Taxability of Deemed Dividend under Section 2(22)(e) of the Income Tax Act – Simplified Explanation
Hello readers,
After a long time, I would like to discuss the concept of deemed dividend under Section 2(22)(e) in a simplified manner:
Before diving into the details of deemed dividend, let’s understand the meaning of dividend and deemed dividend:
Dividend: Dividend refers to the returns received by a shareholder after purchasing shares of a company. It is a form of distribution of profits to the shareholders.
Deemed Dividend: Deemed dividend is an income that is treated as dividend, even if it is not distributed by a closely-held company. The Income Tax Act includes certain transactions and situations that are deemed to be dividend. These transactions are specified under Section 2(22)(e) of the Income Tax Act.
The following transactions are considered as deemed dividend under Section 2(22)(e):
1. Distribution of accumulated profits to shareholders resulting in the release of company assets: If a closely-held company distributes its accumulated profits or assets to its shareholders, it is treated as deemed dividend.
2. Distribution of debentures or deposit certificates to shareholders from the accumulated profits of the company and issuance of bonus shares to preference shareholders from accumulated profits: If a closely-held company distributes debentures or deposit certificates to its shareholders or issues bonus shares to its preference shareholders from its accumulated profits, it is treated as deemed dividend.
3. Distribution to shareholders on the liquidation of the company from accumulated profits: When a closely-held company is liquidated and distributes its accumulated profits to its shareholders, it is treated as deemed dividend.
4. Distribution to shareholders from accumulated profits on the reduction of capital by the company: If a closely-held company reduces its capital and distributes the accumulated profits to its shareholders, it is treated as deemed dividend.
5. Loan or advance made by a closely-held company to its shareholder from accumulated profits: If a closely-held company provides a loan or advance to its shareholder from its accumulated profits, it is treated as deemed dividend.
Taxability of dividend received on or after 01-04-2020:
The taxability of dividends in the hands of the company and shareholders from Assessment Year 2021-22 is as follows:
In the hands of the company:
Previously, domestic companies were required to pay Dividend Distribution Tax (DDT) on the dividends distributed. However, from April 1, 2020, DDT has been abolished. Instead, domestic companies are now required to deduct Tax Deducted at Source (TDS) on the dividends distributed to the shareholders under Section 194.
The TDS rate for domestic companies is 10 percent. However, if the dividend paid to a shareholder during the financial year does not exceed Rs 5,000, no TDS is required to be deducted.
In the hands of resident shareholders:
The tax treatment of dividend income depends on whether it is considered income from business/profession or income from other sources, based on whether the shares are held as a trader/investor or as an investment.
If you deal in securities either as a trader or investor, the dividend income is treated as income from business or profession and is taxed at the normal tax rates applicable to your income.
If you hold shares as an investment, the dividend income is treated as income from other sources and is also taxed at the normal tax rates applicable to your income.
However, there is a special provision for resident individuals who are employees of Indian companies or their subsidiaries engaged in the Information Technology, entertainment, pharmaceutical, or biotechnology industry. If such individuals receive dividends in respect of Global Depository Receipts (GDRs) issued by their employer company under an Employees’ Stock Option Scheme, the dividends are taxed at a concessional rate of 10% without any deductions under the Income-tax Act. It’s important to note that the GDRs should be purchased by the employee in foreign currency.
In the hands of non-resident shareholders:
The dividend income received by non-resident individuals, including Foreign Portfolio Investors (FPIs) and Non-Resident Indian citizens (NRIs), is taxable at a rate of 20% without any deductions under the Income-tax Act.
However, there is an exception for the dividend income of the investment division of an offshore banking unit, which is taxed at a reduced rate of 10%.
Additionally, if the dividend is received in respect of GDRs of an Indian Company or Public Sector Company (PSU) purchased in foreign currency, the tax rate is 10% without any deductions.
Conclusion:
Understanding the tax implications of deemed dividends is essential for both companies and shareholders. With the abolition of Dividend Distribution Tax (DDT) and the introduction of Tax Deducted at Source (TDS), the tax treatment of dividends has undergone significant changes. It is crucial for domestic companies to comply with the TDS provisions while distributing dividends, and shareholders need to consider the applicable tax rates based on their residency status and the nature of their investment. By being aware of the tax rules and regulations surrounding deemed dividends, individuals can ensure proper compliance and make informed decisions regarding their investments.
That concludes our discussion on the taxability of deemed dividends under Section 2(22)(e) of the Income Tax Act. If you have any queries or require further clarification on the information provided, please feel free to reach out to us at [email protected].
Thank you for reading!
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