2008 (11) TMI 273 - AT - Income Tax

Tribunal Rules Deemed Dividend Taxable Only for Registered and Beneficial Shareholders, Dismissing Revenue Appeal.

The Tribunal held that deemed dividend under Section 2(22)(e) of the IT Act, 1961, can only be assessed in the hands of a shareholder of the lender ... Deemed dividend under Section 2(22)(e) - registered shareholder and beneficial owner - payment to a concern in which such shareholder has substantial interest - strict interpretation of deeming provisions - charge to tax in the hands of the shareholderDeemed dividend under Section 2(22)(e) - payment to a concern in which such shareholder has substantial interest - charge to tax in the hands of the shareholder - ordinary and natural meaning of dividend - Deemed dividend under Section 2(22)(e) can be assessed only in the hands of a shareholder of the lender company and not in the hands of a person other than a shareholder. - HELD THAT: - The clause introducing payments to a concern in which 'such shareholder' has substantial interest does not specify the person on whom tax is to be charged and is therefore ambiguous. The legislative purpose of Section 2(22)(e) is to catch distributions of accumulated profits by closely held companies that are routed as loans, advances or payments for the benefit of shareholders; the fiction is intended to tax dividends in the hands of the shareholder. The Tribunal examined purposive and textual considerations, the ordinary meaning of 'dividend' (a share of profits paid to shareholders), the Companies Act prohibition on payment of dividend to non-registered shareholders, and the possible effect of extending the deeming fiction to non-shareholders which would displace the natural meaning of dividend. The Tribunal also rejected reliance on a CBDT circular as not binding where it extends beyond the Act. In consequence, loans or advances to a concern cannot be taxed as deemed dividend in the hands of the concern (non-shareholder); the deemed accrual and charge to tax under Section 2(22)(e) apply to the shareholder on whose behalf or for whose benefit the payment is made. [Paras 36, 37, 38, 41, 42]Deemed dividend under Section 2(22)(e) is assessable only in the hands of the shareholder of the lender company and not in the hands of a non-shareholder concern.Registered shareholder and beneficial owner - interpretation of the expression 'such shareholder' - application of the first and second limbs of Section 2(22)(e) - The expression 'shareholder' in Section 2(22)(e) refers to a person who is both a registered shareholder and the beneficial owner of the shares; absence of either registered or beneficial ownership excludes application of the clause. - HELD THAT: - Earlier judicial construction under the 1922 Act treated 'shareholder' as meaning the registered holder. Where the 1961 Act (and the 1988 amendment) employs the phrase 'shareholder being a person who is the beneficial owner of shares', the participial phrase qualifies 'shareholder' and imposes an additional requirement of beneficial ownership without displacing the requirement of registration. Thus the statutory scheme requires both registered and beneficial ownership (and prescribed share holding thresholds) to attract the relevant limbs of Section 2(22)(e). Consequentially, if a person is only registered holder but not beneficial owner, or beneficial owner but not registered holder, the provisions do not apply. Applied to the assessee, shares held by trustees as legal registered owners for the trust beneficiaries did not satisfy the dual requirement and Section 2(22)(e) did not apply. [Paras 24, 26, 27, 28, 42]A person must be both the registered shareholder and the beneficial owner of the shares to fall within Section 2(22)(e); absence of either element excludes the provision.Final Conclusion: The Revenue's appeal is dismissed. Deemed dividend under Section 2(22)(e) is exigible only in the hands of a shareholder who is both the registered holder and the beneficial owner of the shares; where these conditions are not satisfied (as in the assessee's case where trustees were only legal holders for beneficiaries), Section 2(22)(e) does not apply and the addition is not sustainable. Issues Involved:1. Whether deemed dividend under Section 2(22)(e) of the IT Act, 1961 can be assessed in the hands of a person other than a shareholder of the lender.2. Whether the words 'such shareholder' occurring in Section 2(22)(e) refer to a shareholder who is both the 'registered' shareholder and the beneficial shareholder.Detailed Analysis:Issue 1: Assessment of Deemed Dividend in Non-Shareholder's HandsThe primary question was whether deemed dividend under Section 2(22)(e) can be assessed in the hands of a non-shareholder. The Tribunal examined the historical context and legislative intent behind Section 2(22)(e), noting that it was designed to prevent tax avoidance by closely held companies distributing profits as loans to shareholders or concerns where shareholders have substantial interest.The Tribunal referenced the Hon'ble Rajasthan High Court's decision in CIT v. Hotel Hilltop, which held that deemed dividend could only be taxed in the hands of the shareholder, not the concern. The Tribunal emphasized that the intention behind Section 2(22)(e) was to tax the dividend in the hands of the shareholder because the loans or advances are presumed to ultimately benefit the shareholder.The Tribunal also considered the provisions of Section 5(1) of the Act, which outlines the scope of total income, and concluded that the income must be in the nature of income to be taxed. Since a loan or advance to a concern is not inherently income, it cannot be taxed as deemed dividend in the hands of the concern.Therefore, the Tribunal held that deemed dividend under Section 2(22)(e) can only be assessed in the hands of the shareholder of the lender company and not in the hands of any other person.Issue 2: Definition of 'Such Shareholder'The second issue was whether the term 'such shareholder' in Section 2(22)(e) refers to a shareholder who is both a registered shareholder and a beneficial shareholder. The Tribunal analyzed the language of the statute, historical amendments, and judicial interpretations.The Tribunal referenced the Supreme Court's decisions in C.P. Sarathy Mudaliar and Rameshwarlal Sanwarmal, which clarified that the term 'shareholder' refers to a registered shareholder. The Tribunal also noted that the 1961 Act added the requirement that the shareholder must also be a beneficial owner of the shares.The Tribunal concluded that the expression 'such shareholder' in Section 2(22)(e) refers to a person who is both a registered shareholder and a beneficial shareholder. Therefore, if a person is only a registered shareholder or only a beneficial shareholder, the provisions of Section 2(22)(e) do not apply.Conclusion:1. On the first question: Deemed dividend under Section 2(22)(e) can be assessed only in the hands of a person who is a shareholder of the lender company and not in the hands of a person other than a shareholder.2. On the second question: The expression 'shareholder' in Section 2(22)(e) refers to both a registered shareholder and a beneficial shareholder. If a person is a registered shareholder but not the beneficial shareholder, or a beneficial shareholder but not a registered shareholder, the provisions of Section 2(22)(e) will not apply.The Tribunal dismissed the Revenue's appeal, affirming that the deemed dividend could not be taxed in the hands of the assessee or the intervener as they were not shareholders of the lender company.