Applicability of provisions of section 2(22)(e) to Beneficial Shareholder or Registered Shareholder- Supreme Court Ruling in National Travel v CIT

Jyoti Jain

National Travel Service Vs. CIT (Supreme Court of India)

Sec. 2(22)(e) of the Income Tax Act, 1961 (the Act), is one such deeming provision that has remain point of litigation over various issues since its inception. One such issue is applicability of provisions of section 2(22)(e) when a shareholder is beneficial shareholder or registered shareholder. In this context, a latest ruling of Supreme Court in case of National Travel v CIT Civil Appeal Nos. 2068-2071 of 2012 is available which interprets the law and set aside this controversy. The author summaries this ruling in this write up hoping that readers find this study helpful.

1. Relevant Statutory Provision –Section 2(22)(e) of the Act

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.

However, dividend does not include 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.

Explanation 3 to section 2(22)(e) clarifies the following:

(a) “concern” means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company;

(b) 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.

In Commissioner of Income Tax Vs. C.P. Sarathy Mudaliar [1972] 83 ITR 170, the Supreme Court analyzed the provision and explained the same as under:-

“Any payment by a company, not being a company in which the public are substantially interest, of any sum (whether as representing a part of the assets of the company or otherwise) made after 31.05.1987 by way of advance or loan.

First limb

a) 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 percent of the voting power.

Second limb

b) or to any concern in which, such shareholder is a member or a partner and in which he has a substantial interest.

Third limb

c) or any payment by any such company on behalf, or for the individual benefit, or any such shareholder, to the extent to which the company in either case possesses accumulated profits”.

2. Facts of the case of National Travel v CIT in Civil Appeal Nos. 2068-2071 of 2012

Assessee is a partnership firm consisting of three partners, namely, Mr. Naresh Goyal, Mr. Surinder Goyal and M/s Jet Air Private Limited having a profit sharing ratio of 35%, 15% and 50% respectively. Assessee-firm had taken a loan of Rs. 28,52,41,516/- from M/s Jet Air Private Limited in which assesse was holding 48.19 per cent of the total shareholding in the names of Mr. Naresh Goyal and Surinder Goyal. Thus, the assesse firm was the beneficial shareholder and aforesaid two partners were registered shareholders of the company.

Assessing Officer invoked the provisions of section 2(22)(e) and made the addition in the hands of assesse- firm. Commissioner (Appeals) deleted the addition. ITAT also uphold the order of Commissioner (Appeals) by following the decision of Special Bench in the case of ACIT vs. Bhaumik Colour Pvt. Ltd. 118 ITD 1 (Mum.) (SB). Subsequently, the matter reached to the Delhi High Court.

The Delhi High Court in CIT v National Travel Services (2012) 347 ITR 305 reversed the order of ITAT and restored the addition holding that:

(a) When Section 2 (22) (e) of the Act enacts a deeming provision, it has to be strictly construed. At the same time, it is also trite that such a deeming provision has to be taken to its logical conclusion. If the partnership firm which has purchased the shares is not treated as shareholder merely because the shares were purchased in the name of the partners, that too because of the legal compulsion that shares could not be allotted to the said partnership firm which is a non- legal entity, it would be impossible for such a condition to be fulfilled. That is not the purpose of law.

(b) The partnership firm is synonym of the partners. As per the Circular issued by the SEBI dated 13th March, 1975 interpreting Section 187 (c) of the Companies Act, 1956, a partnership firm is not a person capable of being a member within the meaning of Section 47 of the Companies Act, 1956. Since a partnership firm is not a legal entity by itself but only a compendious way of describing the partners constituting the firm, it is necessary that the names of all the members of the partnership firm should be entered in the Register of Members. Obviously then, with the purchase of shares by the firm in the name of its partners, it is the firm which is to be treated as shareholder for the purposes of Section 2(22)(e) of the Act.

(c) Thus, for the purpose of Section 2 (22) (e) of the Act, partnership firm is to be treated as the shareholder and it is not necessary that is has to be “registered shareholder”.

Aggrieved by the decision of Delhi High Court, assesse- firm approached the Supreme Court.

3. Arguments of assessee before the Supreme Court

The learned counsel on behalf of assesse-firm contented that the Division Bench of Delhi High Court in another case CIT v. Ankitech Private Limited [2012] 340 ITR 14 (Del).had arrived at a conclusion, following other judgments of other Courts and Tribunals, that the expression “shareholder” would continue to mean a registered shareholder even after the amendment made in section 2(22)(e) by the Finance Act, 1987 w.e.f 1-4-1988, and that, this being the case, it was clear that the judgment of Delhi High Court had taken an about turn and had sought to distinguish the earlier judgment when it was squarely applicable.

He also bought notice of an order dated 05.10.2017 passed in case of CIT vs. Madhur Housing and Development Company in Civil Appeal No. 3961 of 2013 in which the Supreme Court had expressly affirmed the reasoning of the aforesaid earlier judgment. Therefore, he contended that the assesse- firm, not being a registered shareholder, could not possibly be a person to whom Section 2(22)(e) would apply.

4. Arguments of revenue before the Supreme Court

The learned counsel on behalf of revenue supported the decision of Delhi High Court by pointing out that the impugned judgment itself had made a distinction between the facts in Ankitech (supra) and in the present case. The impugned judgment had reference only to the second limb of the amended definition, namely, to the limb which deals with any concern in which such shareholder is a member and not to the first limb, which deals with a shareholder being a person who is the beneficial owner of shares. Therefore, the Delhi High Court rightly sidestepped the decision in Ankitech (supra) and correctly arrived at the conclusions.

5. Supreme Court Decision

The Hon’ble Supreme Court noted that the Delhi High Court posed two questions to be answered by it in the present case as follows:

“(1) To attract the first limb of Section 2(22)(e) of the Act, is it necessary that the person who has received the advance or loan is a shareholder and also beneficial owner. To put it otherwise, whether both the conditions are required to be satisfied will depend upon the interpretation to be given to the words “being a person who is a beneficial owner of shares ”which was inserted by
amendment in the aforesaid provision carried out by the Finance Act, 1987 w.e.f 1-4-1988.

(2) Whether the assessee who is a partnership firm can be treated as `shareholder’ because of the reason that it has purchased the shares in the name of the two partners.”

Towards first question, the Delhi High Court stated that the expression “being a person who is a beneficial owner of shares” would be in addition to the shareholder first being a registered shareholder of the company. Therefore, in order to attract section 2(22)(e), both conditions have to be satisfied.

So far as the second question was concerned, the Delhi High Court stated that a partnership firm can be treated as a shareholder but it is not necessary that it has to be a registered shareholder.

The above reasoning of the Delhi High Court was not acceptable as it was not enough to said that Ankitech’s case (supra) referred to the second limb of the definition, whereas the present case referred to the first limb, for the simple reason that the word “shareholder” in both limbs would mean exactly the same thing. Thus, Ankitech’s case (supra), in stating that no change was made by introducing the deeming fiction insofar as the expression “shareholder” is concerned was, wrongly decided and required reconsideration.

The whole object of the provision of section 2(22)(e) is clear from the Explanatory memorandum and the literal language of amended definition. Thus, “shareholder”, post amendment, has only to be a person who is the 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. It is clear therefore that 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, the provisions of section 2(22)(e) gets attracted without more. Hence, the provisions of section 2(22)(e) were correctly applied by revenue authorities.

6. Conclusion

One cannot be a registered owner and beneficial owner in the sense of a beneficiary of a trust or otherwise at the same time. Therefore, 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, the provisions of section 2(22)(e) gets attracted. In the present case, the Supreme Court upheld the deemed dividend addition u/s 2(22)(e) made on assesse- firm with respect to a loan received from a company (in which it beneficially held more than 10% share-capital) though the company had issued shares in the names of two partners of assesse- firm and not in the assesse firm’s name.

With the above ruling, the Supreme Court has cleared the issue regarding tax ability under deemed dividend under section 2(22)(e) in the hands of loan recipient being a beneficial shareholder holding more than 10 percent share capital of a closely held company.

(The author can be reached at jyotijain101@gmail.com)