Analysis of section 2(22)(e) – Deemed Dividend

Introduction

Various provisions of the Income-tax Act, 1961 (‘the Act’) have faced prolonged litigation over the years. Section 2(22)(e) is also one among the list. This article discuses various issues relating to practical applicability of section 2(22)(e) like only advance or loan is subject to sec. 2(22)(e), amount received for corporate guarantee deemed dividend or not.

1. Section 2(22)(e) of the Act provides as under:

“dividend includes 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) ………..

 (ia)…………..;

 (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) ……….

 (iv) ………….”

 2. For applicability of section 2(22)(e) there must be a payment by the company by way of advance or loan

For invoking the provisions of section 2(22)(e), there must be a payment by the company by way of advance or loan and if no loan or advance was given by the company, section 2(22)(e) is not applicable. Therefore, any amount which does not represent loan or advance given by the company during the year under consideration, said amount does not fall within the ambit of provisions of section 2(22)(e).

In this regard, following judicial precedents can be relied upon:

• Exotica Housing & Infrastructure Company Pvt. Ltd. vs. ITO (ITAT Delhi)

Section 2(22)(e) is a deeming provision & should be construed strictly. The section uses the expression “by way of advances or loans” which shows that all payments received from the sister company cannot be treated as deemed dividend but only payments which bear the characteristics of loans and advances. Under the law, all loans and advances are debts, but all debts are not loans and advances. The term ‘loans and advances’ is not defined & has to be understood in the commercial sense. Advances given for purely temporary financial accommodation for business purposes does not attract the deeming fiction.

• DCIT vs. Veena Goyal – [2020] 119 taxmann.com 362 (Jaipur – Trib.)

“7. ……….. the assessee had made payment of value of shares along with the application for allotment of 1120000 shares thus she was not in default of making payment for value of shares applied for on her part. The Company M/s Pinkcity Jewelhouse Pvt. Ltd. did not present the cheque for claim before making the allotment and on allotment of shares on 4.2.13 debited the value of shares to the ledger account of the assessee, thus in fact there was no debit balance as on 4-2-2013. But the learned assessing officer due to the fact the cheque were cleared later on treated Rs. 50 Lacs as deemed dividend.

 8. Provisions of Section 2(22)(e) of the Act comes to play only if the company makes any payment to such shareholder, by way of advance or loan and that too to the extent the company possesses accumulated profit, provided that his/her holding is not less than ten percent of voting power. From provisions of section 2(22)(e) it is clearly evident that the provisions of this section come to play only if the company makes any payment of advance or loan to a shareholder holding not less than ten percent of voting power. In the case of assessee, the company has not paid any sum and in fact amount is being debited by way of Journal Entry and no amount or money has been given as loan or advance to the shareholder. The debit balance has been notionally worked out by the assessing officer by working out the balance in ledger account of shareholder on the basis of clearing date of cheque received (not paid) in the bank account, which is not correct. As per accounting principles entries in the books of accounts are required to be made on the basis of transactions entered which is the receipt of cheque, which was subsequently honoured by the bank, hence the entries appearing in the ledger account is correct and same cannot be ignored and balance cannot be worked out on notional basis and even if he wants to do the same, then also the amount was never paid to the Share Holder but in fact was received from the Share Holder and the date of debit should also be transferred to the date on which the amount was cleared. And as discussed earlier in no way by this company has paid any amount to the shareholder and thus provisions of section 2(22)(e) are not applicable.”

3. Shareholding in lender company and substantial interest in borrower company to be checked at the time of advancement of loan

 If advance or loan is given to a concern then shareholder of lender company must have at least 10% voting power in lender company and a substantial interest in the borrower company at the time of advancement of loan. In this regard, reference can be made to the following judicial precedents:

•  CIT vs. Jignesh P. Shah (Bombay High Court)

 2(22)(e) has to be construed strictly. If assessee is not a shareholder of lending co, section 2(22)(e) does not apply even if funds are ultimately paid by company in which assessee is a shareholder

•  ACIT vs. Gurdeep Singh – [2020] 117 taxmann.com 451 (Chandigarh – Trib.)

Where AO made addition to assessee’s income by invoking provisions of section 2(22)(e) on the ground that assessee was holding more than 10% shareholding, in view of the fact that as per annual return filed before ROC, assessee had already transferred its shareholding in borrower company to lender company before advancement of loan out of surplus funds, impugned addition was to be deleted.

 4. Registered shareholder or beneficial shareholder

 “Shareholder”, means beneficial owner of shares

The term “shareholder”, means beneficial owner of shares. One cannot be a registered owner and beneficial owner in the sense of a beneficiary of a trust or otherwise at the same time. The moment there is a shareholder, who need not necessarily be a member of the Company on its register, who is the beneficial owner of shares, section 2(22)(e) gets attracted without anything more. To state that two conditions have to be satisfied, namely, that the shareholder must first be a registered shareholder and thereafter, also be a beneficial owner is not only mutually contradictory but is plainly incorrect.

National Travel Service vs. CIT (Supreme Court) – 18 January 2018

HUF being beneficial shareholder, 2(22)(e) will apply to loans given to HUF

The argument that as the shares are issued in the name of the Karta, the HUF is not the “registered shareholder” and so section 2(22)(e) will not apply to loans paid to the HUF is not correct because in the annual returns filed with the ROC, the HUF is shown as the registered and beneficial shareholder. In any case, the HUF is the beneficial shareholder. Even if it is assumed that the Karta is the registered shareholder and not the HUF, as per Explanation 3 to s. 2(22), any payment to a concern (i.e. the HUF) in which the shareholder (i.e. the Karta) has a substantial interest is also covered.

Gopal And Sons (HUF) vs. CIT (Supreme Court) – 4 January 2017

 5. Sec. 2(22)(e) is not applicable in case of commercial transactions (CBDT Circular)

 Whether Trade Advances Constitute ‘Deemed Dividends’ u/s 2(22)(e) – CBDT Circular No. 19/2017 dated 12 June 2017

Trade advances, which are in the nature of commercial transactions would not fall within the ambit of the word ‘advance’ in section 2(22)(e) of the Act. Accordingly, henceforth, appeals may not be filed on this ground by Officers of the Department and those already filed, in Courts /Tribunals may be withdrawn/not pressed upon.

 6. Amount received for providing corporate guarantee, not deemed dividend u/s 2(22)(e)

 Where assessee received certain amount from subsidiary company as advance towards security for providing corporate guarantee, it could not be brought to tax as deemed dividend under section 2(22)(e)

• DCIT vs. Accel Limited – [2020] 118 taxmann.com 103 (Madras)

“10. The present appeal is relating to the assessment year 2002-03, questioning the sum of Rs. 3.00 Crores advance made by the subsidiary company to the respondent/holding company. The Commissioner of Income-tax (Appeals), referring to the decision rendered for the assessment year of 2004-05, held that a sum of Rs. 3.00 Crores shown in the balance sheet of the respondent company for the assessment year 2002-03, is only an advance made by its subsidiary company, in the course of the business, for providing corporate guarantee by the respondent, and rejected the contentions of the department. As against the said order, the department has preferred an appeal before the Income-tax Appellate Tribunal Madras “C” Bench, Chennai in ITA No.144/Mds/2015 (for the assessment year 2002-03). The Tribunal has also passed its order in that appeal on 20-5-2016, holding that the Commissioner Income-tax (Appeals) have elaborately dealt with the facts of the case. Further, it has not found any error in the order passed by the Commissioner of Income-tax (Appeals). Therefore, the appeal of the Revenue in I.T.A.No.144/Mds/2015 was dismissed. As against the said order, the department has preferred the present appeal before this Court.

 11. As stated above, this Court already has decided the said issue against the same appellant, holding that the sum of Rs. 3.00 Crores received by the respondent company from its subsidiary relevant to the assessment year 2004-05, is not deemed dividend within the meaning of Section 2(22)(e) of the Act.

 12. Further, the advance received by the respondent from its subsidiary has been shown in the balance sheet of the respondent, relevant to the assessment years 2002-03 and 2004-05. The department has initiated two separate proceedings for the single transaction and the said proceedings have been dragged up to the level of this Court. Obviously, the department would have been well aware of the fact that the amount of Rs. 3.00 Crores advanced by the subsidiary to its holding company, cannot be taxed twice. When such being the position, we are really surprised to see that the initiation of two separate proceedings for the same transaction is not appreciable. Had the department have applied its mind in a proper manner, they could have avoided these type of vexatious proceedings and it would have saved the precious time of this Court as well as the department.”

7. Exclusion from 2(22)(e)

As per Explanation (ii) dividend does not include any advance or loan made to a shareholder or a concern (in which shareholder of lending company has substantial interest) 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.

Where assessee was holding more than 10% of shares in two companies and he obtained loan and advances from said companies on interest and Assessing Officer treated amount of loan and advances to be deemed dividend and added same to income of assessee, since both companies were having money lending as substantial part of their business, no addition could be made by way of deemed dividend in income of assessee – PCIT vs. Mohan Bhagwatprasad Agrawal – [2020] 115 taxmann.com 69 (Gujarat)

8. DDT on Deemed Dividend u/s 2(22)(e)

 Finance Act 2018 levied DDT @ 30% u/s 115-O, on deemed dividend u/s 2(22)(e), in the hands of payer company. However, simultaneously exemption u/s 10(34) is provided to the recipient in respect of said deemed dividend.

Conclusion

 For a smooth sail through and to avoid DDT on any loan or advance given by a company, the following key ratios must be kept in mind while analysing the applicability of the provisions of section 2(22)(e):

i. Section 2(22)(e) applies only on advance or loans given by a company

ii. For applicability of section 2(22)(e) there must be a payment by way of advance or loan

iii. Shareholding in lender company and substantial interest in borrower company to be checked at the time of advancement of loan

iv. For 2(22)(e) “Shareholder”, means beneficial owner of shares

v. 2(22)(e) is not applicable in case of commercial transactions

vi. Amount received for providing corporate guarantee, not deemed dividend u/s 2(22)(e)

vii. 2(22)(e) will not apply to an advance or loan made to a shareholder or a concern (in which shareholder has substantial interest) 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

viii. DDT @ 30% levied on Deemed Dividend u/s 2(22)(e) and section 10(34) exempts in the hands of shareholders. Therefore, no TDS is deductible.