Taxability of dividend has been an interesting facet of tax-law. Currently, dividend declared by the Indian companies is exempt from tax in the hands of shareholders but the declaring company has to pay corporate dividend tax at 17 per cent (approximately) on the dividend so declared to the shareholders.
The concept of deemed dividend was enacted under section 2(22)(e) of the Income-tax Act, 1961 to curb the malpractice of slicing away companyโs profitsโ by way of loans to its major shareholders instead of declaring dividend in order to avoid dividend taxation.
Conceptually, section 2(22)(e) creates a fiction by which loans or advances by a closely held company to its major shareholders (or to certain concerns in which those shareholders have a substantial interest thereof) are treated as dividend for the purpose of levy of income-tax, although such loan or advance may have been given for genuine business purposes and even if the paying company may have received back the loan amount. Thus, the section deems certain payments (to the extent of accumulated profits) as dividend income, which is not income under ordinary commercial parlance. Therefore, the name deemed dividend.
The application of this provision leads to unfair result many times, when the payments of all loans or advances by closely held companies to their major shareholders are deemed as dividend, even though the loan or advance may have been repaid by the shareholder to the paying company within the same financial year. And if another loan of the same amount is taken by the shareholder after the repayment of earlier loan, the same would again be taxed as deemed dividend (to the extent of accumulated profits) in the hands of the shareholder, even when the second loan may also have been repaid during the same financial year. This unrestricted interpretation and implementation of the provision leads to unfair results.
The Indian corporates have already started knocking on the finance ministryโs doors for tax reliefs. In such a situation, it would be in the best of interests of taxpayer community that this unfair provision is amended and rationalised in the ensuing Budget on the following counts:
* Genuine loans and advances, which are repaid during the year, should be excluded from the scope of deemed dividend as they are not a subterfuge for payment of dividend. This is because if the sole object of enacting this provision is to curb the evil of distributing profits under the guise of loans or advances, then an advance or loan, which is repaid in the same year, cannot be said to be a device for distribution of profits.
* Where loans or advances are given by the companies to their shareholder employees on current market rates of interest as per the policy of the company, deemed dividend provisions should not get triggered as even otherwise the company is meeting its obligation by paying taxes on such interest income also;
* Loans and advances given out of business necessities, needs and exigencies should be excluded where such facts can be established. For example, advance given to an employee-shareholder for his foreign business trip on behalf of the company should not be considered as deemed dividend, when the travel expenditure is allowable as business expense to the company and the same travel expense also suffers fringe benefit tax in the hands of the company; and
* Another area of concern is short-term loans/advances given to the majority shareholders (who may be employees or others). These short-term loans/advances are always repayable and treating them as dividend income in the hands of the payee leads to the conclusion that this sum exclusively belongs to the payee.
The issues remain contentious and one hopes that the finance minister brings much needed clarifications on these issues in the forthcoming budget and rationalizes the law in this regard.
(Naveen Aggarwal is the executive director of KPMG).