Section 2 (22)(e) – Amount contributed by a company, in which assessee is substantially interested, towards capital contribution in a firm in which such company and the assessee is a partner, cannot be regarded as dividend in the hands of the assessee, though the capital contribution by the company was disproportionate to its profit sharing ratio.

17.  Lala Mohan
Ramchand vs. ITO (Mumbai)

Members : G. S. Pannu (AM) and Ravish Sood (JM)

ITA No. 5778/Mum/2012

A.Y.: 2006-07.                                                                    
Date of Order: 14^th June, 2017.

Counsel for assessee / revenue: Hiro Rai / Durga Dutt

FACTS 

The assessee was holding 25.5% of share capital of M/s Elite
Housing Development Pvt. Ltd. (EHDPL) and was also a partner in M/s Elite
Corporation with 37.5% share in profits. EHDPL was also a partner in M/s Elite
Corporation (“the firm”) and was having 5% share in profits of the firm.

In the course of reassessment proceedings, the Assessing
Officer (AO) observed that EHDPL was having accumulated profit of Rs.
1,07,11,103 had made an investment of Rs. 73,75,221 in the firm, which
investment according to him was substantially excessive as compared to the
share of profits of EHDPL in the firm. Since the assessee had 37.5% share in
profits of the firm, the firm was characterised by the AO as an eligible
‘concern’ u/s. 2(22)(e) of the Act. The AO had a strong conviction that EHDPL
in the garb of `capital contribution’ had made available its accumulated
profits to the firm and he therefore called upon the assessee to show cause as
to why the investment of Rs. 73,75,221 made by EHDPL in the firm, of which
investment of Rs. 3,00,000 was made during the year under consideration, may
not be assessed as `deemed dividend’ in his hands. The assessee submitted that
EHDPL in its status as a partner of the said firm, had invested an amount of
Rs. 3 lakh on 1.4.2005 by way of its capital contribution and had neither given
any loan or advance to the firm nor the said amount was paid on behalf of the
individual benefit of the assessee, and therefore the provisions of section
2(22)(e) were not applicable. The AO rejected the submissions of the assessee
and assessed the sum of Rs. 3 lakh invested by EHDPL with the said firm as
deemed dividend in the hands of the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
upheld the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD 

The Tribunal observed that now when it is alleged by the
revenue that the `capital contribution’ by EHDPL as a partner with M/s Elite
Corporation is a farce, then it is for the revenue to establish on the basis of
irrebuttable material that what is apparent is not real and thus dislodge and
disprove the claim of the assessee by proving to the contrary.

The Tribunal concurred with the submissions made on behalf of
the assessee viz. that there is no provision in the Indian Partnership Act,
1932, which therein contemplates that the partners’ `capital contributions’ in
the firm is required to be in proportion of their profit sharing ratios. It
held that in the absence of any such embargo on the capital contributions by
the partners having been placed on the statute, it was not persuaded to
subscribe to the adverse inferences drawn by lower authorities, who the
Tribunal found had observed that the substantial contribution by EHDPL as a
partner in the said firm when pitted against the latter’s meagre 5% share in
profit of the said firm was not found to be justifiable. It found merit in the
reasons furnished on behalf of the assessee as to why the capital contribution
by the partners in the firm was mentioned in clause 6 of the partnership deed
at Rs. 25 lakh. It held that it would be absolutely illogical and rather
impossible to expect that EHDPL could have managed to freeze its capital in the
firm at Rs. 25 lakh or any other figure, even if it would have resolved not to
introduce any fresh capital in the firm or withdraw any part of the same. The
Tribunal held that `capital contribution’ by a partner in a firm is differently
placed as against a loan or an advance to the firm. Loans and advances given by
a partner to the firm are substantially different from their `capital
contributions’. It observed that a perusal of section 48 of the Indian
Partnership Act, 1932 which contemplates the mode of settlement of the accounts
of the partners in the case of dissolution of a firm, in itself categorises the
same under different clauses. The Tribunal held that in the backdrop of
substantial turnover and income offered for tax by the firm, viz. Elite
Corporation, it would be incorrect to hold that the same was a dummy concern
which had been brought into existence with the intent to bypass the deeming
provisions contemplated u/s. 2(22)(e) of the Act. It observed that the funds
introduced by EHDPL by way of its capital contribution were utilised by the
firm in the normal course of its business and were not utilised for the
personal benefit of the assessee. It held that this fact supplements and
supports its view that the capital introduced by EHDPL as a partner in the said
firm cannot be characterised as `deemed dividend’ in the hands of the assessee.
The Tribunal set aside the order of CIT(A).