Deemed Dividend Taxation in India

In the realm of corporate taxation in India, deemed dividend has emerged as significant and complex aspect. Deemed dividend refers to such transactions or situations where a company’s payment or distribution is treated as dividend, even if they are not explicitly declared as such. The concept aims to control tax evasion and ensure that shareholders do not circumvent the tax liability associated with traditional dividends. In this article we will explore the Deemed Dividend Taxation in India, its accounting treatment and latest decisions.

What is Dividend?

Firstly, it is important to understand the meaning of words Dividend and Deemed Dividend.

Dividend usually refers to the distribution of profits by a company to its shareholders. However, in view of Section 2(22) of the Income-tax Act, the dividend shall also include the following:

• Distribution of accumulated profits to shareholders entailing release of the company’s assets;
• Distribution of debentures or deposit certificates to shareholders out of the accumulated profits of the company and issue of bonus shares to preference shareholders out of accumulated profits;
• Distribution made to shareholders of the company on its liquidation out of accumulated profits;
• Distribution to shareholders out of accumulated profits on the reduction of capital by the company; and
• Loan or advance made by a closely held company to its shareholder out of accumulated profits.

Deemed Dividend

The meaning of Deemed Dividend Taxation in India is further enumerated under Section 2(22) (e) of Income Tax Act which means and includes

Where a closely held company (company which is not substantially interested) extends loans or advances to:

• Any shareholder, being a person who is the beneficial owner of shares holding not less than 10 percent of voting power or
• To any concern in which such shareholder is a member or a partner and in which he has substantial interest 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.

However, there are certain exceptions which although falling in the above category isn’t considered as deemed dividend. They are:

• Loans by money lending companies
• Loans to shareholders who do not have substantial interest in the company.
• Loans and advances received by shareholders out of share premium account.

Deemed Dividend Accounting treatment

The accounting treatment of deemed dividend is primarily governed by Companies (Accounting Standards) Rules, 2006. It lays down that:

• Deemed dividend shall be recognised on accrual basis.
• Companies are required to disclose the details of deemed dividend in their Financial Statements.
• Company extending loan to its shareholders shall recognize the fair value of loan as deemed dividend.
• When a shareholder benefits from company assets without adequate consideration, the fair value of the benefit received is recognized as a deemed dividend.
• It is reflected as appropriation of profit under Profit and Loss Statement.
• The liability arising from deemed dividends is reflected on the liability side of balance sheet until it is either paid as an actual dividend or reversed due to change in circumstances.
• The financial statements of companies are subject to independent audits by external auditors. Auditors review the accounting treatment of deemed dividends to ensure compliance with accounting standards and appropriate disclosure of information.

Therefore, the accounting treatment of deemed dividend aligns with the principles of transparency, fair value measurement and compliance with accounting standards.

Taxability of Deemed dividend

In the hands of company

After the regulations dated 1 April 2020, the domestic companies shall not be liable to pay Dividend Distribution Tax (DDT) on dividend distributed to shareholders. However, they will be subjected to tax deduction under Section 194 of Income Tax Act, according to which an Indian company shall deduct tax at the rate of 10% from dividend distributed to the resident shareholders if the aggregate amount of dividend distributed or paid during the financial year to a shareholder exceeds Rs.5000.

However, no tax shall be required to be deducted from the dividend paid or payable to Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC) or any other insurer in respect of any shares owned by it or in which it has full beneficial interest.

In the hands of shareholders

The taxability of deemed dividend in the hands of shareholder shall depend upon many factors like residential status of the shareholders, relevant head of income etc.

Taxability in the hands of resident shareholder

Dividend income are taxable under the head ‘Income from other sources’. The assesse can however claim deduction of only interest expenditure which has been incurred to earn that dividend income to the extent of 20% of total dividend income and such income shall be chargeable to tax at normal tax rates as applicable.

Taxability in the hands of non- resident shareholders

A non-resident person generally hold shares of an Indian company as an Investment and, therefore, any income derived by way of dividend is taxable under the head other sources. The dividend income, in the hands of a non-resident person (including FPIs and non-resident Indian citizens (NRIs)), is taxable at the rate of 20% without providing for deduction under any provisions of the Income-tax Act. However, dividend income of an investment division of an offshore banking unit shall be taxable at the rate of 10%.

It is important to note that dividend received in respect of GDRs by both resident and non-resident shareholder shall be charged at concessional tax rate of 10%.

Latest decisions on Section 2 (22) (e) of Income Tax Act

• DCIT Versus Aaryavart Infrastructure P. Ltd.
  The Ahmedabad bench of Income Tax Appellate Tribunal in this case has decided that deemed dividends cannot be taxed in the hands on non-shareholders. The bench has observed that Section 2(22)(e) of the Income Tax Act is only with respect to dividends, and its scope, therefore, cannot be enlarged to extend shareholders also.
• DCIT Versus M/s Solitaire Real infra Private Limited
  The Delhi Bench of Income Tax Appellate Tribunal (ITAT) has held that addition for a deemed dividend made under Section 2(22)(e) of the Income Act can be done in the hands of shareholder only. In this case, the assesse was not a registered shareholder in the concerned company from which the loan was obtained. Therefore, The Tribunal deleted the addition for deemed dividends made under Section 2(22)(e) of the Income Act.
• Dattaprasad Kamat Versus Assistant Commissioner Of Income Tax
  In this case, The Bombay High Court has refused 50% entitlement to beneficial ownership in a husband’s shareholding under the Portuguese Civil Code for ‘deemed dividend” taxability. The court noted that the effect of clause (e) of Section 2(22) is to broaden the ambit of the expression “dividend” by including certain payments that the company has made as a loan or advance for the individual benefit of a shareholder, but the definition does not alter the position that the dividend has to be taxed in the hands of the shareholder alone.

Conclusion

Understanding the tax implications of deemed dividends are crucial for both companies and shareholders. In order to ascertain that the provisions of the Income Tax Act are being ensued, an in-depth evaluation of the types of transactions and benefits given to shareholders is necessary. Seeking professional advice and staying abreast of changes in tax laws are essential to navigate the complexities of deemed dividend taxation in India. Therefore, a team of experts is here to assist you at every step. Feel free to reach us at cagmc.com.