Deemed Dividend Section 2(22)(e)

Subject: Investment by a Company in an LLP with the same individuals owning and managing business affairs of both the Company and the LLP

I was looking for advice on whether a company can advance loans to an LLP wherein the LLP and the Company have the same individuals as Directors cum Shareholders (Company) and Designated Partners (LLP) without invoking the provisions of Section 2(22)(e) wherein loan given by a Company to the body corporate (LLP in this case) is taxed as deemed dividend in the hands of the shareholder.

My understanding of the relevant sections:

As per Section 185(2) of the Companies Act, a company can give a loan within limits as per section 186 to a body corporate (LLP is a body corporate) in which director (shareholder cum director in our case) has more than 25% shareholding (Company giving the loan does not need to be a member of the LLP). However, Section 2(22)(e) of Income Tax Act considers the loan as a deemed dividend if the shareholder is substantially interested in the LLP.

If the company also becomes a partner of the LLP along with the directors cum shareholders, is deemed dividend section still attracted for loan given by Company to LLP in the hands of the shareholder? What should be the Capital sharing ratio in the LLP of the directors / shareholders and the company to not attract the deemed dividend section, if that is possible.

Regards

Great question! This is a nuanced area involving both Company Law and Income Tax provisions. Let me break it down:

1. Company Advancing Loan to LLP

Under Section 185(2) of the Companies Act, 2013, a company can advance loans to a body corporate (LLP is considered a body corporate) subject to limits under Section 186.
The fact that the directors/shareholders of the company are also designated partners in the LLP does not bar the company from giving a loan to LLP.
The company does not need to be a partner in the LLP for this loan to be valid under Companies Act.

2. Deemed Dividend under Section 2(22)(e) of Income Tax Act

Section 2(22)(e) triggers deemed dividend tax in the hands of shareholders when a company gives a loan or advance to:
- A shareholder who holds more than 10% shares in the company, or
- A concern in which such shareholder is a member and has substantial interest (i.e., more than 20% interest).
The question is: Does LLP qualify as a “concern” under Section 2(22)(e)?
- The term “concern” is generally interpreted to include companies and firms.
- LLP is a hybrid structure, but tax authorities have generally treated LLPs similar to firms for tax purposes.
So, if the LLP has same shareholders/directors as the company who hold substantial interest in the LLP, a loan given by the company to the LLP may attract deemed dividend provisions in the hands of those shareholders.

3. If Company is also a Partner in the LLP

If the company itself is a partner in the LLP, along with directors/shareholders, the shareholding ratio and profit-sharing ratio matter.
Deemed dividend under 2(22)(e) applies to shareholders who have substantial interest (generally >20%) in the concern (LLP).
So, to avoid triggering 2(22)(e), the shareholding of individual shareholders/directors in LLP should be less than 20%.
The company's shareholding (partner’s interest) in LLP doesn't attract deemed dividend since it’s not a shareholder but the company itself.
But the key is individual shareholders/directors must not have substantial interest (>20%) in LLP.

4. Capital Sharing Ratio

To avoid the application of Section 2(22)(e):
- The directors/shareholders' combined interest in LLP should be less than 20%.
- The remaining should be held by the company or other unrelated parties.
For example, if the company holds 80% and the rest of the individuals hold 20% or less, deemed dividend may not be attracted.

Summary

Situation	Deemed Dividend Triggered?
Loan to LLP with same shareholders holding >20% in LLP	Yes (Section 2(22)(e) applies)
Loan to LLP with company as partner and individuals <20% interest	No deemed dividend if individual interest <20%
Company alone partner in LLP	Deemed dividend depends on individual shares

Recommendation

Structure the LLP such that individual shareholders/directors have <20% interest in LLP.
Alternatively, limit the loan amount and obtain professional advice to avoid tax complications.
Proper documentation and agreements are key.