Loan & Advances paid to shareholders are considered as Deemed Dividend

Dividend is a sum of money paid by company out of its profits to its shareholders. Dividends are decided by board of directors and approved by shareholders. Company distributing dividend pays Dividend Distribution Tax (DDT) to government.  These are the summarized few points of dividend distribution in india.

One more important definition of Deemed Dividend defined by income tax act. Section 2(22)(e) defines few conditions where Loan & Advances paid to shareholders are considered as deemed dividend.  Let’s understand when it is applicable, Conditions of taxability, when it is exempt.

Applicability

  • A shareholder who is the beneficial owner of shares, and holds a minimum of 10% of the voting rights. It may be noted that the shares so held should not be entitled to a fixed rate of dividend.
  • Any concern in which such shareholder is a member or partner holding a substantial interest.
  • On behalf, or for the individual benefit of such shareholder, to a specified extent.

Taxability

Once this section applies deemed dividends are taxable in the hands company distributing it. Company has to pay DDT at the rate of 15 percent plus surcharge and education cess.

Conditions

  • When Company is a closely held company
  • The loan & Advances are not in ordinary course of business.
  • Deemed dividend would only be extent to accumulated profit of company.

Exemptions

  • When Loan and Advances are made in ordinary course of business. where the lending of money is a substantial part of the business of the company
  • Inter-corporate deposits
  • Payments made by a company with the object of buying back its own shares

The definition of this section is small but scope is very large. There are 100s of case laws on it, where merely giving advance to shareholders had been considered as deemed dividend and they had to pay DDT. Few case laws have been given below:

Tarulata Shyam & Ors. Vs CIT(SC) 108 ITR 345: “Loan advanced to a shareholder was re-paid within 23 days still deemed dividend under Section 2(22)(e)- If the assessee comes under the letter of law, he has to be taxed, however great the hardship may appear to the judicial mind to be.”

Rajesh P. Ved Vs ACII (ITAT, Mum) 1 ITR (Trib) 275: “Accumulated profits means profits upto the date of payment of loan – subsequent repayment of loan not to be considered amount credited to wards remuneration of shareholder cannot be set off against the alleged loan considered as deemed dividend.”

Before giving loan and advances consult your tax advisor. A small mistake can ruin everything.

Keep reading! And reach out to us if you have any queries and you are looking for an CA in Gurgaon, Faridabad, Delhi for further clarification.

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