Direct Tax Laws & International Taxation · Income from Other Sources

Dividend Income and Related Deductions (CA Final Direct Tax)

Updated 5 October 2026 · Fact-checked

Dividend from a company is taxed in the shareholder's hands as income from other sources, at normal or special rates. Deemed dividend is a payment treated as dividend to the extent of accumulated profits, such as a loan by a closely held company to a 10% shareholder. Against dividend income, only interest expense is deductible, capped at 20% of the dividend income.

Understand Dividend Income and Related Deductions

A dividend is a share of a company's profit paid to shareholders. Under the Income-tax Act, 2025, a resident or non-resident shareholder pays tax on it. The company does not pay a separate dividend distribution tax. The dividend is taxed in the shareholder's hands under the head Income from other sources, at the shareholder's applicable rates.

Timing matters. A final dividend is taxed in the tax year in which it is declared. An interim dividend is taxed in the tax year in which the amount is unconditionally made available to the shareholder, for example by cheque, draft or other mode. Do not tax it only because the board has proposed it.

The Act also has a deemed dividend rule, which stops a company from moving profits to shareholders in a form that is not called a dividend. The payment is treated as dividend only to the extent the company has accumulated profits. The main cases are:

(a) distribution of debentures, deposit certificates or bonus shares to preference shareholders out of accumulated profits. Bonus shares count here only when issued to preference shareholders. Other bonus shares are not deemed dividend.
(b) distribution to shareholders on liquidation. The amount is limited to the accumulated profits immediately before liquidation, including profits that were capitalised.
(c) distribution on reduction of capital, to the extent of accumulated profits.
(d) a loan or advance by a closely held company to a shareholder or to a concern in which the shareholder has a substantial interest.

The loan limb is tested most often. It applies when the company is one in which the public is not substantially interested. The borrower must be a shareholder who is the beneficial owner of shares carrying at least 10% of voting power, tested at the time the loan is given. Alternatively, the borrower may be a concern in which such a shareholder has a substantial interest. A concern has a substantial interest of the shareholder when:

in a company, the shareholder holds at least 20% of the voting power; or
in any other concern, the shareholder is entitled to at least 20% of the profits.

Loans made by a company in the ordinary course of its business, where lending money is a substantial part of that business, are excluded. Test each loan or advance separately, on the facts of that payment. The deemed dividend is capped at the accumulated profits the company has on the date the loan or advance is paid, which means the lower of the loan and those profits. A loan is not income by itself, and that is why the profit cap matters.

For deductions, the law is strict. From dividend income you may deduct only interest expense incurred to earn that dividend. The deduction cannot exceed 20% of the dividend income included in total income. The cap applies to the dividend income only and does not limit deductions against other income. Commission, demat charges and other expenses are not allowed against dividend. Recent changes have affected how buy-back proceeds are taxed, so follow the ICAI study material for your attempt on that point.

Key rules to remember

Taxability of company dividend: Dividend (gross) = Income from other sources, taxed in the shareholder's hands; Include the gross amount. TDS deducted is only a credit against tax.
Timing of dividend: Final: tax year of declaration | Interim: tax year when unconditionally made available; Check the date given in the question before picking the tax year.
Deemed dividend on loan or advance: Deemed dividend = Lower of (loan or advance, accumulated profits on the date the loan or advance is paid); Test each payment separately. Applies only to a closely held company, and only if the borrower is a beneficial owner of at least 10% voting power, or a concern in which such a person has a substantial interest (at least 20% of voting power in a company, or at least 20% of profits in other concerns).
Deduction against dividend: Interest deduction = Lower of (interest actually paid to earn the dividend, 20% × dividend income); The cap applies to dividend income only. No other expense is allowed against dividend income.
Other deemed dividend cases: Deemed dividend = Value distributed, limited to accumulated profits (on liquidation: accumulated profits immediately before liquidation, including capitalised profits); Covers preference-share distributions, liquidation and capital reduction. Bonus shares count only when issued to preference shareholders.
Loan carve-out: Loan in ordinary course by a company whose business is substantially money-lending = no deemed dividend; Also check that the company is closely held.

How to solve Dividend Income and Related Deductions questions

Use this method for any question on dividend, deemed dividend or related deductions.

1Identify the payer: is it a company, and is it closely held or one in which the public is substantially interested?
2Classify the receipt: ordinary dividend, or a loan, advance or distribution that may be deemed dividend.
3For a loan, check the borrower: a 10% voting power beneficial owner, or a concern in which that shareholder has a substantial interest (20% or more of voting power or profits). Exclude ordinary-course money-lending loans.
4Find accumulated profits on the date of the loan or distribution, and take the lower of that figure and the amount paid. Do this for each payment.
5Fix the tax year using the declaration date (final dividend) or the date it is made available (interim dividend).
6List the expenses claimed. Allow only interest expense, limited to 20% of dividend income, and disallow all others.
7Add other income under the head, for example interest income, and compute the total.
8State the answer in provision, facts and conclusion form, and mention TDS credit if given.

Quickest way: Three-check shortcut for deemed dividend and deduction

When to use it: Use this when a case gives a long list of loans, shareholders and expenses and you have little time.

Check 1: is the lender a closely held company? If not, there is no loan limb.
Check 2: is the borrower a 10% voting power beneficial owner (or a concern with such a shareholder's substantial interest)? If not, no deemed dividend.
Check 3: deemed dividend = lower of loan and accumulated profits on the date of the loan.
For the deduction, compute 20% of dividend first, then pick the lower of that and actual interest.
Strike out every non-interest expense against dividend, and write one line saying why.

Common mistakes in Dividend Income and Related Deductions

Treating the whole loan as deemed dividend even when accumulated profits are lower.
Students remember that loans to shareholders are taxed but forget the profit cap.
Fix: Always write 'lower of loan and accumulated profits' as the first line of the working.
Applying the deemed dividend rule to a company in which the public is substantially interested.
The words 'closely held' are missed in the facts.
Fix: Tick the company's status before any calculation. If it is not closely held, the loan rule does not apply.
Deducting all interest paid on a loan used to buy shares.
Students think the interest is fully allowable because it relates to dividend income.
Fix: Cap the deduction at 20% of dividend income, taking the lower of that figure and actual interest.
Allowing demat charges, commission or other expenses against dividend.
These look like normal costs of holding shares.
Fix: Only interest expense is allowed against dividend income. Write that in the answer.
Taxing the net dividend after TDS instead of the gross dividend.
The cash received is shown as a lower figure.
Fix: Include the gross amount and claim the TDS as credit against the tax computed.
Using the wrong tax year for dividends, for example taxing an interim dividend on the date of board resolution.
Students mix up declaration and payment.
Fix: Final dividend follows declaration. Interim dividend follows the date the amount is unconditionally made available.

Worked examples

Example 1

Alpha Traders Pvt Ltd is a closely held company. It gave both the loans below on 1 January 2027, when its accumulated profits were ₹7,50,000. It gave an interest-free loan of ₹10,00,000 to Rahul, who is the beneficial owner of shares with 15% of voting power. It also gave a loan of ₹2,00,000 to Meena, who holds shares with 8% of voting power. Alpha's business is trading and it does not lend money as a substantial part of it. What is the deemed dividend?

Show the solution

Alpha is closely held, so the loan limb can apply.
Rahul holds 15% of voting power, which is at least 10%, so he is covered. The loan is not in the ordinary course of a money-lending business.
Deemed dividend for Rahul = lower of loan ₹10,00,000 and accumulated profits ₹7,50,000 on the date of the loan = ₹7,50,000.
Meena holds only 8% voting power, which is below 10%, so the loan to her is not deemed dividend. It remains a loan.
The deemed dividend is taxed in Rahul's hands under Income from other sources.

Answer: ₹7,50,000 is deemed dividend in Rahul's hands; Meena has no deemed dividend.

Example 2

Priya, a resident individual, received dividend of ₹3,00,000 from an Indian listed company; TDS of ₹30,000 was deducted. She earned bank interest of ₹50,000. During the year she paid interest of ₹1,00,000 on a loan taken to buy these shares and demat charges of ₹5,000. Compute her income from other sources.

Show the solution

Gross dividend = ₹3,00,000. TDS is only a credit and is not subtracted from income.
Deduction limit for interest = 20% × ₹3,00,000 = ₹60,000.
Actual interest = ₹1,00,000. Allowed = lower of ₹1,00,000 and ₹60,000 = ₹60,000.
Demat charges ₹5,000 are not allowed against dividend income.
Net dividend income = ₹3,00,000 − ₹60,000 = ₹2,40,000.
Bank interest of ₹50,000 is added with no deduction, since no expense is claimed against it.
Income from other sources = ₹2,40,000 + ₹50,000 = ₹2,90,000. TDS of ₹30,000 is claimed as credit against the tax payable.

Answer: Income from other sources is ₹2,90,000. The excess interest of ₹40,000 and the demat charges of ₹5,000 are disallowed.

Exam tips

Read the first line of the case for the company's status. 'Closely held' decides whether the loan rule applies.
Show the lower-of working explicitly for deemed dividend and for the 20% cap. Marks are given for the comparison.
Write the grounds for each disallowed expense in one sentence, using provision, facts and conclusion.
In an MCQ on this topic, look for traps: voting power below 10%, a public company, or a money-lending business.
Do not quote section numbers unless the question supplies them or you are certain of them. A correct rule stated in words earns the marks.

Practice questions from Income from Other Sources

Dividend Income and Related Deductions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsTaxation of Dividend, Interest and Other Income

Dividend Income and Related Deductions: frequently asked questions

Is dividend taxable in the hands of the shareholder under the new Income-tax Act?

Yes. Dividend from a company is taxed in the shareholder's hands as income from other sources. The company does not pay a separate dividend distribution tax. Apply the shareholder's applicable rates.

How do I compute deemed dividend on a loan to a shareholder?

Check that the lender is a closely held company and the borrower is a 10% voting power beneficial owner or a concern in which such a shareholder has a substantial interest. Then take the lower of the loan amount and the accumulated profits on the date of the loan. That figure is the deemed dividend.

What deductions are allowed against dividend income?

Only interest expense incurred to earn the dividend, and only up to 20% of the dividend income included in total income. The cap applies to the dividend income only, not to other income. Commission, demat charges and other costs are not deductible against dividend.

Is a loan from a company to a shareholder always deemed dividend?

No. The company must be closely held and the borrower must meet the 10% voting power test, or be a concern in which such a shareholder has a substantial interest (20% or more of voting power or profits). Loans in the ordinary course of a money-lending business are excluded, and the amount is capped at accumulated profits.