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SECTION 2(22)(e) – Deemed Dividend – Taxable for Shareholders

Last Update Date : April 26, 2018

Numbers is a nightmare for most of us. But if we clean the walls of our memories, the ones which are specially related to mathematics and its equations, we may be able to see the equation which is very simple and applicable in real life. Yes! It is the same equation: If a = b and b = c, then a = c.
If I am a company and lending to you being a substantial shareholder or I’m lending to a concern in which you (being my shareholder) have substantial interest, the payment in the form of any loan or advance from me to you or the concern shall be assumed to be dividend and shall be charged to tax under the concept of deemed dividend. Let us learn more about this equation.

deemed dividend

Deemed Dividend under Section 2(22)(e)

Any payment by a company, not being a company in which public are substantially interested (i.e. closely held company), of any sum (whether representing a part of the assets of the company or otherwise) by way of loan or advance

  • to a shareholder, being a person who is the beneficial owner of the 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 10% of the voting rights, or
  • to any concern in which such shareholder is a member or a partner and in which he has a substantial interest, or
  • on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits.
  • Also, loan given by a subsidiary company to the holding company would fall within the ambit of Section 2(22)(e).

Exclusions under Section 2(22)(e)

  • Where money lending is the substantial part of the business and the transaction for loan or advance is made in the ordinary course of action, such payment shall not be taxable as deemed dividend.
  • Provided for the above clause, a company can operate a business of money lending only if it has a license from RBI or if it is an NBFC.
  • Any subsequent dividend paid by the company to the extent to which it is set off by the company against any loan or payment that has earlier been treated as dividend under sub-clause (e) shall not be taxed again.
  • However, if the dividend paid is not set off against earlier deemed dividend, then in absence of set off such dividend will be taxable.
  • Any payment made by a company for buyback of its own shares in accordance with provisions of section 77A of the Companies Act, 1956 shall not be taxed as dividend.
  • Distribution of shares in case of demerger by the resulting company to the shareholders of the demerged company also shall not be taxed as dividend.
  • Inter-corporate deposits are not ‘loans and advances’ and are not assessable to tax as deemed dividend.

Taxability

According to the provisions of the section 8 of the Income Tax Act, 1961, dividend income becomes taxable in the year in which it is declared or distributed or paid. As per the provisions of section 10(34) dividend income is exempt in the hands of the shareholders as it is charged to DDT under section 115-O. However, ‘deemed dividend’ as defined above does not come under the ambit of section 115-O and hence, it is taxable in the hands of the shareholders at the marginal rate of tax.

Amendment

The Finance Bill 2018 has proposed to levy the Dividend Distribution Tax (DDT) on ‘Deemed Dividend’ under section 115-O of the Income Tax Act, 1961 at the rate of 30% (plus applicable surcharge and cess) in the hands of the closely held companies to prevent hiding dividend in the form of loans/advances.
The amendment shall apply to the transactions undertaken on or after 1st April, 2018.
As discussed in the guide on section 10(34) the dividend income which are subject to DDT under section 115-O are exempted in the hands of the shareholders under section 10(34).
Since, Deemed dividend under section 2(22)(e) is also proposed to brought under the purview of DDT u/s 115-O, therefore, exemption u/s 10(34) shall also be applicable to shareholders and income from such deemed dividend shall be tax free.

Definitions for the Purpose of above Explanation

  • Accumulated profit means all profits, i.e. commercial profits up to the date of distribution or payment or liquidation and not as profits calculated or assessed for the income tax purposes.
  • Investment Allowance Reserve, Development Rebate Reserves and all other reserves created out of the company’s profit also forms a part of the accumulated profit. However, Share Premium Reserve does not form part of the accumulated profits.
  • It should be noted that any repayment of loan/advance during the same year after the advancement of the loan shall not be deducted from the accumulated profits
  • It should also be noted that Building and Machinery depreciation fund shall not form part of the accumulated profits. The depreciation so calculated shall be as per the income tax provisions even if less depreciation has been provided for in accounts.
  • Concern means an HUF, or a firm or an AOP or BOI or a company.
  • Substantial Interest means that the person shall be entitled to not less than 20% of the profits/income of such concern.

Factors to be Considered

  • The company paying such loans or advances should be a closely held company, i.e. no public shall be substantially interested. However, receiving company can be a public or listed company.
  • The said loans or advances shall be paid by the company to its shareholder who is having substantial interest.
  • The loans or advances must not be in the ordinary course of action of the business.
  • Shareholder should make the company its creditor.
  • Every payment may not be a loan or advance and hence, may not be taxed as deemed dividend.
  • Deemed dividend to be considered only to the extent of accumulated profits of the company till the date of such payment or transaction.
  • TDS under section 194 is chargeable to registered shareholders.

An enemy of an enemy is a friend. The payment by the way of loan or advance to the substantial shareholder is deemed to be dividend and chargeable to tax. Hence, it is difficult to escape from tax under the Income Tax laws. Reach our experts at TaxForum for better tax planning and expert advice.

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