Deemed Dividend u/s 2(22)(e) do not extend to non-shareholders-Supreme Court agrees with High Court

Deemed Dividend u/s 2(22)(e) do not extend to non-shareholders. The fiction not to be extended further for broadening the concept of shareholders – Supreme Court agrees with High Court

ABCAUS Case Law Citation:
ABCAUS 2099 (2017) (10) SC 

Deemed Dividend u/s 2(22)(e) do not extend to non-shareholders

In a recent judgment, the Hon’ble Supreme Court has upheld an important judgment of the Delhi High Court on deemed dividend. While dismissing the Special Leave Petition (SLP) of the Income tax Department (Revenue) held that the judgment of the Delhi High Court is a detailed judgment going into Section 2(22)(e) of the Income Tax Act which arises at the correct construction of the said Section.

The Hon’ble Delhi High Court in 2011, while dismissing a bunch of appeals filed by the Revenue has held that the provisions of deemed dividend u/s 2(22)(e) ) of the Income Tax Act (the Act) do not apply to a non shareholder assessee.

The primary question before the Delhi High Court was whether an assessee who was not the shareholders of the concern giving the loans/advances could be treated as covered by the definition of dividend‘ as contained in Section 2(22)(e) of the Income Tax Act (the Act).

The Delhi High Court had held that the intention behind enacting provisions of Section 2(22)(e) is that closely held companies which are controlled by a group of members, even though the company has accumulated profits would not distribute such profit as dividend because if so distributed the dividend income would become taxable in the hands of the shareholders. Instead of distributing accumulated profits as dividend, companies distribute them as loan or advances to shareholders or to concern in which such shareholders have substantial interest or make any payment on behalf of or for the individual benefit of such shareholder. In such an event, by the deeming provisions, such payment by the company is treated as dividend. The intention behind the provisions of Section 2(22)(e) of the Act is to tax dividend in the hands of shareholders. The deeming provisions as it applies to the case of loans or advances by a company to a concern in which its shareholder has substantial interest, is based on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance.

The Delhi High Court had observed that the legal fiction is relates to dividend. Thus, by a deeming provision, it is the definition of dividend which is enlarged. Legal fiction does not extend to shareholder. The Hon’ble High Court had concluded that loan or advance given under the conditions specified under Section 2(22)(e) of the Income Tax Act 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 High Court had clarified that if a concern which is given the loan or advance is not a shareholder/member of the payer company then under no circumstance, it could be treated as shareholder/member receiving dividend. If the intention of the Legislature was 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.