Mumbai: The Income Tax (I-T) Department has decided to put an end to the contentious issue of taxation of deemed dividend or inter-company loans given to common shareholders of unrelated companies. The department proposes to amend the I-T Act in this regard.

Inter-company loans, known as 'deemed dividends', are used by companies to route dividend in the form of loans to companies which have common shareholders - both in the company giving the loan and the one borrowing it. It is done to avoid paying dividend tax, otherwise paid by the company before it is distributed among shareholders by the I-T rule. While shareholders of the companies get to use the funds out of the dividend, the amount goes out of the tax ambit. Reports said the company receiving the funds argues that being a single entity; it is not a shareholder in the company giving the loan. Thus, the loan cannot be termed deemed dividend.

The trigger has been the investigations carried out by the I-T department, which found there were many such cases where companies had been set up by common shareholders, just to route dividend as inter-company loans, said sources. The I-T department has proposed an amendment to the tax law for allowing taxation of the shareholders of the borrowing company, and not the company itself, since they are the ultimate beneficiary of the proceeds. The amendment has been proposed to incorporate loans given to unrelated companies, but with common shareholders, under Section 10(20) of the Income-Tax Act. It allows taxation of deemed dividend, but only if loans are given to related companies or sister concerns of the dividend distributing company.

Officials said the amendment is required to overrule a recent judgment of the appellate tribunal, which ruled that deemed dividend should be taxed in the hands of the borrowing company and not the shareholders since the company is receiving the loan. This, I-T department views as 'deemed dividend'. The ruling was given in the case of Interventional Technologies, a life-saving medical device making company. The I-T department, on the other hand, is of the view that the company giving the loan is basically investing its surplus or profit, which otherwise would have been distributed as dividend. Therefore, the shareholders of the borrowing company should be taxed since they are the users of the loans in the end.

Officials further added that irrespective of whether or not the amendment comes through, the I-T department has decided to conduct assessment of all such incomes where the point of taxation is contentious like deemed dividend. Under this, in case of deemed dividend, tax assessment would be made not only for the companies, but also for the shareholders. Experts said that by the principles of taxation, assessments for both are done so as to tax an income when the view of the department differs from that of the appellate authority or the assessor. The difference of view may be on whose hands the income would be taxed or for which year it would be taxed, or about the status of the assessor.