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The concept of Deemed Dividend under the Income-tax Act, 1961(the Act) is not new. However, time and again many closely held company assessees and their controlling shareholders, to their surprise and dismay, realise very late the importance of this powerful taxing tool in the hands of the Assessing Officer. The concept of Deemed Dividend is embedded in Section 2(22)(e) of the Income-tax Act, 1961 and was also embedded in section 2(6A)(e) of the Indian Income-tax Act, 1922. In nutshell, the concept envisages taxing certain payments made by closely held companies by way of loans or advances to certain shareholders of the company or to the concerns/companies in which they have substantial interest. Whenever any payment is made by way of loan or advance, the recipient of the loan or advance will be liable to be taxed on this amount as a dividend, to the extent to which the company has accumulated profits, under the deeming provisions of section 2(22)(e) although such loan or advance may have been given for genuine business purposes and even if the paying company may have received back the loan amount. Thus the section deems certain payments as dividend income which is not income under ordinary commercial parlance. Therefore,the name Deemed dividend. The concept of deeming certain payments or loans or advances to substantial shareholders as income was introduced with the object of curbing tax evasion. Upto 31-5-1997 dividend was taxed in the hands of the recipient of the dividend. However many closely held companies never declared any dividend and accumulated profits in the company itself. Since no dividend was declared the same could not be taxed. However the companies did give loans or advances to substantial shareholders or to their concerns/companies who presumably enjoyed these funds but were not liable to pay any tax on the same as the amounts were loans or advances liable to be returned. These amounts of loans or advances are sought to be taxed as dividend by section 2(22)(e) of the Act by way of a deeming fiction.. Taxation of dividend under Income-tax Act, 1961 has undergone substantial changes in recent times. Effective from 1-6-1997 the scheme of taxation of dividend has been modified and is different from the old scheme . The essence of the old scheme was that the recipient of the dividend income was liable to pay the income-tax on the same, subject to certain exemptions. The new scheme essentially makes the dividend tax-free (section 10(33) of the Act) in the hands of the recipient (except cases covered under section 2(22(e)of the Act) and the dividend paying company has been made liable to pay tax on the amount of dividend declared , distributed or paid by it (Section 115-O of the Act). This tax is over and above the corporate income-tax which a company would normally pay. However there is no change in the scheme of taxation of Deemed Dividend contained in the section 2(22) (e) of the Act and such dividends are governed by the old scheme of taxation of dividend i.e. tax on deemed dividend is paid by the recipient and the paying company does not have to pay dividend tax but will be liable to deduct tax at source from such loans or advances/deemed dividend and pay the same to the Government. |
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Section 2 (22) Section 2(22) has 5 clauses (a), (b), (c), (d) and (e) which specify various types of distributions and payments as dividend. Clauses (a). (b), (c) and (d) mainly cover cases of distributions which entail release of assets or create liabilities. While clause (e) covers cases of payments by way of loans or advances and which is the clause mainly dealing with deemed dividend as it is commonly understood and has been dealt with in this article. In Kantilal Manilal v.CIT [1961] 41 ITR 275(SC) the Supreme court held that Section 2(22) deals with various types of cases and creates a fiction by which certain receipts or parts thereof are treated as dividend for the purpose of levy of Income-tax . In CIT v. Martin Burn Ltd.,(1982)136 ITR 805(cal) the Calcutta Highcourt held that Under section 2(22) certain amounts which are actually not distributed are also brought within the net of dividends. Therefore, that section must receive a strict interpretation. 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). Section 2(22) starts with the words " Dividend includes ……….."Thus the definition of dividend is inclusive and not exhaustive. Section 2(22)(e) "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 percent 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 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;" Let us now analyse the clause in detail. is reproduced below:- of Income-tax Act, 1961 defines "dividend" and is the main section for taxation of Dividend. Unless a payment or distribution is covered by this definition, it can not be taxed as "dividend". Once an amount is covered as dividend it will be also considered as income as Section 2(24)(ii) of the Act includes 'dividend' within the definition of 'Income'. |
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As it is clear, clause (e) applies only to companies in which public are not substantially interested i.e. to companies which are commonly known as closely held companies. Section 2(18) of the Act defines a "Company in which public are substantially interested". Section 2(22)(e) does not apply to listed companies, government companies, section 25 companies, companies having no share capital and declared by Board, mutual benefit finance companies declared by Central Government to be a Nidhi or Mutual Benefit society, companies in which one or more co-operative societies hold at least 50% voting shares throughout the year, etc. |
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Clauses (a),(b),(c) and (d) of section 2(22) use the word "distribution" while clause (e) uses the word "payment" which means amount may have been disbursed to one or two or more shareholders and not necessarily be distributed to all the shareholders. Does it mean only payment by cash/cheque or will it cover loan in kind also? Whether a goods loan will be covered? In M.D. Jindal v. CIT [1986] 28 Taxman 509 (Cal.) it was held that Section 2(22)(e) is applicable even if a loan is given in kind. Thus a loan of goods or other assets will also be covered by the clause and it is not necessary that the loan or advance must be given in cash only. |
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The shareholder may be even a corporate entity. Loan given by a subsidiary company to a holding company wll be covered by clause (e). |
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Section 269SS of IT Act specifies that ' for the purpose of this section,"loan or deposit" means 'loan or deposit of money'. A loan creates a relationship of a lender and a borrower. Clause (ii) to section 2(22) provides that "dividend" does not include any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of business, where the lending of money is a substantial part of the business of the company; If a majority of a company's assets and income are from money-lending business, it will be proper to assume that lending of money is a substantial part of the company's business. In Walchand & co. Ltd. V. CIT,(1975)100 ITR 598(Bom) it was held that the onus to prove these facts lies on the assessee. Clause (iii) to section 2(22) provides that "dividend" does not include any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e),to the extent to which it is set off. This clause gives some relief to the assessee by way of avoiding double taxation as well as brings in some scope for Scope for tax-planning. Thus, if a loan is already treated as a dividend it may make sense to declare dividend and adjust the outstanding loan amount against the dividend declared. No tax will be payable by shareholder on such dividend declared. However, if the loan has been repaid by the shareholder and nothing is due by the shareholder against the loan referred in section 2(22)(e), then no set-off would be possible. Also if the sum due by the assessee is on account of some other payments not covered by section 2(22)(e), then set-off will not be possible. It appears that liability to pay tax on distributed profits u/s 115-O can not arise in a case where a dividend paid by a company is set-off by the company as mentioned above, since the amount itself is not to be treated as a dividend . EEEEeee xplanation to section115Q may be referred to for this purpose.
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A benefit means some advantage to a person or something for the good of a person. |
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This is an important saving grace and assessees can claim substantial deduction for Income-tax depreciation out of accumulated profits. This will also call for separate calculation for accumulated profits as per income-tax Act and the same may be different from the accumulated profits as per books of accounts. There is no legal bar to writeback of Depreciation.as per Department of Company Affair's view appearing in Company News and Notes, July 1 1963. However, since write-back of depreciation will be as per book-depreciation, while one needs to calculate Income-tax depreciation as per IT Act for the purpose of calculation of Accumulated profits, such writeback will not have any impact on Accumulated profits.
Explanation 2 to section 2(22) provides that -- The expression "accumulated profits" in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include---------------- Thus it will be imperative for the company to calculate its profits and losses upto the date of payment of loan or advance and then calculate Accumulated profits (or losses).This date may be a date in between the two accounting years. In fact for every loan to such hareholder/concern the company may have to prepare profit and loss account upto that date. |
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These words which are found in clauses (a) to (d) are not found in clause (e) of section 2(22) and, therefore, that provides some relief from the mischief of the section as well as provides some scope for planning .Thus it must be interpreted that to the extent of capitalisation of profits, accumulated profits would reduce for the purpose of this clause but not for other four clauses of section 2(22). What is capitalisation? It will ordinarily mean conversion of profits or reserves or income into capital as per Company's Articles of Association. In P.K.Badiani v. CIT (1976)105 ITR 642 (SC) the Supreme court held that mere transferring of an amount from Profit & Loss account to the Development Reserve account or any other Reserve does not amount to capitalisation of profits. Similarly a transfer to General Reserve will not amount to capitalisation. The reason for allowing reduction of the accumulated profits to the extent of capitalisation of profits seems to be that to the extent of capitalisation, divisible profits i.e. profits available for distribution of dividend will reduce. A company can not distribute dividends out of capitalised profits i.e. capital. Thus if a closely held company wants to give loan or advance to a shareholder or his concern/company which are covered by this clause, it may first issue bonus shares (and thus capitalise the accumulated profits) and then grant such loan or advance. This is one sure way of escaping from the clutches of section 2(22)(e). However, it may involve expenses of filing fees and stamp-duty on increase of authorised share capital. Also a company may not want to increase its capital due to various other reasons. |
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A question that arises is whether the quantum of deemed Dividend assessable in the hands of the assessee will be restricted to his share in the accumulated profits?
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It is not the registered shareholder but the beneficial owner of the shares who is covered by the section 2(22)(e). Also the shareholding as on the date of the loan has to be considered. If preference shareholders are entitled to vote due to default in payment of dividend or in redemption, their holding will also have to be counted. |
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Section 2(32) of the Act states that a "person who has a substantial interest in the company" in relation to a company, means 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, carrying not less than twenty percent of the voting power." As per Explanation 3(b) to Section 2(22) a person shall be 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 twenty percent of the income of such concern. It may be, therefore, worthwhile to first rearrange (by transfer gift or in any other manner) the shareholding pattern or profit sharing ratio to bring it below 20% and then grant a loan or advance to a concern or a company. However, other aspects of rearrangement like capital gain tax, etc. will have to be kept in mind. As per Explanation 3(a) to section 2(22 )"concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company. |
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