Question And Answer
Subject: Deemed Dividend
Querist: Alka Sharma
Answered by:
Date: November 9, 2023
Query asked by Alka Sharma

When lending company has deposited funds in a firm engaged in money lending activities for earning interest and such firm has advanced funds to substantial shareholders of lending company but such substantial shareholders have no control over the firm who has extended funds to substantial shareholders on interest, whether provisions of section 2(22)(e) could be invoked in the case of substantial shareholders even though there is no debit balance in the books of lending company to their account.

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Answer given by

Section 2(22)(e) deals with how the types of loans and advances that the company makes for the shareholder is treated as deemed dividend.

However, for invoking the provisions of section 2(22)(e), the requirement is to establish that payment made by a company to the shareholder or to a concern in which he has a substantial interest falls into the nature and character of loans or advances.

In the aforementioned facts, the company has deposited its funds (investments) in a firm engaged in money lending activities for earning interest. However, the Firm has advance loans to the persons who are the shareholders of the Company and they don’t have control over the firm. Further both the entity i.e. company and firm have money lending as a substantial part of their business, hence there could not be deemed dividend. Further, there is no connection/link to treat the said transaction as deemed dividend as both transactions are on different footings.

In the case of Pr. CIT v. Mohan Bhagwatprasad Agrawal [2020] 425 ITR 119 (Guj)(HC), the Assessee was holding more than 10 percent of shares in two companies in which public were not substantially interest. Assessee obtained loan and advances from companies on interest payable at market rate of 9 per cent. The AO found that main object of both companies was to carry on business of builder, masons and general construction, industrial construction, etc. treated amount of loan and advances to be deemed dividend and added the same to income of assessee. The High Court held that, both companies were having money lending as substantial part of their business, loan and advances taken by assessee were not covered by provisions of section 2(22)(e). Dividend did not include any advances or loan made to a shareholder by the company in the ordinary course of business where the lending of money was a substantial part of the business of the company.

In R. Chitra vs. ITSC [2019] 418 ITR 530 (Mad)(HC) held that merely because an amount is advanced by one company to another with shareholders having substantial shareholdings, deemed dividend is not taxable in the hands of shareholders.

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