SC: Legal fiction in Sec 2(22)(e) does not extend to, or broaden the concept of a shareholder

The Supreme Court has clarified that the legal fiction in Section 2(22)(e) of the Income Tax Act, which deems certain loans or advances from a closely held company to another concern as 'dividend', does not expand the definition of a 'shareholder'. Therefore, if the recipient company is not a shareholder of the company providing the loan, the amount received cannot be taxed as a deemed dividend in the recipient company's hands. The revenue can, however, pursue taxation in the hands of the actual shareholders.

CIT VS. MADHUR HOUSING AND DEVELOPMENT CO.
(SUPREME COURT) /CIVIL APPEAL NO. 3961 OF 2013

Held that - 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 s. 2(22)(e) does not extend to, or broaden the concept of, a "shareholder"

THE BRIEF FACTS

1. In CIT vs. Ankitech Pvt Ltd (2012) 340 ITR 14, the Delhi High Court was concerned with a case where the assessee, a company, received advances of Rs. 6.32 crores by way of book entry from Jacksons Generators Pvt. Ltd, a closely held company.

2. The shareholders having substantial interest in the assessee company were also having 10% of the voting power in Jacksons Generators.

3. The AO & CIT(A) held that as the shareholders who held substantial interest in Jacksons Generators also had substantial interest in the assessee company, for purposes ofSection 2(22)(e) of the Income Tax Act,1961 , the amount received by the assessee from Jacksons constituted "advances and loans" and was assessable as deemed dividend.

4. On appeal, the Tribunal, relying on Bhaumik Colour 313 ITR 146 (Mum) (SB), deleted the addition on the ground that though the amount received by the assessee by way of book entry was "deemed dividend" u/s 2(22)(e), it was not assessable in the hands of assessee company as it was not a shareholder of Jacksons Generators.

5. On appeal by the department to the High Court, the High Court dismissed the appeal on the basis that:

(i) U/s 2(22)(e), 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.

(ii) The legal fiction in s. 2(22)(e) enlarges the definition of dividend but does not extend to, or broaden the concept of, a "shareholder".

6. As the assessee was not a shareholder of the paying company, the "dividend" was not assessable in its hands (Bhaumik 313 ITR 146 (Mum) (SB), approved in Universal Medicare 324 ITR 363 (Bom) & Hotel Hilltop 313 ITR 116 (Raj) followed);

(ii) As the conditions stipulated in s. 2(22)(e) treating the loan and advance as deemed dividend are established in these cases, it is open to the Revenue to take corrective measure by treating this dividend income at the hands of the shareholders and tax them accordingly as otherwise it amounts to escapement of income at the hands of those shareholders.

7. On appeal by the department to the Supreme Court, HELD dismissing the appeal:Having perused the judgment and having heard arguments, we are of the view that the judgment is a detailed judgment going into Section 2(22)(e) of the Income Tax Act which arises at the correct construction of the said Section. We do not wish to add anything to the judgment except to say that we agree therewith.

CONCLUSION

From above judgement of apex court it is clear that in case of Section 2(22)( e) of the Income Tax Act,1961 ,since the entity advancing loan to another entity in which director /member of the first entity has more than 10% shareholding, the deeming provisions of Section 2(22)(e ) is not applicable to the first entity ,since first entity is not holding 10% share of second entity. Its director/member of the first entity has shareholding and hence deeming provisions will be applicable in hand of director/member and not first entity.

DISCLAIMER: The case law presented here is only for sharing information and knowledge with the readers. The views are personal ,shall not be considered as professional advice. In case of necessity do consult with tax professionals for more clarity and understanding on subject matter.