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Deemed Dividend under Income Tax




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 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.

Explanation 1.—The expression "accumulated profits", wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956.

Explanation 2.—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 all profits of the company up to the date of liquidation, [but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place].

Trade advances / commercial transactions held to be not covered under section 2(22)(e) of the act (as per CBDT Circular No. 19/2017):
i.  Advance were made by a company to a sister concern and adjusted against the dues for job work done by the sister concern. It was held that amounts advanced for business transactions do not fall within the definition of deemed dividend under section 2(22)(e) of the Act. (CIT vs. Creative Dyeing & Printing Pvt. Ltd. , Delhi High Court).

ii. Advance was made by a company to its shareholder to install plant and machinery at the shareholder’s premises to enable him to do job work for the company so that the company could fulfill an export order. It was held that as the assessee proved business expediency, the advance was not covered by section 2(22)(e) of the Act. (CIT vs. Amrik Singh, Punjab & Haryana High Court)

iii. A floating security deposit was given by a company to its sister concern against the use of electricity generators belonging to the sister concern. Thecompany utilized gas available to it from GAIL to generate electricity and supplied it to the sister concern at concessional rates. It was held that the security deposit made by the company to its sister concern was a business transaction arising in the normal course of business between two concerns and the transaction did not attract section 2(22)(e) of the Act. (CIT, Agra vsAtul Engineering Udyog, Allahabad High Court)

Explanation of Section 2(22)(e)

1. Applicable to all companies except co. in which public are substantially interested – i.e. applicable to a closely held company only (Private Companies).

2. Any payment of any sum by way of loan or advance to:
a) A shareholder who is a beneficial owner of not less than 10% of voting power.
b) Any concern in which such shareholder is a member/partner and in which he hassubstantial interest.
c) Company – Shareholder has at least 20% voting power.
d) A Concern (other than company) - Shareholder has at least 20% interest.
e) Any payment by such company on behalf or for the individual benefit of any suchshareholder.

3. Dividend would be - to the extent of accumulated profits.

4. Specific exclusions:
a) When given in ordinary course of business where lending is substantial part ofbusiness.
b) Any dividend is paid which is set-off against previously paid amount and treatedas deemed dividend

5. Directorship is no basis to treat a payment as deemed dividend. It’s the shareholding whichis to be considered.

6. Such dividend is not subject to the dividend distribution tax u/s.115-O, and is therefore ataxable income, not exempt u/s. 10(34) of the Act.

7. However, there would be a liability to deduct tax u/s 194 of the Act.

Amendment in Finance Bill 2018

In section 2 of the Income-tax Act,––
(a) in clause (22), after Explanation 2, the following Explanation shall be inserted, namely:––
“Explanation 2A.–– In the case of an amalgamated company, the accumulated profits, whether capitalised or not, or loss, as the case may be, shall be increased by the accumulated profits, whether capitalised or not, of the amalgamating company on the date of amalgamation.”

In section 115-O of the Income-tax Act,––
(a) in sub-section (1), the following proviso shall be inserted, namely:––
‘Provided that in respect of dividend referred to in sub-clause (e) of clause (22) of section 2, this sub-section shall have effect as if for the words “fifteen per cent.”, the words “thirty per cent.” had been substituted;’;
(b) in sub-section (1B), the following proviso shall be inserted, namely:––

“Provided that this sub-section shall not apply in respect of dividend referred to in sub-clause (e) of clause (22) of section 2.”.
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RECENT UPDATES



UNION BUDGET 2018
 30% DIVIDEND DISTRIBUTION TAX ON DEEMED DIVIDEND


At present dividend distributed by a domestic company is subject to dividend distribution tax payable by such company. However, deemed dividend under sub-clause (e) of clause (22) of section of 2 the Act is taxed in the hands of the recipient at the applicable marginal rate. The taxability of deemed dividend in the hands of recipient has posed serious problem of the collection of the tax liability and has also been the subject matter of extensive litigation. With a view to bringing clarity and certainty in the taxation of deemed dividends, it is proposed to delete the Explanation to Chapter XII-D occurring after section 115Q of the Act so as to bring deemed dividends also under the scope of dividend distribution tax under section 115-O. Further, such deemed dividend is proposed to be taxed at the rate of 30 per cent. (without grossing up) in order to prevent camouflaging dividend in various ways such as loans and advances.

This amendment relating to imposition of dividend distribution tax on deemed dividend will apply to transactions referred to in sub-clause (e) of clause (22) of section 2 of the Act undertaken on or after 1st April, 2018. It is proposed to insert a proviso to sub-section (1) of the said section so as to provide for levy of tax at the rate of thirty per cent. on distributed profits in the nature of dividend under sub-clause (e) of clause (22) of section 2. It is further proposed to insert a proviso to sub-section (1B) of the said section 115-O so as to exclude the amount of dividend under sub-clause (e) of clause (22) of section 2 from the applicability of grossing up provisions of the said sub-section.

Clause 39 of the Bill seeks to omit the Explanation occurring after section 115Q of the Income-tax Act.The said Explanation clarifies that the expression “dividends” shall have the same meaning as is given in clause (22) of section 2 but shall not include sub-clause (e) thereof.It is proposed to omit the said Explanation consequent to the amendments made to section 115-O.



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This blog is Created by CA Anil Kumar Jain.