No deemed dividend u/s 2(22)(e) if funds not utilized for the benefit of the substantial shareholder – ITAT
In a recent judgment, ITAT Hyderabad has deleted the addition as deemed dividend u/s 2(22)(e) holding that the payments made by the company had been used for the business purposes of the recipient companies and the funds had not been utilized by the recipient companies for the benefit of the common substantial shareholder.
ABCAUS Case Law Citation:
4315 (2024) (11) abcaus.in ITAT
In the instant case, the assessee had challenged the order passed by the CIT(A) in upholding the addition made in the assessment order towards deemed dividend u/s 2(22)(e) of the Income Tax Act, 1961 (the Act).
A search and seizure operation under Section 132 of the Income Tax Act, 1961 was carried out in a Group of cases on. The appellant company was one of the companies covered under the search.
Consequent to search, the case was selected for scrutiny. The AO found that there was a substantial amount of debit balance outstanding in the name of two companies in the books of the appellant company. The AO further noted that one person was a common director in all the three companies who was holding more than 10% of the voting share.
The AO, after examination of the accounts of the recipient company, observed that the basic ingredients of ‘deemed dividend’ as defined under section 2(22)(e) of the Act, such as common substantial shareholding of the said common shareholder in the Appellant Company, two recipient companies and the availability of accumulated profits by way of reserves in the hands of the appellant company, had been satisfied.
The appellant company and two group companies (recipient companies) were engaged in the same line of business and had carried out trading transactions of purchases and sales with each other in the course of the said business. The appellant company has made payments in respect of purchases made from the recipient companies and received payments in respect of sales made to recipient companies.
The AO analyzed the details of opening balance, sales, purchases, receipts, payments and closing balance in the accounts of the two recipient companies and found that they were in receipt of excess amounts from the appellant company in comparison to the amounts receivable by them against the trading transactions.
However, in terms of CBDT Circular No.19/2017, which stated that the trade advances, which are in the nature of commercial transactions, would not fall under the ambit of the word “advance” in section 2(22)(e), the AO treated the payments made by the appellant company to the extent of 150% of the purchases made from the recipient companies as the payments made in the ordinary course of business and the payments made in excess of such 150% of the purchases as payments having no nexus with the business transactions. The said amounts of excess payments were accordingly held by AO to be constituting deemed dividend u/s 2(22)(e) in the hands of the common substantial shareholder in the appellant company.
The AO observed that the appellant company, being the payer company, was liable to pay dividend distribution tax under the provisions of section 115-O of the Act, in respect of the said deemed dividend u/s 2(22)(e) in the hands of the common substantial shareholder, in view of the amendment made to section 115Q with effect from 01.04.2018 making dividend distribution tax applicable to deemed dividend also. Since no dividend distribution tax has been paid in respect of such deemed dividend by the appellant company, the AO made addition of deemed dividend u/s 2(22)(e) of the Act in respect of which the appellant failed to pay dividend distribution tax, in the assessment order passed u/s 153A in the case of the appellant company.
The CIT(A) sustained additions made by the AO towards deemed dividend u/s 2(22)(e) of the Act.
The Tribunal observed that the appellant company and the recipient companies had carried out trading transactions of purchases and sales with each other in the course of the business. These group companies had made payments in respect of purchases made by them from the other group companies and received payments in respect of sales made by them to other group companies. It was thus proved that those were trade advances, which arose in the course of carrying out purchases in the normal course of the business and which result in closing debit balance in the account of the recipient company in the books of payer company and thus, these trade advances in the ordinary course of business cannot be regarded as payment of ‘loans or advances’ to the recipient company, since the same were undeniably in the nature of commercial transactions.
The Tribunal noted that it is a settled position of law that trade advances given in the normal course of business on account of trading transactions cannot be treated as ‘loans or advances’ so as to constitute deemed dividend u/s 2(22)(e) of the Act. This legal position is fortified by the decisions where it has been held that the provision of section 2(22)(e)(i) is basically in the nature of an explanation. That cannot, however, have bearing on interpretation of the main provision of section 2(22)(e) and once it is held that the business transactions do not fall within section 2(22)(e), there is no need to go further to section 2(22)(e)(ii). The provision of section 2(22)(e)(i) gives an example only of one of the situations where the loan/advance will not be treated as a deemed dividend, but that’s all. The same cannot be expanded further to take away the basic meaning, intent and purport of the main part of section 2(22)(e). This interpretation is in accordance with the legislative intention of introducing section 2(22)(e).
The Tribunal noted that the above view has been expressed by various Courts that trade advances in the nature of commercial transactions would not fall within the ambit of the provisions of section 2(22)(e) of the Act and that such views have attained finality.
The Tribunal opined that the AO had wrongly treated the payments in excess of 150% of the purchases as ‘loans or advance’ and wrongly held the same to be deemed dividend u/s 2(22)(e) of the Act. The approach of the both AO/CIT(A) was arbitrary and not founded on any settled principle laid down by the Courts or on any stipulation conveyed by the Board through a circular regarding the reasonableness of the quantum of trade advances.
The Tribunal observed that as held by the Hon’ble Supreme Court the AO/CIT(A) cannot place himself in the arm-chair of the businessman and usurp his role for deciding what constitutes reasonable level of trade advances that can be given against the purchases.
The Tribunal held that the entire amount of payments made against purchases has to be regarded as ‘trade advances’ without any artificial limitation on the quantum of such trade advances. As a result, the amounts paid to recipient company in excess of 200% of the purchases also have to be regarded as ‘trade advances’ which are in the nature of commercial transactions only and they cannot be characterized as ‘loans or advance’ constituting deemed dividend within the meaning of section 2(22)(e). Therefore, the addition made by the AO and upheld by the CIT(A) towards deemed dividend was therefore wholly untenable.
The Tribunal further observed that Hon’ble Gujarat High Court held that where there is movement of funds on a need basis, unlike transactions in the nature of loans or advances which are usually few in number such transactions are in the form of current adjustment accommodation entries. The Hon’ble Court held that merely adjustments based on large number of adjustment entries occurring in the accounts between the entities, application of section 2(22)(e) would not arise. Similarly, Hon’ble Calcutta High Court held that the transactions between the shareholder and the company were in the nature of current account and the provisions of section 2(22)(e) would not be applicable, where there were transactions of giving money by the company to the shareholder and vice versa in the account. Further, the ITAT, Mumbai held that where the movement of funds is in both ways on need basis between the two companies in which the assessee held substantial interest, the transactions are in the form of current accommodation entries and the amount in question could not be regarded as deemed dividend. The Tribunal Mumbai also held that when the transactions between group companies were current and inter banking accounts containing both receipt and payment entries, same could not be regarded as loans and advance, as contemplated under section 2(22)(e) and no addition could be made as deemed dividend. Similarly, ITAT Delhi held that amounts received from various group companies could not be considered as loans and advance, as contemplated u/s 2(22)(e) since the said transactions between the group concerns are current and inter banking accounts containing both types of entries of giving and
taking of amounts. In another case it was held that the transactions between the two group companies are in the nature of current account transactions and the same cannot be regarded as deemed dividend under section 2(22)(e) of the Act.
The Tribunal opined that the sum and substance of ratio laid down by various courts and Tribunals is that current account transactions between two group companies cannot be regarded as loans or advances as defined u/s 2(22)(e) of the Act. Therefore, the provisions of deemed dividend u/s 2(22)(e) are not applicable to the transactions between the appellant company and recipient companies, as the said transactions bear the character of current adjustment account transactions due to two-way movement of funds on a need basis. Thus, the addition made by the AO towards deemed dividend in the hands of the appellant for the purpose of levy of dividend distribution tax to the extent upheld by the CIT(A) was not warranted.
The third and final proposition canvassed by the appellant was that deemed dividend not attracted when payments to recipient company were utilized for its business and not diverted to or utilized for the benefit of the common substantial shareholder.
The Tribunal noted that the payments made by the appellant company to the two recipient companies during the year did not come under the ambit of deemed dividend u/s 2(22)(e), as the said funds had been used by the recipient companies for the purpose of their business and they had not been diverted to or utilised in any manner for the benefit of the common substantial shareholder. The business expediency/exigencies in making the said payments to the recipient companies had already been explained in earlier part of this order. The funds received from appellant company had been wholly used by the recipient companies for meeting the working capital requirements of the business, financing the acquisition of fixed assets of the business (setting up new units/expansion of existing units), investment in subsidiaries and loans to related parties (subsidiaries). The funds had not been diverted to the common shareholder or were not utilised for the benefit of said shareholder.
The Tribunal further observed that the AO had also accepted the factual position that the funds received from the appellant company had been utilized for financing the current assets of the recipient companies. Thus, there was no finding by the AO on facts that such funds had been diverted by the recipient companies for the benefit of the common substantial shareholder. The Tribunal opined that in view of the above, it was not legally tenable to consider the payments made by the appellant company to the recipient companies as ‘deemed dividend’ in the hands of the common substantial shareholder for the purpose of levy of dividend distribution tax in the hands of the appellant company, in the absence of any benefit derived by such shareholder from the said payments.
The Tribunal observed that Hon’ble Gujarat High Court held in the light of the decision of the Hon’ble Supreme Court that any payment made by a company in which a shareholder has shareholding exceeding 10% of the voting power to any concern in which such shareholder has substantial interest, would be deemed to be dividend in his hands if any benefit from such transaction has been received by such shareholder. The High Court held that the intention of the legislature is to tax funds ultimately received by a shareholder holding not less than 10% voting power in the company, which have been routed through different modes/concerns. The Hon’ble High Court held that what needs to be taxed as deemed dividend is the amount ultimately used for the benefit of the shareholder. The Tribunal noted that the SLP filed by the Revenue against the said decision of the High Court had been dismissed by the Hon’ble Supreme Court by stating that it does not find any ground to interfere with the impugned order passed by the High Court.
In view of the above, the Tribunal opined that it is now a settled law that the payment made by the payer company to the recipient company, in which there is a common shareholder holding not less than 10% and 20% of the voting power respectively, would be deemed to be ‘dividend’ in the hands of such shareholder only if any benefit from such transaction has been received by such shareholder or the amount is ultimately used for the benefit of the shareholder. This settled legal principle has been judicially laid down having regard to the intention of the legislature to tax funds ultimately received by a shareholder holding not less than 10% voting power in the company, which have been routed to him through different concerns in which he holds substantial interest.
The Tribunal observed that the AO expressed the view that the requirement that the payment made by the payer company should result in a benefit to the shareholder so as to construe the same to be in the nature of deemed dividend is not applicable to the limb of section 2(22)(e) dealing with “payments by way of loans or advances made by a company in which the shareholder has not less than 10% voting power to a company/concern in which such shareholder has substantial interest”. The AO stated that the said condition is applicable only to another limb of section 2(22)(e) which deals with the “payments made by the payer company on behalf of or for the individual benefit of the shareholder”.
The Tribunal opined that the said view of the AO was patently contrary to the decision rendered by the Hon’ble Gujarat High Court which had since been affirmed by the Hon’ble Supreme Court. The decision rendered by the Hon’ble Gujarat High Court in the said case that
receipt of benefit by the shareholder on account of payment made by the company in which he holds voting power of not less than 10% is a sine qua non for regarding such payment to be deemed dividend is with specific reference to the limb of section 2(22)(e) dealing with payments by way of loans or advances made by a company in which the shareholder has not less than 10% voting power to a company/concern in which such shareholder has substantial interest”. Therefore, the said decision was squarely applicable to the facts of the appellant’s case.
The Tribunal observed that in the case of the appellant, it was undisputed that the payments made by the appellant company had been used for the business purposes of the recipient companies. The relevant funds had not been utilized by the recipient companies for the benefit of the common substantial shareholder. In view of the said incontrovertible fact and in view of the decisions of the Hon’ble Gujarat High Court and Hon’ble Supreme Court the Tribunal held that the payments made by the appellant company to the recipient companies during the year did not fall under the scope of deemed dividend u/s 2(22)(e) of the Act.
Accordingly the Tribunal held that the addition made by the AO towards deemed dividend in the hands of the appellant for the purpose of levy of dividend distribution tax was not warranted and was deleted.
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