Mahatma Gandhi said, “Constant development is the law of life and a man who always tries to maintain his dogmas in order to appear consistent drives himself into a false position.” It is imperative that laws must be dynamic and must evolve with the times; else, they risk turning obsolete and dysfunctional. Antiquated statutes or legal provisions enshrined therein do not only defeat the legislative intent, but also prove to be an impediment in the evolution of society.
In the current scheme of things, the covid-19 pandemic is changing the course of human history. It has caused an unprecedented human, health and financial crisis, the magnitude of which cannot even be ascertained presently. Our timeline is set to be split into pre- and post-covid eras.
With depleted economic activity, organisations are struggling to stay afloat and meet their obligations towards lenders, with fixed overheads, et al, weighing their efforts down. The central treasury function of large corporations faces the daunting task of managing cash flow to keep group businesses afloat. With cash a scarce commodity in these times, treasury departments would have failed if they did not have a holistic group-level view and are unable to provide timely funds efficiently to group entities.
However, provisions like “deemed dividend” enshrined in the Income tax Act, 1961 (ITA), are major impediments in such fund movements within a group, as the same can lead to onerous tax consequences, especially undesirable for closely-held companies that are fund-starved in these testing times. The deemed dividend provisions are not a new-fangled concept in the ITA, and their analogous provisions also found place in the erstwhile income tax statue of 1922. Over the course of time, the expanse of this legal fiction has been further enlarged.
Before we dive deeper, it is important to understand the raison d'être for this contrivance, as expounded by the apex court, which upheld the constitutional validity of the analogous provisions in the earlier tax statues on the rationale that it was introduced to curb mischief wherein “a small number of shareholders controlling a private company adopt this device of making advances or giving loans to their shareholders for evading the payment of dividend tax”.
Such provisions of the ITA that are premised on real-income theory should not be extended beyond mala fide transactions, which can be tackled by anti-abuse provisions. A loan or advance received by the shareholder of a company is not real income in the true sense, especially where the shareholder returns the money. The only carve-out provided from the applicability of deemed dividend provisions is in the case of loan by a company that is engaged in the money-lending business. The Central Board of Direct Taxes (CBDT) also relaxed the rigours of these provisions in the case of commercial advances based on judicial pronouncements averring trade advances, being in the nature of commercial transactions which cannot be construed as advances—the sine qua non for the applicability of deemed dividend provisions. However, such relaxation has not been extended to commercially bona fide loans extended amongst group companies.
Being an anti-abuse provision, the deemed dividend rule should not be invoked in case of genuine commercial transactions, and should be judiciously applied only in case of purely gratuitous loan. The harsh rule stifles the already skewed finances of operational companies, as the under-stress financial sector, despite multiple sops given by the government, has not lent adequately to them. Commercially-expedient loans have had to be made by corporations in these covid times, and these are being serviced as per repayment schedules and/or carry an interest charge. Such advances should not be considered an alternate way of providing dividends, and so should not attract the provision in question.
Another set of provisions which need tweaking to encourage group treasury functions are rules related to inter-corporate loans under Section 186 of the Companies Act. Such loans are required to carry interest rates that match those of government securities of comparative tenures; this makes these unattractive and renders intra-group financial management cost inefficient. Intra-group financing ought to be entirely exempt from this section’s applicability.
Addressing financial anxiety amid the pandemic could be a challenge. Hence, based on the evolutionary theory of law, it is a need of the hour that India’s deemed dividend law be rationalized and relaxations offered. The country could relax the rigours of provisions for genuine loans to group companies, by specifying end-use requirements. Corporate approvals could be through post-facto ratifications. Further, tax revenue safeguards can be built in by limiting the loan repayment period to, say, five years. Loans can be assumed to be deemed dividends only if any of the conditions are breached.
In these tough times, it is imperative to support business efforts to survive the crisis. We must enable corporate groups to utilise the funds within the group without having to resort to complex structures. This would help India’s economic resilience.
Jagvir Singh is founding partner, Jupiter Law Partners, and Vishwas Panjiar is partner, Nangia Andersen LLP. Nobuhiro Takahashi, advisor of suggestion activities, Japan Chamber of Commerce and Industry in India (JCCII), contributed to this article
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