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CLOSELY-HELD group companies that frequently borrow money from each other should make a note of a recent ruling by the income tax appellate tribunal (ITAT), a quasi judicial tax authority.

The tribunal has said that “deemed dividend cannot be taxed in the hands of non-shareholders.” In order to avoid paying dividend distribution tax (DDT) of 17.5%, profit-making, closely-held (unlisted) companies, many a time, resort to granting loans to interested shareholders—those with over 10% shareholding in the companies—instead of paying them dividend after deducting DDT.

Alternatively, to avoid paying DDT, the companies resort to giving loans to any concern in which such a shareholder holds substantial interest, or in excess of 20% stake. However, in the latter case, since the shareholder is the ultimate recipient of such a payment, it is he and not the concern (which is a non-shareholder in the firm making the advance) that is liable to pay tax.

The ITAT’s ruling pertained to a privately-held company, Interventional Technologies, which is engaged in the business of trading in life-saving medical devices. This company (assessee) is part of a group of five closely-held, profitable companies, which frequently borrowed from and lent funds to each other.

Interventional Technologies received loans from group companies and was selected for scrutiny by an assessing officer (AO), who was of the opinion that the amounts received by it were to be treated as deemed dividend within the meaning of Section 2 (22) (e) of the IT Act. The AO therefore made an addition of Rs 1.01 crore to the total income of the assessee as deemed dividend under the relevant section for the assessment year 2005-06, thereby taxing it at a higher rate of 33.99%.

The company approached the ITAT after the Commissioner Income Tax (Appeals) confirmed the addition made by the AO through an order dated September 16, 2008.

Counsel for the company argued that since Interventional Technologies did not hold any shares of the group companies from which it received the loans, the amounts received could not be treated as deemed dividend.
 â€œIt is argued that the dividend income can be received only by the shareholder and as the assessee company is not a shareholder of the other group companies, the advances received (by it) cannot be treated as deemed dividend,” argued Bhupendra Shah, counsel for the assessee company.

An ITAT Mumbai bench comprising J Sudhakar Reddy and RS Padvekar held that definition of dividend under section 2(22)(e) of the act is an inclusive definition that “enlarges” the meaning of the term “dividend” according to its ordinary and natural meaning to include even a loan or advance.

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