CA Kamal Garg

In terms of Section 2(22)(e) of the Income Tax Act, 1961, “dividend” includes 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:

  1. 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 10% of the voting power, or
  2. 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)

to the extent to which the company in either case possesses accumulated profit

The expression “dividend” u/s 2(22)(e) also includes 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 profit

Explanation 3 to Section 2(22)(e) states that for the purposes of this clause,—

(a) “concern” means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company ;

(b) “concern” means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company ;

Illustration (advance made in the nature of commercial business transaction): Mr. X is in business of manufacturing customized kitchen equipments. He is also the Managing Director and held nearly 65% of the paid-up share capital of ABC Ltd. A substantial part of the business of Mr. X is obtained through ABC Ltd. For this purpose, ABC Ltd. passed on the advance received from its customers to Mr. X to execute the job work entrusted to him. The Assessing Officer held that the advance money received by Mr. X is in the nature of loan given by ABC Ltd. to him and accordingly is deemed dividend within the meaning of provisions of section 2(22)(e) of the Income-tax Act, 1961. The Assessing Officer, therefore made the addition by treating advance money as the deemed dividend income of Mr. X. Examine whether the action of the Assessing Officer is tenable in law.

Recommendation: As per section 2(22)(e), in case a company, not being a company in which the public are substantially interested, makes payment of any sum by way of advance or loan to a shareholder holding not less than 10% of voting power/share capital of the company, then, the payment so made shall be deemed to be dividend in the hands of such shareholder to the extent to which the company possesses accumulated profits. In the present case, Mr. X is holding 65% of the paid-up capital of ABC Ltd. ABC Ltd. has passed on advance received from its customers to Mr. X for execution of job work entrusted to Mr. X. Assuming that ABC Ltd. is not a company in which public are substantially interested, the applicability of the provisions of section 2(22)(e) in respect of such transaction has to be examined. In CIT v. Rajkumar (2009) 318 ITR 462 (Del.), it was held that trade advance given to the shareholder which is in the nature of money transacted to give effect to a commercial transaction, would not be deemed to be dividend in the hands of the shareholder under section 2(22)(e). The Delhi High Court ruling in CIT v. Ambassador Travels (P) Ltd. (2009) 318 ITR 376 also supports the above view. In the present case, the payment is made to Mr. X by ABC Ltd. for execution of work is in the course of commercial business transaction and therefore, it shall not be deemed as dividend in the hands of Mr. X under section 2(22)(e). Hence, the action of the Assessing Officer is not tenable in law.

Illustration (amount given for the individual benefit of shareholder): Mr. M, Managing Director of M/s XYZ Pvt. Ltd. holds 70% of its paid up capital of Rs. 20 Lakhs. The balance as at 31.03.2014 in General Reserve was Rs. 6 Lakhs. The company on 01.07.2014 gave an interest-free loan of Rs. 5 Lakhs to its Supervisor having salary of Rs. 4,000 p.m., who in turn on 18.8.2014 advanced the said amount of loan so taken from the company to Mr. M. The Assessing Officer had taxed the amount of advance in the hands of Mr. M. Is the action of Assessing Officer correct?

Recommendation: The Company had advanced a loan to an employee who in turn had advanced the same to the Managing Director of the company holding 70% of its capital. In accordance with the provisions of section 2(22)(e), the same shall be treated as the payment by a company in which public are not substantially interested, on behalf of, or for individual benefit of any such share holder (who holds not less than 10% of the voting power), to the extent to which the company possesses accumulated profits. In this case, the company has reserves of Rs. 6 Lakhs on 31st March, 2014 and the amount of loan advanced on 1st July, 2014 is Rs. 5 Lakhs. Therefore, the payment is to be treated as deemed dividend. The amount of interest-free loan of Rs. 5 Lakhs given by the company to the supervisor who in turn had given the same to Mr. M, shall be construed as the amount given for the benefit of Mr. M and is treated as deemed dividend chargeable to tax in the hands of Mr. M. This has also been held by the Apex Court in the case of L. Alagusundaram Chettiar v. CIT (2001) 252 ITR 893/(2002) 121 Taxman 587.

Illustration (loan repaid before the end of the accounting year): MNO Ltd. is a company in which the public are not substantially interested. K is a shareholder of the company holding 15% of the equity shares. The accumulated profits of the company as on 31.3.2014 amounted to Rs. 10,00,000. The company lent Rs. 1,00,000 to K by an account payee bank draft on 1.10.2014. The loan was not connected with the business of the company. K repaid the loan to the company by an account payee bank draft on 30.3.2015. Examine the effect of the borrowal and repayment of the loan by K on the computation of his total income for the assessment year 2015-16.

Recommendation: As per section 2(22)(e), any payment by a company, in which the public are not substantially interested, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares holding not less than 10% of the voting power, shall be treated as dividend to the extent to which the company possesses accumulated profits. In the instant case, MNO Ltd. is a company in which the public are not substantially interested. The company has accumulated profits of Rs. 10,00,000 on 31.3.2014. The loan given by the company to K was not in the course of its business. K holds more than 10% of the equity shares in the company. Therefore, assuming that K has voting power equivalent to his shareholding, section 2(22)(e) comes into play and the sum of Rs. 1,00,000, representing the amount lent by the company to K, is includible as dividend in the total income of K for the assessment year 2015-16. Under section 2(22)(e), the liability arises the moment the loan is borrowed by the shareholder and it is immaterial whether the loan is repaid before the end of the accounting year or not. Therefore, the repayment of loan by K to the company on 30.3.2015 will not affect the taxability of the sum of Rs. 1,00,000 as dividend in his hands.

Illustration (loan advanced by the company to the HUF where the Karta is a shareholder (on behalf of his HUF): HLI Private Limited is a company with three shareholders H (40%), L (20%) and I on behalf of his HUF (40%). I (HUF) is a Hindu Undivided Family whose members are Mr. I, Mrs. I and their two sons, G and J. The company gave a loan of Rs. 9 lakhs to I (HUF) on 30th April, 2014, on which date the accumulated profits of the company was Rs. 6 lakhs. What is the tax consequence of this transaction?

Recommendation: The issue under consideration in this case is whether, where the Karta is a shareholder (on behalf of his HUF) of a company in which public are not substantially interested, the loan advanced by the company to the HUF would constitute deemed dividend under section 2(22)(e) to the extent to which the company possesses accumulated profits.

First view: Section 2(22)(e) would be attracted if the loan is given by a company in which public are not substantially interested to a shareholder, being a person who is the beneficial owner of shares holding not less than 10% of voting power. On a plain reading of section 2(22)(e), it appears that the said provision would be attracted only if the person to whom the loan is given is a registered shareholder as well as beneficial owner. If this view is taken, then section 2(22)(e) would not be attracted in this case, since the registered shareholder is Mr. I (on behalf of his HUF), whereas the beneficial owner is his HUF. Therefore, loan given to the HUF would not be deemed as dividend by applying section 2(22)(e). This view was taken by the Supreme Court in Rameshwarlal Sanwarmal v. CIT (1980) 122 ITR 1 (SC).

Second view: Section 2(22)(e) would be attracted if the loan is given by a company in which public are not substantially interested to a shareholder, being a person who is the beneficial owner of shares holding not less than 10% of voting power. Even though on a plain reading of section 2(22)(e), it appears that the said provision would be attracted only if the person to whom the loan is given is a registered shareholder as well as beneficial owner, the Delhi High Court, in CIT v. National Travel Services (2012) 347 ITR 305/(2011) 202 Taxman 327, has taken a view that where loan is given by a company to a firm, being the beneficial owner of shares held in the name of its partners, provisions of section 2(22)(e) would be attracted, since the essential condition to be satisfied is that of beneficial ownership and it is not necessary that the beneficial owner has to be a registered shareholder. If this view is adopted, then section 2(22)(e) would get attracted in this case. The loan to the HUF, being the beneficial owner, would be deemed as dividend in the hands of the HUF. It would, however, be taxable only to the extent to which the company possesses accumulated profits on the date of loan i.e., in this case, Rs. 6 lakh.

Compiled by FCA Kamal Garg, having academic and professional interests in IFRS, Taxation, Corporate Audit and Law Advisory disciplines. For any queries or suggestions he may be approached at cakamalgarg@gmail.com

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