Issue
for Consideration
“Dividend” is inclusively defined
u/s. 2(22) of the Income Tax Act, 1961. Clause (e) of that section provides for
taxation of of any payment by a company, not being a company in which public
are substantially interested, of any sum by way of advance or loan to a
shareholder, who is the beneficial owner of shares holding not less than 10% 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, to the extent to which the
company possesses accumulated profits. As per Explanation 3(b) of 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 per cent of the income of such
concern while in the case of a company, a person carrying not less than twenty
per cent of the voting power shall, by virtue of section 2(32) be considered to
be the person holding a substantial interest in the company.
In the case of loan or advance to a
concern in which a shareholder has a substantial interest, the Supreme Court in
the case of CIT vs. Madhur Housing & Development Co Ltd Ltd. 401 ITR 152,
has recently held that the taxation of deemed dividend would be
in the hands of the shareholder, and not in the hands of the recipient concern.
The ratio of this decision though has been doubted by the apex court in a later
decision in the case of National Travel Services vs. CIT, 401 ITR 154
and the issue therein has been referred to the larger bench of the court.
Whether in bringing to tax the
deemed dividend, in the hands of the shareholders, the amount of the loan
advanced to a concern, is to be apportioned in their hands or not is an issue
that requires consideration. If yes, what shall be the basis on which the
amount is to be apportioned is another issue that is open; in cases where more
than one shareholder holds more than 10% of the voting power in the lending
company, and also has a substantial interest in the recipient concern, in what
proportion would the amount of loan be taxed as deemed dividend amongst such
shareholders – in the proportion of their shareholding in the lending company
or in the proportion of their interest in the recipient concern.
While the Delhi bench of the
Tribunal has held that the taxation of deemed dividend would be in the
proportion of the interest in the recipient concern, the Hyderabad bench of the
Tribunal has taken a contrary view, that such taxation would be in the
proportion of the voting power in the lending company.
Puneet Bhagat’s case
The issue came up for consideration
before the Delhi SMC bench of the Tribunal in the case of Puneet Bhagat vs.
ITO 157 ITD 353.
The facts in this case were that
the assessee held 50% of shares in a company, in which his wife held the
remaining 50%. This company advanced a loan of Rs 10 lakh to another company,
in which the assessee held 53.85% shares, and his wife held 46.11%. At the
relevant point of time, the accumulated profits of the lending company were Rs
14.51 crore.
The assessing officer, following
the decision of the Delhi High Court in the case of CIT vs. Ankitech (P) Ltd
340 ITR 14, held that the deemed dividend had to be taxed in the hands of
the shareholders of the loan recipient company. Since both the assessee and his
wife were equal shareholders in the lending company, he taxed an equal amount
of Rs 5 lakh in the hands of each of the two shareholders.
The Commissioner (Appeals) rejected
the assessee’s appeal, confirming the addition made by the assessing officer.
Before the Tribunal, on behalf of
the assessee, it was argued that though, on the facts of the case, the amount
of loan liable for addition u/s. 2(22)(e) could not be apportioned amongst the
shareholders, both of whom had substantial interest in the concerns, in as much
as no mechanism had been provided in the Act for apportioning the amount of the
deemed dividend in the respective shareholders hands. The fact that there was a
different shareholding pattern of shareholdings in the two companies made the
thing all the more unworkable. Therefore, the computation provisions failed,
and, following the Supreme Court decision in the case of CIT v s. B C
Srinivasa Setty 128 ITR 294, the charging provisions would also fail.
Hence, it was argued that deemed dividend could not be taxed in the hands of
any or both the shareholders.
The Tribunal noted that there was
no dispute that the total amount of loan was taxable as deemed dividend in the
hands of the 2 shareholders, as the 2 shareholders held more than 20%
shareholding in both the lending company as well as the recipient company.
Referring to the argument that the charging sections would fail on account of
failure of the computation provisions, the Tribunal noted that for application
of section 2(22)(e), a loan to a ‘concern’ was also contemplated in the section
itself and therefore the charge could not have failed It also observed that it
would be too technical to hold that the legislature visualised only one
shareholder in the concern and therefore the better view would be to pin the
charge on all the qualified shareholders.
The Tribunal, having held so,
observed that the section clearly stated that the shareholder might be a member
of the concern or a partner thereof, which implied that the interest of the
shareholder in the concern was to be determined with reference to the
percentage of share in income or of the shareholding with the voting power in
the concern, of the qualified shareholder, that received the loan or advance.
According to the Tribunal, it was not necessary that in every case, the
detailed mechanism should be provided by the Act for computing the income. If by
reasonable construction of the section, the income could be deduced, then,
merely on the ground that a specific provision had not been provided, it could
not be held that the computation provisions failed. The Tribunal also observed
that it was well settled law that a construction which advanced the object of
legislation should be preferred to the one which defeated the same.
According to the Tribunal, the
percentage of shareholding in the concern to which the loan was given, was a
determining factor of the quantum of the deemed dividend to be taxed in case of
the shareholder. In the case before it, it noted that the assessee had 53.85%
shareholding with the voting power in the loan receiving company. Therefore,
according to the Tribunal, Rs. 5,38,500 should have been assessed as dividend
in his hands, and the balance Rs.4,61,100 should have been taxed as dividends
in the case of his wife. However, since in the assessee’s case, the AO had made
an addition of Rs. 5 lakh only, the Tribunal upheld the addition of Rs. 5 lakh.
G Indira Krishna Reddy’s case
Recently, the issue again came up
for consideration before the Hyderabad bench of the Tribunal in the cases of G
Indira Krishna Reddy vs. DyCIT (ITA Nos 1495-1497/Hyd/2014) and G V Krishna
Reddy vs. DyCIT (ITA Nos 1498-1500/Hyd/2014) dated 24th May
2017.
In this case, the assessee and her
husband were both shareholders of a company, Caspian Capital & Finance P.
Ltd.holding more than 10% of the share capital of the company. This company
advanced amounts of Rs. 36.10 lakh and Rs. 15 lakh ostensibly by way of share
application money to 2 companies namely, Metro Architectures & Contractors
Pvt.Ltd. and Orbit Travels & Tours Pvt. Ltd. in which the assessee had shareholding of 20%
and 40% respectively, her husband also was holding more than 20% shareholding
in both the companies. The lending company Caspian Capital & Finance P.
Ltd. had accumulated profits exceeding the amounts of share application money
advanced at the relevant point of time.
The assessing officer, based on the
facts, held that such amounts advanced by Caspian Capital & Finance P. Ltd.
were unsecured loans, though termed as share application money. He therefore
added the entire share application money
of Rs. 51.10 lakh as income of the assessee by way of deemed dividend.
Before the Commissioner (Appeals),
on behalf of the assessee it was argued that the entire share application money
had been taxed as deemed dividend in the hands of the assessee as well has her
husband, which had led to double taxation. It was argued that the amount of the
deemed dividend, to be taxed in the asessee’s hands, should be restricted to
the percentage of the assessee’s shareholding in the recipient companies.
The Commissioner (Appeals), while
upholding the taxation of deemed dividend, directed the assessing officer to
apportion the entire advanced amounts between the assessee and her spouse as
per their shareholding pattern in the lending company and not in the recipient
company as was claimed by the assessee subject to the fact that it was taxed in
both hands of the assesseee and her husband. In case there was no taxation in
both hands, the Commissioner (Appeals) held that the question of apportionment
did not arise.
Before the Tribunal, it was argued inter
alia, that the share application money advanced to the recipient companies
should be taxed in proportion to the shareholding of the assessee and her
husband in the recipient company.
The Tribunal rejected the
assessee’s main contention that since the computation mechanism failed, no
addition of deemed dividend could be made. It observed that the entire advances
or loans, given to the concerns of the shareholders having substantial interest
were required to be taxed to the extent of accumulated profits. It observed
that dividend was always distributed to the shareholders of the company, and
the entire advances or loans given to such concerns of shareholders with
substantial interest should be brought to tax to prevent unauthorised
distribution of dividend to the controlling shareholders in the guise of loans
and advances.
On the issue under consideration
the Tribunal observed that there was no other shareholder who had substantial
interest in both the payer company and the recipient company, other than the
assessee and her husband. Therefore, the Tribunal held that the advances given
to the recipient companies were required to be taxed in the hands of both the
assessee and her husband. It however expressed its inability to follow the
decision of the Delhi tribunal in the case of Puneet Bhagat (supra),
wherein the Delhi Tribunal had held that the dividend would be assessable in
the hands of the shareholders in the proportion of the shareholding of the
shareholders in the recipient entity. The Hyderabad Tribunal observed that
dividend was always payable to the shareholders of the payer company, and
non-shareholders had no right in the dividend. Hence, according to the
Tribunal, the question of taxing the deemed dividend as per the proportion of
shareholding in the borrowing company did not arise.
The Hyderabad Tribunal, in holding
as above that the proportion should be in the ratio of the holding in the payer
company, relied upon the observations in the decision of the Mumbai bench of
the Tribunal in the case of ITO vs. Sahir Sami Khatib 57 taxmann.com 13,.
The Hyderabad Tribunal therefore expressed its inability to accept the
contention that the deemed dividend should be assessed in the hands of the
assessee in proportionto the assessee’s shareholding in the recipient company.
Observations
If one analyses the objective
behind section 2(22)(e), as noted by the Hyderabad Tribunal, it is to tax a
shareholder who is circumventing the taxation of dividend by taking the benefit
in a disguised form as a loan to another concern. That being the purpose, it is
no doubt true that the person who has got the benefit should be taxed to the
extent of the benefit that he has derived. However, when a loan is given to a
company or other concerns, one can perhaps say that the shareholders of the
borrowing company or the members of such concerns have received an indirect
benefit in the ratio of their shareholding in the borrowing company or in the
income sharing ratio of such concerns.
The argument on the other hand is
that normally, if the intention of shareholders of a company is to give a loan
to another entity instead of distributing dividend, they would have factored in
the shareholding of that other entity, to ensure that the shareholders of the
lending company get the benefit of the accumulated profits indirectly in the
ratio of their entitlements to such profits in the receiving company.
Given the fact that this is a
taxation of dividend, unless it can be demonstrated that the benefit has
actually flowed to the shareholders in a different ratio, the more appropriate
ratio to be adopted in such cases is the ratio of the shareholding of the
assessee in the lending company. The difference of opinion between
the Delhi and the Hyderabad benches of the Tribunal is limited to the adoption
of the proportion in which such loan is to be taxed; should the proportion be
determined w.r.t the shareholding pattern of the shareholders in a lending
company or should it be w.r.t such pattern in the receiving company or concern.
The decision of the Mumbai bench of
the Tribunal in the case of Sahir Sami Khatib vs. ITO(supra) relied upon
by the Hyderabad Tribunal has been upheld by the Bombay High Court, on the
facts of the case, in [ITA No 722 of 2015] vide its order dated 3rd
October 2018 for reasons not relevant in deciding the issue under
consideration. The Bombay High Court observed in this case:
“Equally, we find that the
reasoning given by the ITAT that there cannot be any proportionate addition of
deemed dividend taking into consideration the percentage of the shareholding in
the borrowing company, does not give rise to any substantial question of law.
In the factual matrix before the ITAT, it held that Section 2(22)(e) of the I.
T. Act, 1961 does not postulate any such situation. This is especially the case
before us as there is only one shareholder that has a shareholding in the
lending company as well as in the borrowing company. This being the case and
purely factual in nature, we do not think that the ITAT was in any event
incorrect in rejecting this argument of the assessee. We may hasten to add that
different considerations may arise if two or more shareholders are shareholders
of the same lending company and the same borrowing company. In such a factual
position it could possibly be argued that the addition ought to be made on a
proportionate basis. However, we are not examining this issue in the present
case as the facts before us are completely different.
The last decision relied upon by Ms
Jagtiani was a decision of the Delhi ITAT wherein it appears that the Delhi
ITAT has allowed the proportionate allocation of deemed dividend on the basis
of the shareholding of the borrowing company. We find this Judgment to be
wholly inapplicable to the facts of the present case as in the facts of this
decision, both the shareholders were holding more than 10% in the lending
company and more than 46% in borrowing company. In fact, there were only two
shareholders of the lending company as well as of the borrowing company. It was
in these peculiar facts that the Delhi ITAT came to a conclusion that the
deemed dividend ought to be proportionately divided. In the facts before us,
and as mentioned earlier, the appellant – assessee is the only shareholder who
is the shareholder of the lending company as well as that of the borrowing
company. This being the case, the ratio of the Delhi ITAT is squarely not
applicable to the facts and circumstances of the present case.”
From these observations of the
Bombay High Court, it is clear that the decision of the Mumbai bench of the
Tribunal in Sahir Sami Khatib’s case was based on entirely
different facts, where there was only one shareholder who fulfilled the
conditions of being the beneficial owner of more than 10% of voting power in
the lending company, and more than 20% of the shareholding in the recipient
company. It was on these facts that both the Mumbai Tribunal and the Bombay
High Court held that there was no question of proportional taxation of deemed
dividend. Therefore, to that extent, the reliance of the Hyderabad bench of the
Tribunal on the decision of the Mumbai bench of the Tribunal was not justified.
Useful reference may be made to the
decision of the Pune bench of the Tribunal in the case of Kewalkumar Jain
vs. ACIT 144 ITD 672, though the issues in that case were slightly
different. In that case, loans were given directly to the four shareholders
holding more than 10% of the shares of the company (the total holding of such
shareholders being 100% of the company), and the aggregate value of such loans
amounting to Rs 3.81 crore exceeded the total accumulated profits of the
company, which amounted to Rs. 2 .61 crore. The assessee had a shareholding of
14%, and received a loan of 0.76 crore.
The assessing
officer had computed the assessee’s share of accumulated profits at 14% of 2.61
crore, amounting to Rs. 0.36 crore, added the assessee’s proportionate share of
the general reserve, and since such amount of Rs.0.42 crore was less than the
loan received by the assessee, had taxed such amount of Rs 0.42 crore as deemed
dividend in the hands of the assessee. In this case, the Commissioner exercised
his revisional powers u/s. 263, setting aside the assessment with a direction
to the assessing officer to arrive at the correct available accumulated profits
for considering the amount of deemed dividend assessable in the hands of the
assessee. According to the Commissioner, there was nothing in section 2(22)(e)
permitting or prescribing the restriction to the proportionate amount of
accumulated profits.
The Tribunal set aside the order of
the Commissioner u/s. 263, noting that the balance of the accumulated profits
had been taxed in the hands of the other shareholders, and hence there was no
error in taxing only the proportionate accumulated profits in the hands of the
assessee. This decision of the Pune Tribunal therefore does indicate that the
relevant ratio for the purpose of taxation of deemed dividend is the proportionate
shareholding in the lending company, where more than one shareholder is
chargeable to tax on the deemed dividend.
Fortunately or otherwise, with
effect from 1st April 2018, this issue would no longer be relevant,
except perhaps for the disclosure by the shareholders of exempt income in their
returns of income, since such deemed dividend would also now be subject to
payment of dividend distribution tax at the rate of 30% u/s. 115-O by the
lending company, and would be exempt in the hands of the shareholders.