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Deemed dividend - loan repaid with interest within 2 months

AMehta (InfoTech Professional) (47 Points)

04 November 2011

Here are the facts of the case:

A company advanced loan to a partnership firm. One partner is holding 20% share in firm. Same partner is also holding more than 10% shares in the company.

The partnership firm repaid the loan within 60 days (within the same financial year). It also paid interest to the company.

Is this still covered under Deemed Dividend?

(Loan was not advanced in regular course of business)

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17 Replies

DIPESH VASA Helping Hand!!!!! (CA FINAL ) (441 Points)
Replied 04 November 2011

NO IT IS NOT A DEEMED DIVIDEND U/S 2(22)(E)

AMehta (InfoTech Professional) (47 Points)
Replied 04 November 2011

Are there any supporting judgements, notifications, circulars, etc. in support of this view?

DIPESH VASA Helping Hand!!!!! (CA FINAL ) (441 Points)
Replied 04 November 2011

AS HE IS NOT A SUBSTANTIALS INTEREST HOLDER M SURE

vik (student) (113 Points)
Replied 04 November 2011

WHY? CAN U EXPLAIN?

AMehta (InfoTech Professional) (47 Points)
Replied 04 November 2011

Actually the partner is substantial shareholder i.e.

has 20% share in firm

has 10% share holding in company

vik (student) (113 Points)
Replied 04 November 2011

THAT'S WHY DON'T THE LOAN TREATED AS DEEMED DIV?

amitmehta_ca (CA, CMA) (99 Points)
Replied 04 November 2011

First of all please tell me whether the company is Pvt Ltd or not ?

amitmehta_ca (CA, CMA) (99 Points)
Replied 04 November 2011

Kindly go through the explaination being provided

/articles/understanding-deemed-dividend-with-latest-case-laws-11385.asp

One more thing i just want to convey that it would amount to deemed dividend and tax needs to deposited on such payment made else you the will goin to get caugght later on this part and den interest + penalty can be levied by ITO.

Kunal (Risk Analyst) (299 Points)
Replied 05 November 2011

Its a case of deemed dividend u/s 2(22)(e). Repayment of loan does not alter the situation n thus it is irrelevant wthr d loan has been paid or not. N it shall be regarded as deemed diviend in hands of partnership firm n nt d shareholder. CO. has to pay tax u/s 1150 at 15% (SC n EC SHEC extra) within 14 days of payment of loan(deemed dividend) to partnership firm.

Member (Management) (325 Points)
Replied 05 November 2011

Whether or not the loan is repaid is of no consequence. It is still deemed dividend as per Section 2(22)(e) in the hands of the firm.

Refer the case of P.Sarada Vs CIT 229 ITR 444 by the SC.

AMehta (InfoTech Professional) (47 Points)
Replied 05 November 2011

Unfortunate that an actual loan transaction is getting taxable due to an assumption of law! This in effect is tax without income.

A pretty draconian provision, IMO. Probably it's the provision like these that compel even an honest tax payer to resort to corruption!

Hari Wadhwa (CA in Practice) (485 Points)
Replied 08 November 2011

Mr Mehta

It's true that even a genuine transaction is covered under the draconion provisions of Sec 2 (22)(e) & hence, the payer company is required to pay tax.

However, despite of this, if it has happend in your case, following wayouts, although, some are advisable & some are mens ria wayouts & hence are not advisable, but, still are produced below at your option to escape/compensate the beat of the effects of this severe provision: -

Option 1: -

Declare ACTUAL dividend.

The effect of this would be that the compnay would not be required to pay tax on this amount as the amount to the extenct it had already taxed earlier as deemed dividend under sec 2(22)(e), would not make compnay liable to pay dividend again on this amount.Thus, a company can provide some benefit to its shareholder against taxes paid.

Option 2: -

Alter Partnesrship Deed.

Change the partnership deed IN BACK DATE (in previous Financial Year), if possible, in such a manner so as to make the partner a NON SUBSTANTIAL holder in the partnership firm, thereby, avoiding the question of deemed dividend in the hands of a firm in which shareholder have substantial interest.

(Pls note that changing Partnership deed in the back date but in the CURRENT YEAR WOULD NOT WORK)

Option3 : -

Forfeit Shares: -

- Pass a resolution in the BOD meeting IN BACK DATE in previous F.Y. demanding call money (if shares are not fully paid) & forfeit shares by showing non payment of call money by the shareholder (being Defaulting shareholder).This practice would be easy to do as no reporting of change in share holding patteren need to be given to stock exchange, being a clsoely held company.

- Make necessary entries in the register of Members to this effect.

- Pay penalty under Companies Act (it would be very less as compared to hit under sec 2(22(e) )for wrong reporting in Annual Return (as you are changing shareholding pattern in the back date)

(Pls note that forfeiting the shares in the back date but in the CURRENT YEAR WOULD NOT WORK)

PLS NOTE that, I am NOT RECOMMENDING the adoption of these wayouts to follow as these are not considered good practices by an honest taxpayer, but, still I have produced these here, just to discuss as a part of professional learning ,discussion & knowledge enhancment.

CA PARAS BAFNA (Practising CA ) (33423 Points)
Replied 08 November 2011

First of all -check whether the company is having accumulated profits upto the date of such payment.

AMehta (InfoTech Professional) (47 Points)
Replied 10 November 2011

Dear Mr. Wadhawa,

Thank you for your inputs. In the circumstances, all options, even though illegal, look legitimate. However, we have decided not to resort to illegal means even though wronged by a draconian provision drafted by some over-zealous idiotic babu. Even the assessing officer agrees that the provision was not meant to cover such transactions and assessee is being wronged here.

Dear Mr. Bafna, there are enough accumulated profits in the company to cover the payment.