1996 (12) TMI 116 - AT - Income Tax

ITAT clarifies computation of deemed dividends under Income Tax Act

The ITAT Madras-B allowed the appeals, maintaining the tax liability but clarifying the computation of deemed dividends under section 2(22)(e) of the ... Deemed dividend under section 2(22)(e) - accumulated profits (commercial profits) - Explanation 2 to section 2(22) - statutory fiction of inclusion of current profits - day-to-day accrual assumption for computation of current profitsDeemed dividend under section 2(22)(e) - accumulated profits (commercial profits) - Whether 'accumulated profits' for the purpose of section 2(22)(e) mean commercial profits and not assessed income, and whether deemed dividend can be computed by reference to assessed profits. - HELD THAT: - The Tribunal holds that the expression 'accumulated profits' in section 2(22)(e) refers to commercial profits accumulated by the company and not to the aggregate of assessed income determined in earlier assessments. Reliance is placed on the reasoning in P.K. Badiani v. CIT as authority for the proposition that 'accumulated profits' cannot be equated to assessed income. The Court explained that the legislative scheme (including Explanation 2) and settled authorities require accumulated profits to be determined with reference to commercial or accounting profits, and there is no justification for arriving at accumulated profits merely by totalling assessed incomes from past assessments. Accordingly the assessee's contention that accumulated profits must be computed as commercial profits is accepted; the Assessing Officer's method of using assessed profits is rejected.Accumulated profits for section 2(22)(e) must be determined with reference to commercial profits and not by aggregating assessed income; the revenue's use of assessed profits is not justified.Explanation 2 to section 2(22) - statutory fiction of inclusion of current profits - day-to-day accrual assumption for computation of current profits - Whether current profits up to the date of payment/distribution are to be included under Explanation 2 and how the Assessing Officer should proceed where daytoday profit computation is not available. - HELD THAT: - The Tribunal accepts the statutory fiction embodied in Explanation 2 that 'accumulated profits' include all profits of the company up to the date of distribution or payment. Where finalised, datespecific accounts are not available, the fiction must be given full effect rather than frustrated; authorities cited in the judgment endorse giving statutory fictions their full logical effect. In such circumstances it is fair and reasonable to assume that profits accrue on a daytoday basis and the Assessing Officer is directed to compute current profits up to the dates of the loans/payments on the basis of commercial profits of the year, and to work out the deemed dividends accordingly. The Tribunal thus affirms the legal principle of including current profits per Explanation 2 but remits the matter to the Assessing Officer for computation in accordance with that principle.Explanation 2 requires inclusion of current profits up to the date of distribution; where daytoday accounts are absent, profits may be assumed to accrue pro rata and the Assessing Officer is to compute the deemed dividends on that basis.Final Conclusion: The Tribunal allowed the appeals for statistical purposes, holding that 'accumulated profits' under section 2(22)(e) mean commercial profits (not assessed income) and that Explanation 2 mandates inclusion of current profits up to the date of payment; the matter is remitted to the Assessing Officer to compute deemed dividends applying these principles (assuming pro rata accrual where daytoday accounts are not available). Issues:- Dispute over computation of deemed dividends under section 2(22)(e) of the Income Tax Act.- Interpretation of the term 'accumulated profits' for the purpose of assessing deemed dividends.- Whether loans taken by shareholders from closely-held companies are liable to be treated as deemed dividends.Analysis:1. The appeals before the ITAT Madras-B involved two assessees who were shareholders of closely-held companies. The Commissioner of Income-tax set aside the assessments for the year 1983-84 under section 263 of the Income Tax Act, directing a re-assessment. The dispute centered around the computation of deemed dividends under section 2(22)(e) of the Act, based on loans taken by the assessees from the companies with accumulated profits.2. The assessees argued that the loans taken were not linked to accumulated profits as the companies had accumulated losses in previous years. They contended that the revenue authorities erred in computing accumulated profits based on assessed profits rather than commercial profits. The assessees emphasized that profits accrue at the end of the accounting year and disputed the department's method of calculation.3. On the other hand, the departmental representative supported the assessment, asserting that loans to shareholders with substantial interest should be treated as deemed dividends based on the company's accumulated profits. The representative relied on the Explanation 2 to section 2(22) to justify the assessment methodology.4. The ITAT analyzed the definition of 'dividend' under section 2(22) and the term 'accumulated profits.' It emphasized that accumulated profits refer to commercial profits accumulated by a company, not merely assessed income. The Explanation 2 broadened the scope to include current profits, necessitating the inclusion of all profits up to the date of distribution for calculating deemed dividends.5. The ITAT rejected the assessees' argument that accumulated profits exclude current profits awaiting finalization. It emphasized giving full effect to legal fictions like Explanation 2 and upheld the department's right to consider day-to-day profits for calculating deemed dividends. The ITAT directed the Assessing Officer to re-calculate the deemed dividends based on commercial profits up to the date of distribution.6. Consequently, the ITAT allowed the appeals for statistical purposes, indicating a favorable decision for the assessees without altering the tax liability. The judgment clarified the interpretation of 'accumulated profits' and the methodology for computing deemed dividends under section 2(22)(e) of the Income Tax Act.