Received Dividend, Loan, or Buyback Proceeds? Decode Deemed Dividend Under Section 2(22) with Practical Examples

Have you received Dividend or something else from company during the year? & don’t know about the tax treatment of certain transactions done by company towards its share-holders for distributing the profits via different ways. Then this article is for you

Let’s decode it

What is Deemed Dividend?

Under the Income Tax Act, 1961, dividend is generally a distribution of profits by a company to its shareholders.

However, authorities recognised that certain transactions between a closely-held company and its shareholders can serve as a proxy for dividend which allows company to easily distribute the profits by avoiding taxes. Such transactions are treated as deemed dividend under Section 2(22)   

Six Clauses of Section 2(22) 

Let’s understand with examples.

Section 2(22)(a): Distribution of Accumulated Profits with Asset Release

• The distribution must result in release of the company’s assets
• Must be to the benefit of shareholders
• To the extent of accumulated profits (including capitalised profits)
• Balance over accumulated profits is treated as return of capital

E.g: ABC Pvt. Ltd. distributes Rs. 10 lakhs worth of machinery to Mr. A (shareholder), instead of cash.

Accumulated profits of the company: Rs. 7 lakhs

Rs. 7 lakh will be deemed dividend in the hands of Mr. A & taxable under IFOS

Section 2(22)(b): Debentures, Deposit Certificates & Bonus to Preference Shares

Any distribution by a company to its shareholders of debentures, debenture stock, or deposit certificates bonus shares to preference shareholders is treated as deemed dividend to the extent of accumulated profits.

Note: Bonus shares issued to equity share holders is not covered under such section hence it won’t considered as deemed dividend.

E.g: XYZ Pvt. Ltd. issues bonus debentures of Rs. 5 lakhs to its shareholders.

Accumulated profits available: Rs. 4 lakhs

Rs. 4 Lakh will be deemed dividend in the hands of share-holder & taxable under IFOS

Section 2(22)(c): Distribution on Liquidation

• Only the accumulated profit component is treated as dividend
• The balance (representing capital) is treated as capital receipts/capital gains in the hands of share holder
• Applicable on final distribution at the time of liquidation

E.g: ABC Pvt. Ltd. is being wound up. Total assets distributed = ₹20 lakhs

Paid up capital: Rs. 10 Lakhs

Accumulated Profits: Rs. 8 Lakhs

Deemed Dividend Rs. 8 lakhs (to the extent of accumulated profits)

Section 2(22)(d): Distribution on Reduction of Capital

Where a company reduces its capital (under Companies Act provisions) and distributes money or other assets to shareholders, the amount distributed to the extent it is attributable to accumulated profits (including capitalised profits) is treated as deemed dividend.

Section 2(22)(e): Loans & Advances

Any payment made by a closely-held company in the form of a loan or advance to:

• A shareholder holding ≥ 10% of voting power OR
• Any concern (HUF, firm, AOP, BOI, company) in which such shareholder has substantial interest (≥ 20% share in profits/Voting)

is treated as deemed dividend to the extent of accumulated profits.

Key Conditions

E.g: 1 RST Pvt. Ltd. gives a loan of Rs. 12 lakhs to Mr. R who holds 15% voting power.

Accumulated profits of Company: Rs. 8 Lakhs

Rs. 8 lakhs will taxable as deemed dividend in Mr. R’s hands

E.g: 2 ABC Pvt. Ltd. gives a loan of Rs. 20 lakhs to XYZ & Co. (Partnership Firm)

Mr. A holds 12% in ABC Pvt. Ltd. AND 30% share in XYZ & Co

Accumulated profits of ABC Pvt. Ltd. Rs. 15 lakhs

Rs. 15 lakhs will taxable as deemed dividend in hands of Mr. A (as the qualifying shareholder)

Section 2(22)(f): Buy-Back of Shares w.e.f 01/10/2024

Earlier the Tax treatment of Buy back is to be taxed as Capital gain under section 46A of income tax Act 1961

However, Section 2(22)(f) was inserted by Finance Act, 2024 w.e.f. 01.10.2024 to treat buy-back consideration as deemed dividend in the hands of shareholders if received by domestic companies.

However, the shareholder can claim the cost of acquisition of shares bought back by company as a STCL/LTCL under capital gain by taking Full Value of Consideration as NIL where the consideration is taxed under 2(22)(f).

Note: Under this section there is no threshold of accumulated profits like othe clauses

E.g: Mr. A holds 500 shares of XYZ Ltd. (listed), purchased at ₹100/share on 25/07/2023

XYZ Ltd. buys back shares at ₹300/share on 17/9/2025

In the Hands of Mr. A FY 25-26, AY 26-27

Deemed dividend us 2(22)(f) taxable under IFOS: Rs. 1,50,000(Rs.300*500)

Capital gain on sell of right: