A closely held Private Limited Company, engaged in real estate business (money lending is not the business of the company) having Authorized Capital of Rs.1 crore and paid up capital of Rs.10 lacs has 4 shareholders namely Mr. A (40%), Mrs. B (5%) Mr. C 50%) and Mr. D (5%). The Share Premium reserve is Rs.50 lacs and surplus in Profit and loss Account as on 31.03.2020 is Rs.154 lacs. Thus, total reserves and surplus amounted to Rs.204 lacs. Net Profit during the year 2020-21 before remuneration to the directors is Rs.534 lacs.
Mrs. B is wife of A, MR C and Mr. D are brothers of A. Mr. A, Mr. C and Mr. D are directors of the company.
The board has authorized payment of remuneration to the director but the resolution is silent about quantum of remuneration, and it is mentioned that the remuneration may be fixed by Mr. C for Mr.A and Mr.D who are looking after all the day-to-day affairs of the company.
Mr. A and D have given unsecured loan to the company in FY 2019-20. Their opening balances in loan accounts are Rs.7 lacs and Rs. 5 lacs respectively.
During the FY 2020-21 on 15.04.2020 Mr. A gave another loan of Rs.10 lacs to the company out of his own capital.
Later Mr. A made several transactions in loan account as he brought in loan and withdrawn money from the company from time to time during the year. As on 31.03.2021 the loan account shows a credit balance of Rs.3 lacs, but the peak debit balance in the loan account during the year was Rs.146 lacs. The details of transactions with Key Management Person will be disclosed in Notes to Accounts, in which the quantum of loan taken and repaid shall be appearing.
Auditor’s view:
In this scenario the statutory auditor who is also the tax auditor opined that the provisions of section 2(22)(e) of the Income Tax Act, 1961 may be attracted and the peak debit balance of Rs.146 lacs might be deemed as dividend and If the said sum of Rs.146 lacs is deemed dividend then the company shall be required to deduct Income Tax at Source i.e. TDS u/s 194 of The Income Tax Act, 1961 @10%.
Non deduction of Income Tax (TDS) shall not result in any disallowance u/s 40(a)(ia) even if the Tax Auditor reports non deduction of Tax in clause 34(A) of Form 3CD but that may trigger the penalty u/s 271C and may also result in taking action against the director for mis-reporting and under reporting of income in the form of deemed dividend. Director’s Opinion
The directors of company are of the opinion that at the year-end there is no debit balance and the fact that there was debit balance in the account of the director during the year shall not be reflected in the balance sheet as at 31.03.2021 and the balance appearing in the balance sheet shall be in credit as on the balance sheet date and the preceding balance sheet date therefore, there will be no possibility of the debit balance in books during the year against a director shall be treated as deemed dividend in terms of s.2(22)(e)of I. Tax Act.
Queries:
1. Can the director may plead that since at the year-end there is a positive balance in the loan account there is no case of deemed dividend?
2. From auditors perspective, in both the scenario i.e. treating the sum of Rs.146 lacs as deemed dividend as per the opinion of the auditor or not considered as deemed dividend a per the opinion of the Directors please advise as to reporting in Form 3CD clause 34(a) regarding non deduction of income tax at source u/s 194 on such deemed dividend, any qualification in report under CARO or Independent Auditors report if the directors are not ready to consider the sum of Rs.146 lacs as deemed dividend.
3. If the company does not make TDS not treating Rs.146 lacs as deemed dividend whether there will be any mis reporting from the perspective of Companies Act or Income Tax Act on part of the Company? What penal consequences shall follow upon the Company ?
4. What are the remedies to the company to save itself from the sum of Rs.146 lacs being deemed as dividend?
5. Can the company pay remuneration to the Director to the tune of Rs.180 lacs and making TDS on Rs.180 lacs u/s 194J @10% and whether such remuneration shall be permissible under provisions of Companies Act ?
09 July 2024
The scenario presented involves several complex issues related to deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961, and its implications for the company and its directors. Here are responses to the queries based on the information provided:
### 1. Director's Pleading Regarding Positive Balance in Loan Account
**Query:** Can the director plead that since there is a positive balance in the loan account at year-end, there is no case of deemed dividend?
**Response:** The plea that there is a positive balance in the loan account at year-end does not necessarily negate the possibility of the peak debit balance during the year being treated as deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961. The tax authorities typically consider the highest debit balance during the year, irrespective of the closing balance, to determine if deemed dividend provisions apply. Therefore, even if the balance is in credit at the year-end, the peak debit balance during the year may still be treated as deemed dividend.
### 2. Reporting in Form 3CD and Auditor's Perspective
**Query:** What should be the auditor's reporting in Form 3CD regarding non-deduction of TDS on deemed dividend, considering differing opinions between the auditor and the directors?
**Response:** - If the auditor concludes that the provisions of deemed dividend under Section 2(22)(e) apply (based on the peak debit balance of Rs. 146 lacs), they should report non-deduction of TDS under section 194 in clause 34(a) of Form 3CD. - This reporting obligation is irrespective of the directors' opinion. Auditors are required to disclose any non-compliance with TDS provisions related to deemed dividend.
### 3. Misreporting and Penal Consequences
**Query:** What are the consequences if the company does not deduct TDS on Rs. 146 lacs treated as deemed dividend?
**Response:** - Non-deduction of TDS on deemed dividend can lead to penalties under Section 271C of the Income Tax Act for failure to deduct tax at source. This penalty is typically equal to the amount of tax that should have been deducted. - Additionally, there could be consequences under the Companies Act for misreporting or non-compliance with statutory provisions.
### 4. Remedies to Avoid Deemed Dividend Treatment
**Query:** What remedies does the company have to prevent Rs. 146 lacs from being treated as deemed dividend?
**Response:** - The company should consider adjusting the loan accounts before the end of the financial year to ensure that there is no debit balance exceeding accumulated profits. - Ensuring proper documentation and justification for transactions in loan accounts is crucial to defend against deemed dividend allegations.
### 5. Payment of Remuneration to Directors
**Query:** Can the company pay remuneration to the director to the tune of Rs. 180 lacs and deduct TDS under section 194J?
**Response:** - Remuneration to directors should comply with the provisions of the Companies Act and should be authorized by the board with specific details regarding quantum and terms. - TDS under section 194J is applicable for professional or technical services rendered by directors. However, the appropriateness of such remuneration should be carefully evaluated to ensure it is not merely a method to avoid deemed dividend implications.
### Conclusion
The situation described involves significant tax and compliance implications. It's essential for the company to seek professional advice from a qualified tax consultant or chartered accountant who can provide tailored guidance based on the specific facts and circumstances. Proper documentation, compliance with statutory provisions, and proactive management of financial transactions are key to mitigating risks associated with deemed dividend and ensuring regulatory compliance.
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