Is Gift to Shareholders Son a Deemed Dividend

The subject, “Is Gift to Shareholder’s Son a Deemed Dividend?” shall be deliberated by utilizing a small situation or a scenario which is explained below. And in this a shareholder’s son was gifted INR 50,000 by a closely held company and the same was considered as a deemed dividend by the Assessing Officer (AO).

Scenario

Mr. A is a shareholder of a closely held company named XYZ Ltd. Other than Mr. A, there are two other shareholders in the company, which include Mrs. A and Mrs. C, who is Mr. A’s mother. More than 70% of the shares of XYZ Ltd. were held by Mr. A during the previous year 2019-20. AO while completing the assessment of XYZ Ltd. found the payment which was made to Mr. D, who was the son of Mr. A, and wanted to treat the same as deemed dividend in the hands of Mr. A as it was paid for the benefit of Mr. A who is the shareholder of the company.
Hence, analysing this scenario in light of the applicable laws’ provisions, we can understand it as follows.

Analysis

Firstly, let’s understand Section 2(22) of the Income Tax Act, which defines a dividend as per the Act.
Referring to provisions of section 2(22)(e) of the Income Tax Act, when a company in which the public does not substantially hold an interest or attention, extends a loan or any advance to:

1. any of its shareholders who has more than 10% voting power in the company or
2. to any company or entity in which such shareholder has substantial interest or attention or
3. for the individual advantage of sucha  shareholder or
4. On behalf of such shareholders to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22).

But there are also certain exceptions to this, which include the following:

1. A loan that is given by a company involved in money lending, provided such loans have been extended in the ordinary course of business.
2. A loan was extended to shareholders, which was subsequently adjusted against the dividend declared and distributed to such shareholders later.

Hence, we can say that for taxing the payment of INR 50,000 in the hands of Mr. A by considering the provisions of section 2(22)(e) of the Income Tax Act as a deemed dividend, the following conditions shall be satisfied, namely:

1. A company should not be one in which the public is substantially interested, or it should be a closely held company.
2. The shareholder should hold at least 10% of the voting power in the company, and
3. The company should possess accumulated profits at the time of making such payment to the shareholder or for the benefit of such shareholder.

And this shall be applicable to the payments which are coming under the below-stipulated ones:

1. The payment of any sum by way of advance or loan to a shareholder.
2. The payment is made on behalf of a shareholder.

iii. The payment is made for the individual benefits of a shareholder.
But referring to the scenario which has been given here it should be noted that, we cannot conclude that such payment of INR 50,000 made to Mr. D who is the son of Mr. A, the major shareholder of XYZ Ltd. was done for the benefit of Mr. A. This is because there is no direct evidence for the same and the other shareholders of the company are Mrs. A, and Mrs. C who is Mr. A’s mother who also holds more than 10% of voting power in the company. And for Mr. D, Mrs. A is his mother, and Mrs. C is his grandmother. But if there is any evidence stating that such payment was done for the benefit of Mr. A, then it shall be deemed as a dividend in the hands of Mr. A, and taxed so.
And nowhere it has been stipulated that such payment was made for covering or discharging any liability held by Mr. A as not one material evidence lies stating that it was made on behalf of Mr. A on the basis of the relationship held by him with Mr. D. So, the mere basis that the payment was made to Mr. D as he was the son of Mr. A does not serve as a point qualifying the treatment of such payment as deemed dividend and taxed in the hands of Mr. A.
Thus, we can conclude that, for considering or taxing a payment under the provisions of section 2(22) or section 2(22)(e) specifically, there should be a piece of material evidence that acts as proof that the payment was made on behalf of or to discharge any liability which was held by a shareholder or in the exclusive interest of such shareholder in whose hands it shall be taxed as per provisions of the Income Tax Act as deemed dividend. The mere existence of a relationship shall not serve as proof for taxing the same as deemed dividend.