Section 2(22)(e) Deemed Dividend: When Company Loans to Shareholders Become Taxable

A loan or advance from a closely-held company to a 10%+ shareholder (or a concern in which such a shareholder holds 20%+ profit) is treated as deemed dividend under s.2(22)(e) ITA 1961, taxable in the shareholder's hands at slab rate, up to the company's accumulated profits. It is not "free money" — the amount is taxable income even though it remains a repayable loan. A ₹15 lakh advance to a 60% shareholder of a company with ₹40 lakh accumulated profits adds ₹15 lakh to the shareholder's taxable income.

What the law actually requires

Section 2(22)(e) ITA 1961 expands "dividend" to include any payment made by a company, not being a company in which the public are substantially interested, by way of loan or advance to:

The deeming fiction applies only to the extent of the company's accumulated profits. Per the Explanation to s.2(22), accumulated profits include all profits (revenue and capital) up to the date of the payment, without deducting capital expenditure / depreciation / unabsorbed allowances. If the loan exceeds accumulated profits, only the profit portion is deemed dividend; the excess remains an ordinary loan.

Exceptions. The clause does not apply where the loan or advance is made in the ordinary course of the company's business, and lending money is a substantial part of that business (a banking or money-lending company). A manufacturing or services company cannot claim this exception.

Repayment before year-end. The position is contested. Some decisions treat a loan repaid before the end of the financial year as outside s.2(22)(e); other decisions hold that the deeming applies at the point the loan is given and repayment does not cure it. The courts are split, and the AO's view will often follow the stricter line.

How the tax lands

Worked example: Priya and Zenith Fabrics Pvt Ltd

Priya holds 60% of Zenith Fabrics Pvt Ltd, a family-owned private company. Zenith has accumulated profits of ₹40 lakh (as computed for s.2(22)(e)). During FY 2025-26, Priya needs liquidity for a personal property purchase and draws ₹15,00,000 from the company by way of a loan, documented in her current account.

• Deemed dividend: ₹15,00,000 — within the ₹40 lakh accumulated profits, so the full advance is deemed dividend under s.2(22)(e).
• Taxable income: ₹15,00,000 added to Priya's income as Income from Other Sources. Her tax, new regime, FY 2025-26:

• The double pain: Priya owes ₹1,09,200 in tax on money that is still a loan she must repay to Zenith. She has taxable income of ₹15 lakh without receiving a "dividend cheque" — the loan itself is the dividend.
• Company side: Zenith gets no deduction, must report the current-account advance in its books, and faces the s.185 CA 2013 question — a loan to a director is prohibited, subject only to the narrow s.185(2) carve-outs (loan as part of uniform service conditions, scheme approved by special resolution, or lending business in the ordinary course). The historic blanket private-company exemption was deleted by the Companies (Amendment) Act 2017. It is also a related-party transaction under s.188 requiring board approval.

Practical implications

• A running current account is the classic trigger. Founders who draw ad-hoc sums "against future salary" or keep a director's current account in debit are creating deemed dividend to the extent of accumulated profits, on top of any s.185 issue.
• Accumulated profits can make small loans expensive. Even a modest advance becomes taxable if accumulated profits are substantial — the ₹15 lakh example is not an outlier.
• TDS uncertainty. The company faces a practical dilemma: s.194 TDS on deemed dividend is argued both ways, and deducting TDS on a loan repayment creates an accounting mess. Document the position with your CA and keep the loan transaction visible in the books — hiding it is worse.
• MCA21 v3 and the AO now cross-reference. Director current-account balances appear in the financial statements, AOC-4, and the annual return; scrutiny officers routinely test them against s.2(22)(e). An unexplained director debit balance is one of the first things an AO looks for in a closely-held company.
• The fix is structural: pay salary via a board-authorised resolution (Companies Act s.197/198; TDS then follows under ITA s.192), declare dividend properly out of profits (Companies Act s.123), or make the shareholder repay and document the repayment — do not leave ad-hoc advances sitting in a debit current account.

Changed FY 2025-26: s.2(22)(e) itself is unchanged, but the enforcement context is not. Post-DDT abolition, deemed dividend is slab-rate income with no corporate-layer offset, and MCA21 v3 now ties director borrowings in the financials to related-party and loan disclosures. There is no new notification to cite — treat this as an enforcement-intensity shift.

Step-by-step: what to do

• Audit the director current accounts. List every director/shareholder debit balance at 31 March and test it against accumulated profits for s.2(22)(e).
• Classify each advance: genuine salary (Companies Act s.197 + ITA s.15/17; TDS under s.192), declared dividend (s.123), or loan (s.185 + s.2(22)(e)). Only salary and dividend are clean.
• If loans exist, get them documented and approved — board resolution, s.188 RPT check, and a repayment schedule. If they cross into accumulated profits, plan the tax.
• Prefer salary over advances. A monthly salary by resolution avoids the deeming fiction and is deductible to the company.
• Compute and provide for the tax on any amount that is deemed dividend; disclose it in your ITR as Income from Other Sources.
• Get the TDS position documented by your CA; if TDS u/s 194 is deducted, issue the appropriate certificate [VERIFY].

FAQ

Does a loan from my own company to me count as dividend?
If you hold 10% or more of the voting power in a closely-held company and the company has accumulated profits, yes — s.2(22)(e) deems the loan a dividend up to those profits. It is taxable even though it is a loan you must repay.

Can the company avoid this by calling it a "current account" drawing?
No. The substance governs. An ad-hoc drawing against a current account is a loan/advance for s.2(22)(e) purposes. Keeping it in a current account does not defeat the deeming; it just makes it harder to see.

Is a loan from a banking company to a shareholder caught?
No — the clause exempts loans made in the ordinary course of business where lending money is a substantial part of the business. A non-financial company cannot claim this.

Does repaying the loan before year-end avoid the tax?
The case law is split; some courts say repayment cures it, others that the deeming applies when the loan is made. Do not rely on the repayment defence without a CA opinion.

How much of the loan is deemed dividend?
Only the amount covered by accumulated profits at the time of payment. The excess over accumulated profits is an ordinary loan, not deemed dividend.

Sources

• Income Tax Act 1961, s.2(22)(e) — deemed dividend on loans/advances to 10%+ shareholders
• Income Tax Act 1961, s.2(22)(a)-(d), s.8 — dividend definition and receipt
• Income Tax Act 1961, s.194 — TDS on dividend (applicability to deemed dividend debated)
• Companies Act 2013, s.185 (loans to directors), s.188 (related party transactions)
• Case law on repayment-before-year-end — conflicting High Court views [VERIFY]

For a compliance audit of your company, visit pvtltd.co

Need help with this?

Our team handles the paperwork. You focus on your business.