Payments from group entities which are not in the nature of loans cannot be shown as deemed divided

Introduction

Dividend basically refers to a reward, cash or otherwise, that a company gives to its shareholders. Dividends can be issued in various forms, such as cash payment, stocks or any other form. However, it is not obligatory for a company to pay dividend. Dividend is usually a part of the profit that the company shares with its shareholders.

The dividend is the amount received by an investor, whether it’s an individual or HUF, on account of holding shares in a company. In simple words, it is the distribution of profits of the company to its shareholders.

Provision of Law

According to Section 2(22)(e) of the Income Tax Act, when a company in which thepublic are not substantially interested, extends a loan or an advance to:

1. any of its shareholders who has more than 10% voting power in the company or
2. to any concern in which such shareholder is substantially interested or
3. for the individual benefit of such shareholder or
4. on behalf of such shareholder

to the extent the company has accumulated profits, such payment would be deemed as a dividend under Section 2(22)(e).

A company in which public is not substantially interested is otherwise called a closely held company. In case of deemed dividend under section 2(22)(e), the tax is charged at the rate of 30%.

Issues of Applicability of Deemed Dividend

Let us refer to the case of M/s. Exotica Housing & Infrastructure Company Pvt. Ltd vs ITO (2020) which pertains to the issue of applicability of deemed dividend provisions

Facts of the Case:-

1. The assessee is engaged in the business of commission agent and property development.
2. The Assessing Officer (AO) completed assessment under section 143(3) of the Income Tax Act, after making the impugned addition under section 2(22)(e) on account of deemed dividend.
3. It was observed by the AO that assessee had received loans and advances from M/s Exotica Housing and Infra Projects Pvt. Ltd which were squared off during the year.
4. The assessee held 98% shares of M/s Exotica Housing and Infra Project Pvt. Ltd.
5. Therefore, AO had taken a view that the amount received was to be considered as deemed dividend in the hands of the assessee.

Submissions by the Assessee before the AO

1. The assessee submitted before the AO that it had taken money from its subsidiary company which was repaid within a short span of time.
2. The transaction between the assessee company and its subsidiary company are in the nature of current account transactions.
3. Hence provisions of section 2(22)(e) were not applicable in the case of the assessee.
4. The AO however, did not accept the contention of the assessee as the amount was taken to discharge its liability by the assessee and advance was not made in the ordinary course of business.
5. The AO accordingly made the addition to the extent of accumulated profit of advance giving company as deemed dividend in the hands of the assessee.

Appeal to Commissioner of Income Tax (Appeals) [CIT(A)]

1. Aggrieved with the order of AO, assessee filed an appeal before the CIT(A).
2. The CIT(A), however, did not accept the contention of the assessee and distinguished all the decisions relied upon by the assessee and dismissed the appeal of assessee.
3. Aggrieved with the order of CIT(A), assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT).

Appeal to ITAT

1. ITAT examined the ledger account of the subsidiary company in the books of the assessee company, which revealed that initially the assessee company had taken loan from the subsidiary company which was repaid and thereafter.
2. It is the assessee company which has given the amount to the subsidiary company on most of the occasions and later on the subsidiary company has returned the amount to the assessee.
3. Therefore, such facts would clearly reveal that provisions of Section 2(22)(e) would not be attracted in the case of assessee company because on most of the occasions the assessee company has advanced the amount to the subsidiary company and ultimately the balance is squared-up at the end of the year.
4. The assessee company had also filed copy of the ledger account of the subsidiary company, which revealed that there was a substantial opening balance and subsidiary company had paid the amount to the assessee company and later on amounts have been returned by the assessee company to the subsidiary company.
5. Assessee submitted that similar pattern of the transactions occurred in current year and in subsequent year as well and no addition have been made by the Revenue Authorities against the assessee company in earlier assessment year as well as in subsequent assessment year on account of deemed dividend under section 2(22)(e).
6. The ledger account of the subsidiary company in assessment year under appeal also clearly reveals that it is the assessee company who have given the amount mostly to the subsidiary company which have been returned to the subsidiary company by the assessee company.
7. Therefore, on such facts when the Revenue did not dispute the transactions in the current account between the assessee company and the subsidiary company in earlier as well as in subsequent year and the assessee company on most of the occasions have made payment to the subsidiary company, which have been returned by assessee company for business purposes, there was no reason to apply provisions of Section 2(22)(e).
8. It is clear from the Orders of the authorities, that assessee has been taken the plea consistently that provisions of Section 2(22)(e), would not apply in the case of the assessee company because assessee company is maintaining the running transactions with its subsidiary company which are clear from the ledger account of this year as well as earlier year and subsequent year and the same are in the nature of mutual and current account.
9. The ledger account of the assessee company and the subsidiary company would clearly show the pattern of the similar transactions in nature which are purely temporarily financial accommodation for the business purposes.
10. The assessee had also pleaded that the assessee and its subsidiary company are in the same business of real estate and money have been used in the ordinary course of business of the assessee company.
11. Therefore, it being the current account maintained between the assessee company and its subsidiary company, deeming fiction should not have been applied against the assessee.
12. It was thus held that when current account is maintained between the parties, provisions of Section 2(22)(e), would not apply.

Section 2(22)(e) is a deeming provision and should be construed strictly. The section uses the term “by way of advance or loans” which shows that all payments from sister concerns cannot be shown as deemed dividend. Only those payments which bear the characteristics of loans or advances will be deemed as dividends. Thus, advances given for temporary financial accommodation to group companies for business purposes cannot be regarded as deemed divided under Section 2(22)(e).