Direct Tax Alert: Deemed dividend provisions not to apply in case of shares held independently by minor
14 January 2021
Section 2(22)(e) of the Income-tax Act, 1961 (IT Act) deals with the issue of “deemed dividend”. It provides that any payment by a company (not being a company in which public are substantially interested), by way of advance or loan to a beneficial owner of shares, holding not less than 10% voting power, or to any concern in which such shareholder has a substantial interest1, to the extent of accumulated profits, shall be deemed to be dividend. Over the years, several issues have arisen relating to practical applicability of Section 2(22)(e) of the IT Act. Some of these issues pertain to
- The nature of transaction whether it is a commercial transaction or amount received for providing corporate guarantee or it represents loan or advance given by the company;
- The timing to determine the shareholding and substantial interest;
- Whether registered shareholder or beneficial shareholder to be considered etc.
In this relation, recently, the Surat Tax Tribunal2 had an occasion to examine whether the shares held by a minor are to be added to the father’s shareholding for the purpose of deemed dividend taxation under section 2(22)(e) of the IT Act. We, at BDO in India, have summarised the ruling of the Surat Tax Tribunal and provided our comments on the impact of this decision hereunder:
Facts of the case
Taxpayer, an individual is Director in 3 Indian private limited companies- VCPPL, VBPL and VPPL. For the relevant year under consideration, VCPPL had given loans to sister concern VBPL and VPPL. The tax officer contended that the Taxpayer is having stake of more than the prescribed limit in all three entities and section 2(22)(e) of the IT Act is attracted on the transaction of loan. The Taxpayer submitted that the loan is given as intercorporate deposit and cannot be added as a deemed dividend. The taxpayer also submitted his shareholding details as well as shareholding details of his minor son in all three entities. It was explained that for the year under consideration, cumulative condition of section 2(22)(e) of the IT Act read with section 2(32) of the IT Act are not attracted as individually the taxpayer is not holding more than 10% of voting power in VCPPL and more than 20% shares in VBPL and VPPL. However, the tax officer noted that the taxpayer was holding 2.47% stake in his individual capacity and 12.77% stake as guardian of minor son in VCPPL. Thus, the effective shareholding of the taxpayer was more than 10% in VCPPL. He further noted that the taxpayer held 10% stake in his individual capacity and 18.5% stake as guardian of minor son in VBPL, which effectively is more than 20% shareholding. The tax officer on perusing the balance sheet of VCPPL observed that the company had accumulated profits for the relevant year under consideration and had extended loan to its sister concern VBPL. On the basis of aforesaid observation, the tax officer made addition of the loan amount under section 2(22)(e) of the IT Act. Aggrieved by the additions made, the taxpayer filed an appeal before the First-Appellate Authority which based on the facts of the case and submissions made by the taxpayer, deleted the additions made by the tax officer. Aggrieved by the order of the First-Appellate Authority, Revenue filed an appeal before the Tax Tribunal.
The Tax Tribunal made the following observations while agreeing with the views of the First-Appellate Authority and ruling in favour of the taxpayer:
- The Tax Tribunal observed the source of shareholding of the minor son and noted that the shares of VCPPL were received by way of the grandfather’s will and a gift from a paternal aunt. Further, the application for shares of VBCL was made by the minor’s mother (natural guardian of minor) and the payment was drawn from the minor’s bank account. Thus, the source of shareholding of the minor son is independent and he is entitled to the benefit of ownership. The taxpayer does not have any beneficial interest in the shares held by the minor son.
- The Tax Tribunal relied on the decision of the Hon’ble Bombay High Court in the case of S.S. Barodawala3 which held that a father, as a guardian, may manage the affairs with regard to the shares standing in the name of his minor sons, but this will not make him the beneficial owner of the shares. To make the father a beneficial owner, the benefit or advantage arising out of the shares must accrue to father. The Tax Tribunal further cited ruling of the Hon’ble Apex Court in the case of C.P. Sarathy Mudaliar4 (while considering the corresponding section 2(6A)(e) of Indian Income-tax Act, 1922) held that section speaks of “shareholder”, it refers to the registered shareholder and not the beneficial owner. It also referred ruling of the coordinate bench of Ahmedabad Tax Tribunal in the case of Minnie Cama5 which held that a deeming provision like Section 2(22)(e) of the IT Act must be strictly construed.
- The Tax Tribunal further affirmed the view of the First-Appellate Authority which had factually distinguished the case of TPSH Sakkalal6 on which reliance was placed by the Revenue Authority. The said case determined that the shares held on behalf of minor children having voting power should be considered for determining taxpayer’s substantial holding.
- The Tax Tribunal stated that the amounts withdrawn from the company could not be deemed to be dividend under section 2(22)(e) of the IT Act. Thus, in view of aforesaid facts and legal discussion, the Tax Tribunal affirmed the order of First-Appellate Authority and held it in favour of taxpayer.
Taxation of deemed dividend is by fiction of law to discourage the act of taking a loan or advance from the company by persons holding certain percentage of equity stake in the company. The decision of the Surat Tax Tribunal is a welcome decision as it fortifies the fact that the provisions of section 2(22)(e) of the IT Act must be strictly construed since it creates a deeming fiction by bringing in amounts paid otherwise than as dividends into the net of dividends itself. The Tax Tribunal has brought out an important fact that merely because a shareholder is minor does not mean that his/her holding should be clubbed with parent/guardian’s shareholding. It is necessary to find the source of such shares held by the minor and to examine the surrounding circumstances. In case where the source is independent of parent/guardian, it is the minor who shall be considered as the beneficial owner.
1As per Section 2(32) of the IT Act, “substantial interest in the company” means shares carrying not less than 20% of the voting power in the company
2ACIT vs. Kamalbhai Jayantilal Shah, IT(SS) Nos. 261 & 262/AHD/2016- Surat Tribunal
3ITO vs. S.S. Barodawala (1983) 4 ITD 186 (Bombay High Court)
4CIT vs. C.P. Sarathy Mudaliar (1986) 83 ITR 170 (Supreme Court)
5Minnie R Cama vs. ITO (1986) 17 ITD 139 (Ahmedabad tribunal)
6CIT vs. TPSH Sakkalal (1996) 236 ITR 981 (Madras High Court)