1) Since the Union Budget for the fiscal year 2012-13 presented on 16th March 2012, and all budgets thereafter, we have seen the direct tax proposals being assiduously organised into various heads. While some of these heads represent the disposition of Government’s policies such as
Ease of doing business, Make in India and Swachchh Bharat, some other heads denote the transient and ad hoc nature of yearly budgetary exercise such as
Rationalisation measures and Tax incentives and reliefs. But there is one head – Widening of tax base – which has figured in some form or the other in direct tax proposals for most budgets during the years 2012 till 2018.
2) The focus of the Government in the recent years has been to boost socio-economic growth, improve investment climate, promote affordable housing and provide fillip to digital economy. All these laudable objectives require funds and one way to generate funds is through tax revenues. To fund them, the Government has been broadening the tax base by bringing in more and more types of transactions within the tax net and also mobilising additional resources to generate higher tax revenues. As a result, the growth rate of direct taxes in the financial years 2016-17 and 2017-18 has been significant at 12.6% and 18.7% (till 15th January 2018) respectively. The number of effective taxpayer base has increased from ₹ 6.47 crores at the beginning of financial year 2014-15 to ₹ 8.27 crores at the end of financial year 16-171.
3) One such measure aimed at widening the tax base proposed in the Budget for the year 2018-19 is amendment to provisions relating to dividends under Section 2(22) of the Income-tax Act, 1961 (the “Act”) and to Dividend Distribution Tax (“DDT”) under Sections 115-O and 115R.
II. Taxation of dividends – Existing scheme
4) As per Section 8 of the Act, any dividend declared by a company or distributed/ paid by it within the meaning of sub-clauses (a) to (e) of Section 2(22) is includible in assessee’s total income. As per Section 2(22), dividend includes:
i. distribution by a company of accumulated profits if such distribution entails the release of company’s assets [Clause (a)];
ii. distribution by a company to shareholders of debentures, debenture-stock, or deposit certificates and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits [Clause (b)];
iii. distribution to shareholders on liquidation of company [Clause (c)];
iv. distribution to shareholders on reduction of share capital [Clause (d)];
v. advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit [Clause (e)].
5) Except for dividends referred to in sub-clause (e) of Section 2(22), DDT is payable by the company @ 15% on the amount of dividends declared/distributed. Consequently, dividend is exempt in the hands of the recipient by virtue of Section 10(34) of the Act, subject to provisions of Section 115BBDA as per which the amount of dividend in excess of ₹ 10 lakhs in a year received by a resident individual, Hindu undivided family or a firm is taxable @ 10%.
6) Under the existing scheme, deemed dividend referred to in sub-clause (e) of Section 2(22) is taxable in the hands of the shareholder/recipient and DDT is not payable thereon by the payer-company.
III. Proposed amendments and analysis
A. Expansion of scope of “accumulated profits”
III(A)(i) Amendment in brief
7) The dividend referred to in the clauses of Section 2(22) intends to cover distribution/payment to the extent of accumulated profits of the company, whether capitalized or not. The scope of “accumulated profits” is set out in Explanation 1 and Explanation 2 below Section 2(22). As per Explanation 2, the expression “accumulated profits” in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation, but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place.
8) Explanation 2A is proposed to be added after Explanation 2 to expand the scope of “accumulated profits” to provide that in case of an amalgamated company, the accumulated profits, whether capitalised or not, or loss, as the case may be, shall be increased by the accumulated profits, whether capitalised or not, of the amalgamating company on the date of amalgamation.
9) The expanded scope will apply to distributions/ payments made on or after 1st April, 2018.
III(A)(ii) Analysis of amendment
10) The expansive scope of the term “accumulated profits” would mean that not only the profits of the company in question are to be considered for determining accumulated profits but even profits of a company which gets amalgamated into the company in question should be considered. E.g. X Limited merges into Y Limited. The accumulated profits of X Limited as on date of amalgamation is ₹ 100 and that of Y Limited as on date of distribution is ₹ 500. Y Limited distributes dividend of nature referable to any of the clauses in Section 2(22) to its shareholders. The accumulated profits of Y Limited for the purpose of computing the amount of “dividend” shall be ₹ 600.
11) The reason for expanding the scope of “accumulated profits”, as stated in the Memorandum explaining provisions of Finance Bill, 2018 (the “Memorandum”), is to get over abusive arrangements whereby a company with large accumulated profits amalgamate into a company with less accumulated profits and the amalgamated company would distribute/ pay dividend out of the accumulated profits of the amalgamating company. In this fashion, the amalgamated company would circumvent the provisions as the accumulated profits would be less. In the case of ACIT v. Gautam Sarabhai Trust No. 23 reported in  81 ITD 677 (Ahd.), the Ahmedabad Bench of the Income-tax Appellate Tribunal (the “Tribunal”) had the occasion to deal with one such case. In this case, the Tribunal held that profits in balance sheet of amalgamating company could not be treated as accumulated profits of amalgamated company and surplus realised by amalgamating company and capitalised by issue of paid-up capital would not be covered under the expression “accumulated profits”.
12) Though the Memorandum does not make reference to this judgment of the Tribunal, the amendment intends to get over arrangements such as the one in that case i.e., of reverse mergers (where large/ profit making company gets amalgamated into a smaller/ loss making company).
13) The intention behind the amendment is to prevent abusive arrangements and not to extend any benefit in the form of reduction of losses of the amalgamating company from profits of amalgamated company. Therefore, the language of Explanation 2A has been carefully worded and refers to “accumulated profits, whether capitalised or not, or loss” of the amalgamated company but refers only to “accumulated profits, whether capitalised or not” of the amalgamating company. The absence of the words “or loss” when referring to amalgamating company makes the intention of the legislature clear that no benefit of losses of amalgamating company would be available to the amalgamated company for reduction from the latter’s accumulated profits for computing the amount of dividend. Though for income-tax purposes, it is settled that “profits” would include “loss”2, such a contention may not be possible to reduce losses of amalgamating company from accumulated profits of the amalgamated company for the purpose of Section 2(22) due to the conspicuous absence of the words “or loss” in one place and their mention in another as stated above.
III(A)(iii) Whether the amendment was necessary and its consequences?
14) The General Anti-Avoidance Rule (“GAAR”) contained in Chapter X-A of the Act is in force. These provisions are intended to tackle abusive arrangements. Therefore, one may say that adequate safeguards already exist to tackle abusive arrangements such as the ones intended to be prevented by this amendment. While giving its views on applicability and implementation of GAAR, the Central Board of Direct Taxes, in Circular No. 7 of 2017, justified the need for GAAR by stating that specific anti-avoidance provisions (commonly known as SAAR) may not address all situations of abuse, and there was need for GAAR. Now even with GAAR, the legislature has come up with a specific amendment to tackle abusive arrangements. Of course, GAAR is applicable only where the tax benefit from an impermissible avoidance arrangement is exceeds ₹ 3 crores3; the effect of this amendment would be that even amalgamations which are not intended to misuse or abuse the provisions of the Act but are driven by expediency and commercial considerations would get covered.
15) By bringing in SAAR to prevent abuse through amalgamations, the legislature has done away with the need to take approvals necessary for invoking GAAR and possibly the consequent litigation arising therefrom.
16) This will lead to significant tax impact on schemes of restructuring, rearrangements and takeovers and may become a disincentive to genuine schemes of restructuring, rearrangements and takeovers where any tax benefit is only incidental. Thus, this measure to widen the tax base is likely to impede the Ease of Doing Business.
B. DDT on dividend under sub-clause (e) of Section 2(22)
III(B)(i) Amendment in brief
17) The Explanation to Chapter XII-D of the Act pertaining to DDT provisions which provides that DDT is not payable by the company on dividend under sub-clause (e) of Section 2(22) is proposed to be deleted. As a consequence of this deletion, companies shall become liable to pay DDT on the advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit.
18) Furthermore, the rate of DDT in such cases is sought to be fixed at 30% as against the usual rate of 15% by inserting a proviso in sub-section (1) of Section 115-O and making sub-section (1B) inapplicable. The Memorandum states that DDT will be chargeable in such cases @ 30% without grossing up and consequently, the grossing-up provision in Section 115-O(1B) is made inapplicable.
19) The amendment will apply to transactions undertaken i.e., payments made on or after 1st April, 2018.
III(B)(ii) Analysis of amendment
20) Explanation below Chapter XII-D provided that for the purpose of DDT provisions, “dividend” would not include advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit [i.e. Section 2(22)(e)].
21) With the deletion of this Explanation, DDT provisions would become applicable to such transactions also and the company would have to pay DDT when it gives loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or pays any amount for such shareholder’s individual benefit. The rate of DDT would be flat 30% by virtue of insertion of proviso to Section 115-O(1) and no benefit of slab rate etc., would be available. As a consequence of this amendment, the amount which was earlier includible in the hands of the shareholders would become exempt by virtue of Section 10(34) of the Act. The effect of this amendment is shifting of incidence of tax from the shareholder/ recipient to the payer-company and denial of slab rates (if applicable) to the recipient.
22) For instance, in the existing scheme, when a closely held company, Z Private Limited, would lend a sum of ₹ 100 to its shareholder (holding more than 10% shares), the shareholder would have to pay tax on ₹ 100 received by him at the marginal rates applicable to him. The benefit of slab rates and minimum exemption limit would be available to the shareholder. After the proposed amendment is incorporated, if Z Private Limited has ₹ 100 for being loaned to the shareholder and discharge tax liability thereon from such ₹ 100, it would have to set aside an amount @ 30% (plus surcharge and cess) from the amount to be actually loaned to discharge DDT liability. In such case, Z Private Limited would be able to lend only ₹ 76.92 and the balance ₹ 23.08 (i.e., 30% of the amount loaned, excluding surcharge and cess) would have to be paid as DDT by it.
III(B)(iii) Whether the amendment serves Government’s intention?
23) The rationale of this amendment, as stated in the Memorandum, is to bring clarity and certainty in the taxation of deemed dividends and prevent camouflaging dividend in the form of loans and advances. It is important to note that the charging provision for taxing loans and advances to a shareholder or to its concern or for its benefit is sub-clause (e) of Section 2(22). There is no amendment in this sub-clause or its exceptions in sub-clauses (ii). Litigation on applicability of this provision majorly revolves around the following points:
i. Whether the giving of the loan or advance constitutes ordinary course of its business for the company;
ii. Whether money lending is a substantial part of the company’s business;
iii. Interpretation of beneficial owner vis-Ã -vis registered owner;
iv. Whether benefit of loan/ advance has been derived or not;
v. Whether recipient is shareholder in the payer company or not;
vi. Whether the advance was in the course of a commercial transaction;
vii. Material time when shareholding must be seen i.e., at the time of giving of loan/ advance or as at the year end;
viii. Applicability to inter-corporate deposits;
ix. Applicability to loan or advance due to business expediency;
x. Applicability to advances made to director to make purchases on behalf of the company;
xi. Applicability to shareholder’s running account in company’s books and credit balances therein;
xii. Applicability when amounts paid under family arrangements;
xiii. Controversies regarding computation of accumulated profits; etc.
24) None of the abovementioned issues would get resolved by the present amendment. Therefore, it is unlikely that the proposed amendment would help to bring in “clarity” in taxation of deemed dividends as sought to be achieved by the present amendment. The Memorandum also states that the provision of Section 2(22)(e) has been subject matter of extensive litigation. However, without any change in the substantive law, litigation also may not reduce.
25) The amendment may bring in “certainty” in collection of tax and may overcome the problem of the collection of the tax. However, it needs to be considered that the amendment only seeks to shift the point of taxation from the shareholder/ recipient to the company. This, per se, may not overcome the problem in collecting taxes. This is because a closely held company may contest action of the Assessing Officers in imposing DDT. A company which can give a loan or an advance to a shareholder or to its concern or for its benefit would even contest imposition of DDT which would ultimately benefit such shareholder. On the whole, the amendment does not seem to be well-thought through and is unlikely to serve the purposes for which it is intended.
C. DDT on dividend payouts to unit holders in an equity oriented fund
III(C)(i) Amendment in brief
26) One more proposal to widen the tax base made by the Government is introduction of DDT on income distributed to a unit holder of equity oriented funds. An amendment has been proposed in Section 115R(2) of the Act to provide that DDT shall be charged @ 10% of the amount of income distributed by a mutual fund. The DDT is liable to be paid by the mutual fund effectively reducing the income in the hands of the unit holder.
27) Clause (b) in second proviso in Section 115R(2) which guards income distributed by equity oriented funds from levy of DDT is proposed to be deleted.
28) The above amendment will apply from 1st April 2018 and would apply from distributions made on or after this date.
III(C)(ii) Analysis of amendment
29) The rationale behind the proposed amendment is to provide a level playing field between growth-oriented funds and dividend distributing funds. The Budget 2018 also proposes to introduce capital gains tax on transfer of long term equity-oriented mutual fund units which have been exempt since the year 2004 upon introduction of Securities Transaction Tax. With introduction of capital gains tax on transfer of long term equity-oriented mutual fund units @ 10%, the Government has proposed to introduce DDT @ 10% on dividend paid by equity oriented fund in order to obviate disadvantage to unit holders of growth schemes vis-Ã -vis unit holders of dividend schemes of equity oriented funds.
30) The DDT to be payable on dividends distributed must be done on gross basis as per Section 115R(2) of the Act and as a result of this amendment, the amount of dividends actually received by unit holders of mutual funds would be lesser. The amount received by the unit holders as dividend would continue to remain exempt under Section 10(35) of the Act.
IV. To sum-up
31) One of the expectations of the Industry from Budget 2018 was abolition of DDT as its abolition was thought to be an aid in
Ease of doing business. Contrary to expectations, the Government has sought to widen its ambit. The above amendments to DDT provisions only suggest that DDT is here to stay as DDT is perceived to facilitate easy collection of taxes. Ease of collecting taxes, though not a separate head for organizing tax proposals in a Budget, after all, is one of the inherent policies in tax collecting exercise for any Government.