Dividend - Sec 56(2) (i)

Dividend means distribution of profits by the management to the real owners- the shareholders. Dividend is chargeable to tax whether paid in cash or kind or paid out of taxable profits or tax -free income, out of revenue profits or capital gains. Dividend is taxable when declared at the Annual General Meeting of a company and not when received, but interim dividend is taxable on the basis of payment.

Income from dividend (not being deemed dividend) from an Indian company is tax free in the hands of the shareholders as the distribution of dividends is taxable in the hands of the company.

5.2. Deemed dividend: -Loan to shareholders- S. 2(22) (e)

According to section 2(22)(e), if a closely held company gives a loan or advance to a person for his individual benefit and the person is having substantial interest (10 per cent)in the company or to a concern(HUF/Firm etc) where the person having substantial interest has at least 20 per cent interest, then the receiver of that loan will be treated as if he has received the dividend amount to the extent of loan and it will be taxable in his hands as dividend income.

This provision has been inserted so as to prevent persons having substantial control and influence over the affairs of a company to take away all funds of the company as low-interest loans for their personal benefit to the prejudice of the other shareholders.

Some other important points should be kept in mind:

1. The dividend under this clause is taxed in the hands of the shareholder, who is entitled to set off the same if and when company declares any dividend. The dividend will be taxable in the year when the loan was given – S.8. (In practice, since the dividend is tax-free in the hands of the shareholder, the set –off provision does not grant any real benefit of set-off to the shareholder.

2. If the loan is repaid, dividend income will still be taxable in the hands of the recipient. The courts have repeatedly held that there is no inequity in this.

3. The loan will be taxable as dividend only to the extent of free reserves of the company.

4. The section will be applicable only on cash loans or advances and not on advances in kind say by way of sale of goods in the normal course of business.

5. Loans or advance made by the lending company for which lending is the main or substantial part of its business will also not be covered by this section ,

6. Any advance or loan made to a shareholder or the concern by a company in the ordinary course of its business, for purchase of its own shares or on demerger etc will also be not be covered under this section;

7. The dividend will also be subject to TDS

8. Substantial interest may be existing at anytime during the year 9. Any deemed dividends u/s 2(22)(e) or dividend from any other

entity is, however taxable in the hands of the recipient.

10.Deduction of expenses on collection and interest on loan, taken for investment in shares, is available against dividend income. Illustration- 1

A takes a loan of Rs 20 lakhs from A Ltd in which he is a shareholder having substantial interest. A returns the loan next day, when he makes his own arrangement for finance. The Company was having free reserves of Rs 10 lakhs only.

Solution:

Out of loan taken from A Ltd., only Rs. 10 lakhs (to the extent of free reserve of the company) will be treated as deemed dividend u/s 2(22)(e). Repayment of loan does not affect the tax liability. If and when A Ltd declares any dividend, A will be entitled to set-off, Since , the final dividend is tax free, A will have no real benefit.

Illustration- 2

A takes a loan of Rs 20 lakhs from B, in which he is a shareholder having substantial interest. The Company was having free reserves of Rs 20 lakhs.

Solution:

Entire loan amount of Rs 20 lakhs will be deemed to be dividend in the hands of B U/s 2(22) (e).

Illustration -3:

In the above case, assume B Ltd is a loss making company having no free reserves

Solution:

Since B Ltd. has no free reserves; the loan taken will not be taxable in the hands of A as dividend.

Illustration- 4

A takes a loan of Rs 20 lakhs from D Ltd. , in which he holds substantial interest in B Limited for one month only. Thereafter, he transfers the shares. The Company was having free reserves of Rs 20 lakhs.

Solution:

Entire loan amount of Rs 20 lakhs will be deemed to be dividend in the hands of B U/s 2(22) (e) even if A holds substantial interest only for a part of the year.

5.3. Deemed dividend – Distribution by Companies: S. 2(22) Any distribution by the a company to its shareholders which entails the assets of the company , or distribution made on liquidation or reduction of capital is regarded as dividend to the extent of accumulated profits of the company.

Similarly, any distribution by a company to its preference shareholder or debenture holders is also regarded as deemed dividend to the extent of accumulated profits of the company.

Dividend in this class is directly taxable in the hands of the company.