Interest Deduction on Dividend Income to Be Disallowed Under Income-tax Act, 2025 from April 2026

In a significant shift in the taxation of passive investment income, the Union Government has proposed to disallow deduction of interest expenditure against dividend income and income from mutual fund units under the Income-tax Act, 2025. The amendment is set to take effect from 1 April 2026, applicable from Tax Year 2025–26 onwards.

Existing Legal Position

Under the Income-tax Act, 2025, dividend income and income from units of mutual funds are taxable under the head “Income from Other Sources.” Section 93 of the Act currently permits taxpayers to claim certain deductions against such income.

Specifically, Section 93(2) allows deduction of interest expenditure incurred for earning dividend income or mutual fund income, subject to a ceiling of 20% of the gross dividend or income from units of mutual funds. This provision recognizes the cost of borrowing incurred by investors for generating passive income.

Proposed Amendment to Section 93(2)

The proposed amendment seeks to completely withdraw the benefit of interest deduction in respect of dividend income and income from mutual fund units.

As per the proposal:

No deduction shall be allowed for any interest expenditure incurred for earning:
- Dividend income, or
- Income from units of mutual funds.

This represents a departure from the existing framework, which allowed partial deduction, and aligns with a broader policy approach of restricting expense deductions against passive income streams.

Effective Date and Applicability

The amendment is proposed to:

Take effect from 1 April 2026, and
Apply for Tax Year 2025–26 onwards.

Accordingly, interest expenses incurred in relation to dividend-paying shares or mutual fund investments will no longer be deductible, irrespective of the quantum of income earned.

Impact on Investors

The proposed change will have notable implications for:

Leveraged investors who borrow funds to invest in dividend-yielding equities or mutual funds.
High-net-worth individuals (HNIs) and family offices using structured debt-backed investment strategies.
Retail investors who rely on dividend income while servicing investment-related loans.

With interest deduction being withdrawn, the effective tax burden on dividend income will increase, particularly for taxpayers in higher tax slabs.

Policy Rationale

While no explicit rationale has been stated in the proposal, the move appears to be aimed at:

Simplifying the tax structure,
Preventing tax arbitrage through interest-backed investments, and
Ensuring parity between different categories of passive income.

The amendment also follows the earlier policy shift that made dividend income fully taxable in the hands of shareholders, replacing the dividend distribution tax regime.

Conclusion

If enacted, the amendment to Section 93(2) of the Income-tax Act, 2025 will mark a significant tightening of deductions available against dividend and mutual fund income. Investors may need to reassess their financing strategies and investment structures in light of the increased tax cost from Assessment Year 2026–27 onwards.

Taxpayers are advised to closely monitor legislative developments and seek professional advice to realign their portfolios ahead of the effective date.