Mazars Tax Update | Edition 13.20

Summary

The Hon’ble Gujarat High Court in the case of Jayesh T Kotak vs DCIT; in R/Special Civil Application No. 15992 of 2015 dated  26/03/2020 has reiterated the legal position by relying upon the decision of Hon’ble Supreme court in the case of Commissioner of Income Tax v. Mukundray K. Shah, (2007) 290 ITR 433 SC, that for applying section 2(22)(e), the Assessing Officer has to establish that the amount was ultimately used for the benefit of the shareholder.

Facts of the case

Assessment in this case was reopened u/s 147 of the Income Tax Act, 1961 on the ground that loan given by M/s. J. P. Infrastructure Pvt. Ltd. (now known as J. P. Iscon Limited) to its sister concern amounting to Rs.12.61 crores should be treated as deemed dividend under section 2(22)(e) of the Act in the hands of the assessee as the assessee was holding 27.49% of the shares in M/s. M/s. J. P. Iscon Ltd..

In reasons recorded, it was nowhere mentioned that any loan or advance has been received by the assessee or any benefit has been received; there is no allegation that income of dividend has been earned by the assessee; and there is no allegation that M/s. J. P. Infrastructure Pvt. Ltd. has accumulated profits. Hence, assessee claimed that in the absence of these overriding considerations, the notice under section 148 of the Act is void ab initio.

Discussion

The declaration of dividend is entirely within the discretion of the company. Therefore, the legislature realizing such fact introduced the provisions of section 2(22)(e) to ensure that the accumulated profits of the company are not distributed to the shareholders in a disguised manner merely to avoid payment of dividend distribution tax.

The provisions of Section 2(22)(e) of the Act plainly seeks to bring within the tax net accumulated profits which are distributed by closely held companies to its shareholders in the form of loans or advances without any underlying justification or business rationale. The purpose being that persons who manage such closely held companies should not arrange their affairs in a manner that they assist the shareholder in avoiding the payment of taxes by having these companies pay or distribute, what would legitimately be dividends in the hands of the shareholder, money in the form of an advance or loan.

Provisions of Section 2(22)(e) are applicable to all the corporate entities in which public is not substantially interested i.e. closely held companies only. Section 2(22)(e) of the Income Tax Act deals with the issue of “Deemed Dividend”. Nomenclature of this section connotes that this section has been brought on statue as “Deeming Fiction”. It means that the income termed as dividend is actually not dividend distributed by a closely held company but the amount paid is still treated as dividend and hence the term “Deemed Dividend”. Section 2(22)(e) contains a deeming provision and hence, it must be strictly construed and that the court should adopt a practical approach.

Now, keeping in view the above intention of legislature and the fact that section 2(22)(e) is a deeming provision, it is important that for the purpose of invoking section 2(22)(e) of the Act, two factors must be postulated. Firstly, whether on the date of payment there existed "accumulated profits" in the concern which advanced the loan and secondly, whether the assessee received ultimate benefit from impugned payment or not;

Hon’ble Gujarat High Court in its latest decision the case of Jayesh T Kotak vs  DCIT; in R/Special Civil Application No. 15992 of 2015 dt. 26/03/2020 has reiterated the legal position in this regard by relying upon the decision of Hon’ble Supreme court in the case of Commissioner of Income Tax v. Mukundray K. Shah, (2007) 290 ITR 433 SC, as under:

“4.2 It was submitted that ……. in the facts of the present case, there is no allegation that any benefit has accrued to the petitioner and as there is no benefit to the petitioner, there is no question to taxing him. It was submitted that if the controlling holder is not benefitted, section 2(22)(e) of the Act would not apply.

4.3 Attention was invited to the objections dated 13.07.2015 raised by the petitioner against the reopening of assessment, to submit that a specific contention had been raised that the petitioner has not received a single rupee as loans and advances, either from the loan giver company, that is, M/s. J. P. Infrastructure Pvt. Ltd. or loan taker companies, that is, Gujarat Mall Management Company Pvt. Ltd. or Aryan Arcade Pvt. Ltd., and hence, there was no question of any deemed dividend in the hands of the petitioner. However, the Assessing Officer has not given any reply to the contention that no benefit has travelled to the assessee. It was urged that the very basis that income has escaped assessment is fallacious inasmuch as when there is no income, there is no question of escapement.

4.7 It was urged that the return is filed electronically and it is not possible to load any further details other than that which are provided in the form. It was submitted that the basic requirement for invoking section 2(22)(e) of the Act is that the petitioner should have received the benefit of the moneys parted with by the company in which he is a substantial shareholder. Whereas in the present case, the petitioner has not received any benefit and consequently, there is no income, there is nothing to disclose.”

Held

The Hon’ble Gujarat High Court held that what needs to be taxed as deemed dividend is the amount ultimately used for the benefit of the shareholder. It is not the case of the Assessing Officer in the reasons recorded for reopening the assessment that the petitioner has received any amount as holder of substantial shares from the loan giver company or the loan receiver company. Therefore, in the absence of any benefit having been received by the petitioner, there was no obligation cast upon him to disclose such transactions.

Accordingly, Hon’ble High Court quashed the notice issued u/s 148 as well as all proceedings pursuant thereto.

Section 2(22)(e) and 115-O: What's New

Hence, now it is well settled by the Hon’ble Gujarat High Court (Supra) by relying upon the decision of Hon’ble Supreme Court (Supra) that mere payment by way of advance or loan to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, is not sufficient for taxing the same u/s 2(22)(e). The Ld. AO has to establish that i) on the date of payment there existed "accumulated profits" in the concern which advanced the loan and ii) the amount is ultimately used for the benefit of the assessee.

However, w.e.f. 01/04/2018, amendments have been introduced in the provisions of section 115-O of the Act whereby on or after 01/04/2018, the payer company will be liable to discharge tax liability for additions made under section 2(22)(e) of the Act instead of the shareholder who received such funds from the company.

Further, in our opinion, the above stated amendments in the provisions of section 115-O of the Act have merely facilitated the mechanism for collection and recovery of tax for the Department. It is still obligatory for the Department to fulfill the conditions laid down by the judgments cited supra, i.e., existence of accumulated profits as well as fact of ultimate benefit to the substantial shareholder before treating a particular payment made by the company to such shareholder as deemed dividend.

Thus, there exists no change in the legislative intent as well as jurisprudence on the impugned issue of section 2(22)(e) of the Act except the recovery mechanism of tax having been facilitated due to amendments in section 115-O of the Act.