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  • Tax Matters: Can trade advances be treated as deemed dividend?

    If a company has commercial transactions with its shareholder and the shareholder has a debit balance, then the payment is to be added as deemed income

    Our private limited company has appealed against trade advances being treated as deemed dividend. Should we follow the matter or pay the tax?

    — Jayesh Panjwani, e-mail

    Section 2(22) clause (e) of the Income Tax (IT) Act, 1961, provides that dividend includes any payment by a company, not being a company in which the public are substantially interested, of any sum by way of advance or loan to a shareholder or a concern. The shareholder is a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits holding not less than 10% of the voting power).

    Concern is an entity in which such a shareholder is a member or a partner and in which he has a substantial interest. Dividend also include any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profit.

    Some courts in the recent past have held that trade advances in the nature of commercial transactions do not fall within the ambit of the provisions of Section 2(22) (e) of the IT Act. The Delhi High Court (HC) has held that if a company has commercial transactions with its shareholder and the shareholder has a debit balance in the books of account of the company due to these commercial transactions, then the payment cannot be treated as ‘Loan or advance' and is to be added as deemed income under Section 2 (22) (e).

    Take the case where advances were made by a company to a sister concern and adjusted against the dues for job work done by the sister concern. In Creative Dyeing & Printing Pvt Ltd, the Delhi HC held that amounts advanced for business transactions do not to fall within the definition of deemed dividend under Section 2(22)(e).

    In another instance, advance was made by a company to its shareholder to install plant and machinery at the shareholder's premises to enable him to do job work for the company so that the company could fulfil an export order. The Punjab and Haryana HC held that as the tax payer proved business expediency, the advance was not covered by Section 2(22)(e).

    In another instance, a floating security deposit was given by a company to its sister concern against the use of electricity generators belonging to the sister concern. The company utilised gas available to it from Gail to generate electricity and supplied it to the sister concern at concessional rates. It was held by Allahabad HC that the security deposit made by the company to its sister concern was a business transaction arising in the normal course of business between two concerns and the transaction did not attract Section 2(22) (e).

    The Central Board of Direct Taxes circular of 2017 has clarified that a settled position that trade advances, which are in the nature of commercial transactions, does not fall within the ambit of the word ‘advance' in Section 2(22)(e). Hence, appeals should not be filed on this ground by officers of the IT department. Those already filed should be withdrawn. So in your case, do not pay the tax.


    Ours small private limited company is into import-export business. Hence, we are not liable for compulsory registration for goods and services tax (GST). But with so much of integration taking place, what are we supposed to do without the Importer-Exporter Code (IEC)?

    Tejash Singh, e-mail

    The Foreign Trade (Development & Regulation) Act, 1992, provides that no person will undertake any import or export except under an IEC number, granted by the Director General of Foreign Trade (DGFT) or the officer authorized by the Director General on this behalf.

    With the implementation of the GST from 1 July 2017, GST identification number (GSTIN) will be used for credit flow of integrated GST (IGST) on import of goods and refund or rebate of IGST related to export of goods. GSTIN is a 15-digit alpha numeric code with the permanent account number (Pan) prefixed by the state code and suffixed by three-digit details of business verticals of the Pan holder. The importer-exporter will need to declare only GSTIN (wherever registered with GSTN) while importing and exporting goods.

    However, obtaining GSTIN is not compulsory for importers and exporters below a threshold limit of turnover. GSTIN cannot become universal as IEC is for import and export business.

    As a measure of ease of doing business, the identity of an entity is to be kept uniform across the ministries and departments. Henceforth, Pan of an entity will be used for IEC, i.e., IEC will be issued by DGFT with the difference that it will be alpha numeric (instead of 10-digit numeric at present) and will be the same as the Pan of the entity. New applicants have to apply to DGFT and their Pan will be authorized as IEC.

    Necessary changes in the system are being carried out by DGFT so that the existing importer-exporter's Pan becomes the IEC. The DGFT system will undertake this migration and the existing IEC holders are not required to undertake any additional exercise. IEC holders are required to quote their Pan in place of IEC in all their future documentation.


    Please briefly explain the transition to the goods and services tax (GST) regime and the impact.

    Kalpana Hirani, e-mail

    The introduction of GST from 1 July 2017 is a significant step in indirect tax reforms in India. A large number of Central and state taxes have been amalgamated into a single tax. GST is based on the principle of destination-based consumption taxation as against the present principle of origin-based taxation.

    The Centre will levy Central GST (CGST) and states will levy state GST (SGST) on every supply of goods and services within a state and Union Territory (UGST) on every supply of goods and services within the Union Territory. Integrated GST (IGST) will be levied on all inter-state supplies by the Centre and then transferred to the destination state.

    IGST is to be paid on all inter-state supplies, be it in the nature of a sale or stock transfer. If the aggregate turnover in a financial year is above the threshold limit for exemption of Rs 20 lakh (Rs 10 lakh per annum for special category states), the business is required to obtain GST registration number. Enrolment for migration to GST has been initiated by the GST Network (GSTN) since November 2016. While some tax payers have completed the process, many tax payers have been facing issues relating to requirements prescribed or lack of clarification.

    GST laws enable carry-forward of eligible credit of taxes incurred under the existing indirect laws into the GST regime. File proper return along with correct GST registration number of goods/service supplier to avail free flow of input credit.

    Goods and/or services supplied on/after the appointed day of GST under a contract entered into prior to the introduction of GST is subject to GST. The difference in price, if any, is to be adjusted via debit or credit note. Tax liability is to be adjusted only if the recipient of the credit note reverses his corresponding credit.

    Refund claims under existing laws filed before or after implementation of GST will be disposed of as per existing laws.


    My granddaughter is three years old. She gets cash gifts up to Rs 75000 on her birthday and other occasions, mainly contributed by her parents, grandparents and uncles. We have deposited the amount in a equity-linked savings scheme (ELSS) scheme of a mutual fund in her name and intend to repeat the procedure every year. The purpose is to build a corpus for her and withdraw the amount after she turns 18. I feel there will not be any tax implication in this investment process as the contribution from close relatives is tax-free and redemption will also be tax-free being long-term capital gains on an equity-oriented scheme. Am I correct?

    — Krishan Aggarwal, e-mail

    An individual or a Hindu undivided family (HUF) is liable for tax under, ‘Income from other sources', if he receives sum of money or property in the form of gifts. However, gifts received from relatives, defined under the Income Tax (IT) Act, 1961, are not liable to tax.

    The definition of relatives means brother or sister of the taxpayer, lineal ascendant or lineal descendant of the taxpayer and brother or sister of the parents of the taxpayer. Hence, if your granddaughter has received gifts from the specified relatives under the IT Act, then such cash gifts are not taxable. Income from such gifts received by the minor granddaughter will be clubbed with income of either of her parents, whosever's income is higher, and chargeable to tax in their hands under Section 64 (1A) of the IT Act.

    A taxpayer who is investing in any units of mutual fund referred under Section 10(23D) of the IT Act or an ELSS notified by the Central government can claim deduction under Section 80C (xiv) up to Rs 1.50 lakh in his own name. If the parents make an investment in the child's name in any of the specific investments under Section 80C, such as ELSS or Public Provident Fund, the parents get the tax benefit and the taxable income gets reduced by the amount invested. The parents can, however, claim a deduction of up to Rs 1.5 lakh under Section 80C of his own and his child's combined investments in such instruments.

    If the parents invest in a taxable investment in the name of the child, they can claim an annual exemption of Rs 1500 per child under Section 10(32) of the IT Act as against the taxable income from such investment, if any.

    ELSS has a three-year lock-in period from the date of allotment of the respective units. As a result, there can only be long-term gains on withdrawal after three years. Thus, capital gains will be exempt in the hands of the tax payer under Section 10(38) of the IT Act if the gains are long-term capital gains on listed security, being equity share in a company, unit of an equity-oriented mutual fund or unit of business trust that is chargeable to the securities transaction tax and the transfer of such security is through a recognized stock exchange.

    An equity-oriented scheme's investible funds are invested in equity shares in domestic companies to the extent of more than 65% of the total proceeds. The scheme should be set up under Section 10(23D) of the IT Act. As ELSS is categorized as equity scheme for taxation purpose, dividends as well as long-term capital gains are tax-free.

    Also, on redemption of the investment after she turns 18, there are no tax implications in her hands.

    The replies are only in the nature of guidelines. The tax counsellors and the publication are not responsible for any decision taken by readers on the basis of the same.
    Readers may e-mail their queries on direct taxation to: tax-matters@capitalmarket.com

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Flash News 24-Sep-2018
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