Company advances treated as deemed dividend under Section 2(22)(e) due to insufficient documentation and questionable routing (22)(e)

The ITAT Mumbai dismissed the assessee's appeal regarding deemed dividend under section 2(22)(e). The assessee received loans/advances from another company where they held substantial shareholding in both entities. The Tribunal distinguished between loans and deposits, noting loans create immediate repayment obligations while deposits have contingent obligations. The assessee failed to provide evidence supporting the transaction as an inter-corporate deposit, including absence of interest provisions, TDS details, or proper documentation. The unexplained routing through a third party raised questions about transaction bonafides. The advance was deemed for securing the assessee's investment benefit, thus not qualifying for deemed dividend exceptions.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal are:

(i) Whether the assessee held a substantial interest in M/s Darshan Impex Pvt. Ltd., specifically whether the assessee was a beneficial owner of shares carrying not less than 20% of the voting power, as required under Section 2(22)(e) of the Income Tax Act, 1961.

(ii) Whether the payment of Rs. 16,00,000/- made by M/s KP Power Pvt. Ltd. to M/s Darshan Impex Pvt. Ltd. constituted a loan or advance liable to be treated as deemed dividend under Section 2(22)(e) of the Act.

(iii) Whether the loan/advance was made in the ordinary course of business of money lending by M/s KP Power Pvt. Ltd., thereby attracting the exception under the second proviso to Section 2(22)(e) of the Act.

(iv) Whether the amount advanced was in the nature of an inter-corporate deposit (ICD) and not a loan or advance within the meaning of Section 2(22)(e).

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Substantial Interest of the Assessee in M/s Darshan Impex Pvt. Ltd.

Relevant legal framework and precedents: Section 2(22)(e) defines "substantial interest" in a company as beneficial ownership of shares carrying not less than 20% of the voting power (Section 2(32)). The Bombay High Court in Duttaprasad Kamat v. ACIT emphasized that the shareholder must be a registered shareholder whose name appears in the register of members under the Companies Act, 1956.

Court's interpretation and reasoning: The Assessing Officer (AO) relied on the return of income filed by M/s Darshan Impex Pvt. Ltd., which showed the assessee holding 50% shareholding, duly verified and signed by the Director. The assessee claimed this was a clerical error and asserted actual shareholding was only 9%, supported by annual returns filed under the Companies Act for FY 2004-05 to 2006-07.

The Tribunal noted that these annual returns were filed only after the reassessment proceedings had commenced and a showcause notice was issued, thus casting doubt on their authenticity and evidentiary value. The assessee failed to produce contemporaneous documentary evidence such as share transfer registers, share certificates, or proof of payment through banking channels for the acquisition of shares.

Key evidence and findings: The Tribunal examined the shareholding pattern from 1990 to 2007, noting that the assessee's family acquired controlling interest only from FY 2004 onwards. However, no documentary proof was provided to substantiate the acquisition or the shareholding below 20%. The return of income showing 50% shareholding was signed and verified by the assessee, making it binding.

Application of law to facts: In absence of credible evidence to rebut the verified return, the Tribunal held that the assessee had substantial interest in M/s Darshan Impex Pvt. Ltd. as per Section 2(32), fulfilling the threshold for invoking Section 2(22)(e).

Treatment of competing arguments: The assessee's contention of clerical error and reliance on belatedly filed annual returns was rejected due to timing and lack of corroborative evidence. The Tribunal declined to remit the matter back for further verification, considering the assessee's inability to furnish evidence.

Conclusion: The assessee was held to have substantial interest in M/s Darshan Impex Pvt. Ltd. during the relevant period.

Issue (ii): Nature of the Payment of Rs. 16,00,000/- and Applicability of Section 2(22)(e)

Relevant legal framework and precedents: Section 2(22)(e) deems any loan or advance by a closely held company to a shareholder or a concern in which the shareholder has substantial interest as a dividend to the extent of accumulated profits. The exception under the second proviso excludes advances made in the ordinary course of business where lending money is a substantial part of the business.

Court's interpretation and reasoning: The assessee contended that the amount was an inter-corporate deposit (ICD) given in the ordinary course of business for business expediency, specifically to enable M/s Darshan Impex Pvt. Ltd. to purchase debentures of M/s King Prawns Pvt. Ltd. from IDBI Bank, thereby protecting the investment of M/s KP Power Pvt. Ltd. The Tribunal admitted additional evidence filed for the first time, including agreements and government permissions, to consider this claim.

The Tribunal noted the assessee's own admission that Rs. 1,00,000/- of the amount was a loan or advance, with Rs. 15,00,000/- claimed as business-related.

Key evidence and findings: The Tribunal found that M/s KP Power Pvt. Ltd. was not engaged in the business of money lending, and the advance was not made in the ordinary course of business. The permissions for windmill installation and land allotment were unrelated to the transaction's nature as a business advance. The transaction appeared to be a financial arrangement to protect investment rather than a genuine business loan.

Application of law to facts: The exception under the second proviso to Section 2(22)(e) did not apply, since lending money was not a substantial part of M/s KP Power Pvt. Ltd.'s business, nor was the advance made in the ordinary course of business.

Treatment of competing arguments: The assessee's argument of business expediency and ICD nature was examined in light of judicial precedents. The Tribunal referred to the Bombay High Court's decision in CIT vs Jayany H Modi and the Kerala High Court's decision in Thomas Philip, emphasizing the necessity of proving that the advance was in the ordinary course of business. The assessee failed to demonstrate this.

Conclusion: The payment was held to be a loan or advance liable to be treated as deemed dividend under Section 2(22)(e).

Issue (iii): Whether the Amount was an Inter-Corporate Deposit (ICD) and Distinction from Loan/Advance

Relevant legal framework and precedents: The Tribunal referred to a Coordinate Bench ruling distinguishing ICD from loans/advances, emphasizing the element of voluntariness from the lender and compliance with the Companies Act, 1956 (including advertising requirements under Rule 58A).

Court's interpretation and reasoning: The Tribunal observed that the assessee failed to produce any documentation or agreements evidencing the nature of the amount as ICD. No terms and conditions, interest payments, TDS on interest, or repayment details were provided. The transaction lacked the element of voluntariness and formalities required for ICDs.

Key evidence and findings: The absence of board resolutions, deposit invitations, or documentary proof of the transaction's nature led the Tribunal to infer the amount was a loan or advance rather than an ICD.

Application of law to facts: The Tribunal applied the legal distinction that a loan creates an immediate obligation to repay, whereas a deposit's repayment is contingent on specified events. The facts did not support the characterization of the amount as an ICD.

Treatment of competing arguments: The assessee's oral submissions were insufficient to establish the ICD nature. The Tribunal relied on judicial precedents and statutory requirements to reject this characterization.

Conclusion: The amount was held to be a loan or advance and not an ICD, thus falling within the scope of Section 2(22)(e).

3. SIGNIFICANT HOLDINGS

"The assessee cannot claim now, by filing a belated return before the ROC that his shareholding was only 9%. Accordingly, I hold that by taking a loan of Rs. 16,00,000/-, the assessee being majority shareholder was clearly in default of the provision of the section 2(22)(c)."

"The 'beneficial owner of shares', 'shareholder' and 'member' referred to therein must be a registered shareholder or a registered beneficial owner whose name appears in the register of members/shareholders under Section 150 or in the register of beneficial owners under Section 152A of the Companies Act, 1956."

"In the absence of such material documentary evidence, and having regard to the declaration in the income tax return-duly signed and verified-reflecting a 50% shareholding, we are unable to accept the assessee's contention that his interest in M/s Darshan Impex Private Limited was below the statutory threshold of 20% voting power so as to fall outside the ambit of 'substantial interest' under the relevant provisions of the Income Tax Act."

"The assessee did not fulfill the requirement of law for getting rid of the definition of deemed dividend. The additional evidence filed by the assessee also nowhere indicate that the advance was in the ordinary course of business of the lender company."

"Merely by mentioning in the ledger account, it was 'Inter Corporate Deposit', the nature and colour of transaction would not change to 'Inter Corporate Deposit', as it continues to be loan/advances. Hence required to be taxed for the purposes of deemed dividend."

Core principles established include:

• The burden lies on the assessee to prove that he did not hold substantial interest as defined under the Act, and mere belated filings are insufficient.
• The register of members under the Companies Act is the authoritative source for determining shareholding for the purpose of Section 2(22)(e).
• The exception to deemed dividend under Section 2(22)(e) applies only if the loan or advance is made in the ordinary course of business where money lending is a substantial part of the business.
• Distinction between loan and inter-corporate deposit depends on voluntariness, documentation, and legal obligations; mere ledger entries are insufficient to alter the nature of the transaction.

Final determinations:

(i) The assessee held substantial interest (50% shareholding) in M/s Darshan Impex Pvt. Ltd. during the relevant period.

(ii) The payment of Rs. 16,00,000/- by M/s KP Power Pvt. Ltd. to M/s Darshan Impex Pvt. Ltd. constituted a loan or advance liable to be treated as deemed dividend under Section 2(22)(e).

(iii) The loan/advance was not made in the ordinary course of business of money lending by M/s KP Power Pvt. Ltd., and thus the exception under the proviso to Section 2(22)(e) did not apply.

(iv) The amount was not an inter-corporate deposit but a loan/advance, and therefore taxable as deemed dividend.

The appeal filed by the assessee was dismissed accordingly.

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