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Deemed Dividend under section 2(22)(e): Taxable again in the hands of shareholders’?

With the amendment introduced by the Finance Act, 2020 deemed dividends are no longer taxable under section 115-O. So, in accordance with the section 56 the deemed dividends will again be taxable in the hands of the shareholder.

Let us analyze the section-wise scenario before and post amendment.

Definition

Section 2(22)(e) of the Income tax Act, 1961 defines the deemed dividend and read as follows: -

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

In simple words, in case the loans or advances are paid by the closely held company to: -

a. shareholder who beneficially holds shares of not less than 10% of voting power or

b. to any concern in which shareholder (as per above) is a member, partner or has substantial interest

then the amount of such loans and advances paid will be treated as deemed dividend u/s 2(22)(e)

Taxability of Deemed dividend before the Amendment by Finance Act, 2020

As per section 10(34) of the Income-tax Act, it is pertinent to note that the income on account of dividends are exempt in the hands of the shareholders.

Section 10(34) of the Income Tax Act, 1961 read as under:

“10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—

(34) any income by way of dividends referred to in section 115-O

Section 115-O of the Income tax Act, as contained in Chapter XII-D, reads as follows:

“115-O. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of fifteen per cent:

Provided that in respect of dividend referred to in sub-clause (e) of clause (22) of section 2, this sub-section shall have effect as if for the words "fifteen per cent", the words "thirty per cent" had been substituted.

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(1B) For the purposes of determining the tax on distributed profits payable in accordance with this section, any amount by way of dividends referred to in sub-section (1) as reduced by the amount referred to in sub-section (1A) [hereafter referred to as net distributed profits], shall be increased to such amount as would, after reduction of the tax on such increased amount at the rate specified in sub-section (1), be equal to the net distributed profits:

Provided that this sub-section shall not apply in respect of dividend referred to in sub-clause (e) of clause (22) of section 2.

Therefore, from the combined reading of section 115-O and section 10(34) it can be inferred that in case the company pays the deemed dividends then it has to pay tax @30% thereon and in the hands of shareholder the same was exempted.

Taxability of Deemed dividend Post-Amendment :

Vide Finance Act, 2020 the following amendments have been made:-

In Section 10 (34) of the Income tax Act, the following second proviso has been added: -

Provided further that nothing contained in this clause shall apply to any income by way of dividend received on or after the 1st day of April, 2020 other than the dividend on which tax under section 115-O and section 115BBDA, wherever applicable, has been paid”

The section 115-O of the Income-tax Act, post-amendment read as below:

“115-O. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003 90[but on or before the 31st day of March, 2020], whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of fifteen per cent:

Provided that in respect of dividend referred to in sub-clause (e) of clause (22) of section 2, this sub-section shall have effect as if for the words "fifteen per cent", the words "thirty per cent" had been substituted.”

From the combined reading of section 10(34) and section 115-O it can be inferred that even in case the deemed dividends are paid after 1st April 2020 then the same will not be taxable under section115-O and will be taxable in the hands of shareholders under section 56 at the applicable marginal rates.

Comments

It will be interesting to note that before amendment by Finance Act, 2018 the deemed dividends u/s 2(22)(e) were taxable in the hands of shareholder under the head of “Income from other sources”. However, vide memorandum to the Finance Act, 2018 it was explained that “The taxability of deemed dividend in the hands of recipient has posed serious problem of the collection of the tax liability and has also been the subject matter of extensive litigation. With a view to bringing clarity and certainty in the taxation of deemed dividend is proposed to be taxed at the rate of 30 per cent. (without grossing up) in order to prevent camouflaging dividend in various ways such as loans and advances”.

So how the department react to the aforesaid amendment is something we need to see.

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