Dividend Income Changes: Removal of Interest Deductions in ITA 2025#
The Old Leverage Strategy#
Under the old Income Tax Act of 1961, dividend income was taxable in the hands of the shareholder at their applicable slab rates (which could be as high as 39% for HNIs).
To mitigate this heavy tax burden, savvy investors and holding companies used a specific loophole. If you took a loan to purchase shares, you were allowed to claim the interest paid on that loan as a deduction against the dividend income received from those shares.
The Restriction: The deduction was capped at a maximum of 20% of the dividend income. Even with the cap, this strategy allowed HNIs to artificially reduce their taxable dividend income by leveraging their portfolios.
The Loophole Closes in ITA 2025#
The government, in its drive to simplify the tax code and maximize revenue, has completely eliminated this benefit in the Income Tax Act, 2025.
Starting April 1, 2026, no deduction shall be allowed for any interest expense (or any other expense like broker fees or portfolio management fees) against income earned by way of dividends or income from units of Mutual Funds/REITs/InvITs.
The Immediate Impact#
- Taxing Gross Income: Dividends will now be taxed on a strictly gross basis. If a PSU stock pays you ₹10 Lakhs in dividends, you must pay tax on the entire ₹10 Lakhs at your slab rate, regardless of whether you are paying ₹5 Lakhs in interest to the bank that funded the purchase.
- Holding Companies Hit: Promoters who use holding companies to buy shares of their operating companies (funding the purchase through debt) will face a massive spike in their tax outflows. The dividends flowing up to the holding company will be fully taxed, while the interest paid to banks will become a dead expense.
Rethinking Dividend Portfolios#
For retail investors and HNIs, this drastically reduces the post-tax yield of "Dividend Aristocrat" portfolios (e.g., heavily investing in PSU stocks like Coal India or ITC solely for the yield).
With dividends being taxed on a gross basis at peak slab rates, and share buybacks now being taxed as Capital Gains, investors must fundamentally shift their strategy toward "Growth" stocks that reinvest capital internally, deferring tax liability until the investor actually sells the shares (generating Long-Term Capital Gains at 12.5%).