Facts of the Case

  1. The assessee company received advances amounting to ₹6,32,72,265/- through book entries from M/s Jakson Generators Pvt. Ltd. (JGPL).
  2. Certain shareholders holding substantial interest in the assessee company also held more than 10% voting power in JGPL.
  3. The Assessing Officer treated the advances as deemed dividend under Section 2(22)(e) of the Income-tax Act, 1961.
  4. The assessee argued that it was not a shareholder of JGPL and therefore the provisions of Section 2(22)(e) could not be invoked against it.
  5. The Assessing Officer and Commissioner (Appeals) rejected the contention and sustained the addition.
  6. The Income Tax Appellate Tribunal deleted the addition holding that although the transaction could fall within the scope of deemed dividend, the same could not be taxed in the hands of the assessee concern as it was not a shareholder of the lending company.
  7. The Revenue challenged the Tribunal's order before the Delhi High Court.

 Issues Involved

  1. Whether loans or advances received by a concern from a closely held company constitute deemed dividend under Section 2(22)(e) of the Income-tax Act, 1961?
  2. Whether such deemed dividend can be assessed in the hands of a concern which is not a shareholder of the lending company?
  3. Whether the expression “shareholder” under Section 2(22)(e) includes a non-shareholder concern receiving the loan or advance?
  4. Whether the Tribunal was justified in deleting the addition made by the Assessing Officer?

 Petitioner’s Arguments

  1. The Revenue contended that Section 2(22)(e) creates a legal fiction and such fiction must be carried to its logical conclusion.
  2. It was argued that where a concern receives loans or advances from a closely held company in which common shareholders have substantial interest, the concern itself should be taxed on such deemed dividend.
  3. Reliance was placed upon CBDT Circular No. 495 dated 22.09.1987 to contend that deemed dividend is taxable in the hands of the recipient concern.
  4. The Revenue submitted that the legislative intent was to prevent tax avoidance by distributing accumulated profits through loans and advances instead of dividends.

 Respondent’s Arguments

  1. The assessee submitted that it was not a shareholder of JGPL.
  2. Section 2(22)(e) contemplates taxation of dividend only in the hands of a shareholder.
  3. A non-shareholder concern cannot be treated as a shareholder merely because common shareholders possess substantial interest in both entities.
  4. Reliance was placed upon the Special Bench decision in ACIT v. Bhaumik Colour (P.) Ltd. and the Bombay High Court decision in CIT v. Universal Medicare (P.) Ltd.
  5. It was argued that if deemed dividend is taxable, it can only be taxed in the hands of the shareholder and not in the hands of the recipient concern.

 Court Findings

The Delhi High Court dismissed all the appeals filed by the Revenue and held as follows:

  1. Section 2(22)(e) enlarges the definition of “dividend” but does not enlarge the definition of “shareholder”.
  2. A concern receiving loans or advances cannot be treated as a shareholder by implication or legal fiction.
  3. Dividend can ordinarily be paid only to a shareholder and taxation of deemed dividend must also follow the same principle.
  4. Where the recipient concern is not a shareholder of the lending company, the amount cannot be assessed as deemed dividend in its hands.
  5. If taxable, the deemed dividend can be assessed only in the hands of the shareholder having substantial interest in both entities.
  6. The Tribunal correctly deleted the addition made in the hands of the assessee concern.
  7. The Revenue was granted liberty to take appropriate action against the concerned shareholders in accordance with law.

Accordingly, all the appeals were dismissed and the questions of law were answered in favour of the assessee and against the Revenue.

 Important Clarification

The Court clarified that:

  • Section 2(22)(e) creates a legal fiction only for expanding the meaning of “dividend”.
  • The provision does not create a legal fiction expanding the meaning of “shareholder”.
  • Therefore, a concern receiving loans or advances cannot be taxed unless it is itself a shareholder of the payer company.
  • Deemed dividend under Section 2(22)(e) is taxable only in the hands of a registered and beneficial shareholder.
  • Business advances and commercial transactions do not automatically fall within the ambit of deemed dividend.

 Sections Involved

  • Section 2(22)(e), Income-tax Act, 1961
  • Section 2(32), Income-tax Act, 1961
  • Section 4, Income-tax Act, 1961
  • Section 5, Income-tax Act, 1961
  • Section 8, Income-tax Act, 1961
  • Section 14, Income-tax Act, 1961
  • Section 56, Income-tax Act, 1961
  • Section 115JB, Income-tax Act, 1961

Link to download the order - https://delhihighcourt.nic.in/app/case_number_pdf/2011:DHC:2648-DB/AKS11052011ITA4622009.pdf

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