CA Rushabh Mehta
The Income Tax Act, 1961 contains various provisions either expressly or impliedly. There are many deeming fiction provisions in the Act viz. section 50C, 43CA, 56(2)(x), etc. One such section is section 2(22)(e) of the Act which provides that an amount of loan or advance given to a shareholder directly or indirectly shall be treated as dividend in the hands of the shareholder except under certain circumstances as laid down in the provision. The relevant section reads as under: –
“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 such 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”
Recently, the Hon’ble Apex Court in the case of National Travel Services v. CIT  89 taxmann.com 332(SC) has held that the view of Delhi High Court in the case of CIT v. Ankitech (P.) Ltd.  11 taxmann.com 100 (Delhi) affirmed by the Hon’ble Apex Court in the case of Madhur Housing and Development Company [2017-TIOL-398-SC-IT] requires reconsideration and have accordingly referred the matter before the Hon’ble Chief Justice of India in order to constitute an appropriate Bench of three learned Judges in order to have a relook at the entire question.
Accordingly, there is still a dilemma as to what is the scope of the said deeming provision. The following questions still require deliberation: –
A. Whether the said provision applies to registered shareholder or beneficial shareholder or both?
B. Whether any concern to whom amount is paid is termed to be a ‘deemed shareholder’ and is to be taxed accordingly in its hands?
Whether the amount given to any other concern is termed as ‘deemed dividend’ and is to be taxed accordingly in the hands of the shareholder?
1. Interestingly, recently, the above issue was discussed in the order of the Hon’ble Apex Court in the case of National Travel Services v. CIT, Delhi  89 taxmann.com 332 (SC). The facts of this case was that the assessee was a partnership firm consisting of three partners namely, ‘N’, ‘S’ and ‘J’ P. Ltd. having a profit sharing ratio of 35 per cent, 15 per cent and 50 per cent respectively. The assessee firm had taken a loan of Rs. 28.52 crores from M/s. Jetair Pvt. Ltd. In said company, the assessee firm subscribed to the equity capital in the name of two of its partners, namely, ‘N’ and ‘S’ (individuals) totaling to 48.19 per cent of the total shareholding. Thus, ‘N’ and ‘S’ were shareholders on the company’s register as members of the company. They held the aforesaid shares for and on behalf of the firm, which happened to be the beneficial shareholder. The question that arose in instant appeal was as to whether section 2(22)(e) got attracted in as much as a loan had been made to a shareholder, who after the 1988 amendment in section 2(22)(e) was a person who was the beneficial owner of shareholding not less than 10 per cent of the voting power in the company, and whether the loan was made to any concern in which such shareholder was a partner and in which he had a substantial interest, which was defined as being an interest of 20 per cent or more of the share of the profits of the firm.
2. Under the above factual background, the Hon’ble Apex Court referred the definition of term ‘dividend’ as contained in the Income Tax Act, 1922 in section 2(6A)(e) as interpreted by the Hon’ble Supreme Court in the case of CIT v. C.P. Sarathy Mudaliar  83 ITR 170 (SC) wherein it held that section 2(6A)(e) gives an artificial definition of ‘dividend’. It does not take in dividend actually declared or received. The dividend taken note of by that provision is a deemed dividend and not a real dividend. The loan granted to a shareholder has to be returned to the company. It does not become the income of the shareholder. For certain purposes, the Legislature has deemed such a loan as ‘dividend’. Hence, section 2(6A)(e) must necessarily receive a strict construction. When section 2(6A)(e) speaks of “shareholder”, it refers to the registered shareholder and not the beneficial owner. The H.U.F. cannot be considered as a shareholder either under section 2(6A)(e) or under section 23A or under section 16(2) read with section 18(5) of the Act. Hence, a loan given to an H.U.F. cannot be considered as a loan advanced to a “shareholder” of a company. This decision was again followed in Rameshwari Lal Sanwarmal v. CIT  2 SCC 371.
The Hon’ble Apex Court taking cognizance of the similar provisions in section 2(22)(e) of the Income Tax Act, 1961 prior to 1988 and thereafter amendment introduced in 1988, held that a reading of the amended definition would indicate that, after 31.05.1987, a “shareholder” is now a person who is the beneficial owner of shares holding not less than 10% of the voting power of the company. Further, referring to the definition of “concern” in Explanation 3 to section 2(22)(e) of the Act and the Explanatory Memorandum, it held that –
“17. We are of the view that it is very difficult to accept the reasoning of the Division Bench. It is not enough to say that Ankitech’s case refers to the second limb of the amended definition, whereas the present case refers to the first limb, for the simple reason that the word “shareholder” in both limbs would mean exactly the same thing. This is for the reason that the expression “such shareholder” in the second limb would show that it refers to a person who is a “shareholder” in the first limb.
18. This being the case, we are of the view that the whole object of the amended provision would be stultified if the Division Bench judgment were to be followed. Ankitech’s case (supra), in stating that no change was made by introducing the deeming fiction insofar as the expression “shareholder” is concerned is, according to us, wrongly decided. The whole object of the provision is clear from the Explanatory memorandum and the literal language of the newly inserted definition clause which is to get over the two judgments of this Court referred to hereinabove. This is why “shareholder” now, 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 Section gets attracted without more. To state, therefore, 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. Also, what is important is the addition, by way of amendment, of such beneficial owner holding not less than 10% of voting power. This is another indicator that the amendment speaks only of a beneficial shareholder who can compel the registered owner to vote in a particular way, as has been held in a catena of decisions starting from Mathalone v. Bombay Life Assurance Co. Ltd.  SCR 117.
19. This being the case, we are prima facie of the view that the Ankitech (P.) Ltd. case (supra) itself requires to be reconsidered, and this being so, without going into other questions that may arise, including whether the facts of the present case would fit the second limb of the amended definition clause, we place these appeals before the Hon’ble Chief Justice of India in order to constitute an appropriate Bench of three learned Judges in order to have a relook at the entire question.”
2. Let us also examine the facts and decision in the case of CIT v. Ankitech (P.) Ltd.  11 taxmann.com 100 (Delhi), ruling of which was affirmed by the Hon’ble Apex Court in the case of CIT v. Madhur Housing and Development Company [2017-TIOL-398-SC-IT]. The facts of the case of Ankitech (supra) are that the assessee-company had received advances of certain amount by way of book entry from M/s. Jackson Generators (P.) Ltd.,(JGPL) and the shareholders having substantial interest in the assessee-company were also having 10 per cent of the voting power in JGPL. The Assessing Officer held that the amount received by the assessee company from JGPL constituted ‘advances and loans’ and be treated as deemed dividend within the meaning of section 2(22)(e) and would be added to the income of the assessee. In this context, the Hon’ble Delhi High Court held that it is an admitted case that under normal circumstances, such a loan or advance given to the shareholders or to a concern, would not qualify as dividend. It has been made so by legal fiction created under section 2(22)(e). This legal provision relates to dividend. Thus, by a deeming provision, it is the definition of dividend which is enlarged. Legal fiction does not extend to ‘shareholder’. When this aspect, is kept in mind, the conclusion would be obvious, viz., loan or advance given under the conditions specified under section 2(22)(e) would also be treated as dividend. The fiction has to stop here and is not to be extended further for broadening the concept of shareholders by way of legal fiction. It is a common case that any company is supposed to distribute the profits in the form of dividend to its shareholders/members and such dividend cannot be given to non-members. The second category specified under section 2(22)(e), viz., a concern, which is given the loan or advance is admittedly not a shareholder/member of the payer company and therefore, under no circumstance, it can be treated as shareholder/member receiving dividend. If the intention of the Legislature would have been to tax such loan or advance as deemed dividend at the hands of ‘deeming shareholder’, then the Legislature would have inserted deeming provision in respect of shareholder as well, that has not happened. In a case like this, the recipient would be a shareholder by way of deeming provision. It is not correct on the part of the revenue to argue that if this position is taken, then the income ‘is not taxed at the hands of the recipient’. Such an argument based on the scheme of the Act as projected by the learned counsels for the revenue on the basis of sections 4, 5, 8, 14 and 56 of the Act would be of no avail. Simple answer to this argument is that such loan or advance, in the first place, is not an income. Such a loan or advance has to be returned by the recipient to the company, which has given the loan or advance. Precisely, for this very reason, the Courts have held that if the amounts advanced are for business transactions between the parties, such payment would not fall within the deeming dividend under section 2(22)(e) of the Act. Insofar as reliance upon Circular No. 495, dated 22-9-1997 issued by Central Board of Direct Taxes is concerned, we are inclined to agree with the observations of the Mumbai Bench decision in Bhaumik Colour (P.) Ltd.’s case (supra) that such observations are not binding on the Courts. Once it is found that such loan or advance cannot be treated as deemed dividend at the hands of such a concern which is not a shareholder, and that according to us is the correct legal position, such a circular would be of no avail. No doubt, the legal fiction/deemed provision created by the Legislature has to be taken to ‘logical conclusion’ as held in Andaleeb Sehgal’s case (supra). The revenue wants the deeming provision to be extended which is illogical and attempt is to create a real legal fiction, which is not created by the Legislature. We say at the cost of repetition that the definition of shareholder is not enlarged by any fiction.
Further, in the latter part of the said decision, it held that under the existing provisions of section 2(22)(e), payment made by way of advance or loan to a shareholder having “substantial interest” in the company was treated as deemed dividend. The shareholder having substantial interest as per provision of clause (32) of section 2 of the Act, was the one carrying not less than 20 per cent voting power. In other words, earlier section 2(22)(e) was applicable to shareholders having substantial interest in the company and the benchmark of the substantial interest was 20 per cent of the voting power. By Finance Act, 1987, this benchmark of substantial interest was done away with. It is important to note here that section 2(32) defining the expression “person who has substantial interest in the company” was not amended. Therefore, to widen the scope of section 2(22)(e), it was necessary to provide for the category of shareholders to whom the section would apply and it was provided by inserting the words “a shareholder, being a person who is beneficial owner of sharesholding not less than 10 per cent of the voting power”. The concept of “voting power” was in built on the provisions of section 2(22)(e ) as it existed prior to 1987 amendment. The insertion of the words “beneficial owner of shares holding not less than 10 per cent of the voting power” to 10 per cent of voting power. A beneficial owner of shares cannot exercise voting power because to exercise the right to vote his/her name must appear in the register of members. In this view of the matter, it will not be correct to say that the ratio laid down by Hon’ble Supreme Court in Rameshwarlal Sanwarmal v. CIT 122 ITR 1 that word ‘shareholder’ in section 2(22)(e) is no more applicable. Moreover, since the purpose of section 2(22)(e), as stated in Circular No. 495, dated 22-9-1987, is to tax the distribution of profits to shareholders, where the same is distributed not by way of dividend but by way of loan or advances, therefore, the view that word ‘shareholder’ has been used as ‘registered shareholder’ cannot be found fault with. Any other view would be against the very spirit of section 2(22)(e) of Income-tax Act. The condition of 10 per cent of the voting power is to be seen qua the shareholder; otherwise, the condition would be of no relevance.”
3. In light of the above, it can be seen that there are two diverse views of the Hon’ble Apex Court as to whether registered shareholder or beneficial shareholder or both is covered u/s. 2(22)(e) of the Act. However, it is well settled that the later decision shall prevail if it considers the former decision. Accordingly, as on date, the decision of National Travel Services (SC) (supra) shall prevail over the decision of Ankitech (Del HC) confirmed in Madhur Housing and Development Co. (SC) (supra). Also, the Hon’ble Apex Court in the case of National Travel Services have given detailed reasons as to why the interpretation of the term ‘shareholder’ post amendment in 1988 has to be made as beneficial shareholder although he may not be a registered shareholder. Hence, from the discussion above, it implies that the provisions of section 2(22)(e) shall be attracted in the hands of the beneficial shareholder and he may be taxed accordingly.
4. Another issue which is vital to understand is whether ‘concern’ as referred to in Explanation 3(a) to section 2(22)(e) shall be treated as beneficial shareholder in all cases or not. In this regard, it is important to analyse the decisions referred above in the correct perspective. It is one of the important point raised in the decision of Ankitech (supra) that firstly, the recipient should be a shareholder to be covered under the ambit of section 2(22)(e) as even logically, it is the shareholder who can be taxed the amount of dividend although of a deeming nature. It further said that the deeming fiction only expands the scope of ‘dividend’ and not ‘shareholder’. This proposition does not appear to have been altered by the Hon’ble Apex Court in its decision of National Travel Services (supra) completely, though it referred the taxability of deemed dividend in the hands of the beneficial shareholder in light of the facts before it.
In this regard, reference can also be made to the CBDT Circular no. 495 dated 22.02.1987 below:-
10.2 With the deletion of sections 104 to 109 there was a likelihood of closely-held companies not distributing their profits to shareholders by way of dividends but by way of loans or advances so that these are not taxed in the hands of the shareholders. To forestall this manipulation, sub-clause (e) of clause (22) of section 2 has been suitably amended. Under the existing provisions, payments by way of loans or advances to shareholders having substantial interest in a company to the extent to which the company possesses accumulated profits is treated as dividend. The shareholders having substantial interest are those who have a shareholding carrying not less than 20 per cent voting power as per the provisions of clause (32) of section 2. The amendment of the definition extends its application to payments made (i) to a shareholder holding not less than 10 per cent of the voting power, or (ii) to a concern in which the shareholder has substantial interest. “Concern” as per the newly inserted Explanation 3(a) to section 2(22) means a HUF or a firm or an association of persons or a body of individuals or a company.
A shareholder having a substantial interest in a concern as per part (b) of Explanation 3 is deemed to be one who is beneficially entitled to not less than 20 per cent of the income of such concern.
10.3 The new provision would, therefore, be applicable in a case where a shareholder has 10 per cent or more of the equity capital. Further, deemed dividend would be taxed in the hands of a concern where all the following conditions are satisfied :
(i) where the company makes the payment by way of loans or advances to a concern ;
(ii) where a member or a partner of the concern holds 10 per cent of the voting power in the company ; and
(iii) where the member or partner of the concern is also beneficially entitled to 20 per cent of the income of such concern.
The aforesaid CBDT Circular refers to the taxability in the hands of the concern receiving any payment if the condition of section 2(22)(e) of the Act is satisfied. However, this cannot be hold good as firstly, the same is not of any binding nature and secondly, as per the discussion made above, such a concern should be at least a beneficial shareholder if not a registered shareholder. In the case of National Travel Services (supra), it was a firm who made the payment of shares and the names of partners were enrolled in the register of companies as shareholders and hence, the assessee firm in that case was termed as a beneficial shareholder.
5. In similar context, attention is also invited to the decision of Gopal & Sons (HUF) V. CIT [2017-TIOL-02-SC-IT], wherein the Hon’ble Apex Court held that the H.U.F. is to be taxed u/s. 2(22)(e) for the sum received from a company as it is the H.U.F. who had subscribed the shares although the karta was the registered shareholder of the company.
6. Thus, it can be concluded that the concern as referred to in Explanation 3(a) to section 2(22)(e) can be taxed only if it is a registered or beneficial shareholder and not otherwise. Similar view is taken by the Hon’ble Madras High Court in the case of PCIT v. Ennore Cargo Container Terminal Pvt. Ltd. [2017-TIOL-695-MAD-IT]. Hence, in such cases, where the recipient concern cannot to be taxed, it is such shareholder as referred in ISSUE A who can be taxed.