Dividend Distribution Tax (DDT) - Dividend u/s 2(22) (e) and Chapter XIID an analysis in view of decision of Tribunal in respect to deemed dividend under section 2 (22) (e)- is taxable in hands of shareholders and not the company.

[DEV KUMAR KOTHARI]

Summary:

In true sense dividends are those distribution of profits which are declared in proportion to share capital held, (on paid basis) by shareholder on the record date. At relevant times company is made liable to pay additional tax on dividend distributed and the shareholder is exempted. Certain payments made by companies in which public is not substantially interested to shareholders who hold substantial interest in the company are deemed as dividend u/s 2 (22) (e), if the company has accumulated surplus. Such payments are in fact in nature of loans and advances and are generally not in proportion of capital held by shareholders. Though there is no release of funds in favor of the borrower-shareholder, and therefore, they are not really dividend. However, These are deemed dividend in hands of shareholders but are not considered as dividend for the purpose of additional tax payable by the company. Therefore such deemed dividend is not exempt in hands of shareholders.

Payment of dividend by companies

Companies can distribute their profit or income including accumulated profit or income to shareholders in certain manners.  Such distribution is called declaration of dividend.  The term dividend has been defined in section 2(22) in an inclusive manner and it also provides certain payments, which will not be included within the definition of dividend.  In this write up detailed discussion of the section is not desirable and we are concerned with dividend within meaning of section 2(22) and the liability of company to pay tax on dividend distributed during relevant period. 

Clause (e) of section 2(22)

As per this clause certain payment by a company in which public are not substantially interest of any sum out accumulated profits of the company made to specified persons, is deemed as dividend. In popularly referral language certain loans and advances made by a company in which public are not substantially interested to substantially interested shareholders is being deemed as dividend. 

Meaning of dividend for Chapter XIID

Chapter XIID contains a special provision relating to tax on distributed profits of domestic companies.  This has only three sections, namely section 115 O, which is a charging section and also prescribes the period, the rate of additional tax, which is payable, and time and manner of payment etc. by company on dividend distributed.  Section 115-P provides for interest payable for non-payment or delayed payment of additional tax by domestic companies. Section 115-Q is about when company is deemed to be in default.  At the end of the chapter, there is an explanation, which reads as follows:

Explanation - For the purposes of this Chapter, the expression "dividends" shall have the same meaning as is given to "dividend" in clause (22) of section 2 but shall not include sub-clause (e) thereof.

A reading of the above explanation shows that this is applicable to the entire Chapter XIID and not to any specific section and according to this explanation for the purpose of this chapter, deemed dividend under clause (e) of section 2(22) is not considered to be dividend. All other types of dividend specifically covered u/s 2(22) or in any other manner (as the definition is inclusive) are considered dividend and the company which distributes profit to its shareholders is liable to pay tax u/s 115 O.  

Why is the explanation?

On perusal of section 2(22) we can find that in case of other modes of distribution of profit, the company may distributes such profit in any manner but it will be to all the shareholders in proportion to the number of shares held by them, if all shares are equal in entitlement. In case there are different types of shares, then dividend will be in proportion to paid-up capital thereon and as per the terms of issue. Whereas in case of payments which are deemed as dividend under clause (e), the payments are not in proportion to the share holding / paid up capital held by different members.  Therefore, the deemed dividend u/s 2(22)(e) is materially different from other types of dividend-covered u/s 2(22).  In fact, the company does not declare a dividend of the nature contemplated in section 2(22)(e), rather the company advances certain money with a condition that the same will be in nature of loan or advance, it may bear interest also and it is refundable.  However, still it is deemed to be dividend in hands of shareholder who receives such payment because the purpose of treating such payment as dividend is to check the practice of giving away money of company to shareholders without paying corporate tax.  This being the factual and legal position, it appears that such deemed dividends are excluded from the ambit of section 115 O and the company is therefore, not liable to pay additional tax on such payments.

An example:

Company: Dividend Rich Manufacturing Company P. Ltd.

The company is a manufacturing company and money lending is not its business.

Paid up capital Rs.500000/- (500000 shares of Re. 1/- each fully paid-up)

Share holders: A, B, C, and D each holding 125000 shares that is each has a stake of 25% and every one is substantially interested.

Dividend declared Rs.10/- per share Rs.50, 00,000/-. This dividend will have to be paid in proportion of shares held by the shareholders on the record date. In this case as all shareholders hold equal number every one will get equal amount of dividend that is Rs.12, 50,000/- as dividend will be paid to each of A, B, C and D.

The company is required to pay additional tax on the sum of Rs.50, 00,000 distributed by way of dividend under section 115 O.

Suppose, the company has accumulated surplus of Rs.Ten crores. It advances a sum of Rs. one crore to Mr.A as loan bearing interest @ 14% p.a. and refundable after one year.

Mr. A holds 25% (that is not less than 10% voting power) stake in the company and therefore clause (e) of subsection 22 of section 2 is applicable in his case.

Any other shareholder has not taken any loan from the company. Here lies the difference; the loan or advance is not in proportion of capital held. 

The sum of Rs. one crore, is not dividend for the purpose of Chapter XII D as it is expressly excluded from the scope of dividend for the purpose of the entire chapter. Therefore, the amount of loan granted to Mr. A, may be deemed dividend under clause (e) of sub section (22) of section 2 but it is not dividend for the purpose of Chapter XII D. Therefore, the company will not be liable to additional tax on this sum. The shareholder Mr. A, may be liable to tax by deeming such sum as dividend u/s 2 (22) (e), unless, he is able to bring it in some exempted category specified in section 2 (22) or if it can be established that the shares are eligible only for a fixed rate of dividend.

When company is not liable to pay tax, the shareholder is liable

From the above discussion it is observed that on deemed dividend u/s 2(22)(e), company is not liable to not pay additional tax u/s 115-0.  Therefore, such dividend is not a dividend referred to in section 115-O.  From the history of section 115-O, we find that it provided for levy of additional tax on companies and exemption in the hands of shareholders simultaneously. When tax u/s 115 O was withdrawn, exemption u/s 10(33) was also withdrawn.  Therefore, it can be said that section 115 O is a special provision and a special manner of collecting tax on distribution of income.  In totality there is no extra burden when we consider the company and its shareholders together.  For this reason also, it can be said that a distribution of profit which does not require payment of additional tax by the company is not intended to be exempted u/s 10(33).

Provisions of old section 10 (33) and new section 10(34) (w.e.f. 01.04.2004) reads as follows:

"Any income by way of dividends referred to in section 115 O"

This clearly shows that dividend referred to in section 115 O are exempted. Dividend referred to in section 115 O is those divided in respect to which the company has paid additional tax under section 115 O.

Recent decision of ITAT

In case of ITO v. Kalyan Gupta, (2007) 107 ITD 570 (Mum.) " E" bench, Mumbai ITAT considered claim of the assessee that a sum of money to which section 2(22)(e) is applicable is also exempt u/s 10(33) {now section 10 (34).}. The assessee contended that the explanation appears after section 115 Q, therefore, it is applicable only to S. 115Q. On reading of the provisions in entirety, the Tribunal held that the words 'dividend' or 'dividends' appears only in section 115 O and not at all in sections 115 P and 115 Q. The explanation starts with the words ' for the purpose of this chapter', therefore, the explanation is applicable to the entire chapter including section 115 O. (in fact practically the explanation is meant only for section 115 O).

Therefore, the Tribunal held that the assessee couldn't claim loans granted by the company which is deemed as dividend u/s 2 (22) (e), as exempt by virtue of section 10 (33) because it is not a dividend referred to in section 115 O.

Conclusion:

It can be said that dividend which has suffered tax by way of additional tax paid by the company who distributed dividend can only be considered as dividend for the purpose of exemption under section 10 (33) or section 10 (34) at the relevant times. As deemed dividend under section 2(22) (e) is not included in meaning of dividend for the purpose of Chapter XII D including section 115 O, therefore it is not a dividend referred to in section 115 O, and therefore the company is not liable to pay additional tax but the deemed dividend will be included in the income of shareholder if other conditions are satisfied.

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