Landmark Judgements of Supreme Court on Section Section 2(22)(e) [Deemed dividend]

Director - No evidence to prove that the advance was in respect of sale of land – Addition as deemed dividend is held to be justified - Where High Court upheld Tribunal’s order holding that certain amount received by assessee, a director of ‘C’ Ltd., from said company constituted deemed dividend under section 2(22)(e) and not as advance in respect of sale of land, SLP filed against said order was to be dismissed

Deemed dividend (Loans or advances to shareholders) - Assessee was a director of ‘C’ Ltd. holding 50 per cent shares of said company. During assessment proceedings, Assessing Officer made addition to assessee's income under section 2(22)(e) in respect of advance received from company - In appellate proceedings, assessee raised a plea that amount in question represented advance received in respect of sale of land to ‘C’ Ltd. Assessee further submitted that sale agreement could not be executed and, thus, amount received as advance was refunded to ‘C’ Ltd. Commissioner (Appeals) having accepted said explanation, deleted addition made by Assessing Officer - Tribunal noted that sale agreement did not have any forfeiture clause and further despite having right of enforcement, assessee did not make any effort in said regard - Further, assessee, being a Director of company was also not aware that how purchase consideration could be arranged by company for payment of land - It was also noted that assessee could not show what efforts were made by company and which bankers were approached for loan. Tribunal thus restored addition made by Assessing Officer. High Court confirmed order passed by Tribunal. On facts, SLP filed against order of High Court was to be dismissed. [In favour of revenue] (Related Assessment year : 2010-11) – [Vikram Krishna v. PCIT (2020) 269 Taxman 477 : 114 taxmann.com 197 (SC)]

Where loans and advances are given in normal course of business and transaction in question benefits both payer and payee companies, same cannot be treated as deemed dividend

Any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be “dividend” on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance. However, the legal fiction in section 2(22)(e) does not extend to, or broaden the concept of, a “shareholder”

High Court relied upon judgment passed by Judgment of Delhi High Court in CIT v. Ankitech (P) Ltd. (2011) 11 taxmann.com 100 (Del.) in which it was held that (i) legal fiction created under section 2(22)(e) enlarges definition of dividend only and it cannot be extended further for broadening concept of shareholders, (ii) a concern in which shareholder of payer company has at least 20 per cent of voting power and loan or advance under this category is given admittedly not to a shareholder/member of payer company, under no circumstances, said concern can be treated as shareholder/member receiving dividend,

(iii)  in a case where conditions stipulated in section 2(22)(e) treating loan and advance as deemed dividend are established, revenue can treat dividend income at hands of shareholders and tax them accordingly, and (iv) where loans and advances are given in normal course of business and transaction in question benefits both payer and payee companies, provisions of section 2(22)(e) cannot be invoked.

Judgment of High Court was to be agreed with. [In favour of assessee] – [CIT v. Madhur Housing & Development Co. (2018) 401 ITR 152 : 93 taxmann.com 502 (SC)]

Even if HUF is not a registered shareholder in lending company, advances/loans received by HUF is taxable as deemed dividend under section 2(22)(e) if Karta-shareholder has substantial interest in HUF

The argument that as the shares are issued in the name of the Karta, the HUF is not the “registered shareholder” and so section 2(22)(e) will not apply to loans paid to the HUF is not correct because in the annual returns filed with the ROC, the HUF is shown as the registered and beneficial shareholder. In any case, the HUF is the beneficial shareholder. Even if it is assumed that the Karta is the registered shareholder and not the HUF, as per Explanation 3 to section 2(22), any payment to a concern (i.e. the HUF) in which the shareholder (i.e. the Karta) has a substantial interest is also covered’

In the instant case, The assessee is a Hindu Undivided Family (HUF). During the previous year to the Assessment Year, the assessee had received certain advances from one M/s. G.S. Fertilizers (P) Ltd. (hereinafter referred to as the ‘Company’). The Company is the manufacturer and distributor of various grades of NPK Fertilizers and other agricultural inputs. In the audit report and annual return for the relevant period, which was filed by it before the Registrar of Companies (ROC), it was found that the subscribed share capital of the said Company was Rs. 1,05,75,000/- (i.e., 10,57,500 shares of Rs. 10/-each). Out of this, 3,92,500 number of shares were subscribed by the assessee which represented 37.12% of the total shareholding of the Company. From this fact, the AO concluded that the assessee was both the registered shareholder of the Company and also the beneficial owner of shares, as it was holding more than 10% of voting power. On this basis, after noticing that the audited accounts of the Company was showing a balance of Rs. 1,20,10,988/- as “Reserve & Surplus” as on 31st March, 2006, this amount was included in the income of the assessee as deemed dividend. In the appeal filed by the assessee, the aforesaid addition was affirmed by the CIT(A). The Tribunal reversed the CIT(A). The High Court reversed the Tribunal. Before the Supreme Court, the assessee argued that being a HUF, it was neither the beneficial shareholder nor the registered shareholder. It was further argued that the Company had issued shares in the name of Shri Gopal Kumar Sanei, Karta of the HUF, and not in the name of the assessee/HUF as shares could not be directly allotted to a HUF. On that basis, it was submitted that provisions of Section 2(22)(e) of the Act cannot be attracted. The Supreme Court had to consider the following question of law:

“Whether in view of the settled principle that HUF cannot be a registered shareholder in a company and hence could not have been both registered and beneficial shareholder, loan/advances received by HUF could be deemed as dividend within the meaning of Section 2(22)(e) of the Income Tax Act, 1961 especially in view of the term “concern” as defined in the Section itself?”

Section 2(22)(e) creates a fiction, thereby bringing any amount paid otherwise than as a dividend into the net of dividend under certain circumstances. It gives an artificial definition of ‘dividend’. It does not take into account that dividend which is actually declared or received. The dividend taken note of by this provision is a deemed dividend and not a real dividend. Loan or payment made by the company to its shareholder is actually not a dividend. In fact, such a loan to a shareholder has to be returned by the shareholder of the company. It does not become income of the shareholder. Notwithstanding the same, for certain purposes, the Legislature has deemed such a loan or payment as 'dividend' and made it taxable at

the hands of the said shareholder. It is, therefore, not in dispute that such a provision which is a deemed provision and fictionally creates certain kinds of receipts as dividends, is to be given strict interpretation. It follows that unless all the conditions contained in the said provision are fulfilled, the receipt cannot be deemed as dividends. Further, in case of doubt or where two views are possible, benefit shall accrue in favour of the assessee.

It is also found as a fact, from the audited annual return of the company filed with ROC that the money towards shareholding in the company was given by the assessee/HUF. Though, the share certificates were issued in the name of the Karta, Gopal Kumar Sanei, but in the annual returns, it is the HUF which was shown as registered and beneficial shareholder. In any case, it cannot be doubted that it is the beneficial shareholder. Even if it is presumed that it is not a registered shareholder, as per the provisions of section2(22)(e), once the payment is received by the HUF and shareholder (Karta, in this case) is a member of the said HUF and he has substantial interest in the HUF, the payment made to the HUF shall constitute deemed dividend within the meaning of clause (e) of section2(22). This is the effect of Explanation 3 to the said section. Therefore, it is no gain saying that since HUF itself is not the registered shareholder, the provisions of deemed dividend are not attracted. [In favour of revenue] (Related Assessment year : 2006-07) – [Gopal And Sons (HUF) v. CIT, Kolkata (2017) 245 Taxman 48 : 77 taxmann.com 71 (SC)]

Deemed dividend – SLP dismissed against the decision of the Delhi High Court in the case of CIT v. Subrata Roy (2015) 375 ITR 207 (Del.)

The Honourable Apex Court has dismissed the special leave petition filed against the order of the Delhi High Court in the case of CIT vs. Subrata Roy wherein it was held that in the case where the amount was advanced by the firm, in which the assessee is a partner, to the assessee, it cannot be said to have been advanced by the company in which the assessee is a shareholder. A certain sum of money was due by the firm to the company. It was the case of the Assessing Officer that the firm was used as a conduit to advance the loan to the shareholder by the company from out of the outstanding receivable from the firm. It was held by the High Court that the sum cannot be said to have been advanced by the company, when it was proved by the assessee that the firm had sufficient funds on its own to advance the money and therefore, the provisions of section 2(22)(e) is not attracted. (Related Assessment year : 1992-93) – [CIT v. Subrata Roy Sahara (2016) 236 Taxman 396 : 138 DTR 33 (SC)]

Application of definition

A perusal of section 2(22)(e) shows that for the purpose of the Act, any payment made by a company of any sum of money by way of advance or loan to its shareholders is deemed to be a dividend. Since the Act has not provided for any other definition of the word ‘dividend’ except the ones enumerated in section 2(22), it should be construed that this definition would be applicable to all provisions which contain the term ‘dividend’ in the Act. - [CIT v. Mysodet (P) Ltd. (1999) 237 ITR 35 : 103 Taxman 336 (SC)]

Payment must be adjusted against accumulated profits

When a loan by a company to a shareholder in the manner set out in section 2(22)(e) is treated as a deemed dividend, it is to be treated as payment out of accumulated profits of the company. Any legal fiction will have to be carried to its logical conclusion. If the payment under section 2(22)(e) is treated as a deemed dividend and is required to be so treated to the extent the company possesses accumulated profits, the logical conclusion is that this payment must be considered as adjusted against the company’s accumulated profits to the extent it is treated as deemed dividend while calculating accumulated profits of the company.