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The power point presentation is on the provision of deemed dividend u/s 2(22)(e) of the Income Tax Act on which I delivered a lecture at Direct Tax Regional Training Institute, Kolkata.Often, the shareholders of closely held companies get a shock when they are caught for the contravention of the provision of section 2(22)(e) and the loans or advance taken by them or their concern is added as income as deemed dividend.

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Page 1: Deemed dividend

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Page 2: Deemed dividend

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Deemed Dividend Statutory Provisions

A session by Prashant Kumar Thakur

At DTRTI , Kolkata18/07/2012

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The term “deemed dividend” is described in section …………..of the I.T.Act ,1962.

1. 2(22)(a)2. 2(22)(b)3. 2(22)©4. 2(22)(d)5. 2(22)(e)6. None

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Surprise ! Surprise !

Nowhere in section 2(22) , the word “deemed” is used.

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Section 2(22)(e)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

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Why section 2(22)(e)?The object behind this provision is succinctly stated in the Circular

No. 495 of 22nd September, 1987 particularly in the Explanatory Notes to Finance Act, 1987 when this provision was amended. It reads as under:-

With the deletion of Section 104 to 109 there was a likelihood of closely held companies not distributing their profits to shareholders by way of dividends but by way of loans or advances to that these are not taxed in the hands of the shareholders. To forestall this manipulation, sub-clause (3) of clause (22) of Section 2 has been suitably amended. Under the existing provisions, payments by way of loans or advance to shareholders having substantial interest in a company to the extent to which the company possesses a accumulated profits is treated as dividend.

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14 benefits out of this session !

1. Why deemed dividend is so important for assessment of HNI?2. 7 conditions for applying section 2(22)(e).3. Which types of companies covered u/s 2(22)(e)?4. What types of share ownership not covered u/s 2(22)(e)?5. What is the meaning of shareholder for section 2(22)(e)?6. What you can not ignore about quantum of shareholding?7. Who is taxed –shareholder or the Firm or Trust or AOP or BOI which

received money ?8. What is the meaning of term “advance” for the purpose of section

2(22)(e)?9. Loan was advanced and returned within two days. Will there be

deemed dividend if all other conditions are satisfied?10. What profits are not “accumulated profits “?11. Whether loan or advance in kind comes under 2(22)(e)?12. Whether “substantial part of business” of a company means major

part ?13. How to detect the cases of deemed dividend in case of Individuals?14. Should there be TDS if there is deemed dividend?

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7 Conditions !1. any payment by a company, not being a company in which

the public are substantially interested2. of any sum (whether as representing a part of the assets of the

company or otherwise) [made after the 31st day of May, 19873. by way of advance or loan4. to a shareholder

1. 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)

2. holding not less than ten per cent of the voting power, 5. or to any concern

1. concern in which such shareholder is a member or a partner2. and in which he has a substantial interest (hereafter in this clause

referred to as the said concern)6. or any payment by any such company on behalf, or for the individual

benefit, of any such shareholder7. to the extent to which the company in either case possesses

accumulated profits

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What is public substantially interested company?

Section 2(18) defines “company in which public is substantially interested” as under:1. Listed companies2. Government companies3. Section 25 companies4. Companies having no share capital and

declared by Board5. Mutual benefit finance companies declared by

Central Govt as Nidhi or Mutual Benefit Society6. Companies in which one or more cooperative

society holds more than 50 % of voting shares throughout the year.

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Which types of companies covered u/s 2(22)(e)?

Section 2(22)(e) applies when loan or advance is given by two types of companies

1. Closely held public company or

2. Private Limited Company

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1. Shares having fixed rate of dividend?2. Shares having no voting rights.

What type of shares ownership not covered u/s 2(22)(e)?

Preference shares : Shares which commands fixed rate of dividends and generally has no voting rights

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Any Sum ??

Does the term “any sum” covers payment in kind or goods? Or

Just cash or cheque payments?

Kolkata High Court in M.D.Jindal vs CIT [1986] 28 Taxman 509 (Cal) held that provision u/s 2(22)(e) is applicable even if loan is advanced in kind.

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Advance ??Mr X is an architect and runs his own consultancy

business under his name . He has shareholding of 50% in ABC Pvt ltd which is in construction business. Time to time , the company passes the architectural job to Mr X also pays advance related to such jobs.

Whether the advance given by ABC Pvt Ltd to Mr X will come under section 2(22)(e)?

Revenue Favour:Dr. Shiv Kant Mishra vs DCIT-Central Circle , Kanpur [2009] 118 ITD

347 (LUCK.) A company comprising of only two directors, viz., assessee, a doctor and his wife, in terms of an MOU, advanced money to assessee for purchase of a land and in turn

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Repayment Does Not Matter

Smt. Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) Miss P. Sarada v. CIT [1998] 96 Taxman 11 (SC). Fact of repayment of loan is not relevant - The Legislature has

deliberately not made the subsistence of the loan or advance, or its being outstanding on the last date of the previous year relevant to the assessment year, a prerequisite for raising the statutory fiction. In other words, even if the loan or advance ceased to be outstanding at the end of the previous year, it can still be deemed as a ‘dividend’ if the other four conditions factually exist to the extent of the accumulated profits possessed by the company. -

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Advance mean loan ??

Delhi High Court in CIT vs Raj Kumar (2009) 181 Taxmann 155 applied judicial interpretation maxim “noscitur a sociis” which means the meaning of word can be known by the company which it keeps or from context

It held “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, in our view, fall within the ambit of the provisions of section 2(22)( e) of the Act

Further reliance can be placed on CIT vs Nagindas M Kapadia (1989) 75 CTR 161 (Bom) and Supreme Court judgment in Bombay Steam Navigation Company Pvt ltd vs CIT (1965) 56 ITR 52 wherein the Apex court held that every sale of goods on credit does not amount transaction of laon.

However, when a company advanced money to its MD who was having substantial shares , for construction of house , which MD was supposed to lease out to company itself, such advance was considered fit for addition u/s 2(22)(e) by Madras High court in CIT vs P.K.Abubucker (2003) 185 CTR 558

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To Shareholder Which one out of following

shareholder is covered u/s 2(22)(e)?

1. Shareholder not beneficial owner2. Shareholder who is beneficial owner3. Beneficial owner but not registered

shareholder

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1922 Act vs 1961 ActUnder 1922 I.T.Act, section 2(6A)e)

( corresponding to section 2(22)(e) had no words or phrase “being a person who is beneficial owner of shares”

Under I.T.Act 1961, section 2(22)(e) requires that the person should be

ShareholderAnd

Beneficial owner of the shares

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Shareholder & Beneficial Owner?

1. A person buys shares and his name is entered in company register.

2. A trust buys shares of a private limited company. The trustee name is entered in the company shareholder register.–Who is the shareholder ?–Who is beneficial owner of the shares?

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Who is to be taxed –shareholder or the Firm or Trust or AOP or BOI which

received money ?

• Mumbai Special bench ACIT vs Bhowmik Colour P Ltd [2009] 313 ITR 146 held – Deemed dividend can be charged in hand of shareholder only and not

any other person who is not shareholder because intention of legislature is to tax dividend only in hand of shareholder and the concern which received payment.

• CIT vs National Travel Services [2011] 202 Taxman 327[Delhi]• Firm on whose behalf a partner name is registered in company as

shareholder, is actually shareholder for the purpose of section 2(22)(e)

Revenue Favour : Skyline India Recruit.com. (P.) Ltd. Vs ITO 9(3) [2008] 24 SOT 402 (MUM.) (SMC) if the payments of any sum by way of advance or loan is given to company in which there is a common shareholder and that shareholder has/have the beneficial interest in both the companies. The loans and advances shall be deemed dividend under section 2(22)( e) of the Act.

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What You Can not Ignore About quantum of shareholding?

The balance sheet of Mr X showed liability in form of loan from M/s ABC Pvt Ltd of Rs 1 Crore. The A.O got the details that the Mr X has 45 % shareholding and M/s ABC Pvt Ltd had accumulated profit of Rs 2 Crore. He added Rs 1 Crore in Mr X hand

And department lost the case before appellate authorities when the fact was brought on the record that on the date of receipt of Rs 1 Crore, Mr X had only 9 % of shareholding .His shareholding increased to 45 % in February i.e after loan receipt.

Refer CIT vs Late C.R.Dass [2011] 57 DTR 201 wherein the assessee received security deposit in form of shares against lease of hs property. The shareholding on the date of receipt of security deposit was 9 % only and later increased on account of security deposit.

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What is not included in Accumulated Profit?

The balance sheet of M/s ABC Pvt Ltd shown accumulated profit of Rs 1 Crore as on 31/03/2011 . A.O found the Mr X 20 % of shareholding received loan of RS 1 Crore. He added Rs 1 Crore u/s 2(22)(e) of the Income Tax Act.

The case was lost before appellate authroity.Before CIT(A) , the assessee brought the facts that accumulated profit was out

of exempt long term capital gains on shares .

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Inclusion & Exclusion from Accumulated Profits

Excluded1. Addition made by A.O for inadmissible expense [P.K.Badiani vs CIT 105

ITR 642 (SC) in which Apex Court held that accumulated profit should be understood to mean commercial profits and not assessed income

2. Capital Gains not chargeable to tax CIT vs Mangesh J Sanzagiri [1979] 119 ITR 962 (Bombay)

3. Balancing Charge under section 41(2) as per CIT vs Urmila Ramesh [1998] 230 ITR 422 (Supreme Court)

4. Share premium is not profit.5. Share forfeiture receipts [1971] 80 ITR 582 (Bombay)

Included 6. General Reserve 7. Income Tax refund8. Chargeable Capital gains9. Development rebate reserve

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What is meaning of “substantial part of the business “?

(ii) any advance or loan made to a shareholder 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

It has been judicially held that in Mrs Rekha Modi vs Ito [2007] 13 SOT 512 (Delhi that the ratio of money lending business during the relevant previous year should be 20 % or more to be considered as a substantial part of business.

Bombay High court in CIT vs Parle Producs Pvt ltd [ 2011] 332 ITR 63 substantial part does not necessarily mean major part of business.

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How to Detect a case of Deemed Dividend in case of Individual?

Balance Sheet observation – for shareholding– For loan or advance taken.

Bank statement credit side description should be obtained