Understanding Section 2(22) of Income Tax Act: Definition of Dividend and Tax Implications

March 16, 2023

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Section 2(22) of the Income Tax Act, 1961 defines the term “dividend” and is an important provision that has significant implications for taxpayers. Dividend is a sum of money paid by a company to its shareholders out of its profits. In this blog, we will discuss section 2(22) of the Income Tax Act in detail.

Table of Contents

Definition of Dividend

Section 2(22) of the Income Tax Act defines dividend as any distribution of a company’s accumulated profits, whether capitalized or not, to its shareholders. It includes:

Any distribution of shares to its shareholders by a company on the reduction of its capital.
Any distribution made to the shareholders of a company on its liquidation.
Any payment made by a company, whether in cash or in kind, on the buyback of its shares.

Exceptions to the definition of Dividend

There are certain exceptions to the definition of dividend as mentioned under section 2(22) of the Income Tax Act. These include:

Any advance or loan given by a company to its shareholders or to its subsidiary company in which the shareholder holds more than 10% of the voting power or to any concern in which such shareholder is a partner or a member, is not considered as a dividend.
Any distribution made by a company to its shareholders out of accumulated profits earned by it before it became a deemed dividend u/s 2(22)(e) is not considered as a dividend.

Deemed Dividend u/s 2(22)(e)

Section 2(22)(e) of the Income Tax Act defines certain transactions as deemed dividends. These include:

Any payment made by a company, whether in cash or in kind, by way of advance or loan to its shareholders or to its concern in which the shareholder holds a substantial interest.
Any payment made by a company on behalf of its shareholders or their concerns in which the shareholder holds a substantial interest.
Any payment made by a company to a shareholder or his concern by way of advance or loan, in connection with the transfer of an asset or the acquisition of an asset by the shareholder or his concern.

Tax implications of Section 2(22)

Dividends received by a shareholder from a company are taxable under the head “Income from Other Sources” in the hands of the shareholder. The company paying the dividend is required to deduct tax at source (TDS) under Section 194 of the Income Tax Act at the time of payment of dividend.

Additional information on section 2(22) of the Income Tax Act is as follows:

Dividend Distribution Tax (DDT) Prior to the Union Budget of 2020, companies paying dividends were required to pay Dividend Distribution Tax (DDT) at the rate of 15% in addition to the tax deducted at source (TDS) on dividend paid to shareholders. However, in the Union Budget of 2020, the Finance Minister abolished DDT and shifted the burden of tax on dividend to the shareholders.

Impact of Section 2(22) on Shareholders Shareholders who receive dividend income are required to report it in their income tax return and pay tax on it at the applicable rate. In case of deemed dividend u/s 2(22)(e), the recipient of the deemed dividend is also required to pay tax on it at the applicable rate.

Impact of Section 2(22) on Companies Companies paying dividend are required to deduct tax at source (TDS) at the rate of 10% (in case of resident shareholders) or 20% (in case of non-resident shareholders) on the amount of dividend paid or credited to the shareholders. The company is also required to file Form 15G/15H if the recipient of the dividend is not liable to pay tax on the dividend.

Conclusion

In conclusion, section 2(22) of the Income Tax Act defines the term “dividend” and has significant implications for taxpayers. It is important for taxpayers to understand the definition of dividend and the exceptions to it to avoid any unintended tax consequences.

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Frequently Asked Questions (FAQs)

What is Section 2(22) of the Income Tax Act?
Section 2(22) of the Income Tax Act defines the term “dividend” and lays down the tax implications of dividends paid by companies to shareholders.

What is deemed dividend u/s 2(22)(e)?
Deemed dividend u/s 2(22)(e) refers to certain transactions that are treated as dividends for tax purposes, including payments made by a company to its shareholders or their concerns in which the shareholder holds a substantial interest.

What are the exceptions to the definition of dividend?
The exceptions to the definition of dividend include any advance or loan given by a company to its shareholders or to its subsidiary company in which the shareholder holds more than 10% of the voting power, and any distribution made by a company to its shareholders out of accumulated profits earned before it became a deemed dividend u/s 2(22)(e).

What is the tax rate on dividend income for shareholders?
The tax rate on dividend income for shareholders is based on their applicable tax slab rates.

What is the rate of TDS on dividend paid by companies to shareholders?
The rate of TDS on dividend paid by companies to shareholders is 10% for resident shareholders and 20% for non-resident shareholders.

What is Form 15G/15H?
Form 15G/15H is a declaration form that can be submitted by a taxpayer to the company paying the dividend if the recipient of the dividend is not liable to pay tax on the dividend.

What is the impact of section 2(22) on companies?
Companies paying dividend are required to deduct TDS and comply with the provisions of the Income Tax Act while paying dividends to shareholders.

Is dividend income taxable in the hands of shareholders?
Yes, dividend income received by shareholders is taxable in their hands under the head “Income from Other Sources”.

Is Dividend Distribution Tax (DDT) still applicable?
No, Dividend Distribution Tax (DDT) was abolished in the Union Budget of 2020 and the burden of tax on dividend was shifted to the shareholders.

What are the consequences of non-compliance with the provisions of section 2(22)?
Non-compliance with the provisions of section 2(22) can lead to penalties, interest, and prosecution under the Income Tax Act.