Investors reduced their taxable dividend income by claiming interest cost, up to 20 percent of the dividend received.
The Budget proposal to scrap setting off interest expenditure incurred for earning dividend income or income from units of mutual funds will make leveraged investments less attractive and impact investors returns.
Dividend income and income from units of mutual funds constitute passive investment receipts taxable under the head “Income from other sources” under the Income Tax Act, 2025. Section 93 of the Act provides for allowing certain deductions against such income. This includes interest expenditure incurred for earning such income, subject to a ceiling of 20 per cent of the gross dividend or income from units of mutual funds.
The Budget has proposed amending the relevant section so that the deduction, allowed on interest expenditure incurred for earning dividend income or income from units of mutual funds, has been removed.
What this means is that if an individual has taken a loan to invest in stocks and mutual funds then the interest paid on that loan can no longer be offset against the dividend income from the stocks or MF units. “Its going to get taxed on a gross basis,” said Rajeshree Sabnavis, Senior Advisor, Grant Thornton Bharat.
The amendment will take effect from April 1.
Aditya Bhattacharya, Partner, King Stubb & Kasiva, Advocates and Attorneys said the change aligns with the broader intent to rationalize tax benefits and curb mismatch claims, signaling a stricter approach towards leveraging interest deductions against passive investment income.
Any sum previously allowed as a deduction, or excluded from total income under the repealed Income-tax Act, 1961, will now be deemed income under the Income-tax Act, 2025, even if no conditions were violated, he said.
tax leakage
Another reason for not allowing the deduction is to plug tax leakage. “People would take loans and use that interest as a deduction. To that extent, the dividend income which was offered for tax was on the lower side,” said Sabnavis.
Investors reduced their taxable dividend income by claiming interest cost, up to 20 percent of the dividend received. With this benefit removed, an investor in the highest tax bracket will now pay extra tax equal to about 6 percent of the dividend amount.
However, this interest cost is not completely lost. The same interest can be added to the purchase cost of the investment to lower the capital gains tax payable when the investment is sold, said Chintak Shah, Vice President, Anand Rathi Wealth.
While the rule change increases tax on dividends today, a part of this can be recovered through lower capital gains tax later, he said, adding that the proposal would affect only those who borrow money to invest in stocks and MFs.
From a legal standpoint, this retroactive deeming ensures continuity and removes potential disputes arising from the shift between statutes, providing taxpayers and practitioners a clear framework for compliance and assessment under the new Act, said Bhattacharya.
Dividend income is taxed at the investor’s slab rate, which can go up to 30 per cent. Capital gains on listed equities continue to be taxed at 12.5 per cent for long-term gains and 20 per cent for short-term gains.
Published on February 2, 2026