Is Levying Tax on Deemed Dividend u/s 2(22)(e), Results in Double Taxation??

As we all are aware that Finance Bill 2018 introduced Levy of Dividend Distribution Tax (DDT) on Deemed Dividend u/s 2(22)(e), will it Results in Double Taxation?

The Finance Bill 2018, has covered deemed dividend u/s 2(22)(e) of Income Tax Act, also levy of dividend distribution tax @ 30%, u/s 115-O of Income Tax Act, in the hands of a closely held company paying such deemed dividends.

Before this amendment, deemed dividends are taxable in the hands of recipient as income from other sources u/s 56 of Income Tax Act, at the applicable marginal rate of tax, and no dividend distribution tax is payable u/s 115-O, on such deemed dividends, by the payer company.

Apprehensions have been raised in some quarters as to whether the proposed amendment will result in double taxation, both in the hands of payer company as well as the recipient of deemed dividend.

In order to address this issue, it will be desirable to examine the legal provisions of the relevant sections of Income Tax Act, in this regards.

Section 2(22)(e) of the Income Tax Act, 1961, defines deemed dividend as,

“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.”

 In simple words, as per provisions of Section 2(22)(e), any sum by way of loans and advances, advanced by a closely held company to its beneficial shareholder holding atleast 10% of the voting power/shareholding or to any  concern in which such shareholder is a member, or a partner and in which he holds atleast 20% of the shareholding/voting power, to the extent of accumulated profits of such closely held company, are considered as deemed dividends.

It is pertinent to mention here that dividend income (other than deemed dividend), is exempt in the hands of recipient, u/s 10(34) of Income Tax Act, which reads as under:

10. 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 Act, as contained in Chapter XII-D, reads as under:

 “Tax on distributed profits of domestic companies

115-O. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of fifteen per cent.”

Therefore, a combined reading of section 10(34) and section 115-O of Income Tax Act, makes it clear that dividend income is exempt in the hands of recipient, as dividend distribution tax is payable by payer company on distribution of such dividend.

However, it is pertinent to mention here that as per existing provisions in Finance Act, 2017, dividend distribution tax u/s 115-O, as contained in Chapter XII-D, is not payable on deemed dividend u/s 2(22)(e) of Income Tax, by virtue of Explanation to Chapter XII-D, occurring after section 115Q of the Act, which reads as under:

Explanation.—For the purposes of this Chapter, the expression “dividends” shall have the same meaning as is given to “dividend” in clause (22) of section 2 but shall not include sub-clause (e) thereof.

The Finance Bill 2018, proposes to levy dividend distribution tax @ 30% u/s 115-O, on deemed dividend u/s 2(22)(e), in the hands of payer company. But whether deemed dividend u/s 2(22)(e), will continue to be taxable in the hands of recipient as well so as to result in double taxation, both in the hands of payer company as well as recipient?

This interesting question is being duly answered by Explanatory Memorandum to Finance Bill 2018.

 The relevant Clauses in this regards viz. Clause 38 & 39, reads as under:

“Application of Dividend Distribution Tax to 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.”

Therefore, a plain reading of above explanation, as contained in Explanatory Memorandum to Finance Bill, 2018, regarding the proposed amendment concerning levy of dividend distribution tax on deemed dividend, makes it abundantly clear that deemed dividends are proposed to be brought under the scope of dividend distribution tax u/s 115-O, by deleting Explanation to Chapter XII-D, occurring after section 115Q of Income Tax Act.

As has already been discussed supra that any income by way of dividends referred to in section 115-O of Income Tax Act, is exempt in the hands of recipient u/s 10(34) of Income Tax Act. Since, deemed dividend u/s 2(22)(e), are proposed to be brought under section 115-O, therefore, exemption u/s 10(34), shall also be available in respect of deemed dividend, in the hands of recipient.

In the light of above stated legal propositions, it becomes duly evident that Finance Bill 2018, proposes to levy dividend distribution tax @ 30% u/s 115-O, on deemed dividend u/s 2(22)(e), in the hands of payer company. However, exemption u/s 10(34) will be available in respect of such deemed dividend, in the hands of recipient. Therefore, there will not be any double taxation.

The doubts in relation to Double Taxation, have arisen, because no direct amendment has been proposed in section 115-O of Income Tax Act, in the Finance Bill 2018, so as to brought deemed dividend also within the ambit of dividend distribution tax u/s 115-O of Income Tax Act, in order to qualify it for exemption u/s 10(34) of Income Tax Act.

However, a more in-depth reading of the Finance Bill 2018 and more particularly the Explanatory Memorandum to Finance Bill 2018, makes it amply clear that deemed dividends u/s 2(22)(e) of Income Tax Act, have been proposed to be brought under the ambit of dividend distribution tax u/s 115-O of Income Tax Act, not by way of direct amendment in section 115-O, but by way of deleting the Explanation to Chapter XII-D, occurring after section 115Q of Income Tax Act.

(Republished with Amendments)