Critical issues in respect of deemed dividend

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: The provisions of section 2(22)(e) of the Income-tax Act, 1961 create a fiction whereby amounts which are paid otherwise than as dividend, are deemed to be dividend. Therefore, this clause must be given a strict interpretation.

In order to attract the provisions of section 2(22)(e) of the Act, four conditions need to be fulfilled: (i) the assessee should be a shareholder of the company ; (ii) the company should be a closely held company in which the public are not substantially interested ; (iii) there must be payment by way of advance or loan to a shareholder or any payment by the company on behalf of or for the individual benefit of the shareholder ; and (iv) there must be accumulated profits in the hands of the company up to the date of such payment.

To attract the first limb of section 2(22)(e), the payment must be to a person who is a registered holder of shares. The word “shareholder” in section 2(22)(e) is followed by the following words “being a person who is the beneficial owner of shares”. This expression only qualifies the word “shareholder” and does not in any way alter the position that the shareholder has to be a registered shareholder. If a person is a registered shareholder but not the beneficial shareholder then the provisions of section 2(22)(e) will not apply. Similarly if a person is a beneficial shareholder but not a registered shareholder then too the first limb of section 2(22)(e) will not apply.

The new category of payment which was considered as dividend introduced by the Finance Act, 1987, with effect from April 1, 1988, by the second limb of section 2(22)(e) is payment “to any concern in which such shareholder is a member or a partner and in which he has a substantial interest”. The expression “such shareholder” in the provision refers to the shareholder referred to in the earlier part of section 2(22)(e), namely, a registered and a beneficial holder of shares holding at least 10% voting power. The very same person must also be a member or a partner in the concern holding substantial interest in the concern.