Deemed dividend (Section 2(22))
Also written Section 2(22) deemed dividend · Deemed dividend
Company payouts not called a dividend but taxed as one under Section 2(22) — liquidation and capital-reduction distributions, a closely-held company's loan to its shareholder, and buyback proceeds.
In plain language
A dividend is usually a simple distribution of profit. But the Income Tax Act widens the net. Section 2(22) names several payouts that are not called a dividend in ordinary language. Yet they are taxed as one anyway.
Why? Because each of these payouts moves company money or assets to shareholders, out of accumulated profits. That is exactly what a dividend does, even if it goes by a different name.
How it works
Section 2(22)'s named categories, as the workbook lists them:
- (a) Distribution of accumulated profits to shareholders, releasing the company's assets.
- (b) Distribution of debentures, debenture-stock or deposit certificates out of accumulated profits, and bonus shares to preference shareholders out of accumulated profits.
- (c) Distribution to shareholders on the company's liquidation, out of accumulated profits.
- (d) Distribution to shareholders out of accumulated profits on a reduction of capital.
- (e) A loan or advance by a closely-held company to its shareholder, out of accumulated profits.
- (f) Payment on buy-back of the company's own shares from a shareholder, under the Companies Act, 2013.
Scheme of taxation. Up to Assessment Year 2020-21, the company itself paid Dividend Distribution Tax (DDT), and shareholders were largely exempt. From AY 2021-22, with DDT abolished, dividend income (including all six Section 2(22) categories) is taxed in the shareholder's hands, at applicable slab rates, under income from other sources, subject to TDS under Section 194 or 194K.
Buyback, specifically. With effect from 1 October 2024, buy-back proceeds are taxed as dividend, with no deduction for expenses allowed. The shareholder's cost of acquisition of the bought-back shares instead becomes a capital loss, available for set-off under the ordinary rules.
A worked example
Illustrative figures.
Sunrise Pvt Ltd, a closely-held company, gives its shareholder Mr Oberoi a loan of Rs 10,00,000 out of its accumulated profits of Rs 25,00,000. Under Section 2(22)(e), this loan is treated as a deemed dividend of Rs 10,00,000 in Mr Oberoi's hands, taxable at his slab rate under income from other sources — even though, on paper, it is a loan he may still be expected to repay.
Separately, if the same company had instead bought back Rs 10,00,000 worth of shares from Mr Oberoi on 15 November 2024 (after the 1 October 2024 change), that Rs 10,00,000 would itself be taxed as dividend, with no expense deduction, while the cost of acquisition of those bought-back shares — say, Rs 2,00,000 — becomes a capital loss of Rs 2,00,000 in his hands.
Why NISM asks about it
Chapter 9 (Income from Other Sources), section 9.2, defines deemed dividend under Section 2(22) with all six categories, then covers the DDT-to-shareholder-taxation shift and the 1 October 2024 buyback change. Expect a question identifying which of several company payouts qualifies as deemed dividend, and the buyback taxation mechanics.
Common exam traps
- A closely-held company's loan to a shareholder can itself be taxed as dividend under clause (e) — this surprises candidates who expect only actual distributions to count.
- DDT ended after AY 2020-21 — from AY 2021-22 the tax shifted to the shareholder, at slab rate, not a flat company-level tax.
- Buyback proceeds became dividend only from 1 October 2024 — before that date, buyback was taxed differently; get the effective date right.
- No expense deduction is allowed against buyback-as-dividend income — the cost of the shares instead becomes a capital loss, a completely separate computation.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Clubbing of incomeSections 60 to 64 add someone else's income to yours — the Act's answer to families who move income to a lower-taxed relative while keeping the asset.
- Deemed credit ruleUnder Section 115UB, income an AIF earns but has not actually paid or credited to investors by year-end is still treated as credited to them on the last day of that year, in their entitled proportion.
- Non-ResidentAn assessee who fails every residency test in section 6 — taxable in India only on income received, accruing or deemed to accrue in India, and on nothing that arises abroad.
- Final dividendA dividend declared at the AGM, taxable in the shareholder's hands in the year it is declared — unlike an interim dividend, which is taxed only in the year it is actually made available to the shareholder.
- Interest on borrowings to purchase securitiesInterest paid on money borrowed to acquire securities, allowed as a permissible deduction from gross interest on securities when computing income from other sources.
- Interest on securities (Section 2(28B))Interest on any security of the Central or a State Government, and interest on debentures or other securities for money issued by a local authority, a company, or a statutory corporation.
- Twenty per cent dividend deduction capA resident may set only interest expenditure against dividend income, and only up to 20% of the total dividend for the year; no other expense is allowed, and a non-resident gets no deduction at all.