Dividend and Deemed Dividend

Dividend can be defined in many ways but in more common parlance it’s just appropriation of profits. There are quite a lot of statues which define the term dividend but we will focus our attention on dividend distributed by companies. Apparently we have selected the definitions of dividend as per companies Act, 2013 and the Income Tax Act, 1961.

The term ‘dividend’ has been defined under Section 2(35) of the Companies Act, 2013. The term “Dividend” includes any interim dividend. It is an inclusive and not an exhaustive definition. According to the generally accepted definition, “dividend” means the profit of a company, which is not retained in the business and is distributed among the shareholders in proportion to the amount paid-up on the shares held by them. There are two recognized terms of dividend investor per se

1. Final Dividend which is generally declared at an annual general meeting at a rate not more than what is recommended by the directors in accordance with the articles of association of a company.
2. Interim dividend which is declared by the Board of directors at any time before the closure of financial year, whereas a final dividend is declared by the members of a company at its annual general meeting if and only if the same has been recommended by the Board of directors of the Company

The Income Tax Act has a wider definition of the term Dividend. However for the sake of brevity we will understand two important clauses only. The term ‘dividend’ has been defined under Section 2(22) of the Income Tax Act, 1961 as

"dividend" includes—

(a)   any distribution by a company of accumulated profits, whether capitalized or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company ;

(e)    any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;

but "dividend" does not include—

 (ii)    any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company ;

On a brief reading one can conclude that clause (a) stated above is the Interim or Final dividend which is quite known to everyone. But IT Act has introduced a deeming fiction for the term dividend by introducing clause (e) to Sec 2(22) which is known as deemed dividend. Not many are familiar with this term. However with growing complexities of the Income Tax Act we felt the need to explain this term as well.

The provision of Deemed Dividend is applicable to a private limited company only.  It is applicable when a private limited company makes a payment to

1. Its beneficiary equity share holder holding 10% or more of voting power. OR
2. to any concern(Company/Firm/Limited Liability Partnership/Proprietorship businesses) in which such shareholder is a member or a partner and in which he has a substantial interest (which means he holds 20% or more of ownership/income of that concern or 10% or more if it is a company) OR
3. any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits

Generally the directors of a private limited company are only its shareholders. Many a times Directors use the companies accumulated profits to pay them as a Loan or advance this resulted in accumulation of huge advances in the names of directors as they were reluctant to pay dividend distribution tax by distributing the profits as dividend. Also there are many personal liabilities of the shareholder directors which are met from company’s funds. In order to curb this practice the Income Tax came up with a provision to tax such distribution of profits as loan or advance or meeting personal liabilities and termed such distribution as deemed dividend.

TAXABILITY

Dividend distributed by companies is exempt u/s 10(34) of the Income Tax Act, however the only condition to claim dividend as exempt income is that the company is required to pay dividend distribution tax u/s 115-O before or on distribution of dividend. It is worthwhile to note that sec 115-O is applicable only to domestic companies and not on Foreign Companies. Therefore dividend received from a foreign Company is always taxable.

Deemed Dividend is not a dividend on which dividend distribution tax u/s 115-O is required to be paid. Hence such dividend is always taxable. However such dividend is taxable only to the extent of accumulated profits of the company. Even if the loan is repaid by the shareholder in the same previous year, the statutory fiction arising at the time of giving loan by the company does not cease to be operative. Such a loan would be taxed as deemed dividend even if repaid in the same previous year. The assessee held 25% shares of the closely held company. The accumulated profits were Rs. 10,000 while the assessee took loan of Rs. 50,000. Here, loan given by the company exceeds the accumulated profits in that case only Rs. 10,000 is taxable as deemed dividend. It is not calculated on percentage of shareholding.

• Dividend is classified under Income from other Sources under the heads of Income.

Conclusion

Dividend has always remained as a choice of many long term investors owing to the exemption provided by the Income Tax Act but with the introduction of deemed dividend the government has tried to plug the non propriety use of company’s funds or rather say loopholes of closely held companies to significant extent.