[Opinion] Deemed Dividend Taxation Under Section 2(22)(e)

Komal Goyal – [2024] 166 taxmann.com 367 (Article)

Facts

• F Co. is a company incorporated in USA. F Co has two subsidiary companies in India, namely A Co and B Co.
• B Co. has given inter-company loans to A Co. Also, B Co has made certain inter corporate deposits with A Co.

Query

• Whether there will be any dividend tax implications in the hands of A Co. for granting of loan by B Co?
• Whether there will be any dividend tax implications in the hands of A Co. for granting of inter-company deposit by B Co?
• Whether there will be any income tax implications in the hands of F Co. in the above arrangement?

Analysis for Assignment 2

2.1 As per the provisions of Section 2(22)(e) of the Act, “dividend” includes 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.

From a plain reading of the above, it can be interpreted that the provisions of deemed dividend are applicable if the following conditions get satisfied:

(a) The company making the payment should be a company in which the public are not substantially interested.

(b) Payment is made in form of advance or loan.

(c) Payment is being made to a shareholder, being a person who is the beneficial owner of shares or a concern 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.

to the extent of accumulated profits of the Company.

Section 2(22)(e) does not specify as to in whose hands [whether the concern receiving the loan or the shareholder, the dividend is taxable.

As per the CBDT Circular No. 495 dated 22nd September 1987 issued by the tax authorities at the time of introduction of the provisions of section 2(22)(e) of the Act, there is a reference that such deemed dividends will be taxed in the hands of the concern receiving the loan i.e. the recipient.

2.2 “company, in which the public are substantially interested” is defined under Section 2(18) of the Act to read as:

(18) “company in which the public are substantially interested”—a company is said to be a company in which the public are substantially interested—
….
(b) if it is a company which is not a private company as defined in the Companies Act, 1956 (1 of 1956)8, and the conditions specified either in item (A) or in item (B) are fulfilled, namely:

(A) shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) were, as on the last day of the relevant previous year, listed in a recognised stock exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and any rules made thereunder;

(B) shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than fifty per cent of the voting power have been allotted unconditionally to, or acquired unconditionally by, and were throughout the relevant previous year beneficially held by—

(a) the Government, or

(b) a corporation established by a Central, State or Provincial Act, or

(c) any company to which this clause applies or any subsidiary company of such company if the whole of the share capital of such subsidiary company has been held by the parent company or by its nominees throughout the previous year.

Therefore, if a company is not listed in the recognised stock exchange in India or 50% of its shareholding is not held by a company in which public are substantially interested, then it is not a company in which public are substantially interested.

Accordingly, in order to apply the provisions of deemed dividend under Section 2(22)(e) of the Act, B Co. should not be listed in the recognised stock exchange in India or 50% of its shareholding should not held by a company in which public are substantially interested.

For the given analysis, we have assumed that B Co. is not listed on a stock exchange in India. Also, B Co. is held by a F Co. which is not listed in India. So, it may be concluded that B co. is a company in which public are substantially interested.

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