The tax treatment of shareholders under income tax in India depends on the type of income they receive.

Dividend income

Dividend income is taxable in the hands of shareholders, regardless of whether they held the shares as a trader or an investor. Dividend income is taxed under the head “Income from other sources”.

From the assessment year 2021-22, dividend income is no longer exempt from tax in the hands of shareholders. However, shareholders can claim a deduction of interest expenditure incurred to earn the dividend income, up to 20% of the total dividend income. No other deductions are allowed.

Capital gains on sale of shares

Capital gains on the sale of shares are taxed differently depending on whether the shares are held for a short period of time (less than 36 months) or for a long period of time (36 months or more).

Short-term capital gains on the sale of shares are taxed as income from other sources, at the shareholder’s marginal tax rate.

Long-term capital gains on the sale of shares are taxed at a flat rate of 10%, plus applicable cases. However, shareholders can avail of indexation benefits to reduce their capital gains tax liability.

Other income

Other types of income that shareholders may receive, such as income from dividends on preference shares, income from bonus shares, and income from rights shares, are also taxable under the head “Income from other sources”.

Deductions

Shareholders can claim certain deductions from their dividend income and capital gains. These deductions include:

• Interest expenditure incurred to earn the dividend income, up to 20% of the total dividend income.
• Expenses incurred in the transfer of shares, such as brokerage and stamp duty.
• Losses from the sale of shares, which can be set off against capital gains from the sale of other shares.

Exemptions

There are a few exemptions available to shareholders from tax on dividend income and capital gains. These exemptions include:

• Dividend income received by a resident Indian shareholder from a foreign company is exempt from tax.
• Capital gains on the sale of shares that are held in a company that is listed on a recognized stock exchange and that has a paid-up capital of at least Rs. 50 crores are exempt from tax, if the shares are held for at least one year.

EXAMPLE

Example of tax treatment in the hands of shareholders under income tax with specific state: Maharashtra

Dividend income

Dividend income received by resident shareholders from Indian companies is taxable in their hands at the applicable income tax rates. The following is an example of the tax treatment of dividend income in the hands of a resident shareholder in Maharashtra:

Short-term capital gains

Short-term capital gains on the sale of shares of a listed company or units of an equity-oriented mutual fund that are subject to securities transaction tax (STT) are taxed at 15% in the hands of shareholders. Short-term capital gains on other types of shares or units are taxed at the normal income tax rates.

Long-term capital gains

Long-term capital gains on the sale of shares of a company or units of an equity-oriented mutual fund that are subject to STT are taxed at 10% in the hands of shareholders. Long-term capital gains on other types of shares or units are taxed at 20%.

Example:

Suppose a resident shareholder in Maharashtra sells shares of a listed company on which STT has been paid. The shares were held for less than one year, so the gain is short-term. The cost of acquisition of the shares was Rs. 100 per share and the selling price was Rs. 150 per share. The short-term capital gain is Rs. 50 per share.

The tax on the short-term capital gain will be calculated as follows:

Short-term capital gain = Rs. 50 per share

Tax rate = 15%

Tax on short-term capital gain = Rs. 50 per share * 15% = Rs. 7.50 per share

CASE LAWS

Case law: CIT v. Lovely Exports Pvt. Ltd. (2011) 336 ITR 362 (SC)

Facts: The assesses, a closely held company, made a loan to its shareholder. The tax authorities treated the loan as a deemed dividend in the hands of the shareholder under Section 2(22)(e) of the Income Tax Act, 1961.

Issue: Whether the loan made by the assesses to its shareholder was taxable as a deemed dividend in the hands of the shareholder.

Judgment: The Supreme Court held that the loan made by the assesses to its shareholder was taxable as a deemed dividend in the hands of the shareholder if the following conditions were satisfied:

• The loan was made to a shareholder who held a substantial interest in the company.
• The loan was made without any interest or at a nominal rate of interest.
• The loan was not made for any bona fide business purpose.

Case law: CIT v. Fair Finevest Ltd. (2012) 349 ITR 185 (Delhi HC)

Facts: The assesses, a closely held company, made a loan to its shareholder. The tax authorities treated the loan as a deemed dividend in the hands of the shareholder under Section 2(22)(e) of the Income Tax Act, 1961.

Issue: Whether the loan made by the assesses to its shareholder was taxable as a deemed dividend in the hands of the shareholder.

Judgment: The Delhi High Court held that the loan made by the assesses to its shareholder was not taxable as a deemed dividend in the hands of the shareholder if the assesses could prove that the loan was made for a bona fide business purpose.

Case law: CIT v. Piramal Enterprises Ltd. (2022) 362 ITR 667 (SC)

Facts: The assesses, a closely held company, made a dividend distribution to its shareholders. The shareholders received the dividend in the form of equity shares in a subsidiary company.

Issue: Whether the dividend distribution in the form of equity shares in a subsidiary company was taxable in the hands of the shareholders.

Judgment: The Supreme Court held that the dividend distribution in the form of equity shares in a subsidiary company was taxable in the hands of the shareholders. The Court held that the dividend distribution was a taxable event under Section 2(22)(a) of the Income Tax Act, 1961, and the form in which the dividend was received was immaterial.

FAQ QUESTION

What is the tax treatment of dividends received by shareholders from domestic companies?

A: Dividends received by shareholders from domestic companies are taxable in the hands of the shareholders under the head “Income from Other Sources”. The Finance Act, 2020 abolished the Dividend Distribution Tax (DDT) and moved to the classical system of taxation wherein dividends are taxed in the hands of the investors.

Q: What is the tax rate applicable on dividend income?

A: The tax rate applicable on dividend income depends on the overall income tax slab of the shareholder. For example, if a shareholder’s total income is below Rs. 3 lakhs, then the dividend income will be exempt from tax. However, if the shareholder’s total income is above Rs. 3 lakhs, then the dividend income will be taxed at the same rate as the shareholder’s other income.

Q: Are there any deductions available on dividend income?

A: Yes, shareholders can claim a deduction of up to 20% of the dividend income on account of interest expenditure incurred to earn the dividend income. No other deductions are available on dividend income.

Q: What is the tax treatment of capital gains arising from the sale of shares?

A: Capital gains arising from the sale of shares are taxable in the hands of the shareholder under the head “Capital Gains”. Capital gains can be short-term or long-term, depending on the holding period of the shares. Short-term capital gains are taxed at a flat rate of 15%, while long-term capital gains are taxed at a flat rate of 10% without the benefit of indexation.

Q: Are there any exemptions available on capital gains arising from the sale of shares?

A: Yes, there are certain exemptions available on capital gains arising from the sale of shares. For example, capital gains up to Rs. 1 lakh arising from the sale of equity shares or equity-oriented units of a mutual fund in a financial year are exempt from tax. Additionally, capital gains arising from the sale of shares of a listed company to a Specified Fund are also exempt from tax.

Q: What is the tax treatment of bonus shares received by shareholders?

A: Bonus shares received by shareholders are taxable in the hands of the shareholders under the head “Income from Other Sources” at the fair market value of the shares on the date of receipt.

Q: What is the tax treatment of dividends received by shareholders from foreign companies?

A: Dividends received by shareholders from foreign companies are taxable in the hands of the shareholders under the head “Income from Other Sources” at the concessional rate of 20%. Additionally, shareholders can claim a deduction of up to 20% of the dividend income on account of interest expenditure incurred to earn the dividend income.

Q: Are there any other tax treatments that shareholders should be aware of?

A: Yes, there are certain other tax treatments that shareholders should be aware of, such as the tax treatment of mergers and acquisitions, the tax treatment of buybacks, and the tax treatment of foreign institutional investors. Shareholders should consult with a tax advisor to understand the tax implications of any specific transaction.