Dividend taxation has now completed a clear policy arc

THE UNION BUDGET 2026 proposes a fundamental shift in the taxation of leveraged investments by disallowing the deduction of interest on borrowings used to invest in shares and mutual fund units. The proposed amendment marks a clear break from the long-standing tax principle that financing costs incurred in the course of earning taxable income should be deductible.

- SANDEEPP JHUNJHUNWALA

Since the introduction of dividend distribution tax (DDT) in 1997, dividends were taxed at the company level and remained exempt in the hands of shareholders. Since dividend income was outside the tax net for investors, the question of deducting interest incurred to earn such income did not arise.

Dividends under tax net

This position changed from FY21, when DDT was abolished and dividends were brought back into the tax net. Recognising that earning dividend income could entail financing costs, the law permitted a deduction for interest incurred in relation to dividends and income from mutual fund units, subject to a cap of 20% of the gross income.