Section 2(40)(e)Special Incomewas Section 2(22)(e) in IT Act 1961

Deemed Dividend — Loans or Advances by Closely Held Companies

When an unlisted closely held company gives loans or advances to certain shareholders or related concerns, those loans are treated as 'deemed dividend' in the hands of the recipient — even if no actual dividend is declared.

Last updated: 8 July 2026

When Does a Loan Become a Deemed Dividend?

Under Section 2(40)(e) of the Income Tax Act 2025, any loan or advance given by a closely held (unlisted) company is treated as a deemed dividend in the hands of the recipient if any of the following conditions are met:

Scenario	Trigger Condition	Result
Loan to a concern (company, firm, AOP/BOI/HUF)	The concern holds 20% or more voting power OR 20% or more profit-sharing ratio in the closely held company at any time during the Tax Year	Deemed Dividend
Loan directly to an equity shareholder	The shareholder holds 10% or more voting power in the closely held company	Deemed Dividend
Loan to any other person on behalf of a shareholder	The shareholder on whose behalf the loan is made holds 10% or more voting power	Deemed Dividend

How Section 2(40)(e) Works

This provision applies only to closely held companies — i.e., unlisted companies where the public are not substantially interested. Listed companies and companies in which the public are substantially interested are outside the scope of Section 2(40)(e).

How Much is Treated as Deemed Dividend?

Not the entire loan amount — only the portion up to the accumulated book profits (Reserves & Surplus) of the company is treated as deemed dividend.

Particulars	Amount
Loan / Advance given	XXX
Accumulated Book Profits (Reserves & Surplus)	YYY
Deemed Dividend = Lower of the two above	Min(XXX, YYY)

Illustration

Accumulated book profits (Reserves & Surplus)	₹15,00,000
Loan given to shareholder (10%+ voting power)	₹20,00,000
Deemed Dividend (lower of loan vs. book profits)	₹15,00,000
Balance of loan NOT treated as deemed dividend	₹ 5,00,000

Key Points to Note

Repayment does NOT cure deemed dividend status — even if the loan is fully repaid and the interest charged is at market rate, the original loan amount is still treated as deemed dividend in the year it was given
Trade advances given in the ordinary course of commercial transactions are NOT treated as deemed dividend, as clarified by CBDT Circular 19/2017
The deemed dividend is taxed in the hands of the recipient shareholder (or concern) as 'Income from Other Sources'
The closely held company does not get a deduction for the loan treated as deemed dividend

Transactions NOT Treated as Deemed Dividend

1.Actual dividend declared and paid by the company that is set off against a loan already treated as deemed dividend under Section 2(40)(e) — to the extent of such set-off, the actual dividend is not taxed again
2.Loans or advances given by a company whose substantial business is money lending — the term 'substantial' is not defined in the Act and must be assessed case-by-case based on revenue contribution, profit contribution, and nature of operations

Set-Off Example — SV Pvt. Ltd.

SV Pvt. Ltd. has Reserves & Surplus of ₹15 lakh. It gives a loan of ₹5 lakh to DP (a 10%+ shareholder) on 17/07/2026 — this ₹5 lakh is immediately treated as deemed dividend. Later, on 10/12/2026, SV declares an actual dividend of ₹10 lakh.

Shareholder	Actual Dividend Received	Treatment
SV (other shareholder)	₹5,00,000	Taxable as actual dividend ✓
DP (loan recipient)	₹5,00,000	Set off against the earlier loan (already taxed as deemed dividend) → NOT taxed again ✗

Set-off Example — SV Pvt. Ltd.

The set-off rule prevents double taxation — DP was already taxed on ₹5 lakh as deemed dividend when the loan was given. When the actual dividend of ₹5 lakh is later declared, it wipes out the loan and is not taxed again in DP's hands.

Directors and shareholders of closely held companies often take loans from the company for personal expenses. Under Section 2(40)(e), such loans are immediately taxable as deemed dividend in the Tax Year they are received — they cannot be deferred by showing them as 'repayable loans' in the company's books.

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Disclaimer: This analysis is based on the Income Tax Act 2025 (Tax Year 2026-27) and is for educational purposes only. Tax laws are subject to change. Always verify with a Chartered Accountant or tax advisor before making decisions.

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