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CA KAMAL GARG, B. Com (H), FCA, DISA (ICAI), Insolvency Professional (IBBI)


Deemed dividend under Income Tax Act, 1961

Section 2(22)(e) provides that dividend includes any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern)] or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits.

However, dividend does not include any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company

Thus, the provisions of Section 2(22)(e) deems certain payments to be dividend if the following conditions are satisfied:

(i)           Payment should be by a company in which public are not substantially interested (i.e. closely held company');

(ii)          Payment should be an advance or loan or the payment should be on behalf, or for the individual benefit, of the shareholder;

(iii)         The shareholder must be the beneficial owner of shares holding not less than 10% of the voting power. For considering the 10% of the voting power what is relevant is the shareholding of the assessee alone and shareholding of his relatives is not to be considered;

(iv)     Payment by way of advance or loan should be to the shareholder or any concern in which the shareholder is a member or a partner and in which he has substantial interest;

(iv)        The company making the payment should have accumulated profits.

The amount of deemed dividend is restricted to the extent to which the company possesses accumulated profits. The accumulated profits are to be computed up to the date of payment after considering provisions of Explanation 1, Explanation 2 and Explanation 2A below section 2(22).

Explanation 3 defines the term 'concern' to include a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company. A person is deemed to have a substantial interest in a concern (other than a company) if he is, at any time during the previous year, beneficially entitled to not less than 20% of the income of such concern.

If at any time earlier, any amount has been taxed under any of the clauses of section 2(22), the accumulated profits will have to be reduced by the amount so taxed.

There may be business transactions between the closely held company and the concerns in which the assessee has substantial interest  - trade advances may arise – Section 2(22)(e) not applicable – CBDT Circular 19/2017, Dated 12th June 12017.

Section 2(32) defines the term 'person who has substantial interest in the company' to mean a person who is the beneficial owner of shares (not being shares entitled to fixed rate of dividend) carrying not less than 20% of the voting power.

Even if the loan or advance is made by the closely held company to the concern, it is chargeable to tax in the hands of the shareholder and not in the hands of the concern - Supreme Court in CIT v. Madhur Housing & Development Co. (Civil Appeal 3961of 2013)[1].

Illustration: Balance Sheet of ‘X’ (P) Limited

Particulars

Amount

Equity Share Capital

2,00,000

Reserves and Surplus 

6,50,000

Cash

8,25,000

P & L (Dr.)

25,000

On 1.4.2017, ‘X’ (P) Limited gives a loan of Rs. 2,00,000 to Mr. S holding 11% voting power. On 2.4.2017, Mr. S repays the loan to the company 

On 31.7.2017,’X’ (P) Limited gives a loan of Rs. 2,00,000 to a firm in which Mr. Z is a partner and holds substantial interest. He also holds 20% voting power in the company on the date of loan 

On 30.9.2017, ‘X’ (P) Limited gives a loan of Rs. 3,00,000 to its supervisor having a salary of Rs. 4,000 p.m., who in turn advanced the said amount of loan to Mr. P, who holds 70% of the paid up capital of ‘X’ (P) Limited 

 

Recommendation:

Accumulated Profits [6,50,000 (-) 25,000]

6,25,000

Loan given to Mr. S on 1.4.2017:

For Company ‘X’ (P) Limited

In the hands of Mr. S

Accumulated Profits = 6,25,000 (-) 2,00,000 = Rs. 4,25,000

Loan of Rs. 2,00,000 – taxable u/s 2(22)(e)

Loan given to firm in which Mr. Z has substantial interest on 31.7.2017:

For Company ‘X’ (P) Limited

In the hands of Mr. Z

Accumulated Profits = 4,25,000 (-) 2,00,000 = Rs. 2,25,000

Loan of Rs. 2,00,000 – taxable u/s 2(22)(e)

Loan given to Mr. P via supervisor on 30.9.2017:

For Company ‘X’ (P) Limited

In the hands of Mr. P

Accumulated Profits = 2,25,000 (-) 2,25,000 = Rs. Nil

Loan of Rs. 2,25,000 – taxable u/s 2(22)(e) but to the extent of available accumulated profits – L Alagusundaram Chettair vs. CIT (2001) (SC)]

 

1. Tax on distributed profits of domestic companies:

Section 115-O(1) provides that notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of 15%.

Section 115-O has also been amended by the Finance Act, 2018 w.e.f. 1st April, 2018, to provide that in respect of dividend referred to in sub-clause (e) of clause (22) of section 2, this sub-section shall have effect as if for the words "fifteen per cent" (15%), the words "thirty per cent" (30%) had been substituted.

The definition of 'dividend' in Explanation to section 115Q has also been deleted, with the result that section 115-O will cover all dividends including deemed dividend under section 2(22)(e). Hence, such deemed dividends will also be liable to DDT under section 115-O. In addition, proviso to section 115-O(1B) has been inserted to provide that the grossing up provision will not apply to deemed dividend under section 2(22)(e).

Thus, where a company having accumulated profits of Rs. 5 crores gives to its shareholder holding 12% of equity share capital, a loan of Rs. 1 crore which now would be regarded as deemed dividend under section 2(22)(e). Till the amendment made by the Finance Act, 2108, the loan was regarded as income of the shareholder and was liable to tax in his own hands. Now, the loan of Rs. 1 crore will be liable to payment of DDT by the company @ 30% of the loan, that is, Rs. 30 lakh (30% of Rs. 1 crore) in this case.

The amount of loan liable to be regarded as dividend under section 115-O shall be exempt in the hands of the shareholder under section 10(34). It is pertinent that section 10(34) exempts "any income by way of dividends referred to in section 115-O"; this suggests that the exemption in the hands of shareholder is absolute and unconditional in respect of dividends referred to in section 115-O, even if the company has not paid appropriate tax under section115-O.

It should be noted that Section 115BBDA provides for additional tax @10% on dividend income exceeding Rs. 10 lakhs. For this purpose, dividend does not include a deemed dividend under section 2(22)(e) [Explanation (a) to section 115BBDA] Hence, such deemed dividend covered by section 115-O will not be liable to further tax under section 115BBDA in the hands of the shareholder. The actual rate of tax under section 115-O (including surcharge & cess) would be 34.944%.

It should be noted that even if a loan is given for a day and is repaid, it will constitute deemed dividend under section 2(22)(e) - Smt. Tarulata Shyam v. CIT[2]. Hence, a company giving a loan for a short period will also be liable to DDT.

2. Some Practical Issues

Issue 1: Details of concerns in which shareholders are interest may not be available: Section 2(22)(e) applies to the following:

(i)                shareholders holding at least 10% of voting power shares;

(ii)               any concern in which the shareholder is a member or partner and in which he has substantial interest,

While a company could have details of registered and beneficial shareholders, it may not have details of concerns in which shareholders are interested. In such circumstances, it is unclear as to how will the company identify that the payment is covered by section 2(22)(e) and it is liable to DDT. Also, unless the articles of association or other documents provide, it is unclear how a company can legally compel a shareholder to give the information regarding concerns in which he is interested and also furnish information to the company as and when there is a change in such information.

Issue 2: Provision for taxation:

While verifying the provision for taxation made by a company, its auditor will now have to confirm that no provision for taxation is required in respect of payments to be regarded as deemed dividend under section 2(22)(e).

Issue 3: Calculation of the pro rata profits for the year:

The deemed dividend is to the extent of accumulated profits of the company. For the purposes of section 2(22)(e), profits which are capitalised are not be to regarded accumulated profits. Explanation 2 to section 2(22) provides that accumulated profits shall include all profits of the company up to the date of payment. Hence, if a company may have given a loan on a date other than the first or last day of the financial year, it will have to calculate the pro rata profits for the year in which payment is made, in order to determine whether loan or advance is out of accumulated profits of the company or not.

Issue 4: Substantial part – meaning thereof:

In terms of section 2(22)(e), dividend does not include any advance or loan made to a shareholder or the concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company. The term 'substantial part' has not been defined in the Act. In various decisions it has been held that the expression 'substantial part' does not connote an idea of being the 'major part' or the part that constitutes majority of the whole. It depends on various factors. Some of the decisions have held that 'substantial part' would indicate 20% i.e. where 20% or more funds have been deployed in the business of lending money the test of substantial part will be satisfied - Tanuj Holdings (P.) Ltd. v. DCIT[3]; CIT v. Jayant H. Modi[4].

About the Author: CA Kamal Garg is a Fellow Member of The Institute of Chartered Accountants of India (ICAI) and a First Class Commerce Baccalaureate from Deen Dayal Upadhyaya College, University of Delhi and an academic resource partner in KGMA, Delhi. He has also qualified post qualification course on Diploma in Information System Audit (DISA) conducted by ICAI. He is also an Insolvency Professional. He is also the faculty resource of Ethical Standards Board (ESB) and Peer Review Board (PRB) of ICAI. He is also a key resource person for development and review of various study contents and webcasts for BOS of ICAI. Besides being a regular guest speaker for IFRS and Management Development Programmes at various forums including ICAI and ICSI, he is also an author of over dozens of book(s) and commentaries. He possesses a rich industry experience in the areas of Corporate Laws (like Companies Act, FEMA, Taxation, Foreign Collaborations, Joint Ventures, etc.), Audits and Management Consultancy.

 

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Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.

 

 

 

 

 

 



[1] (2017) 100 CCH 0046 ISCC

 

[2] (1977) 45 CCH 0241 ISCC : [1977] 108 ITR 345 (SC)

[3] (2016) 46 CCH 0292 KolTrib: 46 ITR (T) 420 (Kol. -Trib.)

[4] (2015) 92 CCH 0315 MumHC : 232 Taxman 337 (Bom.)


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