Introduction: In the realm of corporate finance, dividends represent a fundamental method through which companies distribute their profits to shareholders. While traditionally understood as a straightforward distribution of earnings, the concept of dividends encompasses various forms under tax law, including the intriguing notion of “deemed dividends.” This concept, particularly relevant in the Indian tax context, invokes Section 2(22) of the Income Tax Act, expanding the dividend scope beyond conventional distributions. It is pivotal for taxpayers and corporations alike to grasp the intricacies of deemed dividends, their taxability, the applicability of Tax Deducted at Source (TDS), and potential avenues to mitigate TDS implications. This exploration sheds light on the operational framework, legislative underpinnings, and strategic considerations surrounding deemed dividends, offering a comprehensive understanding of their impact on corporate transactions and individual tax liabilities.
A dividend is the attribution or the distribution of a company’s earnings or we can say profits to its shareholders and is determined by the company’s board of directors in a Board meeting. Dividends may be distributed quarterly or yearly
What is the taxability and applicability of TDS on Dividends?
You might be thinking, what is the responsibility of companies distributing the dividend, do they need to deduct tax?
The answer to this question is yes, in case any dividend income received from a domestic company is taxable in the hand of the shareholder under the head “Income from other sources” and the TDS of flat 10% is deducted by the company if the dividend income paid is in excess of Rs. 5000.
Can you avoid TDS?
Yes, If the investor’s annual income is below the exemption limit then he can submit the form 15G/15H for not deduction of TDS
Now there is a unique concept of deemed dividend!
This concept is governed by section 2(22) of the Income Tax Act which states, that the following receipts are deemed to be dividends:
(a) Any distribution of accumulated profits by a company to its shareholders, whether in the form of capitalization or otherwise, is deemed to be a dividend if it involves the release of any portion of the company’s assets For example if accumulated profits are distributed in cash, it is dividend in the hands of the shareholders if accumulated profits are distributed in kind, for example by delivery of plot of land, etc. entailing the release of the company’s assets, the market value of shares is deemed dividend in the hands of the shareholder.
(b) Any distribution made by a company to its shareholders in the form of debentures, debenture stock, or deposit certificates, regardless of whether they carry interest, as well as any allocation of bonus shares to preference shareholders, will be considered as a dividend, provided that the company has accumulated profits, whether they have been capitalized or not. The market value of such bonus shares is subject to taxation in the hands of the preferred shareholder. In the case of debentures, debenture stock, etc., their value is determined based on prevailing market rates. If no market rate exists, valuation should be conducted according to accepted principles of valuation. It’s important to note that bonus shares issued to equity shareholders do not fall under the category of dividends.
(c) Any distribution to shareholders of a company upon its liquidation, which can be attributed to the accumulated profits of the company immediately preceding the liquidation, whether those profits have been capitalized or not, is considered dividend income. It’s important to note that any distribution made from the profits of the company after the date of liquidation is not treated as dividend income, but rather as a repayment of capital. The term “accumulated profits” encompasses all profits of the company up to the date of liquidation, regardless of whether they have been capitalized. However, in cases where liquidation occurs due to the compulsory acquisition of an undertaking by the Government or any government-owned or controlled corporation, accumulated profits do not include profits earned by the company prior to the three successive previous years immediately preceding the year of such acquisition, with certain exceptions.
(d) Any distribution made by a company to its shareholders upon the reduction of its capital, to the extent that the company has accumulated profits, whether those profits have been capitalized or not, will be treated as a dividend.
But as per the bare act, Dividend Includes dividend referred under section 2(22)(a) to (d) but shall not include sub-clause (e) thereof.
What is Section 2(22)(e)?
It deals with the advance or loan by a closely held company to its shareholder, which means any payment by a company in which the public is not substantially interested which means it is applicable to a private company of any sum by way of advance or loan to any shareholder who is the beneficial owner of 10% or more of the equity capital of the company will be deemed to be a dividend to the extent of the accumulated profits. If the loan is not covered by the accumulated profits, it is not deemed to be a dividend.
Any payment made by a closely held company, where the public is not substantially involved, to a specified concern (such as HUF / Firm / AOP / BOI / Company), in which a shareholder holds beneficial ownership of at least 10% of the equity shares and has a substantial interest (i.e., at least 20% share of the income of the concern), will be treated as dividend income. Additionally, any payments made by such a closely held company on behalf of or for the individual benefit of such a shareholder will also be deemed as dividend income. However, in both scenarios, the maximum limit of the dividend is restricted to the extent of accumulated profits.
Are there any exceptions?
The following payments or loans given would not be deemed as dividends:
a) If the loan is granted in the ordinary course of its business and lending of money is a substantial part of the company’s business, the loan or advance to a shareholder or to the specified concern is not deemed to be a dividend, like for example bank or financial institutions
b) Where a loan had been treated as a dividend and subsequently the company declares and distributes a dividend to all its shareholders including the borrowing shareholder, and the dividend so paid is set off by the company against the previous borrowing, the adjusted amount will not be again treated as a dividend.
Apart from the exceptions cited above, the following also do not constitute “dividend” –
a) Any payment made by a company on the purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956;
b) Any distribution of shares on demerger by the resulting companies to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company).
Which is the year of accrual of dividends?
Section 8 provides that deemed dividend under section 2(22) declared by a company or distributed or paid by it shall be deemed to be the income of the previous year in which it is declared, distributed, or paid, as the case may be. Any interim dividend shall be deemed to be the income of the previous year in which the amount is unconditionally made available to the member who is entitled to it.
Now looking at these exemptions do you think a Loan received from Co. having a common shareholder is treated as a deemed dividend?
In the recent case of Apeejay Surrendra Management Services (P.) Ltd. v. Deputy Commissioner of Income-tax, Circle-8(1), the issue at hand revolved around the application of Section 2(22)(e) of the Income-tax Act, 1961 concerning the concept of deemed dividend, and Section 5 regarding the accrual of income which I discussed earlier in this article in detail. This case pertained to the assessment years 2013-14 and 2014-15.
Have you noticed? it is a private limited company, so clause e will apply
This matter may be summarized as the assessee, Apeejay Surrendra Management Services (Pvt.) Ltd. had received a loan or advances from another group company. The important point to note was that although the assessee was not a registered shareholder of the lending company, there existed a common shareholder who had the power to control the affairs of both the lending company and the assessee.
Now does this power or control signify a substantial interest?
Upon analysis, the Tribunal concluded that the beneficial ownership of shares rested with the common shareholder who had control over both the lending company and the assessee. Therefore, the provision of Section 2(22)(e) was deemed to be applicable only in the hands of the common shareholder and not on the assessee-concern.
The decision rendered by the ITAT was in favor of the assessee, Apeejay Surrendra Management Services (P.) Ltd. The Tribunal held that the deeming provisions of Section 2(22)(e) and the principles governing the accrual of income under Section 5 led to the conclusion that the income in question should be attributed to the beneficial shareholder rather than the company
Therefore, the Tribunal’s decision provided clarity on the application of these provisions in cases where there is a common shareholder exercising control over both the lending company and the recipient concern, ensuring a fair and accurate determination of tax liabilities.
Conclusion: The concept of deemed dividends under the Income Tax Act extends the traditional understanding of dividend distributions, enveloping various transactions that might not outright appear as profit distributions. Section 2(22) intricately defines scenarios where distributions, advances, or loans by companies, particularly closely held ones, are construed as dividends for tax purposes. This broad interpretation aims to prevent the evasion of dividend distribution tax through indirect profit distributions. Understanding the nuances of deemed dividends, including their taxability, TDS implications, and exceptions, is crucial for both companies and shareholders to navigate the tax implications effectively. The case of Apeejay Surrendra Management Services further illustrates the complexities involved in applying these provisions, highlighting the importance of discerning beneficial ownership and the actual recipients of such deemed dividends. For taxpayers, a thorough comprehension of deemed dividends and strategic planning is essential to optimize tax liabilities and ensure compliance with the evolving landscape of tax law.
Note: I have written the above points with the help of Bare Act and case law with some modifications
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