DIVIDENDS – 2(22)(e) |
Dividend Tax ID – (JBC-102) |
What is a loan or an advance ?
Now the question comes that under section 2(22)(e) what refers to a loan or advance. What is covered by loan or advance has been discussed hereunder.
According to Black’s law Dictionary, ‘Loan’ means ‘a lending; delivery by one party to and receipt by another party of sum of money upon agreement, express or implied, to repay it with or without interest’.
‘Advances’ means ‘something which is due to a person but which is paid to him ahead of the time when it is due to be paid’.
According to Dictionary of Accounts by Eric Kohler, ‘advance’ has been defined as payment of cash or the transfer of goods for which accounting must be rendered by the recipient at some later date.
For the provisions of section 2(22)(e) to be attracted, there should be an outgoing or flow of money from the paying company to the shareholders and notional payments by way of book entries would not be covered—G.R. Govindarajulu Naidu v. CIT [1973] 90 ITR 13 (Mad.).
In case of a mutual, open and current account which a shareholder has with a company, every debit, i.e., every payment by the company to the shareholder may not be a loan. To be treated as a loan, every amount paid must make the company a creditor of the shareholder for that amount. If, however, at the time when the payment is made the company were already a debtor of 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. Therefore, the position as regards each debit will have to be individually considered, because it may or may not be loan. What has to be considered is not the balance in account but the position of every payment and, therefore, the debit balance of the shareholder with the company at any point of time could not be taken to represent an advance or loan by the company to the shareholder; nor could the amount outstanding at the end of the accounting year alone be taken as loan within the meaning of section 2(22)(e) CIT v. P.K. Badiani [1970] 76 ITR 369, 380-3 (Bom.). At the end, it can be said that even ICD’s would be covered by the scope of the term ‘loans’.
Tax planning possibilities
The followings are some of the tax planning possibilities in the context of deemed dividend :
Where the company has huge accumulated losses or depreciation, advancing of money to the shareholders, having more than 10 per cent stake in the company, will not burden the shareholder with tax consequences. Also, when the company makes profit, subsequently,
the question of the taxability of deemed dividend cannot arise as the accumulated profits up to the date of loan or advance is only reckoned for applying section 2(22)(e).Where the shareholder has huge depreciation or business loss or other losses eligible for set-off against other incomes, he can avail loan or advance from the company in which he has more than 10 per cent stake. The deemed dividend would be set-off by negative incomes or depreciation as per the set-off provisions of the Act.
Where a shareholder decides to take loan or advance from a company (not being in the regular course of its business), he may reduce his shareholding to less than 10 per cent and thereby avoid rigours of the provisions of section 2(22)(e).
Where the accumulated profit of the company is less than the amount of loan or advance proposed to be obtained by the shareholder, the taxability under section 2(22)(e) is limited only to the extent of the accumulated profits and any excess of loan over accumulated profits of the company will not be chargeable to tax.
Once a loan or advance is taxed under section 2(22)(e) and the subsequent declaration of dividend by the company if set-off against the loan due from the shareholder, there is no tax benefit or exemption to the shareholder. Hence, the shareholder may better receive the dividend distributed, which is in any way exempt under section 10(34).
Even where the shareholder enters into a commercial transaction with the company, taking any advance or loan may be avoided as that advance will be treated as deemed dividend. In CIT v. P.K. Abubucker [2003] 259 ITR 507 (Mad.) the assessee had taken advance for the purpose of construction of building to be let out to the company. The rental income was to be adjusted against the advance given by the company. The Court held that the advance had to be treated as deemed dividend even though it was set-off subsequently against the rental income. In effect, the taxpayer had to pay tax on the deemed dividend by means of fiction of law and the rental income subsequently set-off was also chargeable to tax separately.
Relevant case laws
Any sum given by the company to a shareholder (having more than 10 per cent of the total voting power in the company) or to a concern in which the shareholder has substantial interest (meaning thereby 20 per cent stake in the concern) is taxable as deemed dividend only if the company has accumulated profits. If the company does not possess profits before such loan or advance to the shareholder, nothing is taxable as deemed dividend. - R. Dalmia v. CIT [1982] 133 ITR 169/9 Taxman 171 (Delhi).
Where a shareholder receiving an advance, returns the advance, subsequently, the taxability of deemed dividend cannot be avoided - Smt. Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC).
The recipient of loan or advance from the company (not in the ordinary course of business of the lender) may be another corporate entity. For example, X Co. (P.) Ltd. may have a shareholder, namely, Y Co. (P.) Ltd. with 50 per cent stake in it. Loan or advance given by X Co. (P.) Ltd. to the shareholder will be treated as deemed dividend in hands of the shareholder. - Sadhana Textiles Mills (P.) Ltd. v. CIT [1991] 188 ITR 318 (Bom.).
Where the shares are gifted by a shareholder and the shareholding is reduced to less than 10 per cent before the date of obtaining loan or advance from the company, section 2(22)(e) will not apply and the fact of delayed registration of gift of shares by the company will not affect the borrowing shareholder. The delay in registration of transfer of shares would relate back to the date on which the requisite forms were submitted to the company - CIT v. Smt. S. Parvathavarthini Ammal [1996] 219 ITR 661/87 Taxman 370 (Ker.).
In CIT v. T.P.S.H. Selva Saroja [2000] 244 ITR 671 (Mad.), it was held that where the shareholder-cum-employee had withdrawn money from the company and such sum is treated as loan by the company, the interest on loan is a perquisite under section 17(2) and the loan amount is taxable as deemed dividend under section 2(22)(e). The Court held that the principles behind the provisions of section 17(2) and section 2(22)(e) are entirely different and they do not conflict with each other.
In L. Alagusundaram Chettiar v. CIT [2001] 252 ITR 893/[2002] 121 Taxman 587 (SC), the company advanced loans to an employee who was drawing low salary. The employee in turn advanced the money to the managing director of the company. The Court held that the loan advanced to the managing director through the employee, was taxable as deemed dividend.