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Presented by - Mayur DesaiOctober 30, 2013

Agenda

No Particulars

1 Sec. 2(22)(e) – Provision at a glance

2 Taxability in the hands of2 Taxability in the hands of …

3 Issues

4 Appendix

October 25, 2013 Mayur Desai 2

Sec. 2(22)(e) – Provision at a glanceDividend includes -any payment of any sum, by a company in which the public are not

substantially interested by way of advance or loan to y y y

A Shareholder Any Concern Any Personor or

being the beneficial owner of shares

in which such shareholder is a member or a

on behalf, or for the individual

owner of shares holding ≥ 10 % of voting power

member or a partner and in which he has a substantial

benefit of any such shareholder

interest

to the extent to which the company possesses accumulated profits.


Sec. 2(22)(e) – Provision at a glanceExceptions to sec. 2(22)(e) A l / d d t h h ld / i th di f Any loan/ advance made to shareholder/ concern in the ordinary course of

business where the lending of money is a substantial part of the business of the company• ‘Substantial part of company’s business’ not definedp p y‒ The term ‘substantial’ defined differently at different places in extant Act i.e.

2(32), 40A(2)(b), 80IE(7)(iii), 80IA(4)(iv)(c), 13(3), 10(23C)(iiiab), 9(1)(i) Explanation 5 etc

‒ Contextual interpretation very relevantContextual interpretation very relevant‒ Useful reference for interpretation of term ‘substantial’ for sec. 2(22)(e)

o Mrs. Rekha Modi [2007] (13 SOT 512) (Trib)(Del) - Ratio of money lending business should be 20% or more to be considered "substantial part of the company's businessbusiness

o Parle Plastics Ltd [2011] (196 Taxman 62) (HC)(Bom) - ‘Substantial part’ does not connote an idea of being the ‘major part’ or the part that constitutes majority of the whole. Any business which the company does not regard as small, trivial, or inconsequential as compared to the whole of the business is substantial business .inconsequential as compared to the whole of the business is substantial business . Various factors like turnover, profits etc need to be looked in to determine the same

Any dividend paid by the company which is set off against the whole or part of sum earlier treated as deemed dividend under clause (e) to the extent of which it is set off


which it is set off• Balance dividend (after set off of deemed dividend) would be subject to

DDT

Sec. 2(22)(e) – Provision at a glanceC diti i d t b f lfill d f li bilit f 2(22)( )Conditions required to be fulfilled for applicability of sec. 2(22)(e)

Company - should be one in which the public are not substantially interested i.e. should be closely held

Person - should be a shareholder having ≥ 10% of voting power and should beneficially own the same + relationship should exist at the time of transaction

Payment - should be by way of advance or loan + made out of accumulated profits of the company

In case or advance is to a concern, such shareholder should have a ,substantial interest in that concern (at any time during the year)

Also covers payment on behalf or for individual benefit of such shareholder


Taxability in the hands of

Shareholder‒ Taxable under the head

‘Income from other sources’Taxable at normal rates‒ Taxable at normal rates

and

Company Consider interplay of sec. 14A

‒ Not required to pay tax on such deemed dividend u/s 115O of Issues relating to secthe Act

‒ Liable to withhold tax u/s 194 of the Act

Issues relating to sec. 2(22)(e) are numerous. Key issues are discussed in the

subsequent slides


Issues Sh h ld Wh ?Shareholder - Who?

Sec. 2(22)(e) covers loan or advance given to a shareholder being a person who is the beneficial owner of shares holding ≥ 10% voting power

• Under Income-tax Act, 1922, shareholder meant a registered shareholder only

‒ C.P. Sarathy Mudaliar [1972] (83 ITR 170) (SC)y [ ] ( ) ( )

‒ Rameshwarlal Sanwarmal [1980] (122 ITR 1) (SC)

Expression in sec. 2(22)(e) refers to both registered shareholder and beneficial owner Bhaumik Colour Pvt Ltd [2009] (118 ITR 1) (Tribbeneficial owner – Bhaumik Colour Pvt Ltd [2009] (118 ITR 1) (TribSB)(Mum)

Loan received by a person before becoming a registered shareholder cannot be treated as deemed dividend u/s 2(22)(e) Sagar Sahil Investments (P)be treated as deemed dividend u/s 2(22)(e) - Sagar Sahil Investments (P) Ltd [2010] (120 TTJ 925) (Trib)(Mum)

The person who is beneficial owner would be treated as a shareholder –National Travel Services [2011] (347 ITR 305) (HC)(Del)


National Travel Services [2011] (347 ITR 305) (HC)(Del)

Issues Whether the test of requisite interest needs to be fulfilled with reference to an individual shareholder only? Plain language, generally – the requisite interest of a person alone

(individually) to be considered Test need to be compiled with by individual shareholder

• Smt. Gunvanti R Mehta [1993] (45 ITD 382) (Mum)(Trib)• Gopal Clothing Co (P) Ltd [2012] (ITA No 333/2006) (HC)(Delhi)Gopal Clothing Co. (P) Ltd. [2012] (ITA No. 333/2006) (HC)(Delhi)• Octave Apparel, Ludhiana [2012] (ITA No.31/Chd/2011) (Trib) (Chand)• Kunal Organics (P.) Ltd. [2006] (164 Taxman 169) (Trib) (Ahmed)

No specific provision in the Act unlike sec. 47(xiii), 79 of the Act, and sec. 314(185) of Direct Taxes Code 2010

A deeming provision requires to be constructed strictly

The idea behind having a ‘substantial interest’ test is to capture situations where a person/ shareholder has the ability to influence two firms/ companies. Just because the same group of individuals/ shareholders jointly hold a substantial interest in two firms/ companies, does not


automatically lead to an inference that they will be acting in concert in relation to both firms/ companies

Issues Dividend taxable in whose hand?Dividend taxable in whose hand?

Concern

CBDT Circular 495 dated September 22, 1987

Shareholder only

Hotel Hilltop [2008] (217 CTR 527) (Raj) (HC)

C ( ) ( )Oscar Investments Pvt. Ltd [2005] (7 SOT 330) (Mum)(Trib) & NCK Sons Exports (P) Limited [2006] (102 ITD 311)(T ib)(M )

Bhaumik Colours Pvt. Ltd [2009] (118 ITR 1) (Trib) (SB)(Mum)

Ankitech Pvt. Ltd [2011] (340 ITR 14) (HC) (Del)

MCC Marketing Pvt Ltd [2011] (343 ITR 350) (HC) (Del)ITD 311)(Trib)(Mum)– Circular relied – no argument of taxability in hands of shareholder – issue examined – lender company engaged in

MCC Marketing Pvt. Ltd [2011] (343 ITR 350) (HC) (Del)

Universal Medicare Pvt. Ltd [2010] (190 Taxman 144) (HC)

Shruti Properties P. Ltd [2010] (004 ITR 186)(Trib)(Mum)p y g gbusiness of lending etc

Extermpore Securities and Investments (P) Ltd [2008] (116 TTJ 525)(Trib) (Mum - no

Shruti Properties P. Ltd [2010] (004 ITR 186)(Trib)(Mum)

Chhandmull Batia [1978] (115 ITR 388) (HC) (Cal)

Sarathy Mudaliar (C.P.) [1972] (83 ITR 170)(SC)

argument of taxability in hands of shareholder

Raj Kumar Singh & Co [2005] (149 Taxman 254) (HC)(All)

Consider observations of Delhi HC in case of National Travel


Consider observations of Delhi HC in case of National Travel Services [2011] (347 ITR 305) – In case of Bharti Overseas Trading Company (349 ITR 52), Delhi HC has followed National Travel

Issues L / d id/ i f h t i d f tiLoan/ advance repaid/ given for short period of time

Treated as deemed dividend u/s 2(22)(e)

Liability to tax attaches the moment the loan is borrowed Liability to tax attaches the moment the loan is borrowed• Miss Sarada [1998] (229 ITR 444) (SC)• Tarulata Shyam [1977] (108 ITR 345 )(SC) • Walchand & Co (P) Ltd [1993] (204 ITR 146)(HC)(Bom)Walchand & Co. (P) Ltd. [1993] (204 ITR 146)(HC)(Bom) • Bhagwat Tewari [1979] (105 ITR 62) (HC)(Cal)

Circuitous transaction returned to the lending company on the very same day N t t t d d d di id d d ti 2(22)( ) if th i t ti• Not treated as deemed dividend under section 2(22)(e) - if the intention was to give a loan or an advance, the question of the money being returned to the lender on the same day would not arise - Pravin BhimshiChheda Shivsadan [2012] (11 ITR 705)(Trib)(Mum)[ ] ( )( )( )


Issues L d itLoan vs. deposit

Distinction between loan and deposit - Commentary by Chaurvedi & Pithisara on page 5, 735 (Vol. V, 4th Edition)• Deposit and loan are not identical in meaning • Ordinarily, though not always, in case of deposit, it is the depositor who is

the prime mover; while in case of loan, it is the borrower who is the prime mo ermover

• Deposit is payable on demand whereas obligation to repay loan arises immediately on receipt of loan

Some loans may be deposits and some deposits may be loans; however all Some loans may be deposits and some deposits may be loans; however, all loans are not deposits and all deposits are not loans • Pennwalt India Ltd. (62 Comp Cas 112)(Bom) • Durga Prasad Mandlia (61 Comp Cas 480)(Bom) g ( p )( )

Inter-corporate deposits are not deemed dividend since they are different from loans and advances • Bombay Oil Industries Limited [2009] (28 SOT 383) (Trib)(Mum)


Issues Di tl i di tl i i i i 2(22)( )Directly or indirectly is missing in sec. 2(22)(e) Company A lends to Concern B which in turn on the same day and out of

same funds lends to Shareholder C (substantial shareholder in Company A) • Treated as deemed dividend u/s. 2(22)(e)‒ Nandlal Kanoria [1980] (122 ITR 405) (HC)(Cal)

Concern B lends to Shareholder A out of mixed funds and direct nexus cannot be established between advances from Company A and lending to Shareholder C • Cannot be treated as deemed dividend u/s. 2(22)(e) ‒ Nandlal Kanoria [1980] (122 ITR 405) (HC) (Cal)

A loan by the company to the firm in which its shareholder has substantial interest and from firm to the shareholder, then the burden on revenue to prove that transactions are inter-related. • If there is no nexus between the funds of company with firm and loan to

him - the loan cannot be treated as deemed dividend.


‒ Subrata Roy Sahara [2007] (109 ITD 1)(Trib)(Luck)

Issues Amount paid to the shareholder must be loan/advancesAmount paid to the shareholder must be loan/advances…Misappropriation by the director

• Cannot be treated as deemed dividend ‒ G. Venkatarman [1975] (101 ITR 673)(Mad)

Shareholder has a current account debit balance / overdraft with company • Treated as deemed dividend u/s 2(22)(e)Treated as deemed dividend u/s. 2(22)(e)‒ K.Srinivasan [1963] (50 ITR 788) (HC)(Mad)

Advances made during the ordinary course of business for business expedienciesexpediencies • Does not constitute 'loan' for purposes of sec. 2(22)(e) ‒ Lakra Bros [2007](106 TTJ 250) (Trib)(Chd) ‒ Sri Satchidanand S.Pandit (2008](19 SOT 213)(Trib)(Bom) ‒ NH Securities Ltd [2007](11 SOT 302)(Trib) (Bom)


Issues A t id t th h h ld t b l / d…Amount paid to the shareholder must be loan/advances

Payment made to shareholder in excess of existing debt• Treated as deemed dividend u/s. 2(22)(e)‒ Extermpore Securities & Investments (P.) Ltd.[2008] (116 TTJ 525) (Trib)

(Bom) ‒ Jamnadas Khimji Kothari [1973] (92 ITR 105) (HC)(Bom)


Issues Payment on behalf of / payment for benefit of shareholderPayment on behalf of / payment for benefit of shareholder Loan / advance made to a third party for benefit of shareholder - Managing

Director of a company who is also a shareholder holding more than 20% beneficial interest, obtained loans from the company through other employee , p y g p yof the company • Treated as deemed dividend u/s. 2(22)(e)‒ L. Alagusunduram Chettiar [1977](109 ITR 508) (HC)(Mad)

Payment on behalf of shareholder in satisfaction of a consent decree under orders of the court and debited to shareholder account as loan • Treated as deemed dividend u/s. 2(22)(e)‒ Ravindra D Amin [1994] (208 ITR 815) (HC)(Guj)

Gifts made to relatives of the shareholders where the shareholders did not have the ownership, control and enjoyment of the amounts so gifted

/ ( )( )• Not treated as deemed dividend u/s. 2(22)(e) ‒ P. V. John [1990] (52 Taxman 221) (HC)(Ker)


Issues Loan from one subsidiary to anotherLoan from one subsidiary to another While a holding company, having many wholly owned subsidiaries, receives

loan amount from its various subsidiaries and advances the same to its other subsidiaries? • Such loan transactions would not partake character of deemed dividend ‒ Routine financial transactions managed by the assessee as holding Co

R l b i t ti‒ Regular business transaction‒ Farida Holdings Pvt. Ltd. [2012] (51 SOT 452)(Trib)(Chen)


Issues Share Application Money receivedpp y Share Application Money received by one company from another wherein the

shareholder’s of both the companies are common, holding substantial interest• Cannot be classified as loan/ advance and will not be treated as deemed

dividend‒ Ardee Finvest (P) Ltd [2001] (79 ITD 547) (Trib) (Del)‒ Shubhmangal Credit Capital P. Ltd (ITA No. 7238/Mum/2008)‒ Direct Information Pvt. Ltd (ITA No. 2576/Mum/2011)

Contrary view taken in Hyderabad Chemical Products (72 ITD 323) and Ethiray y ( )Software Services P. Ltd (ITA No. 2741/ Mum/2011)• Considerable time lag between receipt of share application money and

issue of shares. • Share application received was in much excess of authorised capital


Issues Allowability of interest paid on loan u/s 57(iii)Allowability of interest paid on loan u/s 57(iii)

Whether interest paid on loan which is treated as deemed dividend will be admissible as a deduction u/s 57(iii)?

• Not admissible as a deduction

‒ Nandlal Kanoria [1980] (122 ITR 405) (HC)(Cal)


Loan to shareholder exceeding accumulated profitsIssuesLoan to shareholder exceeding accumulated profits

If the loan given to shareholder exceeds accumulated profits

• Loan to the extent of accumulated profits will only be considered as p ydeemed dividend

‒ P. K. Badiani [1976] (76 ITR 369) (Bom) (HC)

Loan to the extent of the full accumulated profits taxed as dividend and not Loan to the extent of the full accumulated profits taxed as dividend and not to the extent of shareholding proportion of receiver of loan

• Mayur Madhukant Mehta [1972] (85 ITR 230) (HC)(Guj)

• Bhagwat Tiwari [1979] (105 ITR 62) (HC)(Cal)

• Arati Debi [1978] (111 ITR 277) (HC)(Cal)

P ti t d t h h ld b d h h ldi ti h Proportionated amongst shareholders based on shareholding ratio when more than one shareholder obtained loan

• Kewalkumar Jain [2013] (37 taxmann.com 248) (Trib)(Pune)


• Mayur Madhukant Mehta (Supra), Arati Debi (Supra) distinguished based on facts of case

IssuesA l t d fitAccumulated profits… Whether profit for extant year is “accumulated profit” or “current profit”

• Refer P. K. Badiani [1976] (76 ITR 369) (Bom) (HC)

Explanation 2 to sec. 2(22) of the Act: • Accumulated profits shall include all profits of the company up to the date

of distribution or payment referred to in those sub-clauses p y Bonus shares will not be considered as accumulated profits

• U/s 2(22)(a) to (d) contains “accumulated profits whether capitalised or not “whereas under section 2(22)(e) contains “accumulated profits” (‘”whetherwhereas under section 2(22)(e) contains accumulated profits ( whether capitalised or not is absent”)

Accumulated profits must be determined on the date on which loan / advance is given


IssuesA l t d fit…Accumulated profits…

Commercial profits or assessed ‐ P. K. Badiani [1976] (105 ITR 642) (SC)– Tea Estates India Private Limited [1976](103 ITR income ? Tea Estates India Private Limited [1976](103 ITR

785) (SC) – Commerical profits

Book depreciation or income‐tax Navnitlal C. Jhaveri [1971] (80 ITR 582) (HC) (Bom) – Tax depreciation

depreciation? ‐Difficuilty may arise in applying ‐ Case law interpreted provisions of 1922

R l ti They merely represent book entry. May not be Revaluation reserve y y p y yincluded as they are not commercial profits.

Development rebate reserve and i t t ll P. K. Badiani [1976] (105 ITR 642) (SC) ‐ Includedinvestment allowance reserve [ 97 ] ( 5 4 ) ( )


IssuesA l t d fit…Accumulated profits…

Share premium and Share forfeiture receipts

- Maipo India Ltd [2008] (116 TTJ 791) (Trib) (Del)- Jaikishan Dadlani [2005] (4 SOT 138) (Trib)(Mum) p

– Not included

Provision for tax and provision for dividend

Damodaran [1972] (85 ITR 590) (HC)(Ker) ‐ not profits or reserves

If loan that was treated as deemed dividend earlier is repaid – can it be added back to the accumulated profits?

Once a certain part of the accumulated profits has been used for determining the deemed dividend it cannot be added back on its repayment

added back to the accumulated profits? –P. K. Badiani [1976] (76 ITR 369) (HC) (Bom)

In determining accumulated profits for sec. 2(22)(e), the amount treated as G N i h [ ]( 8 ITR 6 ) (HC) (M d) Ysec. 2(22)(e), the amount treated as dividend u/s. 2(22)(e) in the past has to be excluded

G. Narasimhan [1979](118 ITR 60) (HC) (Mad) – Yes


Issues Company in which public are substantially interestedCompany in which public are substantially interested Sec. 2(22)(e) not applicable to a ‘company’ in which public is substantially

interested ‘Company’ is defined u/s 2(17) to mean Indian company as well as a body Company is defined u/s 2(17) to mean Indian company as well as a body

corporate incorporated under the laws of a country outside India A company is said to be a ‘company in which public are substantially

interested’ amongst others if :interested amongst others, if :• It is not a private company as defined in the Companies Act, 1956 and its

shares, as on the last day of the relevant previous year, were listed in a recognised stock exchange in India, or:g g ,

• Not less than 51% (40% in case of the companies engaged in the specified business) of the voting power has been held by the Government, a corporation established by a Central, State or Provincial Act, a company in which public are substantially interested (in accordance with sec. 2(18) of the Act) or its WOS throughout the year.

A sub of a foreign company listed outside India, whether ‘a closely held ’ ?


company’ ?• Daimler Chrysler India (P) Ltd (120 TTJ 803) (Trib) (Pune)

Appendix

No Particulars

1 Sec. 2(22)(e) – History

2 DTC v/s Act2 DTC v/s. Act


Sec. 2(22)(e) – History 1922 A t1922 Act Two categories of payment were considered as deemed dividend Any payment by way of advance or loan to shareholder was considered as

dividend paid to shareholderdividend paid to shareholder Any payment by any such company on behalf of for the individual benefit of

a shareholder was considered as dividend1961 Act1961 Act Additional condition Payment should be to a shareholder being a person who is beneficial owner

of shares and who has a substantial interest in the company (≥ 20% of p y (voting rights

1987 Amendment Voting power reduced from 20% to 10% Payment should be to a shareholder who is the beneficial owner of shares

holding ≥ 10% of the voting right New category of payment introduced


Payment to any concern in which such shareholder is a memer or a partner and in which he has a substantial interest (20% voting power)

DTC v/s. ActSec. 2(22)(e) under the Act Clause 314(81)(e) of DT

Any payment by a company in which public not substantially interested, after May 31, 198

Clause (e) – Any payment by a closely heldcompany to the extent of its accumulated

fi [ l 314( 0)]1987 profits [clause 314(50)]By way of advance or loan to a shareholder

Being a person who is the beneficial owner Sub Clause (i) – same effectof the shares holding ≥ 10% of voting powerOr to a concern in which such shareholder is a member or partner and has a

Sub Clause (ii) – Payment to HUF, Firm, AOP, BOI or Company, in which such s a e be o pa t e a d as a

substantial interestO , O o Co pa y, c suc

shareholder is a member or partner and has a substantial interest

Or any payment on behalf, or for the individual benefit of any such shareholder

Sub Clause (iii) – Same effectindividual benefit of any such shareholder

To the extent to which the company in either case possesses accumulated profits


Q ti ?Questions ?


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