Deemed Dividend: Section 2(22) of Income Tax Act

Deemed Dividend is the dividend which is not actually paid as a dividend but assumed to be dividend for the purpose of taxation under Income Tax Law.

It is divided into 5 sections. Here we will discuss every such section one by one –

Sec 2(22)(a) Distribution of Assets deemed as Dividend

Under Sec 2(22)(a), Accumulated profits distributed by the company to its shareholders, whether capitalized or not,

Even if such distribution includes the distribution of all or any part of the assets of the company to the extent company posses accumulated profits, whether capitalized or not shall be deemed to be a dividend and attracts the DDT in the hands of company u/s 115 O.

When as a set is distributed u/s 2(22)(a), the market value of the asset is taken on the date of distribution for the purpose of computing the dividend taxation.

Let’s understand this section with the help of an example –

Balance Sheet of a Company –

Company distributed assets having Book Value of Rs 1,00,000 to its shareholders. Calculate the Deemed Dividend u/s 2(22)(a) having Market Value –

1. 400000
2. 500000
3. 700000

Sol. Accumulated Profit of the Company  (Whether Capitalised or Not)

– Reserves and Surplus + Bonus Shares

– 3,00,000 + 2,00,000 = 5,00,000

Deemed Dividend u/s 2(22)(a) shall be as follows –

Note – Dividend deemed u/s 2(22)(a) shall be taxable in the hands of the company hence it is exempt in the hands of shareholders u/s 10(34).

SEC 2(22)(b) – Distribution of Debentures, Debenture Stock or Deposit Certificate deemed as Dividend

Under Sec 2(22)(b),

1. Distribution of Debenture, Debenture stocks or Deposit Certificate in any form with or without interest by the company to its shareholders shall be deemed as a dividend.
2. Distribution of Bonus shares to the Preference shareholders shall also be deemed as a dividend.

The amount shall be deemed as a dividend only to the extent of company’s accumulated profit, whether capitalized or not.

Let’s understand this section with the help of an example –

Balance Sheet of a Company –

Company has distributed debentures of Rs 5,00,000. Calculate the deemed dividend as per Sec 2(22)(b).

Sol.  Accumulated Profit of the Company  (Whether Capitalised or Not)

– Reserves and Surplus + Bonus Shares

– 1,00,000 + 1,00,000 = 2,00,000

The Company has distributed debentures of Rs 500000 to its shareholders out of which Rs 200000 shall be treated as the deemed dividend to the extent of accumulated profits.

Note – Such Deemed Dividend shall be chargeable in the hands of the company u/s 115O on which it is required to pay DDT @ 15%. And it will be exempt in the hands of the shareholder.

SEC 2(22)(c) – Distribution of Assets on Liquidation deemed as Dividend

Under Sec 2(22)(c),

Distribution of the asset made to the shareholders of the company at the time of its liquidation shall be treated as the deemed dividend to the extent of the accumulated profits of the company immediately before it’s liquidation, whether capitalized or not.

Fair Market Value of the asset shall be taken for the purpose of computing the deemed dividend u/s 2(22)(c).

Note – Section is applicable only in case of Equity Shareholders.

SEC 2(22)(d) Distribution on Reduction of Share Capital Deemed as Dividend

Under Sec 2(22)(d),

Any distribution made by the company on the reduction of share capital to the extent to which company possesses accumulated profits, whether capitalized or not.

For the purpose of computing the Dividend under this Section, FMV of the assets on the date of distribution shall be taken.

For Example –

Balance Sheet of a Company –

In the given example, the company reduced the share capital of Rs 4,00,000 and distributes the reduced capital among the shareholders. Calculate the Deemed Dividend u/s 2(22)(d).

Sol.   Accumulated Profit of the Company  (Whether Capitalised or Not)

– Reserves and Surplus + Bonus Shares

– 1,00,000 + 5,00,000 = 6,00,000

In the given case, Company reduced the share capital up to Rs 400000 and refund such among the shareholders.

Hence, Rs 400000 is treated as deemed dividend u/s 2(22)(d) and the company is liable to pay DDT on such. The above amount is exempt in the hands of shareholder u/s 10(34).

Note – It is applicable in case of Equity Shareholders.

SEC 2(22)(e) Loans and Advance by a Closely-held Company deemed as Dividend

Under Sec 2(22)(e),

Any payment made by a company, not being a company in which public is substantially interested (unlisted company) of any sum by way of advance or loan to,

• A shareholder, being a person who is the beneficial owner of the shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in the profits) holding not less than 10% of the voting power
• Or
• To any concern in which a shareholder is a member or a partner and in which he has a substantial interest.
• Or
• Any payment by any such company on behalf, or for the individual benefit, of any such shareholder

To the extent to which company possesses accumulated profit.

*Dividend taxation u/s 2(22)(e) shall be taxable in the hands of shareholder rather than the company.

Points to Remember –

1. In the given section concern means HUF, or a Firm, or a Company, or an AOP/BOI.
2. Substantial Interest in a concern means a person is beneficially entitled to not less than 20% income of such concern or 20% of the voting power in case of company.
3. In order to compute deemed dividend u/s 2(22)(e), accumulated profit shall be taken up to the date on which loan or advance is given to the person specified in such section.
4. Hence, where the accumulated profits exceed the loan amount on the date when such loan or advance is given to the specified person, the whole amount shall be deemed as dividend u/s 2(22)(e).
5. For the purpose of Sec 2(22), accumulated profits get reduced by the amount deemed as dividend u/s 2(22)(e) even if no adjustment is made in the books.
6. If the shareholder repays the loan even on the next day, it does not affect the applicability of dividend deemed u/s 2(22)(e).
7. The applicability shall also not be affected even if the interest charged to the shareholder at the market rate on the loan or advance given to the shareholder.

Difference Between Sec 2(22)(a), Sec 2(22)(b), Sec 2(22)(c), Sec 2(22)(d) and Sec 2(22)(e) –

1. Sec 2(22)(a), Sec 2(22)(b), Sec 2(22)(c), Sec 2(22)(d) are applicable to all companies while Sec 2(22)(e) shall be applied only in case of closely held companies.
2. DDT shall be paid by the company under Sec 115-O in case of Sec 2(22)(a), Sec 2(22)(b), Sec 2(22)(c), Sec 2(22)(d). However, the dividend shall be taxable in hands of shareholder Sec 2(22)(e), thus DDT shall not be applicable on such.
3. The Company pays DDT under Sec 2(22)(a), Sec 2(22)(b), Sec 2(22)(c), Sec 2(22)(d), hence dividend is exempt in the hands of shareholder u/s 10(34). While dividend under sec 2(22)(e) is not taxable in the hands of shareholder because the company does not pay DDT on such.
4. Under Sec 2(22)(a), Sec 2(22)(b), Sec 2(22)(c), Sec 2(22)(d) accumulated profits whether capitalised or not shall be taken unlike sec 2(22)(e), where only accumulated profits are taken.

Deemed Dividend does not include –

Deemed Dividend u/s 2(22) shall not include the following –

1. Where the company has given money in the ordinary course of business to its shareholders when the money lending is the substantial part of the companies business.
2. Any Dividend paid by the company which is set off against the whole or part of the loan which has been deemed as dividend u/s 2(22)(e).
3. Any distribution made in accordance with clause (c) or clause (d) of Sec 2(22) in respect of preference shares.
4. Payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of Sec 77A of the Companies Act, 1956.
5. Any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company.

Also Read: How to Read Direct Tax in CA IPCC