India: The Conundrum Of Deeming Provisions- Whether Deduction Under Section 80M Is Available In Case Of Deemed Dividend?- Untested Waters

Introduction

Finance Act, 2020, w.e.f. 1 April 2020, removed Section 10(34) of the Income Tax Act, 1961 ("the Act") by virtue of which dividend income was exempt in the hands of the shareholders. On such dividend, Dividend Distribution Tax ("DDT") was required to be paid by the Indian Companies on its declaration/distribution/payment to its shareholders.

"Dividend" traditionally has been defined in Henry v. G.N.Ry, 27 LJ Ch. 1 as under:

"the word "dividend" carries no special significance with it. It is applicable to various subjects; it is not intelligible without knowing the matter to which it is meant as referring; but its ordinary meaning is share of profits"

But under the Act, the definition of dividend is quite exhaustive and includes certain components which are traditionally not understood to be dividend. It would be pertinent to note that initially in the Income Tax (Amendment) Act, 1939, dividend included four types of receipts which are clause (a) to Clause(d) of section 2(22) of the Act as enumerated below. TheFinance Act, 1955, incorporated the amount received as loan in the term dividend.

The following are treated as dividend under the Act -

a) Distribution of company's accumulated profits to the shareholders

b) Distribution of debentures to its shareholders or distribution of bonus to preference shareholders

c) Distribution to the shareholders in the event of liquidation of company

d) Distribution to shareholders on reduction of share capital of the company

e) Payment of any loan or advance to a shareholder of the company holding more than 10% of the voting power

It is very important to see that though the definition of dividend is an all "inclusive" definition, the term "deemed" seems to have been coined from judicial precedents, because of the very nature of the said transaction, which is a loan and yet is treated as a dividend.

Treatment of Deemed Dividend- During the exemption era

Section 115-O levied DDT @ 15% (before grossing up) on dividend declared, distributed or paid. However, in case of deemed dividend under section 2(22)(e), DDT was levied @ 30% (without grossing up). This higher rate of 30% was introduced by The Finance Act, 2018, w.e.f. 1 April 2018 in order to prevent camouflaging the dividend in various ways such as loans and advances. This section has also been abolished with effect from 1 April 2020 and now dividend income is taxable in the hands of the shareholders.

Removal of the Dividend Exemption

Dividend exemption has been phased out gradually. Initially the same was first made taxable in the hands of individuals and HUFs, vide The Finance Act, 2016 for dividends above INR Ten Lakhs. Subsequently the scope was increased to include all assessees within its fold other than corporates who were to be taxed on dividend income above INR Ten Lakhs.

Finally, vide the Finance Act, 2020, the entire taxation system has been inverted and now has moved towards taxation of dividend in the hands of the shareholders. With the inversion of taxation system of dividend, the Finance Act, 2020 reintroduced Section 80M in the Act, which was omitted vide Finance Act, 2003. Section 80M aims at removing the cascading effect by providing deduction on dividends received by a Company to the extent of dividends distributed by such Company. The deduction under section 80M shall be available, if the dividends are distributed one month prior to the due date of filing of Return of Income. Further, the dividend income includes dividend received from a domestic company or a foreign company or a business trust. Sub section (2) aims to bar double benefit of the amount distributed, which means, if deduction is availed for dividend distributed in one year, no deduction shall be available in any other previous year.

Whether deemed dividend under Section 2(22)(e) is dividend for the purpose of Section 80M

With this background in mind, the authors seek to delve on an issue which may arise, especially in relation to clause (e) of section 2(22). It is pertinent to note that, payments /distribution specified in all the clauses of Section 2(22) of the Act are not dividend for the purpose of Companies Act, 2013. Under the Act, dividend includes both cash and in-specie distribution, which is expressly forbidden under the Companies Act, 2013. It is for this very purpose of the Act, that the meaning of definition of dividend has been extended to include various types of distribution/payment.

In view of the change in the system of taxing dividend and difference in the meaning of definition under different Acts, the question may arise as to whether deemed dividend under Section 2(22)(e) can be included under the purview of Section 80M or not.

In this regard, two situations may arise -

1. A situation where a company receives dividend in the nature of deemed dividend and distributes normal dividend to its shareholders - there's no question of whether deduction under section 80M here shall be available or not since dividend income includes all kinds of dividend, whether deemed dividend or not. Hence, deduction under section 80M shall be available subject to the fulfilment of other conditions therein.
2. Another situation arises, where a company receives dividend income (not in the nature of deemed dividend) and pays deemed dividend (whether as loan/advance) to its shareholders. The question arises whether deduction under section 80M shall be available to such kind of payment of dividend. This article focuses on this particular situation.

A deeper dive into Situation 2

In situation 2, there can be two opposing arguments, one in favour of the assessee and one in favour of the Revenue.

An argument in favour of the assessee:

According to the Memorandum to the Finance Bill 2020, section 80M was inserted to remove the cascading effect. If deemed dividend is not included in the dividend for the purpose of section 80M, then there shall be double taxation -

- dividend income shall be taxable in the hands of company with no deduction of the amount of dividend (loan payment or others) and

- such dividend (loan payment or others as deemed dividend) shall be taxable in the hands of the shareholders.

Thus, if deemed dividend is not included under the ambit of section 80M, there is double taxation on the same dividend income. Hence, all types of dividend should be covered under the purview of Section 80M to achieve the purpose of removal of the cascading effect.

In a case¹ before the Hon'ble Calcutta High Court, it was held that the assessee would be entitled to relief under section 80M, in respect of the amount of dividend received from the company as the shareholder on the reduction of the company's capital. In para 11, it has held as under:

"The revenue has not seriously contested the proposition that once the payment is treated as dividend income, the benefit of section 80M cannot be denied to the assessee."

Further, commentary on section 80M by Taxmann provides as under:

Also, in Section 8 of the Act Dividend income provides as follows -

."

It can be seen that even in section 8, the words distributed or paid are treated equally & every type of dividend income becomes a part of the income of the assessee, whether on distribution or actual payment.

From a conjoint reading of the intention of Section 80M, Section 8 and the decision of Hon'ble Calcutta High Court, it can be concluded that all types of dividend, whether deemed dividend or general dividend, should be covered for the purpose of deduction under section 80M. Further, if the Act intended to exclude deemed dividend from the purview of Section 80M, a specific exclusion clause or definition of dividend for the purpose of such section would have been incorporated in the Section itself. For example, in Section 115BBD (Tax on certain dividends received from foreign companies) and section 115BBDA (Tax on certain dividends received from domestic companies), deemed dividend under section 2(22)(e) has been specifically excluded from the definition of dividend for the purpose of those particular sections. In the absence of any such exclusion in section 80M, all kinds of dividends will fall under the purview of Section 80M.

An Argument in favour of the Revenue

The Department may take a view that Section 80M does not include payment of loan covered under section 2(22)(e) since the words used in section 80M is "distributed" and not "paid".

Section 80M states as under:

Further section 194, as amended by Finance Act, 2020, which provides for TDS on dividend states as under:

Section 194 which provides for TDS uses the word "distribution" and "payment" very differently.

Section 2(22) defines the term dividend as under:

The section distinguishes between "distribution" and "payment" made. While other sub-clauses use the word "distribution", 2(22)(e) relating to loan to shareholders, uses the word "payment".

From a combined reading of sections 80M, 194 and 2(22), one may argue that deduction under Section 80M shall not be available to deemed dividend under section 2(22)(e) since in that case, payment is being made to a shareholder which is deemed as dividend, and there is no actual distribution of general dividend to all the shareholders.

In a case² before Hon'ble Supreme Court it was held as under:

Hence, it can be argued that loan payment which is covered under section 2(22)(e) will not be covered under section 80M as the same is not distributed and it is a payment and the dividend deduction is limited only to the amount distributed (which is nil in the case of loan payment to a shareholder). Thus, benefit of 80M deduction cannot be taken for such payments.

Conclusion

Weighing the arguments, it can be seen that the assessee can always rely on the old judicial principle which has become an income tax adage: "when two interpretations are possible, the one in favour of the assessee should be taken"

The Hon'ble Supreme Court in CIT vsVegetable Products Ltd. [1973] 88 ITR 192 (SC) held that if two reasonable constructions of a taxing provision are possible, that construction which favours the assessee must be adopted. Similar views were expressed in the following decisions -

• CIT vs Kulu Valley Transport Co. P. Ltd. [1970] 77 ITR 518 (SC) - It was held that if two views are possible, the view which is favourable to the assessee must be accepted while construing the provisions of a taxing statute.

• CIT vs Madho Pd. Jatia [1976] 105 ITR 179 (SC) - It is well-settled that there is no equity about tax. If the provisions of a taxing statute are clear and unambiguous, full effect must be given to them irrespective of any consideration of equity. Where, however, the provisions are couched in language which is not free from ambiguity and admits of two interpretations, a view which is favourable to the subject should be adopted.

Further, if deemed dividend is not covered for the purpose of deduction under section 80M, then the purpose of section 80M will be defeated for which it was enacted, if it is read in a restrictive manner. It will not remove the cascading effect of taxation of dividend. Hence, all kinds of dividend, whether deemed or general should be included for the purpose of deduction under section 80M as the term "dividend" has been specifically defined in the Act. If the Legislature wanted to cull out an exception from the defined term, the legislature would have done so as has been done in other sections.

At the cost of repetition "deemed dividend" is dividend for all purposes under the Act and it will be harsh, if a view is taken that it will not be considered as such only while granting deduction.

Having said so, the matter will be up for debate as it could be an effective tool for tax planning.

Footnotes