Loans & Advances by Closely Held Company Deemed as Dividend – Section 2(22)(e)

“Dividend” includes‑

Any payment by a closely held company (i.e. Private Limited Company) of any sum by way of advance or loan to:

A.  a shareholder being a person who is the beneficial owner of shares holding not less than 10% of the voting power

or

B.    to any concern in which such shareholder (who is the beneficial owner of shares holding not less than 10% of the voting power) is a member or a partner and in which he has a substantial interest

or

C.    any payment on behalf of or for the individual benefit of any such shareholder

to the extent to which the company possesses accumulated profits.

Note:

1.     Following conditions must be satisfied on the date on which loan/advance is given, to attract section 2(22)(e):

a.     Beneficial Owner of shares

b.    Holding 10% or more voting power

c.      Member/Partner in concern

2.     Concern means a HUF, or a firm or a company or an AOP/BOI.

3.     Substantial interest means 20% voting power/share in profit at any time during the previous year.

4.     Accumulated profits shall include all profits up to the date on which loan or advance is given to the shareholder or concern or any other person referred to in section 2(22)(e).

Example:

ABC Private Limited a closely held company has accumulated profits of Rs. 2,00,000/-. The company has given a loan of Rs. 3,00,000/- to one such shareholder Mr. X. In this case Rs. 2,00,000/- will be considered to be dividend in the hands of Mr. X and balancing Rs. 1,00,000/- will be considered as a loan to Mr. X.

Mr. X is the beneficial owner of 10% equity shares in ABC Private Limited and the company has accumulated profits of Rs.10,00,000/- and has given a loan of `6,00,000/- to a partnership firm XY in which Mr. X is has 20% profit sharing ratio. In this case, the loan so given shall be considered to be dividend in the hands of partnership firm.

ABC Private Limited a closely held company has accumulated profits of Rs. 6,00,000/-. The company has given a loan of Rs. 3,00,000/- to one such shareholder Mr. X and the company ABC Private Limited has also given a loan of Rs. 4,00,000/- to XYZ Private Limited in which Mr. X holds 25% of voting power. In this case Rs. 3,00,000/- will be considered to be dividend in the hands of Mr. X and Rs. 4,00,000/- will be considered as dividend in the hands ABC Private Limited.

Important Findings

1.      The fact that the loan or advance is repaid does not make a difference in the applicability of section 2(22)(e).

2.      Section 2(22)(e) is also attracted if company charges market rate of interest from shareholder.

3.      The company is required to deduct TDS @ 10% under section 194 of Income Tax Act, 1961 on such dividend.

4.      No Dividend Distribution Tax under section 115-O(1) is payable on such dividend.

5.      Dividend under section 2(22)(e) will be taxable in the hands of such shareholder or such concern under the head Income from Other Sources.