1. Deemed Dividend under Section 2(22)(e)
According to Section 2(22)(e), when a company in which the public are not substantially interested*, extends a loan or an advance to:
a. any of its shareholders who has more than 10% voting power in the company or
b. to any concern in which such shareholder is substantially interested or
c. for the individual benefit of such shareholder or
d. on behalf of such shareholder
to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22)(e).
*a company in which public is not substantially interested is otherwise called a closely held company.
Payment under circumstances specified below will not be treated as deemed dividend.
a. Loan given by a company involved in money lending, where loans have been extended in the ordinary course of business
b. Loan extended to shareholders, subsequently adjusted against dividend declared and distributed later
Here is a simple illustration to explain the provisions of deemed dividends.
ABC Pvt Ltd. is a company, the public is not substantially interested in. Hari is one of the company shareholders, who hold 15% shares. The company has accumulated profits of Rs.25 lakhs as on 31 March 2018. The company granted a loan of Rs.100,000 to Hari, by way of an account payee cheque. He repaid the amount on 5 May 2018.
In this case, even if the loan has been repaid by Hari, the loan amount granted to the extent of accumulated profits are treated as deemed dividend.
4. Income tax implications
Earlier (prior to 1 April 2018), companies that pay out deemed dividends would not pay DDT on such payments. However, Budget 2018 introduced an amendment to Section 115-O that addresses this. It mandated such companies to pay DDT at the rate of 30% plus applicable surcharge and cess on transactions carried out on or after 1 April 2018. As a result, the shareholder doesn’t have to pay any taxes on such receipts.
This amendment has been introduced because the taxability of deemed dividend in the hands of recipient made tax collection on it from the shareholder difficult. Further, deemed dividend taxability itself was also a matter of extensive litigation. The amendment has put all this to rest.