Taxpublishers.in - Monday Corner Answer to the Quiz for the week (14 Oct 2024)

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Quiz for the week (14 Oct 2024): Egg (P) Ltd is engaged in manufacturing activity. It has 5 shareholders with each shareholder having 20% voting power in it. During the financial year 2023-24, it advanced Rs.8 lakhs to Mahi & Co in which one of the shareholders has 15% profit sharing rights. Also, it advanced Rs.20 lakhs to Jai (P) Ltd in which it holds 90% shareholding and in which its 5 shareholders have 2% each of voting rights. Both the advances are not in the regular course of business and the accumulated profits of the company on the date of lending far exceeded the loans advanced by it Best Answer : The query posed requires reference to section 2(22)(e) of the Act which can be dissected as under: (i) It is applicable in the case of a company (advancing money), not being a company in which the public are substantially interested; (ii) Advancing any sum (whether as representing a part of the assets of the company or otherwise) 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 10% of the voting power; (iii) 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; (iv) Explanation 3A says that for the purposes of this clause, "concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company; (v) Clause (b) of Explanation 3A says that a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than 20% of the income of such concern; Linking the legal provision to the facts of the case, the Egg (P) Ltd is engaged in manufacturing activity and has given loan to a firm Mahi & Co in which one of the shareholders has 15% profit sharing rights. Since the shareholder has less than 20% of the profit-sharing rights in the concern i.e. Mahi & Co the loan of Rs.8 lakh advanced by Egg (P) Ltd to Mahi & Co is not liable to tax as deemed dividend. In yet another lending, Egg (P) Ltd being the holding company of Jai (P) Ltd has advanced Rs.20 lakhs. In Jai (P) Ltd it has got 90% shareholding. The common shareholders do not have 20% entitlement in the subsidiary company. It is not a case of a subsidiary company advancing money to the holding company, in which case the holding company having 90% stake in the subsidiary company would be squarely hit by section 2(22)(e). Since the amount was advanced by holding company to subsidiary company and the common shareholders have only 2% (not 20%) in the subsidiary company, the provisions of section 2(22)(e) would not apply. However, if the accumulated profits are routed to subsidiary company which in turn distributes the said amount by way of loan to common shareholders, then it could be viewed as colourable device to overcome the deemed dividend taxation. In such case, it is possible to invoke section 2(22)(e) by lifting the veil. One more issue relates to taxation of such loan as 'beneficial owner' being the 5 shareholders in holding company who impliedly control the subsidiary company as well. A reference is invited to the case of CIT v. Rajeev Chandrashekar 2016 TaxPub(DT) 1894 (Karn-HC) where the court held that since the recipient is not a shareholder in the lending company, the loan advanced cannot be treated as 'deemed dividend'. Therefore, the amount of loan received by subsidiary company from the lending company is not taxable as deemed dividend since the recipient is not a shareholder in the lending company. Also, the common partners have less than 20% stake in the borrowing company and thus it could not be taxed as deemed dividend. However, if the borrowed funds are diverted to the shareholders of the subsidiary company, the lending of loan may be treated as colourable or 'make believe' transaction and in such case adverse inference may be drawn.

Quiz for the week (14 Oct 2024):

Egg (P) Ltd is engaged in manufacturing activity. It has 5 shareholders with each shareholder having 20% voting power in it. During the financial year 2023-24, it advanced Rs.8 lakhs to Mahi & Co in which one of the shareholders has 15% profit sharing rights. Also, it advanced Rs.20 lakhs to Jai (P) Ltd in which it holds 90% shareholding and in which its 5 shareholders have 2% each of voting rights. Both the advances are not in the regular course of business and the accumulated profits of the company on the date of lending far exceeded the loans advanced by it

Best Answer :

The query posed requires reference to section 2(22)(e) of the Act which can be dissected as under:

(i) It is applicable in the case of a company (advancing money), not being a company in which the public are substantially interested;

(ii) Advancing any sum (whether as representing a part of the assets of the company or otherwise) 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 10% of the voting power;

(iii) 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;

(iv) Explanation 3A says that for the purposes of this clause, "concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company;

(v) Clause (b) of Explanation 3A says that a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than 20% of the income of such concern;

Linking the legal provision to the facts of the case, the Egg (P) Ltd is engaged in manufacturing activity and has given loan to a firm Mahi & Co in which one of the shareholders has 15% profit sharing rights. Since the shareholder has less than 20% of the profit-sharing rights in the concern i.e. Mahi & Co the loan of Rs.8 lakh advanced by Egg (P) Ltd to Mahi & Co is not liable to tax as deemed dividend.

In yet another lending, Egg (P) Ltd being the holding company of Jai (P) Ltd has advanced Rs.20 lakhs. In Jai (P) Ltd it has got 90% shareholding. The common shareholders do not have 20% entitlement in the subsidiary company.

It is not a case of a subsidiary company advancing money to the holding company, in which case the holding company having 90% stake in the subsidiary company would be squarely hit by section 2(22)(e).

Since the amount was advanced by holding company to subsidiary company and the common shareholders have only 2% (not 20%) in the subsidiary company, the provisions of section 2(22)(e) would not apply.

However, if the accumulated profits are routed to subsidiary company which in turn distributes the said amount by way of loan to common shareholders, then it could be viewed as colourable device to overcome the deemed dividend taxation. In such case, it is possible to invoke section 2(22)(e) by lifting the veil.

One more issue relates to taxation of such loan as 'beneficial owner' being the 5 shareholders in holding company who impliedly control the subsidiary company as well. A reference is invited to the case of CIT v. Rajeev Chandrashekar 2016 TaxPub(DT) 1894 (Karn-HC) where the court held that since the recipient is not a shareholder in the lending company, the loan advanced cannot be treated as 'deemed dividend'.

Therefore, the amount of loan received by subsidiary company from the lending company is not taxable as deemed dividend since the recipient is not a shareholder in the lending company. Also, the common partners have less than 20% stake in the borrowing company and thus it could not be taxed as deemed dividend. However, if the borrowed funds are diverted to the shareholders of the subsidiary company, the lending of loan may be treated as colourable or 'make believe' transaction and in such case adverse inference may be drawn.