In a closely held company, funds often move between the company and its promoters as a matter of convenience: an advance to a director to buy a house, a loan to a sister firm, or a payment of a shareholder's personal expenses recorded as a receivable. The accounts show a loan that will be repaid. Income-tax law, however, may treat the same amount as a dividend and tax it in the shareholder's hands, even though no dividend was declared.
This article explains the deemed dividend provision in Section 2(22)(e) of the Income-tax Act, 1961, its counterpart in Section 2(40)(e) of the Income-tax Act, 2025, who is covered, the exceptions, how the tax is computed, and the checks that should be made before funds are routed between a company and its shareholders.
Key points at a glance
- A loan or advance by a company in which the public are not substantially interested, to a shareholder holding at least 10% of voting power, is treated as dividend to the extent of the company's accumulated profits.
- The provision also covers loans to a concern in which such a shareholder has a substantial interest (20% or more), and payments for the shareholder's individual benefit.
- Under the Income-tax Act, 2025, the provision is Section 2(40)(e), applicable from Tax Year 2026-27.
- Repayment of the loan does not undo the deemed dividend.
- Trade advances in the nature of commercial transactions, and loans by companies whose substantial business is money lending, are excluded.
What is deemed dividend under Section 2(22)(e)?
Section 2(22) defines "dividend" broadly, and clause (e) extends it to certain payments that are not dividends in company law. Any payment by a company in which the public are not substantially interested, by way of advance or loan, is treated as dividend if it is made:
- to a shareholder who is the beneficial owner of shares (not being shares entitled to a fixed dividend) holding not less than 10% of the voting power;
- to any concern in which such a shareholder is a member or partner and has a substantial interest; or
- on behalf of, or for the individual benefit of, such a shareholder.
The amount treated as dividend is limited to the accumulated profits of the company, which include profits up to the date of the payment. The purpose is to prevent distribution of profits in the guise of loans, which would otherwise escape tax in the shareholder's hands.
Section 2(22)(e) under the Income-tax Act, 2025: Section 2(40)(e)
The Income-tax Act, 2025 retains the deemed dividend provision in the definition of dividend in Section 2(40), with loans and advances by closely held companies in clause (e). The structure, the 10% voting power test, the substantial interest test and the limit of accumulated profits continue. Loans made during Tax Year 2026-27 and later are examined under Section 2(40)(e), while earlier years continue to be governed by Section 2(22)(e).
| Element | Requirement |
|---|---|
| Company | Company in which the public are not substantially interested (broadly, a closely held company) |
| Recipient | Shareholder with at least 10% voting power, a concern in which such shareholder has a substantial interest, or any person for the shareholder's benefit |
| Substantial interest in a concern | Beneficial entitlement to at least 20% of the income of the concern |
| Nature of payment | Loan or advance, or payment on behalf of or for the benefit of the shareholder |
| Limit | Accumulated profits of the company, including profits up to the date of payment |
| Provision | Section 2(22)(e) (1961 Act); Section 2(40)(e) (2025 Act) |
Common misconception: "If it is repayable, it cannot be income"
The deemed dividend arises at the time the loan or advance is made. Subsequent repayment does not reverse it, and the same money lent and repaid more than once can create repeated deemed dividends. The accounting label of "loan" does not matter; what matters is the relationship between the company and the recipient and the availability of accumulated profits.
Where the company later declares an actual dividend and sets it off against the amount earlier treated as deemed dividend, the actual dividend to that extent is excluded from the definition, so that the same amount is not taxed twice.
What is excluded from deemed dividend?
Money-lending companies
Loans or advances made by a company in the ordinary course of its business, where lending of money is a substantial part of its business, are excluded.
Trade advances
Courts have held that advances arising from commercial transactions are not "loans or advances" in the sense of the provision. The Delhi High Court in CIT v. Creative Dyeing & Printing (P.) Ltd. (2009) held that advances for business transactions are outside it, and the CBDT accepted this position in Circular No. 19/2017, directing that trade advances in the nature of commercial transactions are not to be treated as deemed dividend.
Payments for the company's own benefit
The Calcutta High Court in Pradip Kumar Malhotra v. CIT (2011) held that where a shareholder permitted its property to be mortgaged for the company's borrowings and the company advanced money in return, the advance was for the company's benefit and not a gratuitous loan for the shareholder's individual benefit.
Group treasury in IFSC
The Finance Act, 2025 excluded certain loans and advances between group entities where one of them is a finance company or finance unit set up in an International Financial Services Centre for global or regional treasury activities, subject to conditions.
Practical point: In whose hands is the dividend taxed when the loan is given to a concern? The Delhi High Court in CIT v. Ankitech (P.) Ltd. (2011) held that deemed dividend is taxable in the hands of the shareholder, not the recipient concern which is not a shareholder. This view has been widely followed, but facts such as registered versus beneficial ownership should be examined carefully.
How is deemed dividend taxed? A worked example
Consider a closely held company with accumulated profits of ₹80,00,000. A director holds 30% of its equity shares. The company advances ₹50,00,000 to the director to purchase a residential flat, with no business purpose.
- Conditions met: closely held company, shareholder with more than 10% voting power, loan not in the ordinary course of a money-lending business.
- Deemed dividend: ₹50,00,000, being within accumulated profits of ₹80,00,000.
- The company is required to deduct TDS on dividend at 10% under Section 194 (Section 393 of the 2025 Act), that is ₹5,00,000.
- In the director's return, the ₹50,00,000 is taxed as dividend income at slab rates. If other income already puts the director in the 30% slab, tax is ₹15,00,000, surcharge at 10% is ₹1,50,000 and cess at 4% is ₹66,000, a total of ₹17,16,000 before TDS credit.
- Repayment of the loan by the director next year does not reduce this tax.
Apart from tax, loans by a company to its directors, or to entities in which directors are interested, are also regulated by Section 185 of the Companies Act, 2013, and should be checked separately.
Checks before funds move between a company and its shareholders
- Is the company one in which the public are substantially interested? If not, the provision may apply.
- Does the recipient hold 10% or more of the voting power, or is it a concern in which such a shareholder has a 20% interest?
- Is the payment a trade advance supported by a commercial transaction, such as an order, supply or service contract?
- What are the accumulated profits on the date of payment?
- Is TDS required, and has the Companies Act position been verified?
- Would an alternative, such as an actual dividend or remuneration, be more transparent in tax and company law terms?
Frequently Asked Questions on Deemed Dividend
What is deemed dividend under Section 2(22)(e)?
It is a loan or advance by a closely held company to a shareholder holding at least 10% voting power, or to a concern in which that shareholder has a substantial interest, treated as dividend to the extent of the company's accumulated profits.
What is the new section for Section 2(22)(e) under the Income-tax Act, 2025?
The corresponding provision is Section 2(40)(e) of the Income-tax Act, 2025, which applies from Tax Year 2026-27.
Does repaying the loan avoid deemed dividend?
No. The deemed dividend arises when the loan or advance is made, and later repayment does not reverse it.
Are trade advances covered by deemed dividend?
No. Advances in the nature of commercial transactions are not treated as deemed dividend, as clarified by CBDT Circular No. 19/2017 and several High Court decisions.
Who pays tax on a loan given to a sister concern?
The Delhi High Court in Ankitech held that the deemed dividend is taxable in the hands of the shareholder, not the concern that received the loan.
Is TDS required on deemed dividend?
Yes. Deemed dividend is subject to TDS as dividend under Section 194 of the 1961 Act, now covered by Section 393 of the 2025 Act.
Conclusion
Deemed dividend is a provision where the accounting entry and the tax treatment can diverge sharply. A loan on paper can become dividend income in assessment, taxed at the shareholder's slab rate, without any cash distribution being declared and without relief on repayment.
With the provision continuing as Section 2(40)(e) of the Income-tax Act, 2025, closely held companies should evaluate the tax character of every movement of funds to shareholders and their concerns before it is made, not after it appears in the books.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.