2005 (4) TMI 10 - AAR - Income Tax

Applicant is an Indian company and is a tax resident of India. It is engaged in the manufacture and trading of threads. It proposes to advance interest bearing loan to M/s. Coats Finance Co. Ltd., (CFL), a company incorporated in England and Wales (UK) and a tax resident of the UK held that proposed loan to be given by applicant to Coats Finance Co. Ltd. (CFL) would not be deemed dividend u/s 2(22)(e) of the Income-tax Act, 1961 to the extent of accumulated profits

Summary

Issues:
1. Whether the proposed loan from an Indian company to a UK company can be considered "deemed dividend" under section 2(22)(e) of the Income-tax Act, 1961?
2. In case the loan is considered as "deemed dividend," which entity will be taxed, and at what rate?

Analysis:

Issue 1:
The applicant, an Indian company, sought an advance ruling on whether a loan to a UK company would be considered "deemed dividend" under section 2(22)(e) of the Act. The applicant proposed to lend to a finance company of its group, which had accumulated profits. The Commissioner argued that the loan should be treated as "deemed dividend" due to substantial interest relationships within the group. The key question was whether the proposed loan satisfied the conditions of "deemed dividend" under section 2(22)(e) of the Act.

The definition of 'dividend' under section 2(22) includes specific conditions that must be met for a payment to be deemed as dividend. The provision is to be construed strictly, and the conditions include the payment being made by a company not substantially interested by the public, having accumulated profits, and being a loan to a shareholder with specific voting power percentages. The shareholder must be the registered shareholder to attract the clause.

The ruling authority analyzed the shareholding pattern of the group and concluded that the proposed loan did not fulfill the conditions of being "deemed dividend." The shareholder of the lender company did not have substantial interest in the borrower, and the loan was not being given for the individual benefit of the shareholder. Therefore, the proposed loan did not meet the criteria to be considered as "deemed dividend" under section 2(22)(e) of the Act.

Issue 2:
The ruling on the first issue determined that the proposed loan did not qualify as "deemed dividend." Consequently, the ruling authority stated that questions 2 and 3, regarding the assessment entity and tax rate, were moot as they were dependent on the first issue. Therefore, the ruling authority did not provide a separate ruling on questions 2 and 3, as they did not survive due to the decision on the primary issue.

In conclusion, the ruling authority held that the proposed loan from the Indian company to the UK company did not constitute "deemed dividend" under section 2(22)(e) of the Income-tax Act, 1961, based on the specific conditions and analysis of the shareholding relationships within the group. The ruling was pronounced on April 6, 2005, by the Authority for Advance Rulings.