“Editorial Update: This article summarizes the shareholder-centric jurisprudence on Section 2(22)(e) and related interpretative developments up to the Finance Act, 2025. The discussion is for academic/professional analysis and is not official CBDT/Departmental guidance. Where the recipient entity is itself a shareholder (or the real beneficiary differs), taxability must be tested on facts under the statute.”
(INDIA) — A Finance Act 2025 update on deemed dividend under Section 2(22)(e) set out a litigation-resistant framework for tax officers and companies assessing loans and advances from closely held firms.
The guide said a significant proportion of additions under Section 2(22)(e) fail at appellate stages because of incorrect identification of applicability conditions, the taxable person, and the legal character of the transaction.
It positioned Section 2(22)(e) as a frequently invoked anti-avoidance provision in Indian corporate taxation, while also describing it as frequently misunderstood.
Section 2(22)(e) of the Income-tax Act, 1961 treats certain loans, advances, or payments made by closely held companies as deemed dividend even when no dividend is formally declared.
The legislative objective, the guide said, remains narrowly defined. Closely held companies historically avoided dividend taxation by distributing accumulated profits to controlling shareholders through loans or advances rather than declared dividends.
That narrow purpose matters for assessments, because the provision targets disguised profit extraction rather than genuine commercial financing transactions.
Applicability starts with the nature of the payer company. The provision applies only when the company making the payment is a company in which the public are not substantially interested, commonly described as a closely held company.
Listed or widely held companies ordinarily fall outside its scope, the guide said, making the first step a threshold check rather than a debate about motive.
From there, Section 2(22)(e) operates only when all statutory preconditions coexist. The guide described four mandatory tests: payment by a closely held company; payment by way of loan, advance, or benefit; existence of accumulated profits on the date of payment; and specified shareholder linkage.
Failure of any single condition renders the provision inapplicable, it added, framing the first stage as a strict gatekeeping exercise rather than a balancing test.
The guide grouped transactions into three categories for analysis. The first involves a loan or advance to a significant shareholder.
A loan granted to a shareholder holding not less than 10% voting power may be treated as deemed dividend, limited to accumulated profits.
The second category covers loans or advances to a concern connected with such a shareholder. In those cases, Section 2(22)(e) applies where a shareholder holds ≥10% voting power in the lending company and that shareholder has ≥20% substantial interest in the recipient concern.
The guide described the concern as potentially acting only as a conduit for shareholder benefit, placing emphasis on the linkage tests and the economic outcome.
The third category covers payments for the benefit of a shareholder. Payments made indirectly for personal benefit of a qualifying shareholder — such as discharge of personal liabilities — are equally covered, it said.
A recurring litigation issue lies in identifying who should be taxed. Judicial interpretation, the guide said, consistently recognises that deemed dividend taxation is shareholder-centric, not recipient-centric.
That distinction drives the “critical enquiry,” it added: who ultimately benefits from the funds.
For assessments, the guide said, that enquiry requires examining both registered shareholding and beneficial ownership. It also urged separating the question of whether Section 2(22)(e) can apply from who can be charged.
On judicial principles, the guide pointed to CIT v. Ankitech Pvt. Ltd. (Delhi High Court) as the most influential ruling on Section 2(22)(e). It said the Delhi High Court held that where a loan is given to a concern which is not itself a shareholder, the amount cannot be taxed in the hands of that concern merely because a common shareholder exists.
The court clarified, the guide said, that Section 2(22)(e) enlarges the definition of dividend but does not expand the category of taxable persons beyond shareholders.
That principle shaped later scrutiny of conduit structures, the guide said, by anchoring taxability to the shareholder who enjoys the benefit rather than the entity receiving funds.
CIT v. Madhur Housing and Development Company (Supreme Court) cemented that approach, according to the guide. It said the Supreme Court dismissed the Department’s appeal against Ankitech, effectively affirming the shareholder-centric interpretation.
The guide said the court’s affirmation settled a long-standing controversy and confirmed that a non-shareholder concern cannot be taxed merely because funds passed through it.
Post-Madhur Housing, it added, sustainable additions require precise identification of shareholder benefit rather than mechanical application of the provision.
A third Supreme Court ruling, National Travel Services v. CIT (Supreme Court), addressed partnership firms receiving loans where partners held shareholding in the lending company, the guide said.
It said the court emphasised substance over form, observing that beneficial ownership and real economic benefit must guide application of Section 2(22)(e). The guide said the ruling reinforced focus on the real beneficiary, economic control, and profit distribution character.
Alongside the shareholder linkage tests, the guide stressed the accumulated profits limitation as a measurement principle. Deemed dividend taxation is strictly limited to accumulated profits available on the date of payment, it said.
It added that commercial profits up to the payment date are included, and that taxability cannot exceed distributable surplus. Any excess loan amount remains outside the deemed dividend scope, the guide said.
To illustrate, it used a numerical example: Loan ₹50 lakh; accumulated profits ₹40 lakh → taxable deemed dividend restricted to ₹40 lakh.
The guide also sought to narrow disputes by identifying commercial transactions outside Section 2(22)(e). It said the provision does not apply to genuine business dealings including trade advances, security deposits, commercial transactions in ordinary course, and loans granted by companies substantially engaged in money-lending business.
The decisive test, it added, is whether the payment represents profit distribution disguised as financing.
In framing the Finance Act 2025 context, the guide said recent legislative developments reinforce the policy objective of taxing shareholder-level profit extraction while preserving exclusion for genuine financing transactions.
It said clarifications relating to financing entities align statutory interpretation with long-standing judicial reasoning distinguishing commercial lending from dividend substitution.
The guide then laid out a practical, litigation-proof assessment framework in two stages, designed to avoid reversals driven by mis-sequencing.
Stage 1 is an applicability analysis, it said, asking whether the company is closely held, whether accumulated profits are available, whether a ≥10% voting shareholder exists, and whether ≥20% substantial interest exists in the concern.
If any answer is negative, the guide said, Section 2(22)(e) fails.
Stage 2 is a chargeability determination. The guide framed this around who derives economic benefit, whether the recipient itself is a shareholder, and whether taxation legally follows the shareholder instead of the conduit entity.
It described confusion between applicability and chargeability as the primary cause of appellate reversals, placing the sequencing of questions at the centre of defensible assessments.
Beyond thresholds and beneficiary identification, the guide warned that applying the wrong assessment-year dividend regime can also undermine an addition. It said correct taxation depends upon the applicable dividend regime, and set out a period-based approach.
Up to AY 2018-19, it said, the treatment is shareholder taxation. AY 2019-20 & 2020-21 fall under the DDT regime.
From AY 2021-22 onwards, it said, the classical system is restored.
The guide said applying the wrong regime frequently renders additions unsustainable, adding a technical layer that can decide outcomes even when Section 2(22)(e) otherwise applies.
It also listed frequent errors leading to litigation. Those mistakes, it said, include taxing the recipient concern without shareholder analysis, ignoring the accumulated profit limitation, treating every advance as a loan, and overlooking beneficial ownership.
Other common mistakes include assuming repayment eliminates deemed dividend exposure and applying dividend regimes retrospectively, it said.
Repayment does not automatically erase deemed dividend once statutory conditions are satisfied, the guide added, underscoring that chargeability turns on conditions at the time of payment and the nature of benefit.
Before making an addition, the guide said a sustainable analysis requires verification of closely held company status, accumulated profits computation, qualifying shareholder (≥10% voting power), and substantial interest (≥20%) in the concern.
It also said assessments should verify the commercial substance of the transaction, the correct taxable person, and the correct assessment-year regime.
At the core, the guide distilled the rule into a single operational principle that it said emerges from statute and jurisprudence. A loan routed through a concern represents an indirect distribution of accumulated profits; taxation ordinarily follows the shareholder who benefits rather than the conduit entity, subject to factual verification.
The conclusion positioned Section 2(22)(e) as a focused anti-avoidance mechanism rather than a blanket taxation provision for corporate loans, warning that the complexity around deemed dividend often arises from misapplication during assessment.
It said a disciplined approach separating applicability, benefit, and chargeability, supported by Ankitech, Madhur Housing, and National Travel Services, reduces avoidable litigation and supports legally sustainable outcomes under the Finance Act 2025.
Master Section 2(22)(e) Deemed Dividend Rules Under Finance Act 2025
The Finance Act 2025 introduces a framework to streamline Section 2(22)(e) assessments, aiming to reduce appellate failures. By distinguishing between genuine business loans and disguised profit extractions, the guide clarifies that deemed dividends are shareholder-centric. It mandates a rigorous four-test verification process and highlights the importance of using the correct assessment-year regime to ensure tax additions remain legally sustainable and resistant to litigation.
