What is Deemed Dividend

Any person who invests in any form expects something in return. Dividend is one such form of return on investment which investors of stocks and mutual funds expects to receive. Dividend refers to the returns a shareholder receives for investing in a company. A deemed dividend refers to a distribution of profits or assets by a corporation that is treated as a dividend for tax purposes, even though it might not be an actual cash payment to shareholders. The Income Tax Act has provided under Section 2(22)(e), the instances where certain transactions are deemed equivalent to dividends for tax purposes, even if no actual dividend payments are done.

Deemed Dividend:
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. Such amount is called as Deemed Dividend. It should be distributed out of company’s accumulated profits only. Only private limited companies whose activities are not of public substantial interest are eligible for a Deemed Dividend.

Substantial Interest:
Substantial Interest in a company refers to significant ownership or financial interest held by an individual or entity in a particular company. Generally, 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. According to Section 2(22)(e), when a company in which the public are not substantially interested, extends a loan or an advance to:

• Any of its shareholders who has more than 10% voting power in the company
• To any concern in which such shareholder is substantially interested
• For the individual benefit of such shareholder
• On behalf of such shareholder to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22)

Section 2(22)(e) of the Income Tax Act, 1961:
As per Section 2(22)(e) of the Income Tax Act, Dividend includes, the following are the payment methods that are considered to be deemed dividends:

• Payments of loans or lending assets to a shareholder who has a substantial interest in that company are treated as a deemed dividend if such payments are done out of accumulated profits
• Loans extended to a holding company by a subsidiary company from accumulated profits
• Advances made by the company to its shareholders to install plant & machinery that enable him to exercise an export order.
• Personal payments of shareholders made by the company.
• Any loan given to the employee which indirectly benefit the company's director.

Taxation of Deemed Dividends:
In Budget 2021 Dividend Distribution Tax (DDT) was abolished. Now the incidence of dividend income taxation is shifted to investors from the companies. Earlier, companies that paid regular dividends to their shareholders had to pay a DDT tax on the dividends distributed. However, the shareholders receiving these dividends did not have to pay any tax on such deemed dividend income received by them. In the 2021 Union Budget, the DDT was abolished. Now, effective from April 2021, dividend income is taxable in the hands of the shareholders, whether received as actual dividends or deemed dividends.

Conclusion:
Deemed dividends are not actual dividend payments but they are payments in the form of loans and advances to its shareholders. However, there are certain instances where it is not considered as deemed dividend like when a company engaged in the business of money lending, where the loan or advance is provided in the ordinary course of its business or Loan or advance given to a shareholder, subsequently adjusted against the dividend declared and distributed by the company etc.

After the abolishment of DDT now shareholders are liable to pay income tax at slab rates on deemed dividend received by them. Deemed dividend will be shown as Income from other sources in the income tax return of such shareholder.