Source: http://www.filereturn.com/tds-deemed-dividend-sec-194
Timestamp: 2019-04-25 00:46:41+00:00

Document:
2. Legislative History of Section 2(22)(e) of the Income Tax Act, 1961.
a. Section 2(6A) of the Indian Income Tax Act, 1922 corresponding to Section 2(22) of the Income Tax Act, 1961 was first introduced by the Indian Income Tax (Amendment) Act 1939.
b. Clause (e) was added to Section 2(6A) of the Indian Income Tax Act, 1922 corresponding to Section 2(22)(e) of the Income Tax Act, 1961 by the Finance Act, 1955. By virtue of this amendment, for the first time, the fiction of treating loans or advances to shareholders as dividend was first introduced in the Income Tax Law.
c. The provisions of Section 2(6A) of the Indian Income Tax Act, 1922 were incorporated in Section 2(22) of the Income Tax Act, 1961 without any amendments.
d. The first and only amendment to Section 2(22)(e) was made by Finance Act, 1987 (w.e.f. 01-04-1988) wherein the phrase “Shareholder who has substantial interest” then appearing was replaced by the phrase “a Shareholder who is a beneficial owner of shares holding not less than 10% of the voting power”.
e. The constitutional validity of the provisions of Section 2(22)(e) was upheld by the Supreme Court in the matter of Navnitlal C. Jhaveri v K K Sen, AAC  56 ITR 198 (SC).
i. ‘Dividend’, in its ordinary connotation, means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum of profit distributed.
(e) payment by a Closely Held Company by way of advance or loan to a shareholder who is a beneficial owner of shares holding not less than 10% of the voting power.
iii. The phrase “Accumulated Profits, whether capitalized or not”, is uniformly used under clauses (a), (b), (c), (d) and (e) of section 2(22).
4. Is it “Deemed Dividend”?
(a) Ironically, the word “Deemed” is not used even once in the Section 2(22).
(b) In this Section 2(22), certain payments by the Company to shareholder are construed as Dividend which would not be dividend under the Ordinary commercial parlance or ‘The Companies Act, 1956’ and hence the term ‘Deemed Dividend’.
(c) In Kantilal Manilal v. CIT (1961) 41 ITR 275 (SC), Held that Section 2(22) creates a fiction by which certain receipts or parts thereof are treated as dividend for the purpose of levy of Income-tax .
5. Intention of Legislature behind introduction of Section 2(22)(e).
Section 2(22)(e) of the Income Tax Act, 1961 plainly seeks to bring within the tax net accumulated profits which are distributed by closely held companies to its shareholders in the form of loans. The purpose being that persons who manage such closely held companies should not arrange their affairs in a manner that they assist the shareholders in avoiding the payment of taxes by having companies pay or distribute, what would legitimately be dividend in the hands of shareholders, money in the form of advance or loan. – Read in CIT v. Raj Kumar (2009) 181 Taxmann 155 (Delhi).
i. The phrase ‘closely-held company’ is not explicitly defined under the Income Tax Act, 1961 but it means a ‘company in which the public is not substantially interested’.
a. a company owned by the Government or the RBI or more than forty percent of the shares are owned by Government or the RBI or a corporation owned by the RBI.
b. a company registered under section 25 of the Companies Act, 1956.
d. Mutual Benefit Finance Company – business of acceptance of deposits from members and notified by the Central Government u/s 620 of the Companies Act, 1956.
e. a company, whose more than 50% Equity Shares (not being Preference Shares) held by one or more Co-operative Societies throughout the previous year.
f. a company not being a Private Company as defined in the Companies Act, 1956, whose Equity Shares were listed on the 31 March of the previous year in a Recognised Stock Exchange.
g. a ‘Government Company’ not being a ‘Private Company’ (both terms being defined in the Companies Act, 1956).
b. a Company not being a Private Company as defined in the Companies Act, 1956 and whose Equity Share are not listed on the 31 March of the previous year in a Recognised Stock Exchange.
i. Section 2(22)(e) does not distinguish between an Indian or a Foreign Company.
ii. Section 2(17) defines “company” to include a body corporate incorporated by or under the laws of a country outside India.
iv. It is further pertinent to note that a Recognised Stock Exchange has been defined in the Income Tax Act, 1961 to mean a stock exchange recognised as such by the Central Government under section 2(f) of the Securities Contracts Regulation Act, 1957 (SCRA). Further, at present only stock exchanges operating in India have been recognised by the Central Government. Accordingly, as a corollary, a Stock Exchange outside India is not Recognised by the Central Government and a Foreign Company listed outside India or also an Indian Company listed outside India (and Not listed in India on the 31 March of the previous year) will be a ‘Closely Held Company’ for the purpose of Section 2(22)(e).
(ii) Any payment, on behalf of, or for the individual benefit of such Shareholder.
1. What is ‘Loan’ or ‘Advance’?
i. The term “Loan or Advance” has not been defined under the Income Tax Act, 1961.
ii. 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.
· A notional payment by way of book entries will not be included.
iv. The Black’s Law Dictionary defines the term “advance” as “a payment made in anticipation of a contingent or fixed future liability or obligation”. Ordinarily, an advance is a payment beforehand and it does not connote the idea of repayment. It is adjusted when the action, for which the money is advanced, is completed.
v. 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. – CIT v Srinivasan (K.) (1963) 50 ITR 788 (Mad).
vi. In the matter of CIT v. Raj Kumar (2009) 181 Taxmann 155 (Delhi), Held, The usual attributes of a loan are that it involves positive act of lending coupled with the acceptance by the other side of the money as loan – it generally carries interest and there is an obligation of repayment. The term ‘advance’ is of wide import & has undoubtedly more than one meaning, depending on the context in which it is used. In its widest meaning, the term ‘advance’ may or may not include lending or the obligation of repayment. The Delhi High Court applied the rule of construction of noscitur a sociis – “the meaning of the word can be gathered from the context” or “by the company which it keeps.” The word ‘advance’ which appears in the company of the word ‘loan’ could only mean such ‘advance’ which carries with it an obligation of repayment. Trade advance which are in the nature of money transacted to give effect to a commercial transactions would not fall within the ambit of the provisions of Section 2(22)(e) of the Act.
Facts A company had advanced to a shareholder a sum for construction of a building to be taken on lease, and the amount so advanced was to be adjusted against future rent.
Held Liable to be assessed as Deemed Dividend.
Facts A MoU was entered into between the assessee and the company whereby the company advanced money to the assessee for purchase of land and, in turn, he was to transfer by way of lease a portion of land in favour of the company. Factually, the assessee constructed a residential building for his personal use on the said land.
Held Tribunal held that neither the business of the company was to carry on construction or deal in real estate nor did the assessee’s case fall in the exception provided in section 2(22). The Tribunal held that the MoU between the company and the assessee was a colourable device adopted for transfer of accumulated profits as loan for an indefinite period. Accordingly, the inclusion of such amount as deemed dividend in the hands of the assessee was upheld by the Tribunal. Thus, the decision went in favour of the revenue.
b. Merely because the company did not have any money lending license, lending of money will not be treated as deemed dividend, if the assessee was lending money in the ordinary course of its business. -Jhamu V. Sughend v DCIT (2006) 284 ITR (AT) 82 (Mum).
a. Stroud’s Judicial Dictionary defines “substantial” as “A word of no fixed meaning, it is an unsatisfactory medium for carrying the idea of some ascertainable proportion of the whole”.
c. Various factors to be looked into to determine whether the business is substantial or not, namely :- Turnover, Profits, Capital Employed, Human Resources.
d. Any business which the company does not regard as small, trivial, or inconsequential as compared to the whole of the business is substantial business.
Facts A managing director of a company, whenever he needed money used to ask an employee to take a loan from the company and the company would pass it on to the employee even without executing any pronote. The employee advanced the loan to the assessee almost immediately and in toto.
Held 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.
Facts 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. Y had made the loans of Rs. 75,000 to the assessee out of loans received by Y from X on the same date. Further, Y had made the loans of Rs. 2,00,000 to the assessee out of loans received by Y from X and another source on the same date.
Held This amount of Rs. 75,000 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.
(b) has substantial interest (when entitled to 20% or more of the income of such concern).
b. Beneficiary – whose name does not appear in the Register of Member u/s 150 but has a beneficial interest in such shares by virtue of Declarations furnished u/s 187-C of The Companies Act, 1956.
a. Shareholder who is a beneficial owner of 10% of more of the Voting Power of the Company – on the date of loan or advance.
b. Section 86(a)(ii) of ‘The Companies Act, 1956’ permits shares with Differential Rights as to Dividend, Voting or otherwise.
d. Even if the whole or part of dividend on the preferred capital is remaining unpaid, and by virtue of Section 87(b) of ‘The Companies Act, 1956’, a preferred shareholder is entitled to vote, these shares are to be excluded if such shares are entitled to a fixed rate of profit.
(a) other than a company if he is, beneficially entitled to not less than 20% income of such concern.
(b) In the case of a company, if he beneficially holds atleast 20% equity capital of the company.
Explanation 3(b) to Section 2(22).
ii. If the loan or advance is given to a concern (HUF, Company, Firm, AOP or BOI) in which the shareholder and beneficiary has a substantial interest, then the deemed dividend u/s 2(22)(e) will be included in the Total Income of THE SHAREHOLDER and NOT THE CONCERN. This view has been expressed in ACIT v. Bhaumick Color (P) Ltd. (2009) 118 ITD 1 (MUM.) (SB) ; CIT v Universal Medical Pvt. Ltd. (2010) 190 Taxman 144 (Bom) ; CIT v. Ankitech (P) Ltd. (2011) 11 taxmann.com 100 (Delhi) ; CIT v. National Travel Services (2011) 202 Taxmann 327 (Delhi). Further, the Circular No. 495 dated 22-9-1997 issued by CBDT – making payments to be included in the Total income of the concern is over-ruled by these decisions.
Rationale: The Legal fiction created under section 2(22)(e) enlarges definition of dividend only; legal fiction is not to be extended further for broadening concept of shareholders.
4. IF SHAREHOLDER IS NON-RESIDENT?
Section 2(22)(e) does not distinguish between a Resident or Non-resident shareholders. Further, it is pertinent to note that by virtue of Clause (iv) sub-section (1) of section 9, “any dividend paid by an Indian company outside India” is ‘Income deemed to accrue or arise in India’. Therefore, Deemed Dividend u/s 2(22)(e) is subject to tax in India in the hands of a Non-resident Shareholder subject to DTAA relief.
Amount of Advance or Loan.
Subject to maximum of Accumulated Profits .
1. What are Accumulated Profits?
i. In the matter of P. K. Badiani v. CIT (1976) 105 ITR 642 (SC), Held, Accumulated profits mean commercial profits and not assessed income….It does not mean the aggregate of the assessed income arrived at after disallowing disbursements and expenditure in fact incurred..
ii. Exception: In Navnitlal C. Jhaveri v. CIT 80 ITR 582(Bom), Held, 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.
2. Is Profit (Loss) of Current Year included in the phrase “Accumulated Profits”?
ii. However, the Supreme Court has held, “The profit accruing during the year cannot be considered as an accumulated profit for the purpose of section 2(22).” Reference is drawn to CIT v. M.V. Murugappan (1970) 77 ITR 818 (SC); CIT v. Ashokbhai Chimanbhai (1965) 56 ITR 42 (SC) ; E.D. Sassoon & Co. Ltd. v. CIT (1954) 26 ITR 27 (SC).
iii. The SC decisions to exclude current year profit (loss) from Accumulated Profits particularly, comes to aid, when there are a series of payments / repayments of loan or advance to the shareholder during the particular year – and If current year profits were included for computation of accumulated profits, then the profit will have to be determined at every point where a payment is made.
3. Examples of Accumulated Profits.
CIT v V. Damodaran (1972) 85 ITR 59 (Ker.).
5. Accumulated Profits is not restricted to Share of Shareholder.
The Amount is not restricted to the respective Shareholder’s share in Accumulated Profits. This view has been expressed in CIT v. Mayur Madhukant Mehta (1972) 85 ITR 230 (Guj.) ; CIT v. Bhagwat Tewari (1975) 105 ITR 62 (Cal.) ; CIT v. Arati Debi (1978) 111 ITR 277 (Cal.).
1. Accrual in the previous year.
a. “Deemed Dividend” accrues in the ‘previous year’ in which the payment was made. (Section 8(a)).
b. Therefore, only payment(s) made during the “current year” is covered & any outstanding balances / interest on loans are to be ignored.
c. The assessing officer may reopen assessment proceedings u/s 147, to bring “deemed dividend” escaping assessment to tax for the preceding assessment years.
d. Any loan(s) which were outstanding beyond the limitation period cannot be assessed to Income-tax. The limitation period is period for which the assessing officer cannot issue Notice u/s 147 for reassessment of income.
e. In CIT, Panaji – Goa v. Parle Plastics Ltd. (2011) 196 Taxmann 62 (Bom.), HELD, Only that amount of loans & advances, which was actually received by the assessee by way of loan or advance during the relevant previous year, could be treated as income by way of ‘deemed dividend’ and the carried forward balance of the loan of the previous year could not be treated as deemed dividend.
i. The principal officer of an ‘Indian Company or a foreign Company which has made arrangement for payment of dividends in India’ is liable to deduct income tax u/s 194 at the rate in force, before making any payment of any sum deemed to be dividend u/s 2(22)(e) of the I. T. Act, 1961.
(3) The dividends declared, if any, shall be payable only within India to all shareholders.
Rationale: Section 40(ia) of the Income Tax Act, 1961 does not refer to payments referred to in Section 194 (dividends) ; and to disallow something, it must have been allowed at first, and Dividend are not allowed as Deduction.
ii. However, the company may be liable to penalty u/s 271C(1)(a) of an amount equal to the ‘amount of tax which such person’ failed to deduct.
There is no specific provision in the Audit Report Form No. 3CD prescribed by the Income Tax Rules, 1962 for reporting of ‘Deemed Dividend’ paid by a Company. However, Clause 27 of Form No. 3CD requires the auditor to disclose whether the assessee has complied with the provisions of Chapter XVII-B relating to Deduction of Tax at Source. Since as per para C2 (supra) Tax is required to be deducted by the principal officer of an Indian Company u/s 194, the Auditor is obliged to report of Non-deduction of TDS u/s 194 in the Audit Report Form No. 3CD.
ii. If the dividend is not so set off but is paid to the shareholders while the loan remains outstanding, the benefit of this exception cannot be obtained. – Walchand & Co. Pvt. Ltd. v CIT (1993) 204 ITR 146 (Bom).
a. Deemed Dividend is taxed under the head Income from Other Sources.
b. No special rate of tax is applicable to deemed dividend and it is taxed as income chargeable to tax at normal rates – slab rates in case of individuals & HUF’s.
then the burden is on the assessee to prove that the case is falling within the exception to the deeming provision u/s 2(22)(e) of the Income Tax Act, 1961. -Walchand & Co. Ltd. v. CIT (1975) 100 ITR 598 (Bom).
E. Disclosures in Revised Schedule VI to Companies Act, 1956 by the Reporting Company – And Its Relevance to Deemed Dividend.
Clause 6A.(g) of General Instructions to preparation of Balance Sheet – requires disclosure by the Reporting Company in its Balance Sheet shares in the company held by each shareholder holding more than 5 percent shares specifying the number of shares held.
Clause 6L. (i)(c) of General Instructions to preparation of Balance Sheet – requires disclosure by the Reporting Company in its Balance Sheet of Long Term Loans and advances to related parties (giving details thereof).
Clause 6L.(ii)(iv) of General Instructions to preparation of Balance Sheet – requires disclosure by the Reporting Company in its Balance Sheet of Long Term Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated.
Clause 6R(i)(a) of General Instructions to preparation of Balance Sheet – requires disclosure by the Reporting Company in its Balance Sheet of Loans and advances to related parties (giving details thereof).

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