The Income Tax Act, 1961 defines several key terms to ensure clarity in tax compliance. One important term is “person who has a substantial interest in the company”, explained under Section 2(32). This definition is crucial for applying provisions related to expense disallowances, especially under Section 40A, where payments to such persons are checked for fairness.
Definition u/s 2(32) of Income Tax Act, 1961
As per Section 2(32) of the Income Tax Act, 1961, unless the context otherwise requires, the term “person who has a substantial interest in the company”, in relation to a company, means 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, carrying not less than twenty per cent (20%) of the voting power.
This definition is important to understand the likely repercussions of certain disallowances u/s 40A of the Income Tax Act, 1961, due to payments of expenses to persons having such interest in the business of the assessee.
In simple terms, this applies to equity shares that give voting rights. Preference shares are excluded because they usually offer fixed dividends and do not affect voting power. The law focuses on beneficial ownership, meaning the person enjoys the real economic benefits of the shares, not just the legal title.
Key Components of the Definition
- Beneficial Ownership: This refers to the actual economic interest in shares, which may differ from the name on the share certificate. This prevents tax avoidance through proxy holdings.
- Excluded Shares: Shares with fixed dividend rates, typically preference shares, are not counted for voting power.
- 20% Voting Power Threshold: The person must hold shares representing at least 20% of total voting rights. This level indicates significant control or influence in the company.
Impact on Expense Disallowances u/s 40A
This definition matters when applying Section 40A(2)(b). Under this rule:
- The Assessing Officer can disallow expenses paid to persons with substantial interest if the payment for goods, services, or facilities is excessive or unreasonable compared to market value.
- The goal is to prevent tax avoidance through inflated payments to related parties.
- Example: If a director or their relative holds 20% voting power, any salary or payment to them may be reviewed to ensure it is at arm’s length.
Understanding who qualifies as a person with substantial interest under Section 2(32) is essential for businesses and professionals. It helps ensure compliance with tax laws and prevents disallowances under Section 40A. Always verify the latest provisions and interpretations before making decisions.
Different Definitions under Income Tax relating to Companies:
Section 2(18): Substantial Interest of Public in Company
Section 2(22A)/ 2(23A) Income Tax: Domestic/ Foreign Company – Meaning