Deemed Dividend value under Income Tax taxable for borrower company only if he is shareholder in the lending entity

 The Delhi Income-tax Appellate Tribunal (‘the Tribunal’) recently held that an unsecured loan received by a company cannot be treated as ‘deemed dividend’ in its hands since the recipient company itself is not a shareholder of the lending company, even though there is a common beneficial shareholder.

What is Deemed Dividend?
In case where closely held company, having an accumulated profits, makes any payment in the nature of advances or loans either to its shareholder beneficially holding 10% or more voting power or to any other entity where such shareholder holds substantial interest in that concern, then such payments are treated as dividends to the extent of the lender company’s accumulated profits. Such deeming fiction is also extended to any payment made on behalf of, or for the personal benefit of, such shareholder.

Facts of the case

·       The taxpayer is a company received an unsecured loan from another group company having accumulated profits

·       The lending company and the borrowing company had a common shareholder holding 100% in the lending company and 49% in the taxpayer borrower company

·       The Assessing Officer (AO) treated the loan as deemed dividend and levied tax on the same in the hands of the taxpayer

·       The CIT(A) upheld the AO’s action holding that the loan transaction fell within the ambit of deemed dividend as the criteria of the common shareholder has met

·       The taxpayer, aggrieved by the decisions of the CIT(A) preferred an appeal before the Tribunal.

Tribunal’s Findings

·       Deemed dividend provisions gets attracted only in the hands of a shareholder of the lending company

·       An entity receiving a loan cannot be treated as a shareholder merely due to common shareholding pattern

·       In the present case, the taxpayer was not a shareholder of the lending company and accordingly, the unsecured loan could not be taxed as deemed dividend in the hands of the taxpayer.

·       Reliance was placed on the Allahabad High Court ruling in CIT vs. Raj Kumar Singh & Co.

·       The order of the CIT(A) was set aside and the Tribunal, deleting the addition made by the AO, passed an order in favour of the taxpayer borrowing company.

Key Takeaway
The deemed dividend provisions create a tax liability in the hands of the shareholder, not in the hands of the recipient entity where such entity is not a shareholder of the lending company. The mere existence of a common shareholder is insufficient. The recipient itself must be a shareholder of the lending company for the deeming fiction to apply.