Amounts to shareholders are deemed dividend under s.2(22)(e) only if gratuitous and tied to beneficial ownership
ITAT KOLKATA - AT held that amounts advanced or loaned by a company to a shareholder qualify as deemed dividend under s.2(22)(e) only where the advance is gratuitous and arises by virtue of the recipient's status as a beneficial owner (holding =10% voting power); advances given in return for a benefit or consideration conferred on the company by the shareholder do not attract deemed-dividend treatment. The tribunal followed HC and SC precedents interpreting "by way of advance or loan" restrictively. Appeal filed by the revenue was dismissed.
ISSUES PRESENTED AND CONSIDERED
1. Whether Section 2(22)(e) of the Income-tax Act is attracted where an NBFC receives loans/advances from another NBFC which (a) charges interest on the loans, (b) advances loans in the ordinary course of its business, and (c) where the borrowing company holds less than 10% of the voting power in the lending company.
2. Whether advances/loans that are not gratuitous but made in return for consideration or in the ordinary course of lending business can be treated as "deemed dividend" under Section 2(22)(e).
3. Whether the Commissioner (Appeals)'s modification of the addition under Section 14A read with Rule 8D (reduction from AO's disallowance to a lower figure) was unsustainable and liable to be set aside by the Tribunal (i.e., whether the Revenue's challenge to the CIT(A)'s adjustment on Section 14A/Rule 8D was maintainable).
ISSUE-WISE DETAILED ANALYSIS
Issue 1: Applicability of Section 2(22)(e) where both parties are NBFCs, interest is charged and shareholding is <10%
Legal framework: Section 2(22)(e) treats any advance, loan or gift by a company to a shareholder (holding not less than 10% of the voting power) as "deemed dividend". The provision contemplates taxation of such advances where the primary causal nexus is the shareholder status and entitlement to benefit by virtue of shareholding.
Precedent treatment: The Tribunal relied on higher court authority recognizing that (i) the phrase "by way of advance or loan" must be construed to capture advances/loans that a shareholder enjoys simply by virtue of being a beneficial owner of shares with requisite voting power, and (ii) loans given in return for consideration or as part of commercial transactions may fall outside the mischief of Section 2(22)(e). A later decision of the High Court applying these principles was followed; the Supreme Court declined special leave against that decision.
Interpretation and reasoning: The Tribunal examined factual matrix: both parties are registered NBFCs; lending was in the ordinary course of business; interest was charged and documented; loans were not gratuitous; shareholding of the borrower in lender was 7.91% (below 10%). Given these facts, the loans were commercial transactions rather than benefits conferred because of shareholding. The Tribunal applied the principle that Section 2(22)(e) targets gratuitous or shareholder-privilege advances and does not extend to arms-length commercial loans made by a finance company to another finance company where consideration (interest) is present and shareholding threshold is not met.
Ratio vs. Obiter: The conclusion that Section 2(22)(e) does not apply where (i) the shareholding is below 10%, and (ii) the loan is in the ordinary course of business with interest charged, is the operative ratio relied upon by the Tribunal. The discussion of administrative circulars and general remarks distinguishing gratuitous loans are supportive but ancillary.
Conclusion: Section 2(22)(e) was not attracted; the CIT(A)'s deletion of the AO's addition under Section 2(22)(e) was upheld and the Revenue's challenge dismissed.
Issue 2: Scope - gratuitous advance vs. commercial loan; effect of consideration/advantage to company
Legal framework: The statutory wording must be construed to capture advances or loans made by a company to a shareholder because of the shareholder status, unless the advance is given in return for consideration/advantage to the company.
Precedent treatment: The Tribunal followed authority holding that advances given as a consequence of some consideration beneficial to the company are not to be treated as deemed dividend under Section 2(22)(e); gratuitous advances to shareholders (enjoyed solely by virtue of shareholding) fall within Section 2(22)(e).
Interpretation and reasoning: The Tribunal placed weight on documentary evidence-loan confirmations, ledger showing interest payments, final accounts of the lender, memorandum and articles, and the commercial character of both entities' businesses (lending/borrowing). These facts demonstrated a reciprocal commercial relationship and absence of gratuitous treatment. Thus the element of being an advance "by reason of being a shareholder" was not present.
Ratio vs. Obiter: The holding that non-gratuitous, interest-bearing loans made in return for consideration/advantage do not constitute deemed dividend under Section 2(22)(e) is treated as binding ratio in the present adjudication. Observations contrasting the CBDT circular's administrative view with judicial construction are ancillary.
Conclusion: The advances were commercial and not gratuitous; Section 2(22)(e) does not apply where the advance arises from ordinary course commercial dealings and consideration exists.
Issue 3: Validity of CIT(A)'s adjustment under Section 14A read with Rule 8D and the scope of Revenue's challenge
Legal framework: Section 14A read with Rule 8D permits disallowance of expenditure incurred to earn exempt income; AO quantified an addition and CIT(A) reduced it to a lower figure after scrutiny.
Precedent treatment: The appeal record shows the CIT(A) modified the AO's disallowance from a higher figure to Rs. 8,76,693/-. The Revenue challenged the CIT(A)'s approach in its appeal but focused principally on the Section 2(22)(e) deletion. The Tribunal examined the impugned order as a whole.
Interpretation and reasoning: The Tribunal reviewed the CIT(A)'s modification and the material on record; no specific infirmity in the CIT(A)'s computation under Section 14A/Rule 8D was identified in the Tribunal's reasoning. The Tribunal treated the CIT(A)'s quantified adjustment as supported by the record and judicial approach applied to Section 2(22)(e) findings.
Ratio vs. Obiter: The Tribunal's upholding of the CIT(A)'s modified Section 14A/Rule 8D figure is a practical conclusion in the context of the appeal; detailed principles of computation were not elaborated and hence observations on computation are largely consequential rather than a general precedent.
Conclusion: The Tribunal did not find infirmity in the CIT(A)'s modification under Section 14A/Rule 8D; the Revenue's challenge to that adjustment was dismissed along with its broader appeal.
Cross-References and Final Disposition
The Tribunal's conclusions on Section 2(22)(e) were informed by and consistent with the cited High Court authority that (a) limits the scope of "by way of advance or loan" to gratuitous shareholder-preferential advances, and (b) excludes advances given in return for consideration or in the ordinary course of business. The Tribunal noted that higher forum review against that authority was declined. Applying those principles to the factual matrix (both parties NBFCs, interest charged, shareholding <10%, documentary evidence of commercial dealings), the Tribunal dismissed the Revenue's appeal and upheld the CIT(A)'s deletions/modifications.
TaxTMI 
AI Drafter ✕
TaxTMI 
