Section 2(22)(e) – For the purposes of artificial categories of dividends u/s. 2(22), accumulated profits do not include any exempt capital gains. Thus, where assessee has negative accumulated profits excluding exempt capital gains, provisions of deemed dividend cannot be invoked in respect of any amount overdrawn by the assessee.
Facts
During the relevant assessment year, the assessee, his son and daughter had overdrawn certain amount from a company in which the assessee was a substantial shareholder holding 41% of shares. The son and daughter were not shareholders in the company.
The AO treated the aforesaid amount overdrawn by the assessee and his son and daughter from the company as deemed dividend u/s. 2(22)(e) and added the same in the income of the assessee.
The CIT(A) held that the deemed dividend could be taxed only in the hands of shareholder holding more than 10% voting power in the company from which monies are drawn. He therefore deleted the addition made towards deemed dividend in respect of the amount overdrawn by the son and daughter, as they were not shareholders of company.
However, he confirmed the addition made towards deemed dividend in respect of the amount overdrawn by the assessee by ignoring assessee’s contention that there was only negative accumulated profits, if the tax exempt long term capital gain was excluded from accumulated profits.
On cross appeals to the Tribunal:
Held
In respect of amount overdrawn by son and daughter
Both the son and daughter of the assessee are not shareholders in the lending company. The deemed dividend, if any, could be assessed only in the hands of the shareholders and not otherwise. This argument was taken by the assessee even before the lower authorities and the revenue has not brought on record any contrary evidence to this fact. Hence, the provisions of section 2(22)(e) could not be invoked in respect of amount overdrawn by the son and daughter.
In respect of amount overdrawn by assessee
The legal fiction created in the Explanation 2 to section 2(22) states that ‘accumulated profits’ shall include all profits of the company up to the date of distribution or payment. For reckoning the said accumulated profits, apart from the opening balance of accumulated profits, only the profits earned in the current year are to be added and then the total accumulated profits should be considered for the purpose of calculation of dividend out of accumulated profits, if any. The said Explanation nowhere contemplates to bring within the ambit of expression ‘accumulated profits’ any capital profits which are not liable to capital gains tax.
In the instant case, the capital gains derived by the company are tax exempt and hence, the same should not be included in accumulated profits and if the said gains are excluded, then there are only negative accumulated profits available with the company.
In the absence of accumulated profits, there is no scope for making any addition towards deemed dividend u/s. 2(22)(e).
Accordingly, the ground raised by the assessee is allowed and appeal of the revenue is dismissed.
Note: Reliance was placed on CIT vs. Mangesh J. Sanzgiri [1979] 119 ITR 962 (Bom. HC) and ACIT vs. Gautam Sarabhai Trust No. 23 [2002] 81 ITD 677 (Ahd. Trib).
