CA NITIN PATHAK AHMEDABAD: November 2015

DEEMED DIVIDEND A DETAILED ANALYSIS OF SECTION 2(22)(e) OF THE INCOME TAX ACT, 1961 AND IT’S LEGAL IMPLICATION:-

CA. Nitin M. Pathak

Poser of Deemed Dividend

Ø Preface:-

Importance of understanding the provision of deemed dividend U/s 2(22)(e) in the present context where dividend is tax free:-

Now a day, in a modern organization, there will exist a complicate business structure of holding & subsidiary companies along with closely held companies. There will be a routine flow of funds between these companies. It is very important to have the knowledge of provisions of deemed dividend under section 2(22)(e) of the Income tax act, 1961 before making any transaction with the closely held companies, to avoid falling into trap of deemed dividend even in case of inter corporate deposit, loans & advances.

Ø Four limbs of section of deemed dividend:-

(i) Assessee:- The assessee should be a shareholder of the company.

(Not the concern)

(ii) Closely held company:-The company should be a closely held

Company in which the public are not

Substantially interested.

(iii) Payment for loan or advance:-There must be payment by way advance or loan to a shareholder or concern or for the individual benefit of the shareholder.

(a) Shareholder having more than 10 % voting power.

(b) Concern( Firm,Company, HUF, AOP, BOI) in such shareholder as per above having more than 20 % beneficial ownership.

(iv) Accumulated profit:-There must be accumulated profits in the hands

of the company up to the date of such payment.

Ø Scope and ambit of Section 2(22)(e):-

· Type of Company : A Closely Held Company i.e. a Company in which the

public is not substantially interested. Here many public company will be covered. This is a biggest misnomer that public company is not covered.

[See Note 5-Definition of "Company in which the public is substantial interested”]

· To Person’s Covered :

(i) Any shareholder who is a beneficial owner of 10% or more of Voting

power of the Company

(but the shares shall not be entitled to a fixed rate of dividend, whether with or without a right to participate in profits); Or

(ii) (a) To a concern (includes HUF, Firm, AOP or BOI, Company) in which such shareholder is a partner or a member; AND

(b)has substantial interest (when entitled to 20% or more of the income of such concern).

See Note 20: For further Clarification

(iii) Concern i.e. Company in which, shareholder who holds 10% or more

voting power in the company, also holds 10% or more voting power of that concern at any time during the previous year.

· Nature of Payments:

(i) Any payment by way of advance or loan [See Note 6] OR

Exception: Loan or advance is granted [See Note 11]

(a) in the ordinary course of its business [See Note 9] and

(b) lending of money is a substantial part of the company’s business.

[See Note 10]

(ii) Any payment, on behalf of, or for the individual benefit of such

Shareholder. [See Note 7]

· Amount of Advance or Loan: Subject to maximum of Accumulated Profits [See Note 8] up to date of payment of Dividend. A loan not covered by Accumulated Profits is not deemed to be dividend.

· Accrual: In the “previous year” in which the payment was made. {Section 8(a)} [See Note 12]

Ø Key Points To Be Noted:-

1. Purpose of Section 2(22)(e):

Section 2(22)(e) of the Income Tax Act, 1961 plainly seeks to bring within the tax net accumulated profits which are distributed by closely held companies to its shareholders in the form of loans. The purpose being that persons who manage such closely held companies should not arrange their affairs in a manner that they assist the shareholders in avoiding the payment of taxes by having companies pay or distribute, what would legitimately be dividend in the hands of shareholders, money in the form of advance or loan.

- Ref: CIT v. Raj Kumar (2009) 181 Taxmann 155 (Delhi).

2. Non-Applicability of Dividend Distribution Tax u/s 115-O of I. T. Act

1961 & Exemption u/s 10(33):

Provisions of Corporate Dividend Tax (Section 115-O) are not attracted in case of “Deemed Dividend” & as a consequence thereof, exemption u/s 10(33) is not available.

(Explanation to Chapter XII-D of the I. T. Act,1961–appears below Section 115Q)

- Ref: 111 TTJ (mumbai) 1005

3. Heads of Income & Rate of Tax:

Deemed Dividend is taxed under the head Income from Other Sources U/s 56 is taxable in the hands of shareholder (Not in the hands of loaned company). Also Deemed Dividend u/s 2(22) (e) is not exempt u/s 10(33) of the Income Tax Act. No special rate of tax is applicable to deemed dividend and it is taxed as income chargeable to tax at normal rates – slab rates in case of individuals & HUF’s.

4. Set-Off To Avoid Double Taxation:

Subsequently, when the company declares dividend, & any such dividend is set-off against the advance, the dividend so adjusted against the advance (which has been deemed as dividend), will not be again treated as dividend).

- Ref: Rajesh P. Ved Vs ACII (ITAT, Mum) 126 TTJ (Trib)711

5. Company in which public is substantially interested [See Section 2(18)]

includes:

(i) a company owned by the Government or the RBI or more than forty

percent of the shares are owned by Government or the RBI or a

corporation owned by the RBI.

(ii) a company registered under section 25 of the Companies Act, 1956.

(iii)a company not having share capital and declared by the Board to be

such company.

(iv) Mutual Benefit Finance Company – business of acceptance of

deposits from members and notified by the Central Government u/s

620of the Companies Act, 1956.

(v) a company, whose more than 50% Equity Shares (not being

Preference Shares) held by one or more Co-operative Societies

throughout the previous year.

(vi) a company not being a Private Company as defined in the Companies

Act, 1956, whose Equity Shares were listed on the 31 March of the

previous year in a Recognised Stock Exchange.

(vii) a ‘Government Company’ not being a ‘Private Company’ (both terms

being defined in the Companies Act, 1956).

This definition is wide enough to cover rest of other companies are covered.

6. What does not constitute a Loan or Advance?

The term “Loan or Advance” has not been defined under the Income

Tax Act, 1961. Basically, the Loan or Advance must create the relationship of

‘lender’ and ‘borrower’ and not merely that of a ‘debtor’ and ‘creditor’. A

relationship of ‘lender’ and ‘borrower’ will generally be created when there is

an outgoing or flow of money from the company to the shareholder.

(i) In the matter of Dr. Fredie Ardheshir Mehta Vs. Union of India [1991] 70 Comp. Cas. 210 (Bom) held that:

Loan means an advance of money, upon the understanding that it shall be

paid back, and it may or may not carry interest. A credit sale resulting in a

Book Debt does not amount to a loan.

Inference- a) Therefore, only an actual payment of money by the company,

upon the understanding of its repayment, shall be termed as loan.

b) Any interest or provision for interest on the loan, resulting in an

increase in the total amount due, shall not be considered a loan for the

purpose of Section 2(22)(e).

- Ref: CIT Panaji–Goa Vs. Parle Products Ltd. (2011) 196 Taxmann 62 (Bom.)

Author’s Comments: The above decision has been rendered in a Case pertaining to the Companies Act. The phrase “Loan or advance” has neither been defined under the Income Tax Act nor the Companies Act. However, the cardinal issue in the instant case was the meaning of the term ‘Loan or Advance’.

- Ref: Chaturvedi and Pithisaria page 5735 (Vol 5, 4^th edition).

(ii) In the matter of CIT Vs. Raj Kumar (2009) 181 Taxmann 155 (Delhi) held that:

The usual attributes of a loan are that it involves positive act of lending

coupled with the acceptance by the other side of the money as loan – it generally carries interest and there is an obligation of repayment.

The term ‘advance’ is of wide import & has undoubtedly more than one meaning, depending on the context in which it is used. In its widest meaning, the term ‘advance’ may or may not include lending or the obligation of repayment.

The Delhi High Court applied the rule of construction of noscitur a sociis – “the meaning of the word can be gathered from the context” or “by the company which it keeps.”

The word ‘advance’ which appears in the company of the word ‘loan’ could only mean such ‘advance’ which carries with it an obligation of repayment.

Trade advance which are in the nature of money transacted it give effect to a commercial transactions would not fall within the ambit of the provisions of Section 2(22)(e) of the Act.

- Ref: CIT Vs. Creative Dyeing & Printing Mills Pvt. Ltd.

CIT Vs. G. Venkataraman [1975] 101 ITR 673 (Mad.)

(iii) Mere creation of debtor-creditor relationship is not enough: There should

be an actual cash advance or loan from the company to the assessee and the

mere creation of a debtor and creditor relationship between the company and

the assessee will not be enough. There should be an outgoing or flow of

money from the company to t he shareholder.

(iv) In the matter of Bombay Steam Navigation Company P. Ltd. Vs. CIT (1965) 56 ITR 52 (SC) held that:

“Every sale of goods on credit does not amount to a transaction of loan. A loan contracted no doubt creates a debt but there may be a debt without contracting a loan.”

(v) Inter-corporate deposits shall not be treated as deemed dividend u/s 2(22)(e) of the I. T. Act, 1961.

- Ref: Bombay Oil Industries Ltd. Vs. DCIT (2009) 28 SOT 383 (Mum)

7. Payments to Relatives of Shareholders or to Third Parties who advance Loans to Shareholder:

Generally speaking– Payments to relatives of shareholders or to Third parties are not covered u/s 2(22)(e).

However, in the peculiar facts & circumstances of the case, payments to relatives of shareholders or to third parties who, in turn use these fund to advance loans to shareholders will be covered under Section 2(22)(e) as ‘Deemed Dividend’. This is because, in addition to “Loans or Advance”, deemed dividend also includes – “Any payment, on behalf of, or for the individual benefit of such Shareholder.”

Illustrations

(i) In the matter of CIT Vs. L. Alagusundaram Chettiar[1977] 109 ITR 508 (Mad.) held that:

Facts A managing director of a company, whenever he needed money used to ask an employee to take a loan from the company and the company would pass it on to the employee even without executing any pronote. The employee advanced the loan to the assessee almost immediately and in toto.

Held the loans made by the company to the employee fell in the category of “benefit” to the assessee managing director and were, therefore, assessable as deemed dividends in his hands.

(ii) In the matter of Nandlal Kanoria Vs. CIT [1980] 122 ITR 405 (Cal.) held that:

Facts the assessee, having substantial interest in a company X, obtained from company Y two loans of Rs. 75,000/- and Rs. 2,00,000/- on July 30, 1968 and September2, 1968, respectively. Company Y had made the loans of Rs. 75,000 to the assessee out of loans received by Y from X on the same date. Further, Y had made the loans of Rs. 2,00,000/- to the assessee out of loans received by Y from X and another source on the same date.

Held this amount of Rs. 75,000/- was a payment by X for the benefit of the assessee and fell within the mischief of section 2(22)(e). The same could not be said of the loan of Rs. 2,00,000/- as on the date of making that loan, Y had received loans not only from X but from another source also and the loan was made out of blended amount.

8. What is “Accumulated Profits”?

In the matter of P. K. Badiani v. CIT (1976) 105 ITR 642 (SC), held that Accumulated profits mean commercial profits and not assessed income. It does not mean the aggregate of the assessed income arrived at after disallowing disbursements and expenditure in fact incurred. The undistributed profit includes profit accumulated of past years as well as current profit till the date of disbursement of loans and advances. For computation of accumulated profit and further explanation see clarification no (q). The details what is to be included & excluded from accumulated profit is explained there.

- Ref: NCK Sons Exports (P) Ltd. Vs. ITO (2006) 102 ITD 311 (MUM)

9. Whether a Loan or Advance is in the “Ordinary Course of Business”?

In determination thereof, the following points have to be considered:

(i) Whether the company is a Non-Banking Financial Company (NBFC) registered with the RBI?

(ii) Whether any Loan or Advance made to any person(s), other than Shareholder(s), Director(s) or their Relatives?

(iii)Terms ~ Rate of interest & Terms of Repayment – is it same as it is given to other borrowers.

In the matter of CIT v Ambassador Travels (P) Limited 318 ITR 376 held that “what is in the nature of ordinary course of business?”

In the above case two companies were in the booking travelling related business. Thus financial transactions involved of both the companies were in the ordinary course of business. The tribunal concluded and Delhi high court did not interfere in its judgment.

In the following cases tribunal judgment gives the clarity regarding what to be considered as ordinary course of business. The crux of the judgment is the loan was given in the ordinary course of business may not be lending business. This judgment reduces the rigors of deemed dividend.

- Ref:

1. Timeless Fashions (P) Ltd. 33 DTR 48.

2. Bharat C. Gandhi 178 Taxmann 83.

3. Usha Commercial (P) Ltd. 120 TTJ 1004

4. DCIT V/s Larka Brothers 106 TTJ 250 Chandigarh

5. Sri Satchidanand S. Pandit V/s ITO 19 SOT 213

6. CIT V/s Raj Kumar 318 ITR 0462

10. What constitutes “Substantial part of the company’s business”?

The term “substantial part of the company’s business” has not been defined under the Income Tax Act. But the same is defined in explanation 3(b) to section 2(22)(e) as not less than 20% of the income of such concern.

In the matter of CIT Vs. Venkateshwara Hatcheries (237 ITR 174) in Supreme Court, held that the definition in one section can be used for understanding the meaning of the word, in another section if the context justifies it. Here for the purpose of deemed dividend it can be concluded the definition of term ‘substantial’ used in the aforesaid section means 20% or more of the income of a concern.

Further, for determination of the fact whether the company was engaged in money lending business, factual position for the relevant ‘previous year’ (i.e. the year in which the loan or advance was made) should be considered qua total income and total business visa a vis lending business.

Thus, if the income from money lending is 20% or more of the total income of the closely held company and the turnover of the loan funds to total funds of the company is above 20%, any loans or advance made by the said company to its principal shareholder cannot be deemed to be dividend.

The same was upheld by Delhi Tribunal in Mrs. Rekha Modi Vs. ITO (2007) (13 SOT 512) and the same was not further challenged by the revenue. In this case for what is substantial part of business was referred by past three years records, memorandum of association, total business vis a vis money lending business in gross as well as net basis & loan funds to the total funds data were used for coming to conclusion.

In the case of CIT Vs. Parle Plastics Ltd.(2011) 332 ITR 63(Bom.) held that, various factors & circumstances will be required to be looked into for deciding what is a substantial part of business. In the case 40 % of total assets were deployed, so it was considered as substantial part of business.

Money advanced as loan by company substantially doing money lending

business could not be treated as deemed dividend under section 2(22)(e).

11. Onus is on the Assessee to prove facts:

The Loan or Advance is in the “Ordinary Course of Business” and Lending

of money constitutes substantial part of the company’s business is on assessee.

- Ref: Walchand & co. Ltd. Vs. CIT , 100 ITR 598 (Bom)

: CIT Vs. Creative dyeing & Printing (P) Limited 184 taxmann 483.

12. Accrual of “Deemed Dividend”:

“Deemed Dividend” accrues in the ‘previous year’ in which the payment was made. (Section 8(a)).

Therefore, only payment(s) made during the “current year” is covered & any outstanding balances / interest on loans are to be ignored. The assessing office may reopen assessment proceedings u/s 147, to bring “deemed dividend” escaping assessment to tax for the preceding assessment years.

Any loan(s) which were outstanding beyond the limitation period will be out of net from tax clutches. The limitation period is period for which the assessing officer cannot issue Notice u/s 147 for reassessment of income.

- Ref: CIT Panaji Vs. Parle Products Ltd. (2011) 196 Taxmann 62 (Bom.)

Only that amount of loans & advances, which was actually received by the assessee by way of loan or advance during the relevant previous year, could be treated as income by way of ‘deemed dividend’ and the carried forward balance of the loan of the previous year (i.e. Opening Balance) could not be treated as deemed dividend.

13. Deduction of Tax at Source u/s 194:

The principal officer of an ‘Indian Company or a foreign Company which has made arrangement for payment of dividends in India’ is liable to deduct income tax u/s 194 at the rate in force, before making any payment of any sum deemed to be dividend u/s 2(22)(e) of the I. T. Act, 1961.

Further, the company may be liable to penalty u/s 271C(1)(a) of an amount equal to the ‘amount of tax which such person’ failed to deduct.

14. Deemed Dividend in the hands of a Non-Resident Shareholder:

Section 2(22)(e) does not distinguish between a Resident or Non-resident shareholders.

Further, it is pertinent to note that by virtue of Clause (iv) sub-section (1) of section 9, “any dividend paid by an Indian company outside India” is ‘Income deemed to accrue or arise in India’.

Therefore, Deemed Dividend u/s 2(22)(e) is subject to tax in India in the hands of a Non-resident Shareholder subject to DTAA relief.

15. Deemed Dividend in case of Loan or Advance by a Foreign Company

to a Resident Shareholder:

Section 2(22)(e) does not distinguish between an Indian or a Foreign Company. Sum paid by a Foreign Company to a resident shareholder has been held as deemed dividend.

- Ref: Gautam Sarabhai v. CIT (1964) 52 ITR 921 (GUJ.)

16. Reporting of Deemed Dividend by the Auditor – in case of Audit u/s

44AB of the Income Tax Act:

There is no specific provision in the Audit Report Form No. 3CD prescribed by the Income Tax Rules, 1962 for reporting of ‘Deemed Dividend’ paid by a Company. However, Clause 27 of Form No. 3CD requires the auditor to disclose whether the assessee has complied with the provisions of Chapter XVII-B relating to Deduction of Tax at Source. Since as per para 14 (supra) Tax is required to be deducted by the principal officer of an Indian Company u/s 194, the Auditor is obliged to report of Non-deduction of TDS u/s 194 in the Audit Report Form No. 3CD.

17. Company Shareholder:

Shareholder may be even a corporate entity. Loan given by a subsidiary

company to a holding company will be covered by this section. It includes 100 % subsidiary.

- Ref: Sadhna Textile Mills (p) Ltd. Vs. CIT(1991) 188 ITR 318

: Star Chemicals Pvt Ltd Vs. CIT 203 ITR 11 ( Mumbai)

18. Shareholder must be registered shareholder ?

In the case of Madura coats (p) ltd. 195 CTR 193 held that lender company MPCL advance to CFL. CFL is a holding company of JPC . The loan and advance will not be covered as CFL is not registered shareholder of MPCL. The facts of the case are narrated as under:-

1. CHL is the main holding company and CPL, TTL and CFL are its subsidiary.

2. CFL is a holding company of JPC.

3. JPC holds 99.998 % shares in MPCL.

4. MPCL loan to CFL.

19. Salary accrues month to month but commission on net profit accrues

to managing director at the end of the year:

In the case of Shyama Charan Gupta Vs. CIT 337 ITR 511 held that,

The withdrawal of commission by managing director from

accumulated profit will be considered as deemed dividend in the case of net

profit, as it accrues at the end of the financial year, but not in case of salary.

20. Quantum of dividend: Up to accumulated profit and not in the proportion of shareholding, but full amount.

The principle is that where loan given by the company exceeds the accumulated profits, deemed dividend would be to the extent of accumulated profits and balance of loan amount would not be deemed dividend. If the accumulated profit is less than the loan amount, entire loan amount would be deemed dividend.

The entire loan amount will be deemed dividend not in the proportion of shareholder’s holding.

Example:

The assessee held 25% shares of the closely held company. The accumulated profits were Rs. 4,000 while the assessee took loan of Rs. 29,000. Here, loan given by the company exceeds the accumulated profits. Thus, entire accumulated profits are to be taken into account under section 2(22)(e). Only Rs. 4000/- will be considered as deemed dividend.

Though shareholder has only 25% of Rs. 4,000, but whole of the amount will be considered deemed dividend under section 2(22)(e).

- Ref: CIT Vs. Mayur Madhukant Mehta(1972) 85 ITR 230 (Guj)

(Above judgment relied on 112 ITR 0577 & referred in 162 ITR 0460)

: CIT Vs. Arati Debi [1978] 111 ITR 277 (Cal.)

: Followed CIT Vs. Bhagwat Tewari 105 ITR 62 (Cal)

Ø Further Clarification:-

a) Retention Period of loan :-

The period of retention of loan is not relevant. Even temporary advances or loans do fall within the mischief of section 2(22)(e). Even if it is repaid within same previous year deemeding fiction will be applicable.

- Ref: Smt. Tarulata Shyam Vs. CIT [1977] 108 ITR 345 (SC)

: Miss P. Sarada Vs. CIT [1998] 96 Taxman 11 (SC)

: Walchand & Co. Ltd. Vs. CIT (1975) 100 ITR 598 (Bom.)

b) Misappropriation by director:-

i. A director of the closely held company, holding more than 10% voting power, has misappropriated an amount of Rs. 10 lacs. The misappropriated amount can be taxed for deemed dividend u/s. 2(22)(e), if the company has accumulated profits, & the director holding more than 10% shares has the authority to make advances, loans and any payment referred to in section 2(22)(e), in the normal course of business and he abuses such power.

ii. In the case of CIT Vs. G. Venkataraman (1975) 101 ITR 673 Madras held that, the amount misappropriated by the director cannot be treated as deemed dividend in his hands, since in such a case there is no lending or advancing by the company.

c) Registered Vs. beneficial shareholder:-

i. Loan to HUF-Registered Shareholder-Not Taxable

- Ref: 122 ITR 1 (SC) 43 ITR 352 (SC)

The word shareholder used in section 2(22)(e) can only mean a registered shareholder. It is difficult to see how a beneficial owner of shares whose name does not appear in the register of shareholders of the company can be said to be a ‘shareholder’. He may be beneficially entitled to the shares but he is certainly not a ‘shareholder’. Thus, it is only where a loan etc., is advanced by the company to a registered shareholder and the other conditions set out in the section are satisfied that the amount of loan, etc., would be liable to be regarded as deemed dividend. The amount of loan, etc., cannot fall within the mischief of this section if it has been granted to a mere beneficial owner of the shares who is not a registered shareholder.

The loan granted to HUF will not be taxable as deemed dividend even though HUF is a beneficial shareholder & shares are held in the name of Karta.

- Ref: Rameshwarlal Sanwarmal Vs. CIT (1980) 122 ITR 1 (SC).

The brief facts were that the loan was advance to HUF who is the beneficiary shareholder. HUF held the shares in the name of Karta. The deemeding provision was not applied, as HUF is not the registered shareholder but beneficial shareholder. The company law does not recognize u/s 187(c) the HUF status.

The same is followed in:- 132 ITR 30 ( Raj)

:- 132 ITR 806( Raj)

Referred in :- 139 ITR 833 ( Bom)

:- 150 ITR 276 (Guj)

:- 156 ITR 612 ( Delhi)

:- 347 ITR 305 ( Delhi)

Applied in :- 179 ITR 73 ( Calcutta)

:- 199 CTR 88

There is another judgment:

In the case of Kishhanchand bajaj Vs. CIT 60 ITR 500 (SC) with regard to dividend is taxable in the hands of HUF as he is the real owner and Karta is registered owner.

In the case of C.P. Sarathy Mudaliar Vs. CIT 83 ITR 170 SC held that the same was not taxable in the hands of HUF. Hence loan given to HUF will not fall under deemed dividend.

In the case of Income tax officer Vs. S.S Shetty 14 TTJ71 (Bom.), the tribunal held that the loan advanced by a private company to HUF of which the members were direction in the company cannot be deemed as ‘dividend’ in the hands of HUF as HUF was not a registered shareholder.

ii. Loan in case of partnership firm liable for deemed dividend ?

· Whether a loan taken by a firm is liable for deemed dividend, though the shares were purchased by a firm through partner?

The shares in the company were purchased in the name of partners by the firm. The loan were taken by the firm. The firm was beneficial owner and not registered shareholder. The firm is liable for deemed dividend.

As per CIT Vs. National Travel Services 202 Taxman 327 :Delhi High Court, it will be taxable in the hands of firm. Firm is deemed shareholder u/s 2(22)(e). The High court has gone into the crux of the matter the only reason why firm is not liable for deemed dividend is it’s name can not be included in shareholder register was because of:

A. The firm is not a legal entity

B. The SEBI”s circular dated 13^th March,1975 interpreting Section

187 (C) of the Companies Act

C. Gone to record that if it fails in its mechanism to charge HUF, Firm, AOP or BOI the whole purpose of deemed dividend will be defeated, hence deemed dividend applies. It will produce absurd result if firm goes out of net of deemed dividend.

D. Reference made of K.P. Varghese Vs. Ito 131 ITR 0597 (SC), if plain reading produce absurd result , court must modify the language used , even if do some violence.

Before coming to conclusion it:

Relied on: C.P. Sarathy Mudaliar Vs. CIT 83 ITR 170 SC

: Rameshwarlal Sanawarmal Vs. CIT 122 ITR 1SC Circular no 495 of

22^nd September, 1987.

Cases referred: 120 TTJ 865; 242 CTR 129; 217 CTR 527 ; 237 CTR 147 ; 21 CTR 104; 24 CTR 358

· In CIT Vs. Rajkumar singh & Co.295 ITR 9

Loan advance to a firm by a company will not be considered as deemed dividend if shares held by partners of the firm and firm is neither a registered nor a beneficial shareholder.

· In the case of CIT Vs. Hotel Hilltop 313 I.T.R. 116 held that,

H Ltd. advance loan to A and B partners of the firm. Even if all the partners of the firm are the shareholders of the company but still deemed dividend is not applicable to firm, but to the partners individually. The firm is neither a register shareholder nor the beneficial shareholder.

Gist of the case is as under:-

· In the assessee-firm constituted of two partners ran a hotel business. It entered into an agreement with a private limited company formed by the two partners with their close relations under which the management of the firm’s hotel was to be handed over to the company. The assessee-firm received a sum of Rs. 10 lakhs as advance against security. The assessee-firm filed its return of income for the assessment year 1991-92, declaring an income of Rs. 72,000 disclosing the amount received from the company as an advance against security. The Assessing Officer made an addition to the income of the assessee treating the amount as deemed dividend under section 2(22)(e) of the Act. The Commissioner (Appeals) deleted the addition on the ground that the firm was not a shareholder of the company. The Tribunal confirmed the deletion.

· On appeal, the Rajasthan High Court held that the assessee was not shown to be the shareholder of the company and the two individuals who were partners of the firm were the majority shareholders of the company. Therefore, the security advanced by the company to the assessee could not be deemed to be dividend as the assessee(firm), as firm was not a shareholder in the company. The addition can not be made in the hands of a firm, but possibly in partners.

· In the case of CIT Vs Ankitech Pvt ltd and others 242 CTR 129 Delhi

held that dividend definition is expanded, not the definition of shareholder hence concern which is given loan or advance by a company cannot be treated as shareholder or member of the later simply because a shareholder of the lender company holding voting power of 10 % or more there in has substantial interest in such concern, hence such loan and advances cannot be treated as deemed dividend.

· In the case of Raj Kumar Singh and Co. Vs. DCIT 52 TTJ 221 (All), the Tribunal held that section 2(22)(e) can be invoked only in case of registered shareholder and not a beneficial shareholder. Shares, through belonging to the firm but registered in the name of partners, the firm cannot be made liable under section 2(22)(e) in respect of loans obtained from the company.

There is an amendment in the provision wef. from 1st April, 1998. The

same cannot be taken retrospectively. This judgment is to not valid to this

extent.

iii. Firm taken a loan from concern & considered as deemed dividend:-

Facts of the case:- The assessee is a partnership firm consisting of three partners namely Mr. Naresh Goyal, Mr. Surinder Goyal and M/s Jet Enterprises Pvt. Ltd. having profit sharing ratio of 35%, 15% and 50% respectively. The assessee firm had taken a loan of Rs 28,52,41,516/- from M/s Jetair Pvt Ltd New Delhi. In this company the assessee has invested by subscribing to the equity share numbering 1,43,980 of Rs 100 each which constitute 48.18% However, the shares were purchased in the name of the two partners namely Mr. Naresh Goyal and Mr. Surinder Goyal. Thus, whereas Mr. Naresh Goyal and Mr. Surinder Goual are the respective share holders, the assessee is the beneficial share holder.

iv. Loan given to Trust:-

Trust being the beneficial shareholder but not registered shareholder deemeding provision will not apply to apply to trust when the shares is held in the name of trustee.

In the case of Assistant Commissioner of income tax Vs. Bhaumik colour (P) limited 120 TTJ 865(Mumbai).

Assessee Company (BCPL) took an interest bearing loan from UPPL. BCPL was not a shareholder of UPPL. N trust held 20% share in BCPL and 10% share in UPPL. N trust consisting of 3 trustees and 5 beneficiaries. None of the beneficiaries were trustees. A.O. assessed it as deemed dividend.

Mumbai Tribunal held that for invoking deemed dividend such concern must be both registered shareholder as well as beneficial shareholder. In the present case N trust was only a registered shareholder and not beneficial shareholder. The same was approved in Seamist Properties (P) ltd Vs. ITO 95 TTJ 201 (Mumbai).

d) Once advance is considered as dividend it is reduced from accumulated profit, the repayment of advance does not affect the position of accumulated profit :-

The Supreme Court in the case of CIT Vs. G. Narasimhan (1999) 236 ITR 327 (SC) held that accumulated profits, whatever they may be, get definitely reduced by the amount already deemed to be dividend under section 2(22)(e) even if no adjustment is made in the books of account. If any deemed dividends are repaid they will not augment accumulated profits. “Once an amount goes out of accumulated profits as a loan and the loan is to be deemed to be dividend, the same amount when repaid cannot again be capable of attracting the fiction and be deemed to be dividend”.

To illustrate, suppose accumulated profits are Rs. 10000, a shareholder having substantial interest in the company takes a loan of Rs. 7000. This is deemed dividend. It is returned in the same year and another loan of Rs. 5000 is taken. The second loan will be hit by the provisions of section 22(22)(e) to the extent of Rs. 3000 only because the earlier loan returned by the shareholder does not augment accumulated profits.

e) Whether TDS to be deducted for deemed dividend:

There are clear cut provisions u/s 194 providing for deduction of tax at source and therefore the company is bound to deduct tax whenever the payment made falls within the provision of section 2(22)(e).

In the case of Anz Reality (P) Ltd. Vs. ITO, ITAT, Jaipur 120 TTJ 142 (Jaipur) held that section 194 does not require TDS when payment is made to a non shareholder. Section 194 expressly provides for deduction of tax only when payment is made to a shareholder. TDS is applicable for deemed dividend to shareholder but not the concern in which he has substantial interest.

f) Penalty U/s 271(1)(c) for non deduction of TDS :

The deemeding fiction causing inclusion deemed dividend, will not automatically attracts penalty U/s 271(1)(c). Penalty is a separate code or assessment itself. Every addition need not be levied penalty, applies here also.

Therefore mere inclusion of dividend in the hands of shareholder would not

automatically trigger penalty. Penalty in respect of dividend income taxes u/s 2(22)(e) cannot be levied.

- Ref:

i. A. P. Madhavan Vs. ITO 8 TTJ 343 (Mad. Trib.)

Mere negligence with no deliberate act on the part of assessee will not

attract penalty as per Pune bench.

ii. Shri Ulhas S. Sabane in Pune bench: ITA No. 190/PN/2006 dated 30.08.2007: No penalty

g) Payment under court order:-

The deemeding fiction u/s 2(22)(e) is attracted even in case of a payment made

on behalf of a shareholder under the order of the court.

- Ref: Ravindra D. Amin Vs. CIT (208 ITR 815)

h) Trade Advance:-

Advance will not be considered as deemed dividend as advance is always for a specific purpose. Since the term advance has been used in conjunction with the term loan, it should also get a meaning akin to loan. Therefore reasonable interpretation of the term ‘advance’ could mean such advance which carried with it an obligation of repayment.

i. In the case advance was made for purchase to the proprietary concern was considered as deemed dividend to the extent cumulative profit.

- Ref: CIT Vs. Nagindas M. kapadia (177 ITR 393)(Mum)

Followed in : 318 ITR 462 ( Del)

338 R 538 ( Calcutta)

ii. Trade advances which are carried to commercial transaction will not be covered.

- Ref: CIT Vs. Raj Kumar 318 ITR 0462

: CIT Vs. Nagindas M. Kapadia 177 ITR 393

i) Debit balance in running account:-

Any debit balance if it is in the nature of advance out of current account is in discharge of its existing debts or against purchases or availing services & both are in ordinary business activity, it will not be a deemed dividend.

- Ref: Mumbai ITAT Sat Prakash Goyal Vs. ITO TIOL-633- ITAT-MUM

j) Loan to employee shareholders:-

Loan to employee ( having substantial interest) will be though deemed

dividend liable to repay to the company as well as perquisite rule will be

applied. The character of money does not change, still repayment by an

employee is required.

In a case one Company grants loan to employee shareholder holding

more than 10% of the voting power, the loan would be regarded as deemed dividend u/s. 2(22)(e). However, the deemeding fiction has to be applied limited to the purpose for which it is enacted. Accordingly, Madras High Court in case of CIT Vs. T.P.S.H. Selva Saroja (244 ITR 671) observed that merely because of treatment as deemed dividend the shareholder does not become the owner of the money and he expected to return the same. Therefore, in case where the loans are granted to employee, the imputed interest on such loan would be taxable as perquisite in the hands of the employee shareholder.

The deemed dividend does not change the character of receipt. It only changes the taxability of the receipt. Thus one has to repay the loan or advance as the case may be.

k) Capitalized profit by way of bonus share:-

When profit is capitalized by issue of bonus shares, the loan given will

not be in the scope deemed dividend U/s 2(22)(e).

In case of P. K. Badiani Vs. CIT (1976) 105 ITR 642 (SC), the apex Court held that if accumulated profits are capitalized, there can be no deemed dividend as the words “whether capitalized or not” which occur in clauses (a) to (d) of section 2(22)(e) are absent from clause (e).

However, it should be noted that issue of bonus shares to preference shareholders is specifically covered under sub-clause (b).

l) Inter corporate deposit deemed dividend will be applicable:-

Recipient can be a corporate entity. The provisions of section 2(22)(e) are applicable also to the advance or loan made to a corporate entity . The person include corporate entity.

- Ref: Sadhana Taxtiles Mills (P.) Ltd. Vs. CIT [1991]188 ITR 318 (Bom.)

Is Followed in 203 ITR 11 (Bombay)

m) Money lending primary & substantial business activity during the relevant previous year, deemed dividend not applicable:-

Where an assessee was shareholder in a company doing only money-lending business, loan taken by an assessee could not be treated as deemed dividend even though company had accumulated profits as there was a substantial part of a business was of a money lending.

- Ref: CIT Vs. Sivesubramaniam [1997] 141 CTR (Mad.) 34

n) Relevant date for determining shareholder’s percentage:-

Date of execution of transfer deed and not registration of transfer deed by the company is relevant date to determine the shareholding. Where because of transfer of shares by execution of transfer deeds, assessee’s shareholding in company had fallen below 20 per cent, loan taken by assessee could not be treated as dividend and in such a case date on which company registered transfer of shares was of no consequence .

In this case the shares were transfer through execution of gift deed. But due to minor being a shareholder the registration formality was delayed hence tribunal never doubted about the genuineness of a transaction. So date of registration is not relevant for considering the shareholder percentage.

- Ref: CIT Vs. Smt. S. Parvathavarthini Ammal [1996] 87 Taxman 370/219

ITR 661 (Ker.)

o) Payments may be towards personal liabilities of shareholder like insurance, etc is covered :-

The payment made on behalf of shareholder is also cover in this section like insurance premium, income tax, etc.

- Ref: CIT Vs. K. Srinivasan [1963] 50 ITR 788 (Mad.).

p) Advances by any nature will be deemed dividend:-

One of the director took advance against rent receivable was consider as deemed dividend.

Advance paid by company to its managing director which was adjustable against rent payable to managing director - Where assessee was managing director of company and company had agreed to pay an advance of Rs. 10 lakhs when it had taken the first floor on lease from assessee for the purpose of meeting the cost of construction of the other three floors and the lease deed provided explicitly that the advance so paid was to be adjusted against the rent payable for the other three floors, advance was to be treated as deemed dividend in assessee’s hands.

- Ref: CIT Vs. P.K. Abubucker [2003] 259 ITR 507/[2004] 135 Taxman 77 (Mad.)

q) Meaning of word accumulate profit:-

The following are the items which are to be included or to be excluded in computing accumulated profits:

Sr. No.	Items to be excluded from accumulated profit	Items to be included from accumulated profit
a)	Provision for taxation CIT Vs. V. Damodaran[1972]85 ITR 59 (ker.)	Development rebate/General reserve 105 ITR 642
b)	Proposed dividend CIT Vs. G. Narasimhan (1979) 118 ITR 60 (Mad)	Refund of income-tax
c)	Depreciation calculated at the rate given under the IT Act will be excluded 80 ITR 582(Bom)	Depreciation as per books of accounts will be added to accumulated profit
d)	Balancing charge CIT Vs. Urmila Ramesh (1998) 230 ITR 422 (SC)	General reserves
e)	Capital gains not chargeable to tax	Capital gains chargeable to tax
f)	Share Premium is not accumulated profits.	Loan from exempt income including agriculture income will be included:- S.Kumaraswami Vs.ITO [1961] 43 ITR 423 (Mad.)
g)	Share forfeiture receipts – are not accumulated profits (Jai Kishan Dadlam (2005) 4 SOT 138 (Mum))
h)	Bonus share

r) In whose hands will the payment deemed to be dividend if the loans or advances are made to concern or person on behalf of or for the benefit of substantial shareholder?

In the case of CIT Vs. Hotel Hilltop (2008) 217 CTR (Raj.) 527 held that payment should be made on behalf on individual shareholder. The shareholder is liable, not the concern.

In the case of CIT Vs. Universal Medicare Private Ltd. (3324 ITR 263) approved the position taken by the special bench decision in case of ACIT vs. Bhaumik Colour P. Ltd. Holding that the definition does not alter the legal position that dividend has to be taxed in the hands of the shareholder only.

However CBDT circular No. 495 dated 22 September 1987, 168 ITR 87 states that deemed dividend is taxable in the hands of concern but judgment say otherwise.

s) Constitutional Validity:

Section 2(22)(e) has been held to be constitutionally valid in Navnitlal C. Javeri v.K.K.Sen, AAC [1965]56 ITR 198 (SC).

t) Loan on surrender value of the policy: Any loan given by life insurance companies to their policy holders-shareholders in the normal course of business on the security of insurance policies and within the limits of their surrender value should not be treated as dividends.

- Ref: Circular No.43 (LXXVI-7) dt. 27th Oct., 1955

- Payment by company to a firm in which shareholder is partner for repayment of advances in regular course of business cannot be deemed dividend under section 2(22)(e)

- Ref: Mukundray K. Shah Vs. CIT (2005) 197 CTR (Cal) 563 : (2005) 277

ITR 128 (Cal)

u) Loan obtained by the shareholder through proprietary concern would be treated as deemed dividend under section 2(22)(e). :

- Yes. Ref: Nandlal Kanoria Vs. CIT (1980) 122 ITR 405 (Cal) : TC41R.311

v) Shareholder doing business with company and always having debit balance ? When a shareholder has a business with the company and when his accounts with the company is always on debit side, the amount in question would be regarded as loan by the company to the shareholder and if there are accumulated profits to cover the debit balance, the amount in question would be regarded as deemed dividend under section 2(22)(e)

- Ref: CIT Vs. Jamnadas Khimji Kothari (1973) 92 ITR 105 (Bom) TC41R.320

w) Whether Book debts will be covered by "loans and advances"?

Where the assessee-shareholder, having business of his own, was transacting business with the company and the account of the assessee in the company always showed a debit balance, it was held that the said debit balance would amount to a loan from the company to the assessee.

- Ref: CIT Vs. Jamnadas Khimji Kothari [1973] ITR 105 (Bom.)

x) Whether interest paid on loan which is treated as deemed dividend will be admissible as a deduction under section 57(iii)?

Section 57(iii) allows a deduction for any expenditure (not being

capital expenditure) laid out or expended wholly and exclusively for the

purpose of making or earning such income.

Ref: Nandlal Kanoria Vs. CIT [1980] 122 ITR 405(Cal.)

The Calcutta High court held that interest paid on loan treated as deemed dividend under section 2(22)(e) is not admissible as a deduction under section 57(iii).

y) Loan received before he became a director:

Loan received by assessee before becoming a registered shareholder of the lender company can not be treated as deemed dividend.

- Ref: Sagar Sahil Investment (P) Ltd. 120 TTJ 925

In case of leasing out of property: Any advance received as deposit by company in connection with leasing out of property of director cannot be treated as Deemed Dividend.

Ref: ACIT Vs. Madras Madurai Properties (P) Limited

z) Amounts advanced by a company to its directors under a Board resolution , for specific purpose, would not fall under mischief of section 2(22)(e):

Yes. Ref: ACIT Vs. Harshad V Doshi 49 DTR 181

aa) In case of debenture account: Amounts given by a company to an assessee against his debenture account cannot be treated as Loans or advances for purpose of section 2(22)(e).

- Ref: Anil Kumar Agarwal Vs. ITO. 51 DTR 251

bb) In case of another company: Loans or advances given by a company to another company, which is not a shareholder of lender company, can not be treated as deemed dividend.

- Ref: Sadana Brothers Sales (P) Limited Vs. ACIT

cc)Security deposit given by a company to its sister concern, a firm cannot be regarded as deemed dividend under section 2(22)(e).

- Ref: DCIT Vs. Atul Engineering Udyog

dd) In the case of non-shareholders: “Deemed dividend” not assessable if recipient is not a shareholder.

- Ref: CIT Vs. Ankitech Pvt Ltd.

ee)Assessee is a director in two companies holding substantial shareholding in both. Certain sum was transferred from one company to another at instance of assessee. Assessee having substantial credit balance with company, cannot held as loan or deposit nor can be assessed as deemed dividend.(Asst. years 2001-02, 2005-06)

- Ref: Asst Vs. C. Rajini 9 ITR ( Trib) 487.

ff) What is apparent may not be real?

- Ref: M.D. Jindal Vs. CIT(Cal) 164 ITR 28

In this case Mr. Jindal purchased iron rods from the company for construction on two plots purchased by him jointly with his wife on which he has a substantial interest. The company purchased two flats from the same plots. The high court said what is apparent is not real & deemed dividend applied for purchase of iron rods.

gg) Common shareholders having substantial interest in both the companies liable for deemed dividend ?

- Ref: NCK Sons Exports Vs. ITO 102 ITD 311 ( Mumbai)

Advance received from SVMPL will be liable for deemed dividend as K & T shareholder having more than 10 % shares in SVMPL ,were also having more than 20 % of equity shares in NCK Sons exports.

hh) Subsequent increase in the holding after the advances were made?

Since on the date on which the security deposit was given by the company to the assessee , the assessee held less than 10 percent beneficial interest in the company , the amount of security deposit can not be treated as deemed dividend under section 2(22)(e), merely on the ground that share holding increased to 44% on issue of shares by the company in lieu of security deposit.( A. Y. 1998-99).

- Ref: CIT Vs. Late C.R.Das 57 DTR 201.

MAT	Minimum Alternate Tax
DDT	Dividend Distribution Tax
DD	Deemed Dividend
TDS	Tax Deducted at Source
TCS	Tax Collection at Source
CTC Planning	Cost To Company Tax Planning for Salary Income

CA NITIN PATHAK AHMEDABAD

About Me

Saturday 7 November 2015

Presentation on CTC planning, investment option and how to effective in work area

Tax Planning and Different Investment options deliberated on PPT

Friday 6 November 2015

SEMINAR ON "CORPORATE TAXATION AND MAT" AT ICMAI AHMEDABAD BRANCH

Sunday 1 November 2015

ARTICLE "DEEMED DIVIDEND" UNDER SECTION 2(22)(e) OF INCOME TAX ACT.

DEEMED DIVIDEND A DETAILED ANALYSIS OF SECTION 2(22)(e) OF THE INCOME TAX ACT, 1961 AND IT’S LEGAL IMPLICATION:-

Poser of Deemed Dividend

Ø Preface:-

Importance of understanding the provision of deemed dividend U/s 2(22)(e) in the present context where dividend is tax free:-

Ø Four limbs of section of deemed dividend:-