Written by Tushar Mudgil, pursuing Diploma in Entrepreneurship Administration and Business Laws offered by Lawsikho as part of his coursework. Tushar is currently working as a Law Clerk cum research assistant with Delhi State Legal services Authority and graduated in LLB in 2018.
Dividend generally means the sum paid to or received by the shareholder out of the total distributed profits of the company in proportion to his shareholding in that company. This kind of income is taxable income under income tax act and comes under the ambit of income from other sources.
Whereas the word deemed has not been defined anywhere.
However, income tax act deals with deemed dividend under section 2(22) (a) to 2(22) (e), which talks about the income which is considered as dividends.
The following provisions of section 2(22) of income tax act define the term deemed dividend:
(a) Any distribution by the company of the accumulated profits, whether capitalized or not, and if such distribution entails the release by the company to any of its shareholders of all or any part of the assets of such company;
(b) Any such distribution to shareholders by the company of debentures, debentures stock, or deposit certificates in any form, which can be with or without interest, and any distribution to its preference shareholders of shares by way of bonus, to extend to which company possesses accumulated profits;
(c) Any such distribution by the company made to its shareholders by way of liquidation, to the extent to which company accumulates profits immediately before its liquidation;
(d) Any such distribution by the company to its shareholders by reduction of its capital, to such extent to which company possesses accumulated profits, which arose after the end of previous year;
(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 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;
It is important to note here that the beneficiary of deemed dividend should be the shareholder of the company, the Hon’ble Supreme Court while hearing multiple appeals also conclusively held that the provisions of the deemed dividend will not apply to the borrower of the company and shall only attract to the shareholder of the company.
We can simplify the above provisions for constituting dividend under the following heads:
- Distribution made by a company out of all the accumulated profits (earnings).
- Distribution made by a company out of debentures, debenture stock or deposit certificates.
- Distribution made by a company out of the liquidation of company’s asset.
- Distribution made by a company out of reduced capital to extend to which company posses accumulated profit.
- Any other payment made by the company (which represents part of assets of the company or otherwise) to shareholder either by way of advance or loan and where such shareholder is the beneficial owner of shares of the company.
But dividend does not include the following:
- In the event of liquidation, the shareholder will not be entitled to participate in surplus assets arising out of the liquidation process, it is excluded from liquidation.
- If a company’s substantial part of the business is money lending, then any advance or loan given to shareholder by the concerned company in the ordinary course of business would not be a taxable dividend.
- Any such dividend is not a taxable dividend where the company against any loan sets off the amount or advance to such extent, which was earlier, treated as dividend within the meaning of subclause (e).
- Where any such payment is made by the company for buyback of its own share from shareholder according to section 68 of the Companies Act 2013.
- Any Distribution of shares made by the company to shareholder out of demerger of the company (whether or not there is any reduction in capital or not).
Advance for Business Transaction
Any amount paid ahead of its payment is known as an advance. The question is whether any advance made for the business transaction by the closely held company to its shareholder having interest in that company would amount to the deemed dividend? Certain judgments have been made in this regard:
- CIT vs. Arvind Kumar Jain: Delhi High Court held that payments may be made by companies to its shareholders who are having interest in company, but where such payments are made in nature of business transaction between the parties, such advances or payments of loans cannot be treated as deemed dividends within the meaning of section 2(22)(e).
- DCIT vs. Lakhra Brothers: Chandigarh ITAT held that where any amount is advanced during the ordinary course of business expediencies, it cannot be said that there was the intention of such company to give loan. Such amount advanced cannot be treated as loan and hence such amount cannot be treated as deemed dividend.
- Bagman Constructions Pvt Ltd: The Karnataka High Court Held that loans or advances given to a shareholder as a consideration for purchase of goods or capital asset which would directly benefit the company advancing the loan cannot be treated as deemed dividend under section 2(22)(e) of the income tax act.
Amendments to Deemed Dividend Tax
The finance bill of 2018 proposed to levy tax on Deemed Dividend as Dividend Distribution Tax (DDT) under section 115-O of Income Tax Act, 1961 at rate of 30% from companies to prevent hiding of dividends in form of loans/advances.
Now the question, which arises, is that as per the amendment of Finance Act 2018, does the Dividend Distribution Tax (DDT) on Deemed Dividend under section 2(22)(e) result in double taxation?
As per the earlier provision under Finance Act 2017, deemed dividend was taxable in the hands of recipients as income from other sources under section 56 of income tax act and no dividend distribution tax was to be paid under section 115-O on such deemed dividend by the paying company.
Hence there were apprehensions that now as per new provision the company will have to pay DDT under section 115-O of income tax act and the recipient will also have to pay tax under section 56 of income tax act as income from other sources, hence it will lead to double taxation.
We can understand this by understanding the legal provisions of the concerned question.
Section 2(22)(e) in simple words means, any sum by way of loans and advances, advanced by closely held company to its beneficial shareholder who is holding at least 10% of the voting power or to any such shareholder who is member or a partner who holds at least 20% of the voting power , to extent of accumulated profits of such closely held company, are considered as deemed dividend.
We must also observe that under section 10(34) of Income Tax Act deemed dividend is exempted in hands of the recipient, which says that, in computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—
“34. any income by way of dividends referred to in section 115-O.”
Section 115- O of income tax says that any amount in respect of income declared or distributed by such company by way of dividends, whether out of current or accumulated profits shall be chargeable to additional income tax at rate of fifteen percent.
Therefore when we read section 10(34) and section 115-O of income tax act together we understand that dividend income is tax-free in the hands of recipient, as dividend distribution tax is payable by the paying company on distribution of such dividend.
Compliances to be followed by closely held company
- Companies to pay Dividend Distribution Tax under section 115-O of income tax act.
- TDS under section 194- the officer of the company, which is paying dividend, is liable to deduct tax at source under section 194 of Income Tax Act before making any payment in respect of divided.
- If a company fails to deduct the tax at source,S, then such company may be liable to penalty under section 271C (1) (a) of amount equal to amount of tax which was supposed to be deducted.
- If a company declares dividend & and such dividend is set off against the advances, then the dividend so adjusted against the advance will not be treated again as dividend.
Compliances to be followed by the taxpayer
- Deemed dividends are to be declared as income under the head of income from other sources.
- No special rates are charged on deemed dividends and it is charged as normal income tax rate.
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