Now pay 30% tax on loans given to Company’s owners – DDT on Deemed dividends

Do you know if the company lends any amount to the company’s owner, the same is treated as income in the hand of shareholders and company is required to pay 30% dividend distribution tax (commonly known as “DDT”)?

This is strange but true! Anything is possible under the income tax and hence, loan is regarded as income and tax is levied thereon. In simple words, if you are a shareholder holding more than 10% and receive any amount as a loan or advance, then the same shall be treated as deemed dividend in the hands of the owners and shall be liable for 30% dividend distribution tax (DDT).

The government of India through Finance bill 2018, has proposed to levy 30% DDT on the loan’s given to the company’s shareholders. This has been done to discourage all private companies from providing any kind of loan to its shareholders in lieu of profits.

Let us understand the procedure in depth so as to understand the complete fuss about this strange law.

Why loan is considered as income (dividend)? – The concept of Deemed dividend (Section 2(22)(e))

There is an pretty old concept of deemed dividend under Income tax act where any loan or advance to the substantial shareholder (holding more than 10% share capital) of the company is deemed as dividend and TDS @10 was levied. The loan or advance is treated as dividend to plug the loopholes in the law.

What was the loophole?

For any company to pay its dividend to the shareholder, it needs to pay dividend tax (known as DDT) @15% to the government of India. DDT is levied on all the dividend income. Now to save this DDT, the owner of the private companies takes loan from the company and which they never return. Since, loan cannot be considered as income, DDT was not levied and this is how they save the tax of 15%.

Government changes law

Hence, in order to plug the loophole, the government introduced section 2(22)(e) which states that any loan or advance to the substantial shareholder shall be treated as dividend and companies needs to deduct TDS @ 10%.

But now, the government has changed the law in order to make it more stringent by levying DDT on deemed dividend under section 2(22)(e).

Now, if the company lends any loan to its shareholders (owning more than 10% of the share capital), then the company will needs to pay 30% as DDT tax to the government of India.

What if the loan is genuine with regular repayments on records?

The above section is very harsh and shall cover each and every loan under its ambit whether it is a genuine one or not, DDT shall apply. Hence, doesn’t matter if the loan has been repaid entirely by the shareholder, the section shall apply and company will need to pay 30% as DDT.

Applicability of section 2(22)(e) - Deemed dividend

This section is applicable only to closely held companies. Closely held companies are those in which the public are not substantially interested, i.e. private companies and public companies.

Further, this section is applicable on all payment made to a shareholder (or to any other person for his benefit) who is a substantial owner of atleast 10% of the equity share capital.

Furthermore, if the loan or advance is given to any concern in which such shareholder is a member or partner and in which he has a substantial interest. Let us understand this by way of a diagram.

 

Due dates for payment of DDT on deemed dividend

Once DDT is applicable, the same must be paid within 14 days of giving loan to the shareholder. If the DDT is not paid to the government within the time frame, then the tax will have to be paid within interest.

When loan is not regarded as dividend – Exceptions to section 2(22)(e)

Though the section 2(22)(e) may be the harsh section, but still it has some exceptions i.e. where you save yourself from the taxful clutches. Let us discuss the useful exceptions to deemed dividend i.e. Section 2(22)(e).

• Accumulated profits: It is a well settled law that dividend can only be paid out of profits and hence, deemed dividend under section 2(22)(e) is applicable only if the company possesses accumulated profits. E.g. you paid loan of Rs.10 lakh but company has profits up to Rs.5 lakh. In that case only Rs.5 lakh shall be taxable as deemed dividend.
   

• No dividend in case of loss: If the company has loss then there will be no deemed dividend. This is because section 2(22)(e) is applicable only in case of loss.
   

• No deemed dividend in case of commercial advance or trade advance: The Central Board of Direct taxes (CBDT) has issued a circular no.19/2017 dated 12th June, 2017 stating that commercial or trade advance shall not be covered under the definition of deemed dividend. Here are few examples of trade advances:

• Advances made by a company to a sister concern and adjusted against the dues for job work done by the sister concern. It was held that amounts advanced for business transactions do not to fall within the definition of deemed dividend under section 2(22)(e) of the act. (CIT vs. Creative Dyeing & Printing Pvt. Ltd., Delhi High Court).

• A floating security deposit was given by a company to its sister concern against the use of electricity generators belonging to the sister concern. The Company utilized gas available to it from GAIL to generate electricity and supplied it to the sister concern at concessional rates. It has held that the security deposit made by the company to its sister concern was a business transaction arising in the normal course of business.

Conclusion

The deeming fiction of the section 2(22)(e) is a harsh section indeed and hence, one must be cautious about it and should not ignore. For more information, please email us at info@hubco.in.