2009 (5) TMI 17 - HC - Income Tax

Trade advances by closely held company not treated as deemed dividends under Section 2(22)(e), appeal dismissed

COMMISSIONER OF INCOME TAX Versus SHRI RAJ KUMAR

HC held that payments characterized as trade advances by a closely held company do not fall within Section 2(22)(e) as deemed dividends. Applying noscitur ... Nature of Advances Received from CEI - deemed dividend u/s 2(22)(e) - rule of construction 'noscitur a sociis' - Whether trade advances given to the assessee (shareholder) by Company can be treated as deemed dividend under Section 2(22)(e) - HELD THAT:- It is clear that sub-clause (e) of Section 2(22) of the Act, which is pari-materia with clause (e) of Section 2(6A) of the 1922 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. The purpose being that persons who manage such closely held companies should not arrange their affairs in a manner that they assist the shareholders in avoiding the payment of taxes by having these companies pay or distribute, what would legitimately be dividend in the hands of the shareholders, money in the form of an advance or loan. In our view, the word 'advance' has to be read in conjunction with the word 'loan'. Usually attributes of a loan are that it involves positive act of lending coupled with acceptance by the other side of the money as loan: it generally carries an interest and there is an obligation of re-payment. On the other hand, in its widest meaning the term 'advance' may or may not include lending. The word 'advance' if not found in the company of or in conjunction with a word 'loan' may or may not include the obligation of repayment. If it does then it would be a loan. Thus, arises the conundrum as to what meaning one would attribute to the term 'advance'. The rule of construction to our minds which answers this conundrum is noscitur a sociis. In the instant case, however, a discussion with respect to which has been made hereinabove, the issue is whether the payment received by the shareholder would at all fall within the four corners of provisions of Section 2(22)(e) of the Act. The question of law as framed by us is answered in favour of the assessee and against the Revenue - trade advance does not fall within the ambit of the provisions of Section 2(22)(e) of the Act - Appeal is dismissed. Issues Involved:1. Whether trade advances given to the assessee by CEI can be treated as deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Nature of Advances Received from CEI:The primary issue revolves around whether the trade advances received by the assessee from CEI qualify as deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961. The facts reveal that the assessee, a proprietor of M/s Premier Engineering Corporation, received advances from CEI, a company in which he holds 65% of the paid-up share capital. The Assessing Officer (AO) classified these advances as deemed dividends, citing that they were loans given by CEI to the assessee, who held more than 10% of the shares in CEI.2. Assessing Officer's Findings:The AO scrutinized the return filed by the assessee and found that a sum of Rs 14,59,770/- was shown as 'advances received from customers.' The AO concluded that Rs 12,28,517/- of this amount, based on CEI's accumulated profits, was deemed dividend under Section 2(22)(e). The AO distinguished the judgment in CIT vs Nagindas M. Kapadia and relied on the Supreme Court judgment in Miss P. Sarada vs CIT, indicating that the legal fiction of deemed dividend was triggered as soon as the assessee received the amount, regardless of its ultimate use or repayment.3. CIT(A) Findings:The CIT(A) reversed the AO's decision, stating that the advances were trade advances for manufacturing customized kitchen equipment, not loans from accumulated profits. The CIT(A) noted that the advances were related to future supplies and were backed by sales made upon manufacture. The CIT(A) also considered the explanation that the balance confirmation from CEI was an inadvertent mistake and that the amounts were correctly reflected in the audited balance sheet.4. Tribunal's Findings:The Tribunal upheld the CIT(A)'s decision, confirming that the advances were not loans but trade advances. It found that the money received was used to manufacture kitchen equipment supplied to CEI and there was no obligation to repay the amount. The Tribunal agreed with the CIT(A) that the judgment in Nagindas M. Kapadia applied, excluding such trade advances from the ambit of Section 2(22)(e).5. Revenue's Arguments:The Revenue argued that the ambit of Section 2(22)(e) was broad enough to include any payment to a shareholder holding more than 10% of shares in a closely held company. They contended that trade advances should also fall within this ambit, relying on the AO's findings and the interpretation of the provision.6. Assessee's Arguments:The assessee maintained that the advances were for commercial transactions and not loans. They emphasized the findings of the CIT(A) and the Tribunal, which were based on detailed examination and factual evidence. The assessee also argued that the judgments in P. Sarada and Tarulata Shyam were not applicable as they dealt with the repayment of deemed dividends, not the nature of the advances.7. High Court's Analysis:The High Court examined the legislative intent and historical context of Section 2(22)(e), noting that the provision aimed to tax accumulated profits distributed as loans to shareholders to avoid tax. The court applied the rule of noscitur a sociis, interpreting 'advance' in conjunction with 'loan,' implying an obligation of repayment. The court concluded that trade advances, being commercial transactions without repayment obligations, do not fall within the ambit of Section 2(22)(e).8. Conclusion:The High Court held that trade advances given to the assessee by CEI do not constitute deemed dividends under Section 2(22)(e) of the Act. The court dismissed the Revenue's appeal, affirming the decisions of the CIT(A) and the Tribunal. The substantial question of law was answered in favor of the assessee, and the appeal was dismissed without any order as to costs.