e) loans don’t need company-level TDS, but they do need disclosure – Clause 36 of Form 3CD in the tax audit report specifically requires reporting of such loans.
• Overlooking the accumulated profits test: Companies sometimes assume any loan to a shareholder is automatically a deemed dividend. It is only taxable up to the level of accumulated profits on that date – a loss-making company with no accumulated profits triggers no deemed dividend at all, however large the loan.
• Ignoring Companies Act restrictions separately: Sections 185 and 186 of the Companies Act, 2013, separately restrict or regulate loans to directors and related parties – clearing the income tax test does not automatically mean the loan is permitted under company law.

A deemed dividend is taxed at 30% on the deemed dividend amount, and cess and surcharge are added to it to arrive at the final tax liability. Before 2018, deemed dividends were exempt from income tax. From April 2018 to April 2020, it was mandated that the companies deduct DDT (Dividend Distribution Tax) at the time of making payment to the shareholder, even for deemed dividends. However, after FY 21, the onus of paying tax on dividends is now shifted to the shareholders. Typically, dividend income is automatically shown in the pre-filled returns (through the Annual Information Statement) of an individual if the company has submitted the required details.

Deemed dividends are eligible to be considered as dividends provided they fulfil all the conditions. A loan or an advance given by a company to its shareholders is considered a deemed dividend except in the following cases:

1.Loans and advances are given out of the share premium account

2.Loans and advances are adjusted against dividends declared and distributed

3.The company’s business is money lending

4.The shareholder does not own more than 10% of the company

5.The company is a company in which the public is substantially interested, which means it is not a closely held company.

Between 2018 and 2020, deemed dividends were also eligible for DDT (Dividend Distribution Tax) at the rate of 30%.

Before a company declares dividends, the following points should be carefully considered.

• The rate of dividend they wish to declare cannot be more than the average rate of dividend declared in the immediately preceding 3 years. If the company has not declared a dividend in each of the three years, this rule can be ignored.
• The total amount of dividends distributed from accumulated profits cannot be more than one-tenth of the total paid-up share capital and free reserves as per the last audited financial statements.
• The amount drawn from the accumulated profits must first cover the losses, and then the balance can be used to declare dividends.
• The balance of reserves after dividend distribution should not be less than 15% of the paid-up share capital as per the last audited financial statements.
• TDS on dividends – the company paying dividends to a resident shareholder must deduct 10% TDS under Section 194 if the dividend paid exceeds ₹10,000 in a financial year (this limit was raised from ₹5,000 by Budget 2025).
• DDT (Dividend Distribution Tax) – DDT has been abolished since 1 April 2020. Shareholders are liable to pay tax on dividends, which is added to their total taxable income at the time of filing their income returns.
• Dividend declared by a loss-making company – if a loss-making company wishes to declare a dividend, dividends can only be declarstrictly; it should not be extended to genuine commercial transactions simply set off against the profit of the current year.

Section 2(22)(e) is one of the most litigated provisions in Indian tax law, mainly because tax officers often try to stretch it to cover transactions it was never meant for. A few settled principles from case law are worth knowing:

• Only an actual registered shareholder can be taxed: In ACIT v. Bhaumik Colour Pvt. Ltd (Special Bench) and the 2025 ITAT Ahmedabad ruling in Mateshwari Bus Operations Pvt. Ltd v. ITO (TDS), the tribunals held that if the company receiving the loan is not itself a registered shareholder of the lending company, Section 2(22)(e) cannot apply – even if a common individual controls both companies.
• A deemed dividend is taxed in the shareholder’s hands, not the borrowing concern’s. Where a loan is given to a concern (firm/HUF/company) in which a shareholder has a substantial interest, courts have clarified that the tax falls on the shareholder personally, not on the concern that physically received the money.
• Once taxed, it cannot be taxed again: The Supreme Court in CIT v. G. Narasimhan held that once an amount has been taxed as a deemed dividend, the company’s accumulated profits are notionally reduced by that amount – so the same funds cannot trigger deemed dividend tax twice.
• Strict, narrow interpretation: Tribunals consistently describe Section 2(22)(e) as a “deeming provision” that must be read strictly – it should not be extended to genuine commercial transactions just because they happen to involve a shareholder.

Practical takeaway: If your company is ever questioned on a loan to a shareholder, whether the recipient is a genuine shareholder and whether the company actually had accumulated profits on that date are usually the two facts that decide the outcome.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as investment, financial or taxation advice, nor as an invitation, solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice before making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.