[aaykarbhavan] Fw: [IT Reporter] TDS FOR GOVT-PVT EMPLOYEE FOR F.Y. 2012-13 [1 Attachment], Judgments Received from R R Makwana and Pavan Singla

• CIT vs. Smifs Securities Ltd (Supreme Court)
  "Goodwill" is an intangible asset eligible for depreciation u/s 32
   
  Pursuant to an amalgamation of another company with the assessee, the difference between the consideration paid by the assessee and the net value of assets of the amalgamating company was treated by the assessee as "goodwill" and depreciation of Rs. 54 lakhs was claimed thereon u/s 32(1)(ii). The AO rejected the claim on the ground that (i) "goodwill" was not an "intangible asset" as defined in Explanation 3 to s. 32(1) and (ii) the assessee had not paid anything for the same. The Tribunal and High Court upheld the assessee's claim. On appeal by the department to the Supreme Court, HELD dismissing the appeal:
  
  
• In order to attract the provisions of section 2(22)(e), the important consideration is that there should be loan/advance by a company to its shareholder. Every amount paid must make the company a creditor of the shareholder of that amount. At the same time, it is to be borne in mind that every payment by a company to its shareholders may not be loan/advance. In the present case, the amount was withdrawn by the assessee from the company only to meet her short term cash requirements. By virtue of offering personal guarantee and collateral security for the benefit of the company, the liquidity position of the assessee had gone down. In the strict sense if it is to be construed the amount forwarded by the company to the assessee was not in the shape of advances or loans. The arrangement between the assessee and the company was merely for the sake of convenience arising out of business expediency. In the facts and circumstances of the case, it is not appropriate to hold that the amount withdrawn by the assessee partakes the character of deemed dividend under the provisions of section 2(22)(e).
  IN THE ITAT CHENNAI BENCH 'A'
  Assistant Commissioner of Income-tax, Company Circle-V(3)
  v.
  Smt. G. Sreevidya
  IT APPEAL NO. 1270 (MDS.) OF 2011
  [ASSESSMENT YEAR 2006-07]
  JUNE 28, 2012
  ORDER

  ---

  Vikas Awasthy, Judicial Member – The present appeal has been filed by the Revenue impugning the order of the CIT(A)-V, Chennai dated 06.04.2011.
  2. The facts in brief of the case are that the assessee had filed return of income relevant to the assessment year 2006-07 on 31.10.2006 declaring total income of Rs. 6,78,056/-. The case of the assessee was selected for scrutiny and notice under section 143(2) and 142(1) were issued. The assessee is a Managing Director of M/s. Ravindra Services (P) Ltd. (hereinafter referred to as RSPL) having substantial ownership of shareholding and 10% of voting power. The assessee had taken a loan of Rs. 17,65,517/- from RSPL which was subsequently repaid by the assessee. The Assessing Officer treated the said amount as deemed divided and made addition under the head "other sources" invoking the provisions of section 2(22)(e)of the Act. Apart from the above, the Assessing Officer made addition of Rs. 2,62,035 towards the rent received from RSPL under the head 'Income from House Property'. Further, an addition of Rs. 1,20,718/- was made in the total income of the assessee as 'undisclosed income'. The assessee preferred an appeal against the assessment order dated 10.02.2008. The CIT(A) allowed the appeal of the assessee vide order dated 6.4.2011 deleting the additions under the provisions of section 2(22)(e) as well as additions made under other heads.
  3. The present appeal has been filed by the Revenue assailing order of the CIT(A) only on the ground that CIT(A) has erred in deleting the addition of Rs. 17,65,517/- made by the Assessing Officer as deemed dividend under section 2(22)(e) of the Act.
  4. Mr. Shaji P. Jacaob, DR appearing on behalf of the Revenue vehemently opposed the order of the CIT(A). He submitted that the loan was granted by RSPL to the assessee who is having substantial interest in the company having more than 10% voting power. The amount advanced by the company to the assessee falls within the ambit of definition of "deemed dividend" under section 2(22)(e) of the Act as the company was having accumulated profits to that extent when the amount was advanced to the assessee. He further submitted that the repayment of loan amount as alleged by the assessee cannot be criteria to take out the said amount from the ambit of the provisions of section 2(22)(e). He strongly contended that the CIT(A) has erred in relying on the following cases:-
   (i)  CIT v. Creative Dyeing & Printing (P.) Ltd. [2009] 318 ITR 476
  (ii)  CIT v. Ambassador Travels (P.) Ltd. [2009] 318 ITR 376
  (iii)  CIT v. Rajkumar [2009] 318 ITR 462
  The D.R. submitted that case of the assessee is squarely covered by the judgement of the Hon'ble Supreme Court of India in the case of Miss P. Sarada v. CIT [1998] 229 ITR 444 as well as Smt. Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC). He further relied on the judgement of the Hon'ble Madras High Court in the case of CIT v. P.K. Abubucker [2003] 259 ITR 507 .
  5. On the other hand, Dr. Anita Sumanth, counsel appearing on behalf of the assessee submitted that the order passed by the CIT(A) is a well reasoned and detailed order. She submitted that the amount was advanced to the assessee as per her pre-condition of granting bank guarantee and a collateral security for funding of the company. The counsel submitted that the assessee had given personal guarantee and had given collateral security to facilitate availing of credit facility by the company. At the time of extending guarantee/security the assessee had sought liberty to withdraw funds from the company as and when required by her for personal purposes. It was thus in this background, the assessee had withdrawn certain amount from the company and had also repaid the amounts withdrawn periodically. Therefore, the transaction between the assessee and the company was purely out of business consideration. The counsel further contended that if the assessee would not have given bank guarantee and collateral security, the operations of the company would have come to a standstill. The counsel submitted that the amount was advanced by the company to the assessee purely on the terms of commercial expediency. In order to support her contentions the counsel relied on the judgement of the Hon'ble Calcutta High Court in the case of Pradip Kumar Malhotra v. CIT [2011] 338 ITR 538  and the judgements of the Hon'ble Delhi High Court in the following cases:-
  (i)  Creative Dyeing & Printing (P.) Ltd. (supra)
  (ii)  Ambassador Travels (P.) Ltd. (supra)
  (iii)  Rajkumar (supra).
  6. We have heard the submissions made by the respective parties and have gone through the documents on record, orders of the lower authorities as well as the judgements referred to by the respective parties. The provisions of section 2(22)(e) are reproduced herein below:-
  "2(22)(e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) [made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being 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 ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern)] or 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 profits.
  but "dividend" does not include-
   (i)  a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ;
  [(ia)  a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964, [and before the 1st day of April, 1965] ;]
  (ii)  any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company ;
  (iii)  any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off;
  [(iv)  any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956);
  (v)  any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company)."
  The definition laid down by section 2(22) is inclusive and not exhaustive. The following payments of distributions by a company to its shareholder are deemed as dividends to the extent of accumulated profits of the company although these payments may not be dividends under the provisions of Companies Act:-
  (a)  any distribution or release of company's assets;
  (b)  any distribution of debentures, debenture stock, deposit certificates and bonus to preference share- holders;
  (c)  distribution on liquidation of company;
  (d)  distribution on reduction of capital
  (e)  any payment by way of loan or advances by a closely held company to a shareholder holding substantial interest provided the loan should not have been made in the ordinary course of business and money lending should not be a substantial part of the company's business.
  7. In order to attract the provisions of section 2(22)(e), the important consideration is that there should be loan/advance by a company to its shareholder. Every amount paid must make the company a creditor of the shareholder of that amount. At the same time, it is to be borne in mind that every payment by a company to its shareholders may not be loan/advance. In the present case, the amount was withdrawn by the assessee from the company only to meet her short term cash requirements. By virtue of offering personal guarantee and collateral security for the benefit of the company, the liquidity position of the assessee had gone down. In the strict sense if it is to be construed the amount forwarded by the company to the assessee was not in the shape of advances or loans. The arrangement between the assessee and the company was merely for the sake of convenience arising out of business expediency. In the facts and circumstances of the case, it is not appropriate to hold that the amount withdrawn by the assessee partakes the character of deemed dividend under the provisions of section 2(22)(e) of the Act.
  8. The case of the assessee is squarely covered by the Division Bench judgement of the Hon'ble Calcutta High Court in the case of Pradip Kumar Malhotra (supra), wherein the facts were similar to the facts of the instant case. In Pradip Kumar Malhotra's case (supra) assessee had substantial holding in a private company. The assessee permitted his immovable property to be mortgaged to the bank for enabling the company to take the benefit of loan. The Board of Directors of the company passed a resolution to obtain interest free deposit upto Rs. 50 lakhs as and when required. The assessee obtained from the company a sum of Rs. 20,75,000/- by way of security deposit. Out of this amount, a sum of Rs. 20 lakhs was returned by the assessee to the company. The Assessing Officer added the sum of Rs. 20,75,000/- as deemed dividend. The Hon'ble High Court while allowing the appeal of the assessee held that for retaining the benefit of loan availed of from the bank, if decision was taken to give advance to the assessee such decision was not to give gratuitous advance to its shareholder but to protect the business interest of the company. The sum of Rs. 20,75,000/- could not be treated as deemed dividend. The Division Bench of the Hon'ble Calcutta High Court followed the decision of the Hon'ble Delhi High Court in the case of Creative Dyeing & Printing (P.) Ltd. (supra). In the instant case also the assessee was allowed to withdraw funds from the company as per requirement for personal purposes against the personal guarantee and the collateral security given by her to facilitate her availing of credit facility of the company.
  9. It is a well settled law that loan or advance given to a shareholder by a company in which public is not substantially interested and which had accumulated profits, the amount advanced as loan to such shareholder is deemed to be dividend as per the provisions of section 2(22)(e) of the Act. However, the facts and circumstances of each case have to be scrutinized before applying the ratio of the cases holding above well settled law. In the facts and circumstances of the instant case, judgements relied upon by the DR in the cases of Miss P. Sarada (supra), P.K. Abubucker (supra) and Smt. Tarulata Shyam (supra) are not applicable.
  10. The Commissioner of Income Tax (Appeals) vide order dated 6.4.2011 has rightly deleted the addition made on account of "deemed dividend" by the Assessing Officer. We do not find any infirmity in the order passed by the Commissioner of Income Tax (Appeals). In view of our aforesaid findings, the appeal of the Revenue fails and the same is dismissed being devoid of any merit.
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• DEEMED DIVIDEND
  The concept of Deemed Dividend under the Income-tax Act, 1961(the Act) is not new. However, time and again many closely held company assessees and their controlling shareholders, to their surprise and dismay, realise very late the importance of this powerful taxing tool in the hands of the Assessing Officer.
  
  
  The concept of Deemed Dividend is embedded in Section 2(22)(e) of the Income-tax Act, 1961 and was also embedded in section 2(6A)(e) of the Indian Income-tax Act, 1922. In nutshell, the concept envisages taxing certain payments made by closely held companies by way of loans or advances to certain shareholders of the company or to the concerns/companies in which they have substantial interest. Whenever any payment is made by way of loan or advance, the recipient of the loan or advance will be liable to be taxed on this amount as a dividend, to the extent to which the company has accumulated profits, under the deeming provisions of section 2(22) (e) although such loan or advance may have been given for genuine business purposes and even if the paying company may have received back the loan amount. Thus the section deems certain payments as dividend income which is not income under ordinary commercial parlance. Therefore, the name Deemed dividend.
  
  
  The concept of deeming certain payments or loans or advances to substantial shareholders as income was introduced with the object of curbing tax evasion. Upto 31-5-1997 dividend was taxed in the hands of the recipient of the dividend. However many closely held companies never declared any dividend and accumulated profits in the company itself. Since no dividend was declared the same could not be taxed. However the companies did give loans or advances to substantial shareholders or to their concerns/companies who presumably enjoyed these funds but were not liable to pay any tax on the same as the amounts were loans or advances liable to be returned. These amounts of loans or advances are sought to be taxed as dividend by section 2(22)(e) of the Act by way of a deeming fiction.
  
  
  Taxation of dividend under Income-tax Act, 1961 has undergone substantial changes in recent times. Effective from 1-6-1997 the scheme of taxation of dividend has been modified and is different from the old scheme. The essence of the old scheme was that the recipient of the dividend income was liable to pay the income-tax on the same, subject to certain exemptions. The new scheme essentially makes the dividend tax-free (section 10(33) of the Act) in the hands of the recipient (except cases covered under section 2(22(e)of the Act) and the dividend paying company has been made liable to pay tax on the amount of dividend declared , distributed or paid by it (Section 115-O of the Act). This tax is over and above the corporate income-tax which a company would normally pay. However there is no change in the scheme of taxation of Deemed Dividend contained in the section 2(22) (e) of the Act and such dividends are governed by the old scheme of taxation of dividend i.e. tax on deemed dividend is paid by the recipient and the paying company does not have to pay dividend tax but will be liable to deduct tax at source from such loans or advances/deemed dividend and pay the same to the Government.
  
  
  Section 2 (22)
  Section 2(22) has 5 clauses (a), (b), (c), (d) and (e) which specify various types of distributions and payments as dividend. Clauses (a), (b), (c) and (d) mainly cover cases of distributions which entail release of assets or create liabilities. While clause (e) covers cases of payments by way of loans or advances and which is the clause mainly dealing with deemed dividend as it is commonly understood and has been dealt with in this article.
  
  
  In Kantilal Manilal v.CIT [1961] 41 ITR 275(SC) the Supreme court held that Section 2(22) deals with various types of cases and creates a fiction by which certain receipts or parts thereof are treated as dividend for the purpose of levy of Income-tax .
  
  
  In CIT v. Martin Burn Ltd.,(1982)136 ITR 805(cal) the Calcutta High court held that Under section 2(22) certain amounts which are actually not distributed are also brought within the net of dividends. Therefore, that section must receive a strict interpretation.
  
  
  Section 2(22)(e) has been held to be constitutionally valid in Navnitlal C. Javeri v. K.K.Sen, AAC [1965]56 ITR 198 (SC).
  
  
  Section 2(22) starts with the words " Dividend includes ……….."Thus the definition of dividend is inclusive and not exhaustive.
  
  
  Section 2(22)(e)
  "any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) [made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being 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 ten percent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as said concern)] or 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 profits;"
  
  
  Let us now analyse the clause in detail.
  Section 2(22) of Income-tax Act, 1961 defines "dividend" and is the main section for taxation of Dividend. Unless a payment or distribution is covered by this definition, it can not be taxed as "dividend". Once an amount is covered as dividend it will be also considered as income as Section 2(24) (ii) of the Act includes 'dividend' within the definition of 'Income'.
  
  
  Companies in which Public are not substantially interested.
  As it is clear, clause (e) applies only to companies in which public are not substantially interested i.e. to companies which are commonly known as closely held companies. Section 2(18) of the Act defines a "Company in which public are substantially interested". Section 2(22)(e) does not apply to listed companies, government companies, section 25 companies, companies having no share capital and declared by Board, mutual benefit finance companies declared by Central Government to be a Nidhi or Mutual Benefit society, companies in which one or more co-operative societies hold at least 50% voting shares throughout the year, etc.
  
  
  Payment of any Sum.
  Clauses (a),(b),(c) and (d) of section 2(22) use the word "distribution" while clause (e) uses the word "payment" which means amount may have been disbursed to one or two or more shareholders and not necessarily be distributed to all the shareholders.
  
  
  Does it mean only payment by cash/cheque or will it cover loan in kind also? Whether a goods loan will be covered? In M.D. Jindal v. CIT [1986] 28 Taxman 509 (Cal.) it was held that Section 2(22)(e) is applicable even if a loan is given in kind. Thus a loan of goods or other assets will also be covered by the clause and it is not necessary that the loan or advance must be given in cash only.
  
  
  Shareholder
  The shareholder may be even a corporate entity. Loan given by a subsidiary company to a holding company will be covered by clause (e).
  
  
  Loan or advance
  Section 269SS of IT Act specifies that ' for the purpose of this section," loan or deposit" means 'loan or deposit of money'. A loan creates a relationship of a lender and a borrower.
  
  
  Can a bonafide loan given to a major shareholder for a short duration be covered by this section? In CIT v. Bhagwat Tewari [1979] 105 ITR 62 (Cal) it was held that a bonafide loan for a short duration is treated as dividend if all the conditions of section 2(22) (e) are satisfied.
  
  
  What is the position when a shareholder has a current account with the company? When a current account shows a debit balance of the shareholder in company's books, it will take character of a loan. Therefore, position after every entry will have to be ascertained.
  
  
  In order to attract the provisions of section 2(22)(e), the important consideration is that there should be loan/advance by a company to its shareholder. Every payment by a company to its shareholder may not be loan/advance. To be treated as loan every amount paid must make the company a creditor of the shareholder for that amount. If, however, at the time when payment is made, the company is already the debtor of the shareholder, the payment would be merely a repayment by the company towards its already existing debt. It would be a loan by the company only if the payment exceeds the amount of its already existing debt and that too only to the extent of the excess. If the shareholder has a current account with the company, the position as regards each debit will have to be considered individually, as it may or may not be a loan. In such case the debit balance of the shareholder with the company at any point of time cannot be taken to represent an advance/loan by the company; nor can the amount at the end of the previous year be alone taken as loan.CIT v. P.K. Badiani[1970] 76 ITR 369 (Bom.).
  
  
  Whether an overdraft taken by a major shareholder from the company will be covered as deemed dividend? An overdraft taken by a shareholder from the company is treated as loan and taxable as dividend if conditions of section 2(22)(e) are satisfied—CIT v. K..Srinivasan [1963] 50 ITR 788 (Mad.).
  
  
  What will be the position when a major shareholder misappropriated some amount from the company? Amount misappropriated by the director cannot be treated as deemed dividend in his hands since in such a case there is no lending or advancing by the company. It cannot be said that in such a case the company has paid anything and unless there is an actual payment by the company as a loan or advance to the assessee, it cannot be treated as dividend under section 2(22)(e). CIT v. G. Venkataraman [1975] 101 ITR 673 (Mad.)
  
  
  If a loan is repaid before the end of the previous year, the section will be attracted? Yes, even if a loan is repaid before the end of the previous year the section will be attracted. In Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) the Supreme court held that under section 2(22) the liability to tax attaches to any amount taken as loan by the shareholder from a controlled company to the extent it possesses accumulated profits at the moment the loan is borrowed and it is immaterial whether the loan is repaid before the end of the accounting year.
  
  
  Whether Book debts will be covered by "loans and advances"? Where the assessee-shareholder, having business of his own, was transacting business with the company and the account of the assessee in the company always showed a debit balance, it was held that the said debit balance would amount to a loan from the company to the assessee. CIT v. Jamnadas Khimji Kothari [1973] ITR 105 (Bom.)
  
  
  Every sale of goods on credit does not amount to a transaction of loan. A loan contracted no doubt creates a debt but there may be a debt without contracting a loan. Bombay Steam Navigation Company P. Ltd. v. CIT(1965) 56 ITR 52(SC).
  
  
  Whether Security deposit to a major shareholder for use of premises will be covered under clause (e)? Genuine security deposit without any element of loan may not be considered as a loan.
  Whether loans or advance to relatives of a major shareholder will be covered? Loans to relatives of substantial shareholders are not covered as loans or advances to the shareholder. However such loans or advances may be covered as" payment on behalf of or for the individual benefit" of the shareholder.
  
  
  Clause (ii) to section 2(22) provides that "dividend" does not include any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of business, where the lending of money is a substantial part of the business of the company;
  
  
  If a majority of a company's assets and income are from money-lending business, it will be proper to assume that lending of money is a substantial part of the company's business.
  
  
  In Walchand & co. Ltd. V. CIT,(1975)100 ITR 598(Bom) it was held that the onus to prove these facts lies on the assessee.
  
  
  Clause (iii) to section 2(22) provides that "dividend" does not include any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e),to the extent to which it is set off.
  
  
  This clause gives some relief to the assessee by way of avoiding double taxation as well as brings in some scope for Scope for tax-planning. Thus, if a loan is already treated as a dividend it may make sense to declare dividend and adjust the outstanding loan amount against the dividend declared. No tax will be payable by shareholder on such dividend declared.
  However, if the loan has been repaid by the shareholder and nothing is due by the shareholder against the loan referred in section 2(22)(e), then no set-off would be possible. Also if the sum due by the assessee is on account of some other payments not covered by section 2(22)(e), then set-off will not be possible.
  
  
  It appears that liability to pay tax on distributed profits u/s 115-O can not arise in a case where a dividend paid by a company is set-off by the company as mentioned above, since the amount itself is not to be treated as a dividend. Explanation to section115Q may be referred to for this purpose.
  
  
  Payment on behalf of or for the individual benefit of a person
  
  
  A benefit means some advantage to a person or something for the good of a person.
  
  
  A managing director of a company, whenever he needed money used to ask an employee to take a loan from the company and pass it on to him even without executing any pronote. Can he be said to have received any benefit? It was held that the loans made by the company to the employee fell in the category of "benefit" to the assessee managing director and were, therefore, assessable as deemed dividends in his hands—CIT v. L.Alagusundaram Chettiar [1977] 109 ITR 508 (Mad.).
  
  
  In one case, the assessee, having substantial interest in a company X, obtained from company Y two loans of Rs. 75,000 and Rs.2,00,000 on July 30, 1968 and September2, 1968, respectively. The question for consideration was whether these amounts could be treated as deemed dividend in the hands of the assessee under section 2(22)(e) on the ground that Y had made these loans to the assessee out of loans received by Y from X on the same dates. The Court held (in Nandlal Kanoria v. CIT [1980] 122 ITR 405 (Cal.)), that there was no loan given by X to the assessee. However, as the loan of Rs. 75,000 was given by Y to the assessee out of an equal amount received as loan from X on the same date, this amount was a payment by X for the benefit of the assessee and fell within the mischief of section 2(22)(e). The same could not be said of the loan of Rs. 2,00,000, as on the date of making that loan, Y had received loans not only from X but from another source also and the loan was made out of blended amount.
  Of accumulated Profits.
  In P. K. Badiani v CIT(1976)105 ITR 642(SC) the Supreme court held that Accumulated profits mean commercial profits and not assessed income. It does not mean the aggregate of the assessed income arrived at after disallowing disbursements and expenditure in fact incurred.
  
  
  In Navnitlal C. Jhaveri v. CIT [1971]80 ITR 582(Bom) a question arose that while calculating accumulated profits depreciation as per books should be considered or as per IT Act? The Bombay High court held that while calculating accumulated profits an allowance for depreciation at the rates provided by the Income-tax Act itself has to be made by way of deduction.
  
  
  This is an important saving grace and assessees can claim substantial deduction for Income-tax depreciation out of accumulated profits. This will also call for separate calculation for accumulated profits as per income-tax Act and the same may be different from the accumulated profits as per books of accounts.
  
  
  As the Accumulated profits have to be commercial profits, additions made by the ITO due to concealed income can be included in accumulated profits. However, by the same logic, additions made by the Income-tax officer on account of inadmissible expenses or disallowances can not be included in accumulated profits.
  
  
  Even loan obtained by the assessee-shareholder from a company from out of its Accumulated profits, which are exempt in the hands of the company as agricul tural income, is to be treated as deemed dividend in the hands of the assessee. S. Kumaraswami v.ITO [1961] 43 ITR 423 (Mad.)
  
  
  Whether balancing charge u/s 41(2)will form part of accumulated profits?.In CIT vs. Urmila Ramesh (1998) 230 ITR 422 the Supreme Court held that the amount of balancing charge under section 41(2) of the Act, did not represent Accumulated profits.
  
  
  Whether capital gains can be included in Accumulated profits? Presently Capital gains are covered by the expression 'accumulated profits' except capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956. However, capital gains which are not taxable per se can not form part of Accumulated profits.Thus any distribution out of such non-taxable accumulated capital gains can not be treated to be taxable as deemed dividend. See CIT v. Mangesh J. Sanzgiri, (1979) 119 ITR 962(Bom). Thus capital gains on sale of agricultural land which is outside the purview of definition of "capital asset" as per section 2(14) of the Act should not form part of the Accumulated profits.
  
  
  Whether Revaluation reserves can be included in Accumulated profits? It appears that revaluation reserves can not be included in Accumulated profits as they are not in the nature of commercial profits as commonly understood and represent a mere book entry.
  
  
  Whether credit to Profit & Loss Account due to write-back of depreciation on account of change in method of depreciation will form part of accumulated profits?
  
  
  There is no legal bar to write back of Depreciation. As per Department of Company Affair's view appearing in Company News and Notes, July 1 1963. However, since write-back of depreciation will be as per book-depreciation, while one needs to calculate Income-tax depreciation as per IT Act for the purpose of calculation of Accumulated profits, such write back will not have any impact on Accumulated profits.
  
  
  Development Rebate Reserve and Investment Allowance Reserve will form part of Accumulated profits.
  
  
  Provision for tax and provision for dividend can not form part of Accumulated profits.CIT v V. Damodaran[1972]85 ITR 59(ker.).This is obvious because each of them represent a liability and is not in the nature of profits or reserves.
  
  
  In determining the Accumulated profits available for the purpose of section 2(22)(e), the amount treated as deemed dividend under section 2(22)(e) in past have to be excluded. CIT v. G. Narasimhan [1979] 118 ITR 60 (Mad).
  
  
  Example -Rs
  a)Accumulated profits80,000
  b)Loan advanced to a major shareholder and treated as dividend 60,000
  c)Balance Accumulated profits a)-b)20,000
  d)Loan repaid by shareholder60,000
  e)Shareholder again borrows in the same year70,000
  f)Second deemed dividend to the extent of balance Accumulated profits20,000
  Explanation 2 to section 2(22) provides that — The expression "accumulated profits" in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include—————-
  
  
  Thus it will be imperative for the company to calculate its profits and losses up to the date of payment of loan or advance and then calculate Accumulated profits (or losses).This date may be a date in between the two accounting years. In fact for every loan to such shareholder/concern the company may have to prepare profit and loss account up to that date.
  Whether capitalised or not
  These words which are found in clauses (a) to (d) are not found in clause (e) of section 2(22) and, therefore, that provides some relief from the mischief of the section as well as provides some scope for planning .Thus it must be interpreted that to the extent of capitalisation of profits, accumulated profits would reduce for the purpose of this clause but not for other four clauses of section 2(22). What is capitalisation? It will ordinarily mean conversion of profits or reserves or income into capital as per Company's Articles of Association.
  
  
  In P.K.Badiani v. CIT (1976)105 ITR 642 (SC) the Supreme court held that mere transferring of an amount from Profit & Loss account to the Development Reserve account or any other Reserve does not amount to capitalisation of profits.
  Similarly a transfer to General Reserve will not amount to capitalisation.
  
  
  The reason for allowing reduction of the accumulated profits to the extent of capitalisation of profits seems to be that to the extent of capitalisation, divisible profits i.e. profits available for distribution of dividend will reduce. A company can not distribute dividends out of capitalised profits i.e. capital. Thus if a closely held company wants to give loan or advance to a shareholder or his concern/company which are covered by this clause, it may first issue bonus shares (and thus capitalise the accumulated profits) and then grant such loan or advance. This is one sure way of escaping from the clutches of section 2(22)(e). However, it may involve expenses of filing fees and stamp-duty on increase of authorised share capital. Also a company may not want to increase its capital due to various other reasons.
  
  
  Quantum of dividend
  A question that arises is whether the quantum of deemed Dividend assessable in the hands of the assessee will be restricted to his share in the accumulated profits?
  In CIT v. Mayur Madhukant Mehta [1972] 85 ITR 230 (Guj.) it was held that there is nothing in sub-clause (e) of section 2(22) to restrict the deemed dividend to that portion of Accumulated profits which corresponds to the assessee's shareholding in the capital of the company.
  If a loan is given by a company to a shareholder who owns 25 percent of share capital, the amount of loan to the extent of entire Accumulated profits (and not to the extent of 25 percent of Accumulated profits) will be treated as dividend. CIT v. Arati Debi [1978] 111 ITR 277 (Cal.).
  When a loan is treated as a deemed dividend and is repaid by the shareholder will it be added in the "accumulated profits"? Section 2(22)(e) must be so interpreted that once an amount goes out of "accumulated profits" as a loan and the loan is to be deemed as dividend the same amount when repaid cannot again be capable of attracting fiction and be deemed as dividend.. To avoid the happening of any such eventuality, the "accumulated profits" must be notionally reduced by the amount of all loans which are to be treated as dividends under section 2(22)(e) .CIT v. P.K. Badiani. [1970] 76 ITR 369 (Bom.).
  Benficial owner of not less than 10% of the voting power
  It is not the registered shareholder but the beneficial owner of the shares who is covered by the section 2(22)(e). Also the shareholding as on the date of the loan has to be considered. If preference shareholders are entitled to vote due to default in payment of dividend or in redemption, their holding will also have to be counted.
  Concern in which Substantial interest
  Section 2(32) of the Act states that a "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 percent of the voting power."
  As per Explanation 3(b) to Section 2(22) a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty percent of the income of such concern.
  
  
  It may be, therefore, worthwhile to first rearrange (by transfer gift or in any other manner) the shareholding pattern or profit sharing ratio to bring it below 20% and then grant a loan or advance to a concern or a company. However, other aspects of rearrangement like capital gain tax, etc. will have to be kept in mind.
  
  
  As per Explanation 3(a) to section 2(22 )"concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company.
  
  
  Other Points
  Whether interest paid on loan which is treated as deemed dividend will be admissible as a deduction under section 57(iii)? Section 57(iii) allows a deduction for any expenditure (not being capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. In Nandlal Kanoria v. CIT [1980] 122 ITR 405(Cal.) the Calcutta High court held that interest paid on loan treated as deemed dividend under section 2(22)(e) is not admissible as a deduction under section 57(iii ).
  Whether deduction u/s 80-L or 80-M is available for deemed dividend? Deemed dividends, like normal dividends, are eligible for deductions under section 80L or section 80M . However, from the assessment year 1998-99, deductions under sections 80L and 80M are not available in view of amendment/omission of the relevant section.

Manish Kumar Agarwal, FCA

Now a days, in a modern organization , there will exist a complicate business structure of holding & subsidiary companies along with closely held companies. There will be routine flow of funds between these companies. It is very important to have the knowledge of provisions of deemed dividend under section 2(22)(e) of the Income tax act, 1961 before making any transaction with the closely held companies.

The provisos of section 2(22)(e) is reproduced below for your kind reference :

any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) ⁹³[made after the 31st day of May, 1987, by way of advance or loan to a shareholder⁹⁴, being 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 ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern)] or 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 profits⁹⁵ ;

                     but "dividend" does not include—

          (i)   a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ;

    ⁹⁶[(ia)   a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964, ⁹⁷[and before the 1st day of April, 1965] ;]

         (ii)   any advance or loan made to a shareholder ⁹⁸[or the said concern] by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company ;

        (iii)   any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off;

    ⁹⁹[(iv)   any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A ¹ of the Companies Act, 1956 (1 of 1956);

         (v)   any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company).]

                     Explanation 1.—The expression "accumulated profits", wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956.

                     Explanation 2.—The expression "accumulated profits" in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation, ²[but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place].

                     ³[Explanation 3.—For the purposes of this clause,—

         (a)   "concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company ;

         (b)   a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern ;]

The concept of Deemed Dividend is embedded in Section 2(22)(e) of the Income-tax Act, 1961 and was also embedded in section 2(6A)(e) of the Indian Income-tax Act, 1922. In nutshell, the concept envisages taxing certain payments made by closely held companies by way of loans or advances to certain shareholders of the company or to the concerns/companies in which they have substantial interest. Whenever any payment is made by way of loan or advance, the recipient of the loan or advance will be liable to be taxed on this amount as a dividend, to the extent to which the company has accumulated profits, under the deeming provisions of section 2(22)(e) although such loan or advance may have been given for genuine business purposes and even if the paying company may have received back the loan amount. Thus the section deems certain payments as dividend income which is not income under ordinary commercial parlance. Therefore, the name Deemed dividend.

The concept of deeming certain payments or loans or advances to substantial shareholders as income was introduced with the object of curbing tax evasion. Upto 31-5-1997 dividend was taxed in the hands of the recipient of the dividend. However many closely held companies never declared any dividend and accumulated profits in the company itself. Since no dividend was declared the same could not be taxed. However the companies did give loans or advances to substantial shareholders or to their concerns/companies who presumably enjoyed these funds but were not liable to pay any tax on the same as the amounts were loans or advances liable to be returned. These amounts of loans or advances are sought to be taxed as dividend by section 2(22)(e) of the Act by way of a deeming fiction..

Taxation of dividend under Income-tax Act, 1961 has undergone substantial changes in recent times. Effective from 1-6-1997 the scheme of taxation of dividend has been modified and is different from the old scheme . The essence of the old scheme was that the recipient of the dividend income was liable to pay the income-tax on the same, subject to certain exemptions. The new scheme essentially makes the dividend tax-free (section 10(33) of the Act) in the hands of the recipient (except cases covered under section 2(22(e)of the Act) and the dividend paying company has been made liable to pay tax on the amount of dividend declared , distributed or paid by it (Section 115-O of the Act). This tax is over and above the corporate income-tax which a company would normally pay. However there is no change in the scheme of taxation of Deemed Dividend contained in the section 2(22) (e) of the Act and such dividends are governed by the old scheme of taxation of dividend i.e. tax on deemed dividend is paid by the recipient and the paying company does not have to pay dividend tax but will be liable to deduct tax at source from such loans or advances/deemed dividend and pay the same to the Government.

Section 2 (22) of Income-tax Act, 1961 defines "dividend" and is the main section for taxation of Dividend. Unless a payment or distribution is covered by this definition, it can not be taxed as "dividend". Once an amount is covered as dividend it will be also considered as income as Section 2(24)(ii) of the Act includes 'dividend' within the definition of 'Income'.

Section 2(22) has 5 clauses (a), (b), (c), (d) and (e) which specify various types of distributions and payments as dividend. Clauses (a). (b), (c) and (d) mainly cover cases of distributions which entail release of assets or create liabilities. While clause (e) covers cases of payments by way of loans or advances and which is the clause mainly dealing with deemed dividend as it is commonly understood and has been dealt with in this article.

Following points are to be understood with reference to the above:

 [A]  Accumulated Profits for the Purposes of Section 2(22)(e)

 (i) General

 Sub-clause (e) applies when distribution or payment referred to therein are connected with accumulated profits. The undistributed income, when accumulated from year to year, generates what is known as "accumulated profit". Accumulated profits shall include all profits of the company till the date of distribution or payment referred to in sub-clause (e).

(ii) Current Profits

 Current profits are included in "accumulated profits" in section 2(22)(e) of I.T. Act 1961. The expression "accumulated profits" was defined in the 1961 Act so as to include current profit upto date of distribution or payment.

 (iii) Accumulated profits – How to be Computed

 The phrase "accumulated profits" does not mean aggregate of assessed profits but commercial profits. If certain disbursements have been disallowed in the assessment proceedings but the expenditure had in fact been incurred, they should be excluded from accumulated profits. In computing commercial profits, all the disbursements made and expenditure incurred for the purpose of business should be taken into account. The following are the items which are to be included or to be excluded in computing accumulated profits:

Sl. No.	Items to be excluded	Items to be included
a)	Provision for taxation and dividend	Development rebate
b)	Depreciation	Refund of income-tax
c)	Difference between depreciation calculated at the rate given under the IT Act and rate adopted in books	Development rebate reserve
d)	Balancing charge	General reserves
e)	Capital gains not chargeable to tax	Capital gains chargeable to tax

  

[B] Advance Or Loan To A Shareholder By A Closely – Held Company 

  I)  Who should be given loan or Advance

Loan or Advance is given by a closely held company (i.e. Private Limited Company) to-

 (i) Shareholder holding 10% or more voting power in that company;

 (ii) Concern i.e. HUF, Firm, AOP, BOI in which, Shareholder who holds 10% or more voting power in the company, also holds 20% or more of the income of that concern at any time during the previous year;

 (iii) Concern i.e. Company in which, Shareholder who holds 10% or more voting power in the company, also holds 10% or more voting power of that concern at any time during the previous year.

 II)  Loan or Advance

 The expression used in section 2(22)(e) is "advance or loan". It ordinarily means payment of cash or transfer of goods for which accounting must be rendered by the recipient at some later date. Thus, there would be advance by the company when goods are transferred to shareholder. The expression "advances" also refers to something which is due to be paid to the shareholder but which is paid to him ahead of time when it is due to be paid.

 The transaction of loan involves lending and delivery by one party and receipt by another party of sum of money upon express or implied agreement to repay it with or without interest.

III)  Effect of repayment of loan

As soon as loan is advanced to shareholder by closely held company from accumulated profits statutory fiction under section 2(22)(e) becomes operative and such loan is deemed to be dividend. Such loan does not cease to be deemed dividend on account of any subsequent event. Even if the loan is repaid by the shareholder in the same previous year, the statutory fiction arising at the time of giving loan by the company does not cease to be operative. Such a loan would be taxed as deemed dividend even if repaid in the same previous year.

IV)  Subsequently declared dividend set off against previously granted loan

 Where a loan granted by the company is treated as dividend under section 2(22)(e) and the company subsequently declares regular dividends and sets it off against the said loan, the dividends so set off would not be treated as dividend in the hands of the shareholder.

V)  Exception where substantial part of business of the company is money – lending

Where the lending of money is a substantial part of the business of the company, "dividend" would not include any advance or loan made in the ordinary course of business to a shareholder or to the concern in which such shareholder has substantial interest.

[C] Quantum of deemed dividend

The principle is that where loan given by the company exceeds the accumulated profits, deemed dividend would be to the extent of accumulated profits and balance of loan amount would not be deemed dividend. If the accumulated profits exceed the loan amount, entire loan amount would be deemed dividend and not the amount proportionate to shareholder's interest in the shareholding of the company. If there are no accumulated profits, there would not be any question of loan being treated as deemed profits.

Example:

The assessee held 25% shares of the closely held company. The accumulated profits were Rs. 4,000 while the assessee took loan of Rs. 29,000. Here, loan given by the company exceeds the accumulated profits. Thus, entire accumulated profits are to be taken into account under section 2(22)(e). And only 25% of Rs. 4,000 should not be regarded as deemed dividend under section 2(22) (e).  

[D] Taxability of Deemed Dividend under section 2(22)(e)

Deemed Dividend u/s 2(22)(e) is taxable in the hands of shareholder u/s 56 of the Income Tax Act and it is not taxable in the hands of company.

Also Deemed Dividend u/s 2(22)(e) is not exempt u/s 10(33) of the Income Tax Act.

Now, lets discuss some intricate queries arising out of the aforesaid definition.

Q 1. What kinds of advances are covered within the scope of section 2(22)(e)?

It has been held by Rajasthan High Court in re CIT v. Raj Kumar (2009) 23 DTR (Del) 304 that the word 'advance' has to be read in conjunction with the word 'loan' i.e., a payment shall be construed as a loan or advance if it involves following attributes–

• Positive act of lending coupled with acceptance by the other side of the money as a loan;
• Generally carries interest
• Obligation of repayment is inherent.

 Considering the rule of construction viz., noscitur a sociis and keeping in view the intent of introducing the provisions [i.e., to plug the evasion of tax by payment of dividends in the guise of loans & advances to the principal shareholders], any advance which does not carry with it the obligation of repayment cannot fall within the four corners of the deeming provision. Consequently, trade advances made in then ordinary course of business that are adjusted against supply of goods/services do not fall within the ambit of section 2(22)(e).

Q 2. In whose hands will the payment deemed to be dividend if the loans or advances are made to concern or person on behalf of or for the benefit of substantial shareholder?

It is general principle that a payment can be taxed as dividend only in the hands of a shareholder. The same cannot be taxed as such in the hands of a non shareholder. This view has been reiterated by Rajasthan High Court in re CIT v. Hotel Hilltop (2008) 217 CTR (Raj.) 527 wherein it was held that the essential requirement of section 2(22)(e) is that payment should be made on behalf of or for the individual benefit of substantial shareholder. Thus, the provision is intended to attract the liability of tax on the person on whose behalf or for whose benefit the amount is paid by the company.

In re CIT v. Bhaumik Colour P. Ltd (2009), the special bench of Mumbai tribunal held that the inclusive definition of section 2(22)(e) enlarges the scope of the term dividend by including loans & advances. The legal fiction created by the said section is operative only so long as the deemed dividend is taxed in the hands of the shareholder. If the legal fiction is extended to loans & advance to a non shareholder, the very term 'dividend' will lose its identity.

One of the exceptions to section 2(22)(e) is that dividend shall not include any dividend  paid by the company which is set off by the company against the whole or any part of the sum previously paid by it and treated as dividend within the meaning of sub clause (e) to the extent it is so set off.

In the event of the payment of loan or advance by a company to a concern being treated as dividend and taxed in the hands of the concern then the benefit of set off cannot be allowed to the concern, because the concern can never receive dividend from the company which is only paid to the shareholder, who has substantial interest in the concern. The above provision, further, contemplate that deemed dividend be taxed in the hands of shareholder only. 

Q 3. One of the exceptions to section 2(22)(e) is that dividend shall not include any loans or advance made to a shareholder or the said concern by the company in the ordinary course of its business, where lending money is substantial part of the business of the company. Elaborate?

The term 'substantial' appearing in the aforesaid exception is not defined. But the same is defined in explanation 3(b) to section 2(22)(e) as not less than 20% of the income of such concern. Following the judgement of supreme court in CIT v. Venkateshwara Hatcheries (237 ITR 174) wherein it was held that the definition in one section can be used for understanding the meaning of the word in another section if the context justifies it, it can be concluded the definition of term 'substantial' used in the aforesaid section means 20% or more of the income of a concern.

Thus, if the income from money lending is 20% or more of the total income of the closely held company and the turnover of the loan funds to total funds of the company is above 20%, any loans or advance made by the said company to its principal shareholder cannot be deemed to be dividend. The same was upheld by Delhi Tribunal in Mrs. Rekha Modi v. ITO (2007) (13 SOT 512) and the same was not further challenged by the revenue.

 Further, in deciding whether the company is engaged in money lending business, factual position only for the relevant previous year in question has to be considered i.e., the year in which the loan or advance has been given to principal shareholder holding 10% or more of voting power. The same has been upheld in the aforesaid judgement of the tribunal

Case Law Study :

• In Kantilal Manilal v.CIT [1961] 41 ITR 275(SC) the Supreme court held that Section 2(22) deals with various types of cases and creates a fiction by which certain receipts or parts thereof are treated as dividend for the purpose of levy of Income-tax .

• In CIT v. Martin Burn Ltd.,(1982)136 ITR 805(cal) the Calcutta High court held that Under section 2(22) certain amounts which are actually not distributed are also brought within the net of dividends. Therefore, that section must receive a strict interpretation.

• Section 2(22)(e) has been held to be constitutionally valid in Navnitlal C. Javeri v. K.K.Sen, AAC [1965]56 ITR 198 (SC).
• A loan of money results in a debt but every debt does not involve a loan [ Bombay Steam Navigation Co. (1953)(P) Ltd. vs. CIT (1965) 56 ITR 52 (SC) : TC16R.881];

• Any loan given by life insurance companies to their policy holders-shareholders in the normal course of business on the security of insurance policies and within the limits of their surrender value should not be treated as dividends [Circular No.43 (LXXVI-7) dt. 27th Oct., 1955];

• Payment by company to a firm in which shareholder is partner for repayment of advances in regular course of business cannot be deemed dividend under section 2(22)(e) [Mukundray K. Shah vs. CIT (2005) 197 CTR (Cal) 563 : (2005) 277 ITR 128 (Cal)];

• Withdrawal over and above credit balance is to be treated as deemed dividend. For example, When company has accumulated profits, withdrawal by a shareholder over and above the credit which he has with the company would be deemed dividend when the shareholder had no credit balance in any other account [CIT vs. P. Sarada (1985) 46 CTR (Mad) 328 : (1985) 154 ITR 387 (Mad) : TC41R.306];

• Loan obtained by the shareholder through proprietary concern would be treated as deemed dividend under section 2(22)(e) [Nandlal Kanoria vs. CIT (1980) 122 ITR 405 (Cal) : TC41R.311];

• Shareholder doing business with company and always having debit balance Explanation: When a shareholder has a business with the company and when his accounts with the company is always on debit side, the amount in question would be regarded as loan by the company to the shareholder and if there are accumulated profits to cover the debit balance, the amount in question would be regarded as deemed dividend under section 2(22)(e) [ CIT vs. Jamnadas Khimji Kothari (1973) 92 ITR 105 (Bom) : TC41R.320]. However, where company has made advances to the concern of the shareholder towards purchases to be made by the company from the said concern, such advances would not be deemed dividend under section 2(22)(e) [CIT vs. Nagindas M. Kapadia (1989) 75 CTR (Bom) 161 : (1989)177 ITR 393 (Bom) : TC41R.321];

• Money advanced as loan by company substantially doing money lending business could not be treated as deemed dividend under section 2(22)(e) [CIT vs. V. S. Sivesubramaniam (1997) 141 CTR (Mad) 34]

• (income tax officer vs Kalyan m Gupta (2007) 111 TTJ (mumbai)1005,(2007)107 ITD 34 (Mumbai),(2007)11 SOT 530

Kalyan Gupta was a shareholder with more than 10 per cent interest in Om Shipping Agents (P) Ltd. He received a loan of Rs 73 lakh from the company. This was outstanding as on March 31, 1998. After hearing the assessee, the income-tax officer (ITO) added Rs 73 lakh as deemed dividend assessable under Section 2(22)(e).

It was pleaded that the amount was only a temporary borrowing and not in the nature of loan or advance. As this argument was not accepted, another submission was raised to the effect that the dividend exemption provision under Section 10 should be given effect in respect of the sum of Rs 73 lakh.

This provision came into effect from the assessment year 1998-99. What applies to dividend income should also apply to deemed dividend under Section 2(22)(e). The Bench examined Sections 115O, 115P and 115Q in Chapter XIID of the Act. It referred to the Explanation given in this chapter: "For the purposes of this Chapter, the expression "dividend" shall have the same meaning as is given to "dividend" in clause (22) of Section 2 but shall not include sub-clause (e) thereof."

The loan or advance to the substantial shareholder is treated as deemed dividend under Section 2(22)(e). The Explanation at the end of Chapter XI B stipulates that the expression 'dividends' shall not include this type of deemed dividends comprising loans and advances. Thus, deemed dividend referred to in Section 2(22)(e) has been excluded from the ambit of Chapter XIIB. Tax is not levied on the company with regard to such deemed dividend. Consequently, the exemption provided under Section 10 is not applicable to "deemed dividend" referred to in Section 2(22)(e)

• In order to attract the provisions of section 2(22)(e), the important consideration is that there should be loan/advance by a company to its shareholder. Every payment by a company to its shareholder may not be loan/advance. To be treated as loan every amount paid must make the company a creditor of the shareholder for that amount. If, however, at the time when payment is made, the company is already the debtor of the shareholder, the payment would be merely a repayment by the company towards its already existing debt. It would be a loan by the company only if the payment exceeds the amount of its already existing debt and that too only to the extent of the excess. If the shareholder has a current account with the company, the position as regards eachdebit will have to be considered individually, as it may or may not be a loan. In such case the debit balance of the shareholder with the company at any point of time cannot be taken to represent an advance/loan by the company; nor can the amount at the end of the previous year be alone taken as loan.CIT v. P.K. Badiani[1970] 76 ITR 369 (Bom.).

•  Whether an overdraft taken by a major shareholder from the company will be covered as deemed dividend? An overdraft taken by a shareholder from the company is treated as loan and taxable as dividend if conditions of section 2(22)(e) are satisfied—CIT v. K..Srinivasan [1963] 50 ITR 788 (Mad.).

• What will be the position when a major shareholder misappropriated some amount from the company? Amount misappropriated by the director cannot be treated as deemed dividend in his hands since in such a case there is no lending or advancing by the company. It cannot be said that in such a case the company has paid anything and unless there is an actual payment by the company as a loan or advance to the assessee, it cannot be treated as dividend under section 2(22)(e). CIT v. G. Venkataraman [1975] 101 ITR 673 (Mad.)

• If a loan is repaid before the end of the previous year, the section will be attracted? Yes, even if a loan is repaid before the end of the previous year the section will be attracted. In Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) the Supreme court held that under section 2(22) the liability to tax attaches to any amount taken as loan by the shareholder from a controlled company to the extent it possesses accumulated profits at the moment the loan is borrowed and it is immaterial whether the loan is repaid before the end of the accounting year.

• Whether Book debts will be covered by "loans and advances"? Where the assessee-shareholder, having business of his own, was transacting business with the company and the account of the assessee in the company always showed a debit balance, it was held that the said debit balance would amount to a loan from the company to the assessee. CIT v. Jamnadas Khimji Kothari [1973] ITR 105 (Bom.)

• Every sale of goods on credit does not amount to a transaction of loan. A loan contracted no doubt creates a debt but there may be a debt without contracting a loan. Bombay Steam Navigation Company P. Ltd. v. CIT(1965) 56 ITR 52(SC)

• Whether Security deposit to a major shareholder for use of premises will be covered under clause(e)? Genuine security deposit without any element of loan may not be considered as a loan.

• Whether loans or advance to b will be covered? Loans to relatives of substantial shareholders are not covered as loans or advances to the shareholder. However such loans or advances may be covered as" payment on behalf of or for the individual benefit" of the shareholder.
• Clause (ii) to section 2(22) provides that "dividend" does not include any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of business, where the lending of money is a substantial part of the business of the company;

If a majority of a company's assets and income are from money-lending business, it will be proper to assume that lending of money is a substantial part of the company's business.

In Walchand & co. Ltd. V. CIT,(1975)100 ITR 598(Bom) it was held that the onus to prove these facts lies on the assessee.  The same was also confirmed in the case of  CIT v Creative dyeing & Printing (P) Limited 184 taxmann 483.

• Clause (iii) to section 2(22) provides that "dividend" does not include any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e),to the extent to which it is set off.

This clause gives some relief to the assessee by way of avoiding double taxation as well as brings in some scope for Scope for tax-planning. Thus, if a loan is already treated as a dividend it may make sense to declare dividend and adjust the outstanding loan amount against the dividend declared. No tax will be payable by shareholder on such dividend declared.

However, if the loan has been repaid by the shareholder and nothing is due by the shareholder against the loan referred in section 2(22)(e), then no set-off would be possible. Also if the sum due by the assessee is on account of some other payments not covered by section 2(22)(e), then set-off will not be possible.

• A managing director of a company, whenever he needed money used to ask an employee to take a loan from the company and pass it on to him even without executing any pronote. Can he be said to have received any benefit? It was held that the loans made by the company to the employee fell in the category of "benefit" to the assessee managing director and were, therefore, assessable as deemed dividends in his hands—CIT v. L.Alagusundaram Chettiar [1977] 109 ITR 508 (Mad.).

• In one case, the assessee, having substantial interest in a company X, obtained from company Y two loans of Rs. 75,000 and Rs.2,00,000 on July 30, 1968 and September2, 1968, respectively. The question forconsideration was whether these amounts could be treated as deemed dividend in the hands of the assessee under section 2(22)(e) on the ground that Y had made these loans to the assessee out of loans received by Y from X on the samedates.The Court held (in Nandlal Kanoria v. CIT [1980] 122 ITR 405 (Cal.)), that there was no loan given by X to the assessee. However, as the loan of Rs. 75,000 was given by Y to the assessee out of an equal amount received as loan from X on the same date, this amount was a payment by X for the benefit of the assessee and fell within the mischief of section 2(22)(e). The same could not be said of the loan of Rs. 2,00,000, as on the date of making that loan, Y had received loans not only from X but from another source also and the loan was made out of blended amount

• In Navnitlal C. Jhaveri v. CIT [1971]80 ITR 582(Bom) a question arose that while calculating accumulated profits depreciation as per books should be considered or as per IT Act? The Bombay High court held that while calculating accumulated profits an allowance for depreciation at the rates provided by the Income-tax Act itself has to be made by way of deduction.

• Even loan obtained by the assessee-shareholder from a company from out of its Accumulated profits, which are exempt in the hands of the company as agricul tural income, is to be treated as deemed dividend in the hands of the assessee. S.Kumaraswami v.ITO [1961] 43 ITR 423 (Mad.)

• Whether balancing charge u/s 41(2)will form part of accumulated profits?.In CIT vs. Urmila Ramesh (1998) 230 ITR 422 the Supreme court held that the amount of balancing charge under section 41(2) of the Act, did not represent Accumulated profits.

• Provision for tax and provision for dividend can not form part of Accumulated profits.CIT v V. Damodaran[1972]85 ITR 59(ker.).This is obvious because each of them represent a liability and is not in the nature of profits or reserves.

• These words which are found in clauses (a) to (d) are not found in clause (e) of section 2(22) and, therefore, that provides some relief from the mischief of the section as well as provides some scope for planning .Thus it must be interpreted that to the extent of capitalisation of profits, accumulated profits would reduce for the purpose of this clause but not for other four clauses of section 2(22). What is capitalisation? It will ordinarily mean conversion of profits or reserves or income into capital as per Company's Articles of Association.

• Similarly a transfer to General Reserve will not amount to capitalisation.

The reason for allowing reduction of the accumulated profits to the extent of capitalisation of profits seems to be that to the extent of capitalisation, divisible profits i.e. profits available for distribution of dividend will reduce. A company can not distribute dividends out of capitalised profits i.e. capital. Thus if a closely held company wants to give loan or advance to a shareholder or his concern/company which are covered by this clause, it may first issue bonus shares (and thus capitalise the accumulated profits) and then grant such loan or advance. This is one sure way of escaping from the clutches of section 2(22)(e). However, it may involve expenses of filing fees and stamp-duty on increase of authorised share capital. Also a company may not want to increase its capital due to various other reasons.

• In CIT v. Mayur Madhukant Mehta [1972] 85 ITR 230 (Guj.) it was held that there is nothing in sub-clause (e) of section 2(22) to restrict the deemed dividend to that portion of Accumulated profits which corresponds to the assessee's shareholding in the capital of the company.

• If a loan is given by a company to a shareholder who owns 25 percent of share capital, the amount of loan to the extent of entire Accumulated profits (and not to the extent of 25 percent of Accumulated profits) will be treated as dividend. CIT v. Arati Debi [1978] 111 ITR 277 (Cal.).

• When a loan is treated as a deemed dividend and is repaid by the shareholder will it be added in the "accumulated profits"? Section 2(22)(e) must be so interpreted that once an amount goes out of "accumulated profits" as a loan and the loan is to be deemed as dividend the same amount when repaid cannot again be capable of attracting fiction and be deemed as dividend.. To avoid the happening of any such eventuality, the "accumulated profits" must be notionally reduced by the amount of all loans which are to be treated as dividends under section 2(22)(e) .CIT v. P.K. Badiani. [1970] 76 ITR 369 (Bom.).

• Whether interest paid on loan which is treated as deemed dividend will be admissible as a deduction under section 57(iii)? Section 57(iii) allows a deduction for any expenditure (not being capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. In Nandlal Kanoria v.CIT [1980] 122 ITR 405(Cal.) the Calcutta High court held that interest paid on loan treated as deemed dividend under section 2(22)(e) is not admissible as a deduction under section 57(iii)

• Trade advance to shareholder not to be considered as Deemed dividend. Refer CIT v Raj Kumar 318 ITR 462.

• Financial transactions in normal course of business  – cannot be considered as deeemed dividend u/s 2(22)(e). Refer CIT v Ambassador Travels (P) Limited 318 ITR 376.

• Deemed dividend is taxable in the hands of shareholder not to the company. Refer, CIT v Universal Medicare Private Limited 324 ITR 263.

• Money lending being one of the six main objects of the lender company and the said business having been carried on by it in preference to other business, the loan given to the assessee was in the course of money lending business and therefore, assessee's case is not covered by the provisions of s. 2(22)(e), income criteria from a particular source of income was not relevant. Refer, Krishnoics Ltd. 120 TTJ 650.

• The Tribunal accepted assessee contention that both the companies were non-banking companies and the amounts were given in the ordinary course of business hence the receipt of loan as deemed dividend cannot be taxed. Refer Usha Commercial (P) Ltd. 30 SOT 37.

• Assessee company having received advances from another company in the normal course of business, same can not be treated as deemed dividend u/s. 2(22)(e). Refer, Timeless Fashions (P) Ltd. 33 DTR 48.

• Assessee procured loan from a company in which he was a Director and was holding 50% equity shares. The said company was in business of lending of money, and on amount given as loan to assessee it charged Interest. Held, that s. 2(22)(e) can not be attracted as it was a business transaction of the company. Refer, Bharat C. Gandhi 178 Taxmann 83.

 

• Loan received by assessee before becoming a registered shareholder of the lender company can not be treated as deemed dividend u/s. 2(22)(e). Refer, Sagar Sahil Investment (P) Ltd. 120 TTJ 925

• Inter Corporate Deposits (ICDs) are different from loans or advances and would not come within purview of deemed dividend u/s. 2(22)(e). Refer, Bombay Oil Industries Ltd. 28 SOT 383.

• It has been held that for the purpose of s. 2(22)(e) of the Income-tax Act (Act), accumulated profits would mean commercial profits. In determining his commercial profit, depreciation, which has been recognized as a charge towards profit both under the Companies Act, 1956 as well as the Act has to  be reduced from the commercial profit for the purpose of S. 2(22)(e) of the Act. Refer, Yasin Hotels (P) Ltd. 30 SOT 47.

• Deemed dividend can be assessed only in the hand of a shareholder of lender company and not in the hands of a person other than shareholder. The expression 'shareholder' referred to in s. 2(22)(e) refers to both – a registered shareholder and a beneficial shareholder. Thus, if a person is registered shareholder but not beneficial shareholder or vis-a-versa then provisions of s. 2(22)(e) would not apply. Refer, Bhaumik Colour (P) Ltd. 118 ITD 1.

• Deemed dividend under section 2 (22) (e), can only be assessed in hands of person, who is share holder of lender company and not in hands of a person other than shareholder. Refer, MTAR Technologies (P) Ltd v Asst CIT 39 SOT 465.

• Where lending of Money was a substantial part of business of a lending company, money given by it way of  adbance or loan to assessee could not be regarded as a dividend u/s 2(22)(e). Refer,  CIT v Parle Plastics Limited.

• Any advance received as deposit ny company in connection with leasing out of property of director cannot be treated as Deemed Dividend. Refer, ACIT v Madras Madurai Properties (P) Limited.

• Amounts advanced by a company to its directors under a Board resolution , for specific purpose, would not fall under mischief of section 2(22)(e). Refer, ACIT v Harshad V Doshi 49 DTR 181.

• Amounts given by a company to an assessee against his debenture account cannot be treated as Loans or advances for purpose of section 2(22)(e). Refer, Anil Kumar Agarwal v ITO. 51 DTR 251.

• Loans or advances given by a company to another company, which is not a shareholder of lender company, cant be treated as deemed dividend. Refer, Sadana Brothers Sales (P) Limited v ACIT.

• Security deposit given by a company to its sistern concern, a firm cannot be ragarded as deemed dividend under section 2(22)(e). Refer, DCIT  v Atul Engineering Udyog.

• "deemed dividend" not assessable if recipient not shareholder. Refer, CIT vs. Ankitech Pvt Ltd.

• Assessee is a director in two companies holding substantial shareholding in both. Certain sum was transferred from one company to another at instance of  assessee. Assessee having substantial credit balance with company, cannot held as loan or deposit nor can be assessed as deemed dividend.( Asst years 2001-02, 2005-06).

• Assessee is a director in two companies holding substantial shareholding in both. Certain sum was transferred from one company to another at instance of  assessee. Assessee having substantial credit balance with company, cannot held as loan or deposit nor can be assessed as deemed dividend.( Asst years 2001-02, 2005-06). Refer, Asst vs. C. Rajini 9 ITR ( Trib) 487.

• Since on the date on which the security deposit was given by the company to the assessee , the assessee held less than 10 percent beneficial interest in the company , the amount of security deposit can not be treated as deemed dividend under section 2 (22) (e) , merely on the ground that share holding increased to 44% on issue of shares by the company in lieu of security deposit.( A. Y. 1998‐99). Refer, CIT v Late C.R.Das 57 DTR 201

INCOME TAX REPORTS (ITR)

INCOME TAX REPORTS

Volume 346 Part 4 (Issue dated 27-8-2012)

HIGH COURTS
Advance tax --Interest--No material on record that assessee committed default in payment of advance tax--Tribunal justified in remitting matter to Assessing Officer for decision afresh--Income-tax Act, 1961, s. 234B-- CIT v . Kotak Securities Ltd . (No. 2)
(Bom) . . . 352
Business expenditure --Purchase of software--Is revenue expenditure--Income-tax Act, 1961, s. 37-- CIT v . Amway India Enterprises (Delhi) . . . 341
----Repairs--Current repairs--Is revenue expenditure--Income-tax Act, 1961, s. 37-- CIT v . Amway India Enterprises (Delhi) . . . 341
----Software expenses--Expenditure not to create new asset or a new source of income but to upgrade system--Extent of expenditure cannot be a decisive factor in determining its nature--Treatment in books of account not conclusive--Software expenditure is revenue expenditure--Income-tax Act, 1961, s. 37-- CIT v . Asahi India Safety Glass Ltd . (Delhi) . . . 329
Capital or revenue expenditur e--Software expenses--Allowable--Income- tax Act, 1961-- CIT v . Kotak Securites Ltd . (No. 1) (Bom) . . . 349
Depreciation --First stock exchange membership card--Entitled to depreciation--Income-tax Act, 1961-- CIT v . Kotak Securites Ltd . (No. 1) (Bom) . . . 349
----First stock exchange membership card--Entitled to depreciation--Income-tax Act, 1961-- CIT v. Kotak Securities Ltd . (No. 2) (Bom) . . . 352
Reassessment --Reassessment after four years--Failure by assessee to disclose material facts--Income from other sources--Reopening of assessment to disallow interest on borrowings for purchase of shares--No failure by assessee--Reassessment not permissible--Income-tax Act, 1961, ss. 57(iii), 147, 148-- Ashank D. Desai v . Asst. CIT
(Guj) . . . 326
AUTHORITY FOR ADVANCE RULINGS
Non-resident --Royalty--Provision of social media monitoring service for company, brand or product, for subscribing clients--Subscriptions are royalty chargeable to tax in India--Tax deductible at source on payments--Income-tax Act, 1961, ss. 9(1)(vi), Expln. 2(iv), 195--Double Taxation Avoidance Agreement between India and Singapore, art. 12-- ThoughtBuzz Pvt. Ltd., In re . . . 345

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Respected Sir/friends

Kindly find enclosed herewith an progrrame in excel to calculate tax liablity of an Govt/pvt employee for the financial year 2012-13.This might be useful for employees as well as DDO.

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