The Hindu Business Line : Both circular and artificial

DEEMING provisions are a part and parcel of any law framed in India. The intent appears to be to catch transactions that the law would not be able to lay down. The Income-Tax Act does have a number of deeming provisions.

Two recent decisions from the Authority for Advance Rulings (AAR) explained the provisions relating to deemed dividend as envisaged by Section 2(22). The Section recognises certain forms of distribution by a company as income in the nature of deemed dividend.

In the Briggs of Burton (India) (P) Ltd (2005 145 Taxman 400) case, the company allotted bonus redeemable preference shares to existing equity shareholders.

The shares were redeemable within the next 10 financial years from the date of allotment. The Section states that "... any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company."

Concluding that such distribution cannot be termed as dividends was easy considering the ratio of the Supreme Court decision in CIT vs Dalmia Investment Co Ltd (1964 52 ITR 567) and the Gujarat High Court ruling in Sashibala Navnitlal vs CIT (1964 54 ITR 478), where it was held that bonus shares only involves distribution of capitalised accumulated profits and do not entail release of any assets.

In the Madura Coats (P) Ltd (2005 145 Taxman 366) case, the issue was a bit more complicated.

The Indian company proposed to give a loan to its foreign parent company. The shareholding of the foreign company was bizarre with a catena of more than 360 companies.

The company to which it intended to give a loan was itself a subsidiary of another company and the Commissioner felt that the company receiving the loan had a substantial interest in the Indian company and, hence, Section 2(22)(e) would come into play, thereby making this a deemed income.

The AAR opined that the definition of the term dividend in Section 2(22) is both circular and artificial since the definition contains the very term it seeks to define and adds specified payments within its ambit.

Judicial decisions over the years have ensured that the provisions have to be read strictly (CIT vs CP Sarathy Mudaliar — 1972 83 ITR 170). The requisites of deemed dividend include:

Payment to be made by a company in which the public are not substantially interested;

The company to have accumulated profits;

The payment to be made by way of advance or loan to a shareholder who is a beneficial owner of shares holding not less than 10 per cent of the voting power or to any concern in which such shareholder is a member or by the company on its behalf for the individual benefit of such shareholder.

The keyword appeared to be "shareholder". Going by the Supreme Court decision in Rameshwarlal Sanwarmal vs CIT (1980 122 ITR 1), the AAR ruled that shareholder would mean the registered shareholder.

Unravelling the maze of companies and their complicated shareholding pattern, the AAR ruled that the proposed loan was not to a shareholder and, hence, could not be hit by the deeming fiction of Section 2(22)(e).

This is one of the Sections that merit a relook so that the provision is less circular and artificial.

(The author is a Hyderabad-based chartered accountant.)

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