Understanding Deemed Dividend with Latest Case Laws

Manish Kumar Agarwal, FCA

Now a days, in a modern organization , there will exist a complicate business structure of holding & subsidiary companies along with closely held companies. There will be routine flow of funds between these companies. It is very important to have the knowledge of provisions of deemed dividend under section 2(22)(e) of the Income tax act, 1961 before making any transaction with the closely held companies.

The provisos of section 2(22)(e) is reproduced below for your kind reference :

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) ⁹³[made after the 31st day of May, 1987, by way of advance or loan to a shareholder⁹⁴, 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 profits⁹⁵ ;

                     but “dividend” does not include—

          (i)   a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ;

    ⁹⁶[(ia)   a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964, ⁹⁷[and before the 1st day of April, 1965] ;]

         (ii)   any advance or loan made to a shareholder ⁹⁸[or the said concern] by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company ;

        (iii)   any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off;

    ⁹⁹[(iv)   any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A ¹ of the Companies Act, 1956 (1 of 1956);

         (v)   any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company).]

                     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, ²[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].

                     ³[Explanation 3.—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)   a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern ;]

The concept of Deemed Dividend is embedded in Section 2(22)(e) of the Income-tax Act, 1961 and was also embedded in section 2(6A)(e) of the Indian Income-tax Act, 1922. In nutshell, the concept envisages taxing certain payments made by closely held companies by way of loans or advances to certain shareholders of the company or to the concerns/companies in which they have substantial interest. Whenever any payment is made by way of loan or advance, the recipient of the loan or advance will be liable to be taxed on this amount as a dividend, to the extent to which the company has accumulated profits, under the deeming provisions of section 2(22)(e) although such loan or advance may have been given for genuine business purposes and even if the paying company may have received back the loan amount. Thus the section deems certain payments as dividend income which is not income under ordinary commercial parlance. Therefore, the name Deemed dividend.

The concept of deeming certain payments or loans or advances to substantial shareholders as income was introduced with the object of curbing tax evasion. Upto 31-5-1997 dividend was taxed in the hands of the recipient of the dividend. However many closely held companies never declared any dividend and accumulated profits in the company itself. Since no dividend was declared the same could not be taxed. However the companies did give loans or advances to substantial shareholders or to their concerns/companies who presumably enjoyed these funds but were not liable to pay any tax on the same as the amounts were loans or advances liable to be returned. These amounts of loans or advances are sought to be taxed as dividend by section 2(22)(e) of the Act by way of a deeming fiction..

Taxation of dividend under Income-tax Act, 1961 has undergone substantial changes in recent times. Effective from 1-6-1997 the scheme of taxation of dividend has been modified and is different from the old scheme . The essence of the old scheme was that the recipient of the dividend income was liable to pay the income-tax on the same, subject to certain exemptions. The new scheme essentially makes the dividend tax-free (section 10(33) of the Act) in the hands of the recipient (except cases covered under section 2(22(e)of the Act) and the dividend paying company has been made liable to pay tax on the amount of dividend declared , distributed or paid by it (Section 115-O of the Act). This tax is over and above the corporate income-tax which a company would normally pay. However there is no change in the scheme of taxation of Deemed Dividend contained in the section 2(22) (e) of the Act and such dividends are governed by the old scheme of taxation of dividend i.e. tax on deemed dividend is paid by the recipient and the paying company does not have to pay dividend tax but will be liable to deduct tax at source from such loans or advances/deemed dividend and pay the same to the Government.

Section 2 (22) of Income-tax Act, 1961 defines “dividend” and is the main section for taxation of Dividend. Unless a payment or distribution is covered by this definition, it can not be taxed as “dividend”. Once an amount is covered as dividend it will be also considered as income as Section 2(24)(ii) of the Act includes ‘dividend’ within the definition of ‘Income’.

Section 2(22) has 5 clauses (a), (b), (c), (d) and (e) which specify various types of distributions and payments as dividend. Clauses (a). (b), (c) and (d) mainly cover cases of distributions which entail release of assets or create liabilities. While clause (e) covers cases of payments by way of loans or advances and which is the clause mainly dealing with deemed dividend as it is commonly understood and has been dealt with in this article.

Following points are to be understood with reference to the above:

 [A]  Accumulated Profits for the Purposes of Section 2(22)(e)

 (i) General

 Sub-clause (e) applies when distribution or payment referred to therein are connected with accumulated profits. The undistributed income, when accumulated from year to year, generates what is known as “accumulated profit”. Accumulated profits shall include all profits of the company till the date of distribution or payment referred to in sub-clause (e).

(ii) Current Profits

 Current profits are included in “accumulated profits” in section 2(22)(e) of I.T. Act 1961. The expression “accumulated profits” was defined in the 1961 Act so as to include current profit upto date of distribution or payment.

 (iii) Accumulated profits – How to be Computed

 The phrase “accumulated profits” does not mean aggregate of assessed profits but commercial profits. If certain disbursements have been disallowed in the assessment proceedings but the expenditure had in fact been incurred, they should be excluded from accumulated profits. In computing commercial profits, all the disbursements made and expenditure incurred for the purpose of business should be taken into account. The following are the items which are to be included or to be excluded in computing accumulated profits:

[B] Advance Or Loan To A Shareholder By A Closely – Held Company 

  I)  Who should be given loan or Advance

Loan or Advance is given by a closely held company (i.e. Private Limited Company) to-

 (i) Shareholder holding 10% or more voting power in that company;

 (ii) Concern i.e. HUF, Firm, AOP, BOI in which, Shareholder who holds 10% or more voting power in the company, also holds 20% or more of the income of that concern at any time during the previous year;

 (iii) Concern i.e. Company in which, Shareholder who holds 10% or more voting power in the company, also holds 10% or more voting power of that concern at any time during the previous year.

 II)  Loan or Advance

 The expression used in section 2(22)(e) is “advance or loan”. It ordinarily means payment of cash or transfer of goods for which accounting must be rendered by the recipient at some later date. Thus, there would be advance by the company when goods are transferred to shareholder. The expression “advances” also refers to something which is due to be paid to the shareholder but which is paid to him ahead of time when it is due to be paid.

 The transaction of loan involves lending and delivery by one party and receipt by another party of sum of money upon express or implied agreement to repay it with or without interest.

III)  Effect of repayment of loan

As soon as loan is advanced to shareholder by closely held company from accumulated profits statutory fiction under section 2(22)(e) becomes operative and such loan is deemed to be dividend. Such loan does not cease to be deemed dividend on account of any subsequent event. Even if the loan is repaid by the shareholder in the same previous year, the statutory fiction arising at the time of giving loan by the company does not cease to be operative. Such a loan would be taxed as deemed dividend even if repaid in the same previous year.

IV)  Subsequently declared dividend set off against previously granted loan

 Where a loan granted by the company is treated as dividend under section 2(22)(e) and the company subsequently declares regular dividends and sets it off against the said loan, the dividends so set off would not be treated as dividend in the hands of the shareholder.

V)  Exception where substantial part of business of the company is money – lending

Where the lending of money is a substantial part of the business of the company, “dividend” would not include any advance or loan made in the ordinary course of business to a shareholder or to the concern in which such shareholder has substantial interest.

[C] Quantum of deemed dividend

The principle is that where loan given by the company exceeds the accumulated profits, deemed dividend would be to the extent of accumulated profits and balance of loan amount would not be deemed dividend. If the accumulated profits exceed the loan amount, entire loan amount would be deemed dividend and not the amount proportionate to shareholder’s interest in the shareholding of the company. If there are no accumulated profits, there would not be any question of loan being treated as deemed profits.

Example:

The assessee held 25% shares of the closely held company. The accumulated profits were Rs. 4,000 while the assessee took loan of Rs. 29,000. Here, loan given by the company exceeds the accumulated profits. Thus, entire accumulated profits are to be taken into account under section 2(22)(e). And only 25% of Rs. 4,000 should not be regarded as deemed dividend under section 2(22) (e).

[D] Taxability of Deemed Dividend under section 2(22)(e)

Deemed Dividend u/s 2(22)(e) is taxable in the hands of shareholder u/s 56 of the Income Tax Act and it is not taxable in the hands of company.

Also Deemed Dividend u/s 2(22)(e) is not exempt u/s 10(33) of the Income Tax Act.

Now, lets discuss some intricate queries arising out of the aforesaid definition.

Q 1. What kinds of advances are covered within the scope of section 2(22)(e)?

It has been held by Rajasthan High Court in re CIT v. Raj Kumar (2009) 23 DTR (Del) 304 that the word ‘advance’ has to be read in conjunction with the word ‘loan’ i.e., a payment shall be construed as a loan or advance if it involves following attributes–

• Positive act of lending coupled with acceptance by the other side of the money as a loan;
• Generally carries interest
• Obligation of repayment is inherent.

 Considering the rule of construction viz., noscitur a sociis and keeping in view the intent of introducing the provisions [i.e., to plug the evasion of tax by payment of dividends in the guise of loans & advances to the principal shareholders], any advance which does not carry with it the obligation of repayment cannot fall within the four corners of the deeming provision. Consequently, trade advances made in then ordinary course of business that are adjusted against supply of goods/services do not fall within the ambit of section 2(22)(e).

Q 2. In whose hands will the payment deemed to be dividend if the loans or advances are made to concern or person on behalf of or for the benefit of substantial shareholder?

It is general principle that a payment can be taxed as dividend only in the hands of a shareholder. The same cannot be taxed as such in the hands of a non shareholder. This view has been reiterated by Rajasthan High Court in re CIT v. Hotel Hilltop (2008) 217 CTR (Raj.) 527 wherein it was held that the essential requirement of section 2(22)(e) is that payment should be made on behalf of or for the individual benefit of substantial shareholder. Thus, the provision is intended to attract the liability of tax on the person on whose behalf or for whose benefit the amount is paid by the company.

In re CIT v. Bhaumik Colour P. Ltd (2009), the special bench of Mumbai tribunal held that the inclusive definition of section 2(22)(e) enlarges the scope of the term dividend by including loans & advances. The legal fiction created by the said section is operative only so long as the deemed dividend is taxed in the hands of the shareholder. If the legal fiction is extended to loans & advance to a non shareholder, the very term ‘dividend’ will lose its identity.

One of the exceptions to section 2(22)(e) is that dividend shall not include any dividend  paid by the company which is set off by the company against the whole or any part of the sum previously paid by it and treated as dividend within the meaning of sub clause (e) to the extent it is so set off.

In the event of the payment of loan or advance by a company to a concern being treated as dividend and taxed in the hands of the concern then the benefit of set off cannot be allowed to the concern, because the concern can never receive dividend from the company which is only paid to the shareholder, who has substantial interest in the concern. The above provision, further, contemplate that deemed dividend be taxed in the hands of shareholder only. 

Q 3. One of the exceptions to section 2(22)(e) is that dividend shall not include any loans or advance made to a shareholder or the said concern by the company in the ordinary course of its business, where lending money is substantial part of the business of the company. Elaborate?

The term ‘substantial’ appearing in the aforesaid exception is not defined. But the same is defined in explanation 3(b) to section 2(22)(e) as not less than 20% of the income of such concern. Following the judgement of supreme court in CIT v. Venkateshwara Hatcheries (237 ITR 174) wherein it was held that the definition in one section can be used for understanding the meaning of the word in another section if the context justifies it, it can be concluded the definition of term ‘substantial’ used in the aforesaid section means 20% or more of the income of a concern.

Thus, if the income from money lending is 20% or more of the total income of the closely held company and the turnover of the loan funds to total funds of the company is above 20%, any loans or advance made by the said company to its principal shareholder cannot be deemed to be dividend. The same was upheld by Delhi Tribunal in Mrs. Rekha Modi v. ITO (2007) (13 SOT 512) and the same was not further challenged by the revenue.

 Further, in deciding whether the company is engaged in money lending business, factual position only for the relevant previous year in question has to be considered i.e., the year in which the loan or advance has been given to principal shareholder holding 10% or more of voting power. The same has been upheld in the aforesaid judgement of the tribunal

Case Law Study :

• In Kantilal Manilal v.CIT [1961] 41 ITR 275(SC) the Supreme court held that Section 2(22) deals with various types of cases and creates a fiction by which certain receipts or parts thereof are treated as dividend for the purpose of levy of Income-tax .

• In CIT v. Martin Burn Ltd.,(1982)136 ITR 805(cal) the Calcutta High court held that Under section 2(22) certain amounts which are actually not distributed are also brought within the net of dividends. Therefore, that section must receive a strict interpretation.

• Section 2(22)(e) has been held to be constitutionally valid in Navnitlal C. Javeri v. K.K.Sen, AAC [1965]56 ITR 198 (SC).
• A loan of money results in a debt but every debt does not involve a loan [ Bombay Steam Navigation Co. (1953)(P) Ltd. vs. CIT (1965) 56 ITR 52 (SC) : TC16R.881];

• Any loan given by life insurance companies to their policy holders-shareholders in the normal course of business on the security of insurance policies and within the limits of their surrender value should not be treated as dividends [Circular No.43 (LXXVI-7) dt. 27th Oct., 1955];

• Payment by company to a firm in which shareholder is partner for repayment of advances in regular course of business cannot be deemed dividend under section 2(22)(e) [Mukundray K. Shah vs. CIT (2005) 197 CTR (Cal) 563 : (2005) 277 ITR 128 (Cal)];

• Withdrawal over and above credit balance is to be treated as deemed dividend. For example, When company has accumulated profits, withdrawal by a shareholder over and above the credit which he has with the company would be deemed dividend when the shareholder had no credit balance in any other account [CIT vs. P. Sarada (1985) 46 CTR (Mad) 328 : (1985) 154 ITR 387 (Mad) : TC41R.306];

• Loan obtained by the shareholder through proprietary concern would be treated as deemed dividend under section 2(22)(e) [Nandlal Kanoria vs. CIT (1980) 122 ITR 405 (Cal) : TC41R.311];

• Shareholder doing business with company and always having debit balance Explanation: When a shareholder has a business with the company and when his accounts with the company is always on debit side, the amount in question would be regarded as loan by the company to the shareholder and if there are accumulated profits to cover the debit balance, the amount in question would be regarded as deemed dividend under section 2(22)(e) [ CIT vs. Jamnadas Khimji Kothari (1973) 92 ITR 105 (Bom) : TC41R.320]. However, where company has made advances to the concern of the shareholder towards purchases to be made by the company from the said concern, such advances would not be deemed dividend under section 2(22)(e) [CIT vs. Nagindas M. Kapadia (1989) 75 CTR (Bom) 161 : (1989)177 ITR 393 (Bom) : TC41R.321];

• Money advanced as loan by company substantially doing money lending business could not be treated as deemed dividend under section 2(22)(e) [CIT vs. V. S. Sivesubramaniam (1997) 141 CTR (Mad) 34]

• (income tax officer vs Kalyan m Gupta (2007) 111 TTJ (mumbai)1005,(2007)107 ITD 34 (Mumbai),(2007)11 SOT 530

Kalyan Gupta was a shareholder with more than 10 per cent interest in Om Shipping Agents (P) Ltd. He received a loan of Rs 73 lakh from the company. This was outstanding as on March 31, 1998. After hearing the assessee, the income-tax officer (ITO) added Rs 73 lakh as deemed dividend assessable under Section 2(22)(e).

It was pleaded that the amount was only a temporary borrowing and not in the nature of loan or advance. As this argument was not accepted, another submission was raised to the effect that the dividend exemption provision under Section 10 should be given effect in respect of the sum of Rs 73 lakh.

This provision came into effect from the assessment year 1998-99. What applies to dividend income should also apply to deemed dividend under Section 2(22)(e). The Bench examined Sections 115O, 115P and 115Q in Chapter XIID of the Act. It referred to the Explanation given in this chapter: “For the purposes of this Chapter, the expression “dividend” 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 loan or advance to the substantial shareholder is treated as deemed dividend under Section 2(22)(e). The Explanation at the end of Chapter XI B stipulates that the expression ‘dividends’ shall not include this type of deemed dividends comprising loans and advances. Thus, deemed dividend referred to in Section 2(22)(e) has been excluded from the ambit of Chapter XIIB. Tax is not levied on the company with regard to such deemed dividend. Consequently, the exemption provided under Section 10 is not applicable to “deemed dividend” referred to in Section 2(22)(e)

• In order to attract the provisions of section 2(22)(e), the important consideration is that there should be loan/advance by a company to its shareholder. Every payment by a company to its shareholder may not be loan/advance. To be treated as loan every amount paid must make the company a creditor of the shareholder for that amount. If, however, at the time when payment is made, the company is already the debtor of the shareholder, the payment would be merely a repayment by the company towards its already existing debt. It would be a loan by the company only if the payment exceeds the amount of its already existing debt and that too only to the extent of the excess. If the shareholder has a current account with the company, the position as regards eachdebit will have to be considered individually, as it may or may not be a loan. In such case the debit balance of the shareholder with the company at any point of time cannot be taken to represent an advance/loan by the company; nor can the amount at the end of the previous year be alone taken as loan.CIT v. P.K. Badiani[1970] 76 ITR 369 (Bom.).

•  Whether an overdraft taken by a major shareholder from the company will be covered as deemed dividend? An overdraft taken by a shareholder from the company is treated as loan and taxable as dividend if conditions of section 2(22)(e) are satisfied—CIT v. K..Srinivasan [1963] 50 ITR 788 (Mad.).

• What will be the position when a major shareholder misappropriated some amount from the company? Amount misappropriated by the director cannot be treated as deemed dividend in his hands since in such a case there is no lending or advancing by the company. It cannot be said that in such a case the company has paid anything and unless there is an actual payment by the company as a loan or advance to the assessee, it cannot be treated as dividend under section 2(22)(e). CIT v. G. Venkataraman [1975] 101 ITR 673 (Mad.)

• If a loan is repaid before the end of the previous year, the section will be attracted? Yes, even if a loan is repaid before the end of the previous year the section will be attracted. In Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) the Supreme court held that under section 2(22) the liability to tax attaches to any amount taken as loan by the shareholder from a controlled company to the extent it possesses accumulated profits at the moment the loan is borrowed and it is immaterial whether the loan is repaid before the end of the accounting year.

• Whether Book debts will be covered by “loans and advances”? Where the assessee-shareholder, having business of his own, was transacting business with the company and the account of the assessee in the company always showed a debit balance, it was held that the said debit balance would amount to a loan from the company to the assessee. CIT v. Jamnadas Khimji Kothari [1973] ITR 105 (Bom.)

• Every sale of goods on credit does not amount to a transaction of loan. A loan contracted no doubt creates a debt but there may be a debt without contracting a loan. Bombay Steam Navigation Company P. Ltd. v. CIT(1965) 56 ITR 52(SC)

• Whether Security deposit to a major shareholder for use of premises will be covered under clause(e)? Genuine security deposit without any element of loan may not be considered as a loan.

• Whether loans or advance to b will be covered? Loans to relatives of substantial shareholders are not covered as loans or advances to the shareholder. However such loans or advances may be covered as” payment on behalf of or for the individual benefit” of the shareholder.
• Clause (ii) to section 2(22) provides that “dividend” does not include any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of business, where the lending of money is a substantial part of the business of the company;

If a majority of a company’s assets and income are from money-lending business, it will be proper to assume that lending of money is a substantial part of the company’s business.

In Walchand & co. Ltd. V. CIT,(1975)100 ITR 598(Bom) it was held that the onus to prove these facts lies on the assessee.  The same was also confirmed in the case of  CIT v Creative dyeing & Printing (P) Limited 184 taxmann 483.

• Clause (iii) to section 2(22) provides that “dividend” does not include any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e),to the extent to which it is set off.

This clause gives some relief to the assessee by way of avoiding double taxation as well as brings in some scope for Scope for tax-planning. Thus, if a loan is already treated as a dividend it may make sense to declare dividend and adjust the outstanding loan amount against the dividend declared. No tax will be payable by shareholder on such dividend declared.

However, if the loan has been repaid by the shareholder and nothing is due by the shareholder against the loan referred in section 2(22)(e), then no set-off would be possible. Also if the sum due by the assessee is on account of some other payments not covered by section 2(22)(e), then set-off will not be possible.

• A managing director of a company, whenever he needed money used to ask an employee to take a loan from the company and pass it on to him even without executing any pronote. Can he be said to have received any benefit? It was held that the loans made by the company to the employee fell in the category of “benefit” to the assessee managing director and were, therefore, assessable as deemed dividends in his hands—CIT v. L.Alagusundaram Chettiar [1977] 109 ITR 508 (Mad.).

• In one case, the assessee, having substantial interest in a company X, obtained from company Y two loans of Rs. 75,000 and Rs.2,00,000 on July 30, 1968 and September2, 1968, respectively. The question forconsideration was whether these amounts could be treated as deemed dividend in the hands of the assessee under section 2(22)(e) on the ground that Y had made these loans to the assessee out of loans received by Y from X on the samedates.The Court held (in Nandlal Kanoria v. CIT [1980] 122 ITR 405 (Cal.)), that there was no loan given by X to the assessee. However, as the loan of Rs. 75,000 was given by Y to the assessee out of an equal amount received as loan from X on the same date, this amount was a payment by X for the benefit of the assessee and fell within the mischief of section 2(22)(e). The same could not be said of the loan of Rs. 2,00,000, as on the date of making that loan, Y had received loans not only from X but from another source also and the loan was made out of blended amount

• In Navnitlal C. Jhaveri v. CIT [1971]80 ITR 582(Bom) a question arose that while calculating accumulated profits depreciation as per books should be considered or as per IT Act? The Bombay High court held that while calculating accumulated profits an allowance for depreciation at the rates provided by the Income-tax Act itself has to be made by way of deduction.

• Even loan obtained by the assessee-shareholder from a company from out of its Accumulated profits, which are exempt in the hands of the company as agricul tural income, is to be treated as deemed dividend in the hands of the assessee. S.Kumaraswami v.ITO [1961] 43 ITR 423 (Mad.)

• Whether balancing charge u/s 41(2)will form part of accumulated profits?.In CIT vs. Urmila Ramesh (1998) 230 ITR 422 the Supreme court held that the amount of balancing charge under section 41(2) of the Act, did not represent Accumulated profits.

• Provision for tax and provision for dividend can not form part of Accumulated profits.CIT v V. Damodaran[1972]85 ITR 59(ker.).This is obvious because each of them represent a liability and is not in the nature of profits or reserves.

• These words which are found in clauses (a) to (d) are not found in clause (e) of section 2(22) and, therefore, that provides some relief from the mischief of the section as well as provides some scope for planning .Thus it must be interpreted that to the extent of capitalisation of profits, accumulated profits would reduce for the purpose of this clause but not for other four clauses of section 2(22). What is capitalisation? It will ordinarily mean conversion of profits or reserves or income into capital as per Company’s Articles of Association.

• Similarly a transfer to General Reserve will not amount to capitalisation.

The reason for allowing reduction of the accumulated profits to the extent of capitalisation of profits seems to be that to the extent of capitalisation, divisible profits i.e. profits available for distribution of dividend will reduce. A company can not distribute dividends out of capitalised profits i.e. capital. Thus if a closely held company wants to give loan or advance to a shareholder or his concern/company which are covered by this clause, it may first issue bonus shares (and thus capitalise the accumulated profits) and then grant such loan or advance. This is one sure way of escaping from the clutches of section 2(22)(e). However, it may involve expenses of filing fees and stamp-duty on increase of authorised share capital. Also a company may not want to increase its capital due to various other reasons.

• In CIT v. Mayur Madhukant Mehta [1972] 85 ITR 230 (Guj.) it was held that there is nothing in sub-clause (e) of section 2(22) to restrict the deemed dividend to that portion of Accumulated profits which corresponds to the assessee’s shareholding in the capital of the company.

• If a loan is given by a company to a shareholder who owns 25 percent of share capital, the amount of loan to the extent of entire Accumulated profits (and not to the extent of 25 percent of Accumulated profits) will be treated as dividend. CIT v. Arati Debi [1978] 111 ITR 277 (Cal.).

• When a loan is treated as a deemed dividend and is repaid by the shareholder will it be added in the “accumulated profits”? Section 2(22)(e) must be so interpreted that once an amount goes out of “accumulated profits” as a loan and the loan is to be deemed as dividend the same amount when repaid cannot again be capable of attracting fiction and be deemed as dividend.. To avoid the happening of any such eventuality, the “accumulated profits” must be notionally reduced by the amount of all loans which are to be treated as dividends under section 2(22)(e) .CIT v. P.K. Badiani. [1970] 76 ITR 369 (Bom.).

• Whether interest paid on loan which is treated as deemed dividend will be admissible as a deduction under section 57(iii)? Section 57(iii) allows a deduction for any expenditure (not being capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. In Nandlal Kanoria v.CIT [1980] 122 ITR 405(Cal.) the Calcutta High court held that interest paid on loan treated as deemed dividend under section 2(22)(e) is not admissible as a deduction under section 57(iii)

• Trade advance to shareholder not to be considered as Deemed dividend. Refer CIT v Raj Kumar 318 ITR 462.

• Financial transactions in normal course of business  – cannot be considered as deeemed dividend u/s 2(22)(e). Refer CIT v Ambassador Travels (P) Limited 318 ITR 376.

• Deemed dividend is taxable in the hands of shareholder not to the company. Refer, CIT v Universal Medicare Private Limited 324 ITR 263.

• Money lending being one of the six main objects of the lender company and the said business having been carried on by it in preference to other business, the loan given to the assessee was in the course of money lending business and therefore, assessee’s case is not covered by the provisions of s. 2(22)(e), income criteria from a particular source of income was not relevant. Refer, Krishnoics Ltd. 120 TTJ 650.

• The Tribunal accepted assessee contention that both the companies were non-banking companies and the amounts were given in the ordinary course of business hence the receipt of loan as deemed dividend cannot be taxed. Refer Usha Commercial (P) Ltd. 30 SOT 37.

• Assessee company having received advances from another company in the normal course of business, same can not be treated as deemed dividend u/s. 2(22)(e). Refer, Timeless Fashions (P) Ltd. 33 DTR 48.

• Assessee procured loan from a company in which he was a Director and was holding 50% equity shares. The said company was in business of lending of money, and on amount given as loan to assessee it charged Interest. Held, that s. 2(22)(e) can not be attracted as it was a business transaction of the company. Refer, Bharat C. Gandhi 178 Taxmann 83.
  

• Loan received by assessee before becoming a registered shareholder of the lender company can not be treated as deemed dividend u/s. 2(22)(e). Refer, Sagar Sahil Investment (P) Ltd. 120 TTJ 925

• Inter Corporate Deposits (ICDs) are different from loans or advances and would not come within purview of deemed dividend u/s. 2(22)(e). Refer, Bombay Oil Industries Ltd. 28 SOT 383.

• It has been held that for the purpose of s. 2(22)(e) of the Income-tax Act (Act), accumulated profits would mean commercial profits. In determining his commercial profit, depreciation, which has been recognized as a charge towards profit both under the Companies Act, 1956 as well as the Act has to  be reduced from the commercial profit for the purpose of S. 2(22)(e) of the Act. Refer, Yasin Hotels (P) Ltd. 30 SOT 47.

• Deemed dividend can be assessed only in the hand of a shareholder of lender company and not in the hands of a person other than shareholder. The expression ‘shareholder’ referred to in s. 2(22)(e) refers to both – a registered shareholder and a beneficial shareholder. Thus, if a person is registered shareholder but not beneficial shareholder or vis-a-versa then provisions of s. 2(22)(e) would not apply. Refer, Bhaumik Colour (P) Ltd. 118 ITD 1.

• Deemed dividend under section 2 (22) (e), can only be assessed in hands of person, who is share holder of lender company and not in hands of a person other than shareholder. Refer, MTAR Technologies (P) Ltd v Asst CIT 39 SOT 465.

• Where lending of Money was a substantial part of business of a lending company, money given by it way of  adbance or loan to assessee could not be regarded as a dividend u/s 2(22)(e). Refer,  CIT v Parle Plastics Limited.

• Any advance received as deposit ny company in connection with leasing out of property of director cannot be treated as Deemed Dividend. Refer, ACIT v Madras Madurai Properties (P) Limited.

• Amounts advanced by a company to its directors under a Board resolution , for specific purpose, would not fall under mischief of section 2(22)(e). Refer, ACIT v Harshad V Doshi 49 DTR 181.

• Amounts given by a company to an assessee against his debenture account cannot be treated as Loans or advances for purpose of section 2(22)(e). Refer, Anil Kumar Agarwal v ITO. 51 DTR 251.

• Loans or advances given by a company to another company, which is not a shareholder of lender company, cant be treated as deemed dividend. Refer, Sadana Brothers Sales (P) Limited v ACIT.

• Security deposit given by a company to its sistern concern, a firm cannot be ragarded as deemed dividend under section 2(22)(e). Refer, DCIT  v Atul Engineering Udyog.

• “deemed dividend” not assessable if recipient not shareholder. Refer, CIT vs. Ankitech Pvt Ltd.

• Assessee is a director in two companies holding substantial shareholding in both. Certain sum was transferred from one company to another at instance of  assessee. Assessee having substantial credit balance with company, cannot held as loan or deposit nor can be assessed as deemed dividend.( Asst years 2001-02, 2005-06).

• Assessee is a director in two companies holding substantial shareholding in both. Certain sum was transferred from one company to another at instance of  assessee. Assessee having substantial credit balance with company, cannot held as loan or deposit nor can be assessed as deemed dividend.( Asst years 2001-02, 2005-06). Refer, Asst vs. C. Rajini 9 ITR ( Trib) 487.

• Since on the date on which the security deposit was given by the company to the assessee , the assessee held less than 10 percent beneficial interest in the company , the amount of security deposit can not be treated as deemed dividend under section 2 (22) (e) , merely on the ground that share holding increased to 44% on issue of shares by the company in lieu of security deposit.( A. Y. 1998‐99). Refer, CIT v Late C.R.Das 57 DTR 201.

I hope that above will be able to clarify your doubts in respect of deemed dividend to certain extent. Please write to [email protected] for any further clarification.