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Dividend refers to the returns a shareholder receives for investing in a company.
For example, let us say that Company ‘A’ is making sound amounts of net profit and wants to distribute the profits with its shareholders, The board of the company decides to give 3% returns per share to every shareholder. Each share unit costs Rs. 100, so for every share, the shareholder receives Rs. 30; this amount is called a ‘Dividend’.
Whereas the deemed dividend is a particular amount or asset loaned to a shareholder who has a substantial share in that company, for the purpose of taxation, the loaned amount is considered to be a ‘deemed dividend.’ The loan or advancement amount should only be provided from the company's accumulated profits. It is to be noted that only private limited companies whose activities are not of public substantial interest are eligible for a Deemed Dividend.
"Substantial interest" in a company generally refers to a significant ownership stake or financial interest held by an individual or entity in a particular business. When a shareholder holds at least 10% of shares and 10% of the voting interest in a company, he is said to have a substantial interest in that company.
In many cases, substantial interest is determined by the percentage of ownership or control an individual or entity holds in a company. For instance:
The concept of substantial interest often plays a crucial role in tax laws, especially concerning matters such as:
Let us say that Mr. X is a shareholder of company ’Z’, He holds shares worth 20%. As of April 10, 2020, Company Z has an accumulated profit of Rs. 5,00,000. Now, Mr.’X’ approaches the board to request a loan of Rs. 1,00,000. Mr.’X’ being a shareholder having substantial interest in company Z, the board agrees to loan him Rs. 1,00,000, after a month i.e, on May 10th. Mr. X returns the loaned amount back (which is before the end of the current financial year), although Mr. X has returned the amount, Rs. 1,00,000 made from the accumulated profits, the loaned amount will be treated as ‘Deemed Dividend’.
Section 2(22)e of the Income Tax Act deals with how the types of loans and advances the company makes for the shareholder are deemed dividends. The following are the payment methods that are considered to be deemed dividends under this act,
Few transactions, although has the nature of lending advances, are not treated as a deemed dividend, such as,
Before April 2018, deemed dividends were exempted from being taxed under the dividend distribution tax. For the financial year 2018-19, deemed dividends made to shareholders were taxed.
Deemed dividends are subject to a 30% dividend distribution tax for the company under section 2(22)e of the Income Tax Act, but the tax is exempted for the shareholder.
Therefore, for deemed dividends paid to shareholders, the company will be taxed 30% of the loan amount, even though the shareholder settled the loan amount in the same financial year.
Section 2(22)(e) defines certain transactions or payments made by a company to its shareholders or their associates as deemed dividends for taxation purposes, even if they aren't officially categorized as dividends.
Transactions that might be considered deemed dividends include distributions of accumulated profits, loans, advances, or assets provided to shareholders or their associates by the company.
Deemed dividends are typically subject to taxation at the hands of the recipient shareholders or associates as per the income tax rates applicable in their jurisdiction.
Exceptions might exist, such as loans given in the ordinary course of business, or transactions that are specifically exempted or not covered by the provisions of the Act. Specific provisions can vary across different jurisdictions.
It's essential to maintain clear records and documentation regarding transactions between a company and its shareholders or associates. Seeking advice from tax professionals or legal experts is advisable before engaging in transactions that might fall under the purview of deemed dividends.
This section prevents companies from distributing profits to shareholders in the form of loans, advances, or assets without categorizing them as dividends to avoid taxation. By deeming certain transactions as dividends, it ensures proper taxation of these distributed profits.
For detailed and specific guidance, individuals and companies should refer directly to the Income Tax Act of their respective jurisdiction or consult with tax professionals well-versed in local tax laws.
