What is Deemed Dividend:
The deemed dividend is not defined under the income tax act 1961. The dividend generally means a dividend distributed and paid by the company out of its profit to the shareholders in proportion to their shareholdings. A deemed dividend means an income tax on an artificial income, where the company distributes profit to the shareholders by any means other than dividends.
Every private limited company or limited company distributes profits to their shareholder. Dividends can either be interim or final. Any dividend distributed during the year after announcing the quarterly or half-yearly result is called an interim dividend and the dividend which the company distributes in the annual general meeting after announcing the annual financial result is called as final dividend. In the modern world, companies find unique ways to distribute their profit to make the income tax liability very low in the hands of companies and shareholders.
Under the income tax act section 2(22) provides the kind of deemed dividend that a company distributes to its shareholders is taxable in the hands of shareholders. Let us discuss the deemed dividend that has been enacted by the income tax act to plug in the loopholes in the income tax act.
a. Any distribution of accumulated profit entailing the release of the company’s assets: Section 2(22)(a)
Dividend includes any distribution by the company of its accumulated profits, whether capitalized or not, which entails a release by the company to its shareholders of all of any part of its assets. To fall under the definition of the dividend under section 2(22)(a) it needs to fulfil both conditions i.e. it should be distributed from accumulated profits and second, it entails a release by the company of its assets.
Where a company capitalized its profit and issues bonus shares to its shareholders, the allotment of bonus shares doesn’t entail the release of assets by the company. The company merely capitals its retained earnings from the amount available for distribution by increasing its capital. The profit remains within the company after the allotment of bonus shares.
Under the income tax act, bonus shares are not dividends when they are issued to equity shareholders. But bonus shares issued to preference shares are taxable under the income tax act.
b. Any distribution of debentures, debentures-stock, deposit certificates, and bonus to preference shareholders: Section 2(22)(b)
Where a private limited company in gurgaon or a limited company in gurgaon, distributes debentures, debentures-stock, deposit certificates, and bonus to its shareholders from the accumulated profits whether capitalised or not shall be treated as dividends as consequently be taxable in the hands of shareholders and reported in the income tax return.
c. Distribution on liquidation of the company: Section 2(22)(c)
Any amount distributes by the private limited company in Gurgaon or limited company out of the accumulated profit whether accumulated or not shall be treated as dividends. Practically the liquidator has no right to declare dividends. He only distributes assets of the company among its shareholders. However, income tax act works completely opposite to the practical situations which treats the amount taxable, distributed on liquidation by the liquidator. Section clears that the distribution of past years’ profits or even current year profit up to the date of liquidation is treated as a dividend and will be taxable in the hands of shareholders and be reported in the income tax return.
d. Distribution on reduction of capital: Section 2(22)(d)
Any distribution on reduction of capital is treated as a dividend in the hands of the shareholders. The company may distribute its accumulated profits, pay off any share capital which is in excess of the want of the company which on reduction will be taxable as a dividend and be reported in the income tax return of the taxpayer.
e. Loans and advances to shareholders and other benefits: Section 2(22)(e)
Any payment of any sum to its shareholder directly or indirectly in form of loans and advances is to be treated as deemed dividends under the income tax act. Under section 2(22)(e) three types of payments are covered:
- Any payment of any sum by way of advance or loan to its shareholders,
- Any payment on behalf of shareholders, and
- Any payment for the benefit of the shareholders.
Payment made by the company to other company in the ordinary course of business or inter-corporate loan will not be treated as deemed dividends.
The conditions have been prescribed under section 2(22)(e) in order to attract the definition of deemed dividend:
- Company should not be one in which the public is substantially interested i.e it can be a private limited company,
- Company possesses accumulated profit at the time of making payment,
- loan or advance to the shareholder who beneficially owns at least 10 per cent equity capital or to a HUF, partnership firm, association of firm or body of the individual, in which such shareholder is beneficially entitled to at least 20 per cent of the income or to a company in which such shareholder beneficially owns at least 20 per cent of equity capital of the private limited company in gurgaon.
The purpose of the enactment of this section is to plug the loophole. The private limited company used to distribute dividends by different means and did not pay income tax on dividends. After the enactment, any amount of loan or advance given to its equity shareholders irrespective of the purpose of the loan shall be taxable as a dividend (CIT vs Ravindra 208 ITR 815). Merely entries in the books of accounts do not represent payment and shall not be treated as a deemed dividend (Govindarajulu vs CIT 90 ITR 13, CIT vs Savithiri 236 ITR 1003)
The following shall not be treated as a dividend;
- any payment made by the company on the purchase of its own shares in accordance with the provisions contained in the companies act,
- any distribution of shares made in the accordance with the scheme of 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.
- The definition of dividend is applicable to all the provisions of the income tax act. Sometimes it creates an artificial liability to income tax, hence it should be strictly interpreted
- What is taxable as dividend need not necessarily be paid in money, it may be paid money’s worth by the delivery, say, goods or securities or shares in another company. (Kantilal vs CIT 41 ITR 275 (Supreme court)
- A shareholder is liable to pay income tax on his dividend income and the company must deduct TDS under section 194 of the act.
Conclusion:
Where a profit stands in the books of account of the company then, it becomes a sensitive matter to give any amount to shareholders either directly or indirectly, no matter whether it was paid as a dividend or not. The income tax department, tax such transactions. The income by way of dividend is taxable in the hands of shareholders under section 56 under the head ‘Income from other sources’ and it should be reported in the income tax return. It is advisable for the directors of a private limited company to take the legal advice of a chartered accountant in Gurgaon before making any such transaction happens. Since in many tribunals’ judgements refund of the loan of advance did not reverse the changeability of income tax.
It is important to note that, if the shareholder is an individual/HUF/Association of person/Body of individual/artificial judicial person, the surcharge on dividend income shall not exceed 15 per cent.
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