Section 2(22) (e) deemed dividend

Deepak Dargad (Chartered Accountant....)   (9787 Points)

18 April 2013  

Yesterday i am reading an article about Sec 2(22)(e) on internet , I find this file on net , so I share it with you all, hope its help us all




Deemed Dividend -Section 2(22)(e) of Income Tax Act 1961

Loans & Advances to Directors and Family members of Closely held Companies



Private Limited Companies generally give Loan or Advance to their director and family members who are again shareholders holding 10% or more voting power or to a concern in which such shareholder has substantial interest. Such loan or advance is treated as deemed dividend covered under section 2(22)(e) and taxable in the hands of shareholders or concern as the case may be.



 Let us first read  Section 2(22)(e) of Income Tax Act 1961:

“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”

 Following points are to be understood with reference to the above:


 [A]  Accumulated Profits for the Purposes of Section 2(22)(e)


(i) General

 Sub-clause (e) applies when distribution or payment referred to therein are connected with accumulated profits. The undistributed income, when accumulated from year to year, generates what is known as "accumulated profit". Accumulated profits shall include all profits of the company till the date of distribution or payment referred to in sub-clause (e).


(ii) Current Profits

 Current profits are included in "accumulated profits" in section 2(22)(e) of I.T. Act 1961. The expression "accumulated profits" was defined in the 1961 Act so as to include current profit upto date of distribution or payment.


 (iii) Accumulated profits – How to be Computed


 The phrase "accumulated profits" does not mean aggregate of assessed profits but commercial profits. If certain disbursements have been disallowed in the assessment proceedings but the expenditure had in fact been incurred, they should be excluded from accumulated profits. In computing commercial profits, all the disbursements made and expenditure incurred for the purpose of business should be taken into account. The following are the items which are to be included or to be excluded in computing accumulated profits:





Items to be excluded

Items to be included


Provision for taxation and dividend

Development rebate



Refund of income-tax


Difference between depreciation calculated at the rate given under the IT Act and rate adopted in books

Development rebate reserve


Balancing charge

General reserves


Capital gains not chargeable to tax

Capital gains chargeable to tax



[B] Advance Or Loan To A Shareholder By A Closely - Held Company 

 I)  Who should be given loan or Advance

 Loan or Advance is given by a closely held company (i.e. Private Limited Company) to-

 (i) Shareholder holding 10% or more voting power in that company;

 (ii) Concern i.e. HUF, Firm, AOP, BOI in which, Shareholder who holds 10% or more voting power in the company, also holds 20% or more of the income of that concern at any time during the previous year;

 (iii) Concern i.e. Company in which, Shareholder who holds 10% or more voting power in the company, also holds 10% or more voting power of that concern at any time during the previous year.



II)  Loan or Advance

 The expression used in section 2(22)(e) is "advance or loan". It ordinarily means payment of cash or transfer of goods for which accounting must be rendered by the recipient at some later date. Thus, there would be advance by the company when goods are transferred to shareholder. The expression "advances" also refers to something which is due to be paid to the shareholder but which is paid to him ahead of time when it is due to be paid.

 The transaction of loan involves lending and delivery by one party and receipt by another party of sum of money upon express or implied agreement to repay it with or without interest.



III)  Factors to be  considered w.r.t. Loan or Advance

  •  A loan of money results in a debt but every debt does not involve a loan [ Bombay Steam Navigation Co. (1953)(P) Ltd. vs. CIT (1965) 56 ITR 52 (SC) : TC16R.881];
  •  Section 2(22)(e) does not say that in order to come in the category of deemed dividend, loan should be of particular minimum duration. A loan for few days would be within its ambit. Thus duration of loan is not material [Walchand & Co. Ltd. vs. CIT (1975) 100 ITR 598 (Bom) : TC41R.305];
  • Any loan given by life insurance companies to their policy holders-shareholders in the normal course of business on the security of insurance policies and within the limits of their surrender value should not be treated as dividends [Circular No.43 (LXXVI-7) dt. 27th Oct., 1955];
  •  Payment by company to a firm in which shareholder is partner for repayment of advances in regular course of business cannot be deemed dividend under section 2(22)(e) [Mukundray K. Shah vs. CIT (2005) 197 CTR (Cal) 563 : (2005) 277 ITR 128 (Cal)];
  •  Withdrawal over and above credit balance is to be treated as deemed dividend. For example, When company has accumulated profits, withdrawal by a shareholder over and above the credit which he has with the company would be deemed dividend when the shareholder had no credit balance in any other account [CIT vs. P. Sarada (1985) 46 CTR (Mad) 328 : (1985) 154 ITR 387 (Mad) : TC41R.306];
  •  Payment by the company towards the personal expenses of the shareholder would be treated as deemed dividend [CIT vs. K. Srinivasan (1963) 50 ITR 788 (Mad) : TC41R.173];
  •  Loan obtained by the shareholder through proprietary concern would be treated as deemed dividend under section 2(22)(e) [Nandlal Kanoria vs. CIT (1980) 122 ITR 405 (Cal) : TC41R.311];
  •  Shareholder doing business with company and always having debit balance Explanation: When a shareholder has a business with the company and when his accounts with the company is always on debit side, the amount in question would be regarded as loan by the company to the shareholder and if there are accumulated profits to cover the debit balance, the amount in question would be regarded as deemed dividend under section 2(22)(e) [ CIT vs. Jamnadas Khimji Kothari (1973) 92 ITR 105 (Bom) : TC41R.320]. However, where company has made advances to the concern of the shareholder towards purchases to be made by the company from the said concern, such advances would not be deemed dividend under section 2(22)(e) [CIT vs. Nagindas M. Kapadia (1989) 75 CTR (Bom) 161 : (1989)177 ITR 393 (Bom) : TC41R.321];
  •  Money advanced as loan by company substantially doing money lending business could not be treated as deemed dividend under section 2(22)(e) [CIT vs. V. S. Sivesubramaniam (1997) 141 CTR (Mad) 34]



IV)  Effect of repayment of loan


As soon as loan is advanced to shareholder by closely held company from accumulated profits statutory fiction under section 2(22)(e) becomes operative and such loan is deemed to be dividend. Such loan does not cease to be deemed dividend on account of any subsequent event. 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.



V)  Subsequently declared dividend set off against previously granted loan

 Where a loan granted by the company is treated as dividend under section 2(22)(e) and the company subsequently declares regular dividends and sets it off against the said loan, the dividends so set off would not be treated as dividend in the hands of the shareholder.



VI)  Exception where substantial part of business of the company is money –



Where the lending of money is a substantial part of the business of the company, "dividend" would not include any advance or loan made in the ordinary course of business to a shareholder or to the concern in which such shareholder has substantial interest.



[C] Quantum of deemed dividend


The principle is that where loan given by the company exceeds the accumulated profits, deemed dividend would be to the extent of accumulated profits and balance of loan amount would not be deemed dividend. If the accumulated profits exceed the loan amount, entire loan amount would be deemed dividend and not the amount proportionate to shareholder's interest in the shareholding of the company. If there are no accumulated profits, there would not be any question of loan being treated as deemed profits.





The assessee held 25% shares of the closely held company. The accumulated profits were Rs. 4,000 while the assessee took loan of Rs. 29,000. Here, loan given by the company exceeds the accumulated profits. Thus, entire accumulated profits are to be taken into account under section 2(22)(e). And only 25% of Rs. 4,000 should not be regarded as deemed dividend under section 2(22) (e).




[D] Taxability of Deemed Dividend under section 2(22)(e)


Deemed Dividend u/s 2(22)(e) is taxable in the hands of shareholder u/s 56 of the Income Tax Act and it is not taxable in the hands of company.


Also Deemed Dividend u/s 2(22)(e) is not exempt u/s 10(33) of the Income Tax Act.

(income tax officer vs Kalyan m Gupta (2007) 111 TTJ (mumbai)1005,(2007)107 ITD 34 (Mumbai),(2007)11 SOT 530

Kalyan Gupta case

Kalyan Gupta was a shareholder with more than 10 per cent interest in Om Shipping Agents (P) Ltd. He received a loan of Rs 73 lakh from the company. This was outstanding as on March 31, 1998. After hearing the assessee, the income-tax officer (ITO) added Rs 73 lakh as deemed dividend assessable under Section 2(22)(e).

It was pleaded that the amount was only a temporary borrowing and not in the nature of loan or advance. As this argument was not accepted, another submission was raised to the effect that the dividend exemption provision under Section 10 should be given effect in respect of the sum of Rs 73 lakh.

This provision came into effect from the assessment year 1998-99. What applies to dividend income should also apply to deemed dividend under Section 2(22)(e). The Bench examined Sections 115O, 115P and 115Q in Chapter XIID of the Act. It referred to the Explanation given in this chapter: “For the purposes of this Chapter, the expression “dividend” shall have the same meaning as is given to “dividend” in clause (22) of Section 2 but shall not include sub-clause (e) thereof.”

The loan or advance to the substantial shareholder is treated as deemed dividend under Section 2(22)(e). The Explanation at the end of Chapter XI B stipulates that the expression ‘dividends’ shall not include this type of deemed dividends comprising loans and advances. Thus, deemed dividend referred to in Section 2(22)(e) has been excluded from the ambit of Chapter XIIB. Tax is not levied on the company with regard to such deemed dividend. Consequently, the exemption provided under Section 10 is not applicable to “deemed dividend” referred to in Section 2(22)(e).