Bought Shares with a Loan? Here's How Much Interest You Can Deduct Against Your Dividend Income

Before Financial Year 2020-21, dividends were largely tax-free in the hands of shareholders under the old Section 10(34), because companies paid Dividend Distribution Tax (DDT) under Section 115-O before distributing profits.

The Finance Act, 2020 abolished DDT. From FY 2020-21 onward, dividend income became taxable directly in the hands of the recipient, at their applicable income tax slab rate. To balance this shift, the law allowed a limited deduction for the cost of earning that dividend — but lawmakers capped it at 20% to prevent taxpayers from using large interest deductions to wipe out their entire dividend income.

The formula is simple: Deduction allowed = Lower of (Actual interest paid) or (20% of gross dividend income).

• 1Add up the total dividend income received during the financial year.
• 2Calculate 20% of that dividend income.
• 3Compare it with the actual interest you paid on the borrowed funds during the same year.
• 4Claim whichever amount is lower.

Worked Example 1

• 1Dividend received: ₹1,00,000
• 2Interest paid on the loan used to buy shares: ₹30,000
• 320% of dividend income = ₹20,000
• 4Since ₹20,000 < ₹30,000 → deduction allowed = ₹20,000
• 5Taxable dividend income = ₹1,00,000 − ₹20,000 = ₹80,000
• 6The remaining ₹10,000 of interest paid gets no tax benefit — it cannot be carried forward or adjusted against any other income.

Worked Example 2

• 1Dividend received: ₹20,000
• 2Interest paid: ₹6,000
• 320% of dividend income = ₹4,000
• 4Since ₹4,000 < ₹6,000 → deduction allowed = ₹4,000
• 5Taxable dividend income = ₹20,000 − ₹4,000 = ₹16,000

Worked Example 3 (interest lower than the cap)

• 1Dividend received: ₹50,000
• 2Interest paid: ₹5,000
• 320% of dividend income = ₹10,000
• 4Since ₹5,000 < ₹10,000 → the entire ₹5,000 is deductible
• 5Taxable dividend income = ₹50,000 − ₹5,000 = ₹45,000

• 1Only interest qualifies — no other expense related to earning dividend income is deductible under this section.
• 2The 20% cap is absolute — even if your actual interest cost is much higher, you cannot claim more than one-fifth of your dividend income.
• 3No carry-forward of excess interest — unlike business losses or capital losses, the disallowed portion of interest simply lapses; it cannot be set off in a future year or against another income head.
• 4Applies only to investment-purpose interest — the loan must have been taken specifically to purchase the shares (or mutual fund units) on which the dividend was earned. Interest on unrelated loans cannot be claimed here.
• 5Taxed at slab rate — the net dividend income (after this deduction) is added to your total income and taxed at your applicable income tax slab rate; there's no special concessional rate for dividends.
• 6Different treatment for traders — if shares are held as stock-in-trade (i.e., you're a trader, not an investor), dividend and related interest may instead be assessed under "Profits and Gains of Business or Profession," where different rules on interest deduction under Section 36(1)(iii) apply, without the 20% cap.
• 7Report under Schedule OS — while filing your Income Tax Return, dividend income and this interest deduction are reported under Schedule OS (Income from Other Sources).

Since dividends are now taxable in your hands, companies deduct TDS (Tax Deducted at Source) before paying you.

• 1TDS is deducted at 10% if your dividend income from a company exceeds the prescribed threshold in a financial year (this threshold has been revised upward in recent years — check the current limit applicable for your assessment year).
• 2If PAN is not furnished, TDS is deducted at a higher rate of 20% under Section 206AA.
• 3You can claim credit for this TDS while filing your return; it isn't a final tax, just tax collected upfront.
• 4If your total income is below the basic exemption limit, you can submit Form 15G/15H to the company or its registrar to avoid TDS altogether.

• 1Keep clean records: Maintain the loan sanction letter, interest certificates from your bank or NBFC, and a clear paper trail showing the borrowed funds were used specifically to purchase the shares in question.
• 2Separate your loans: If you use one loan for multiple purposes (e.g., partly for shares, partly for personal use), only the interest attributable to the share-purchase portion is eligible — so it helps to keep investment borrowing separate from personal borrowing.
• 3Track dividend income and interest cost every year: Since the 20% cap is calculated year-wise, your deduction can vary depending on how much dividend you actually receive versus how much interest you pay in that particular financial year.
• 4Don't expect to zero out dividend tax through interest: Given the 20% ceiling, if your interest cost is proportionally high relative to your dividend yield, you will still end up paying tax on a large chunk of the dividend.

If you've borrowed money to invest in dividend-paying shares, you're entitled to some tax relief — but it's a limited one. Under Section 57(i), you can deduct interest paid on that loan only up to 20% of the dividend income received, and no other related expense qualifies. Understanding this cap in advance helps you plan your borrowing and investment strategy more realistically, rather than assuming the entire interest cost will offset your dividend tax liability.

As always, since tax provisions are amended frequently through annual Finance Acts, it's wise to verify the applicable rules for the specific assessment year with a tax professional or the official Income Tax Department website before filing your return. This is especially true for buybacks right now — the rules have changed twice in under two years, so always check which regime applies to the specific date of your buyback transaction.