Deemed Dividend Addition u/s 2(22)(e) Quashed for Lack of Jurisdiction and Absence of Actual Loan

ITAT Ahmedabad allowed the assessee's appeal, holding the addition under s.2(22)(e) as invalid both on legal and factual grounds. It held that in a limited scrutiny, the AO could not examine or make addition on the issue of deemed dividend without obtaining prior approval for conversion to complete scrutiny; hence the assessment on that issue was without jurisdiction and bad in law. On merits, it found no deemed dividend since the bank had unilaterally passed and immediately reversed the entries, the assessee neither requested nor utilized the sums, and no loan or advance from the company to the assessee existed.

---

---

1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether, in a case selected for limited scrutiny on specified issues, the Assessing Officer was legally competent to examine and make an addition on account of deemed dividend under section 2(22)(e) of the Income Tax Act without obtaining prior approval for conversion to complete scrutiny.

1.2 Whether the book entries transferring funds from the company's bank account to the assessee's bank account and reversing them on the same or next day, as per the bank's requirement in relation to a cash credit facility, constituted "loans or advances" so as to be taxable as deemed dividend under section 2(22)(e) of the Income Tax Act.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of addition under section 2(22)(e) in a limited scrutiny assessment without conversion to complete scrutiny

Legal framework (as discussed by the Tribunal)

2.1 The case was selected for limited scrutiny on two specified issues: (i) sales turnover mismatch, and (ii) increase in capital. The Tribunal referred to CBDT Instructions governing the scope of "Limited Scrutiny" and the procedure and preconditions for its conversion into "Complete Scrutiny", including Instructions dated 26.09.2014, 29.12.2015, 14.07.2016 and 30.11.2017. These instructions mandate that: (a) enquiry in limited scrutiny cases shall ordinarily be confined to the issues for which the case was selected; (b) enlargement of scope to complete scrutiny requires formation of a reasonable view of potential under-assessment of income based on credible material and prior approval of the administrative Commissioner; and (c) assessments made in violation of these binding instructions are bad in law.

2.2 The Tribunal relied on a prior Co-ordinate Bench decision interpreting the same CBDT Instructions, holding that in a limited scrutiny confined to a particular issue (e.g., increase in share capital), the Assessing Officer cannot, without approval from the competent authority, suo motu expand the scope to unrelated issues (e.g., depreciation on goodwill), and that any such assessment in violation of CBDT Instructions is unsustainable.

Interpretation and reasoning

2.3 The Tribunal found as a matter of fact that the issue of deemed dividend under section 2(22)(e) was not part of the reasons or parameters for which the case was selected for limited scrutiny.

2.4 It was further found that the Assessing Officer did not obtain permission from the competent authority to: (i) enlarge the scope of scrutiny; or (ii) convert the limited scrutiny into complete scrutiny, before taking up and making addition on the deemed dividend issue.

2.5 Applying the reasoning from the Co-ordinate Bench decision and CBDT Instructions, the Tribunal held that the jurisdiction of the Assessing Officer in a limited scrutiny is confined to the issues for which the case was selected. The mere fact that another issue emerges from the assessment proceedings does not, by itself, permit expansion of scope without following the prescribed procedure and obtaining mandatory administrative approval.

2.6 The Tribunal treated CBDT Instructions as binding on the Assessing Officer, and noted that CBDT has specifically viewed unauthorized expansion of limited scrutiny jurisdiction as a serious lapse, even leading to disciplinary action in some cases, thereby reinforcing that non-compliance vitiates the assessment on such extraneous issues.

Conclusions

2.7 The Tribunal held that the addition made by the Assessing Officer on account of deemed dividend under section 2(22)(e) was beyond the scope of the limited scrutiny, and without requisite approval for conversion to complete scrutiny, and hence was bad in law.

2.8 On this jurisdictional ground alone, the addition under section 2(22)(e) was held to be unsustainable.

Issue 2: Whether the impugned amounts constituted "deemed dividend" under section 2(22)(e)

Interpretation and reasoning

2.9 On facts, the Tribunal recorded that the assessee was a substantial shareholder (32.54%) and director of the company and that bank entries showed credits to the assessee's account from the company's bank account on three dates aggregating to Rs. 1,95,00,000.

2.10 The assessee's explanation, accepted by the Tribunal, was that the company had a cash credit facility with a bank; the bank, for its internal/technical reasons and to keep the cash credit account running smoothly and show debit balances/targets at each quarter-end, directed that funds be moved from the company's account to the assessee's account and that these entries were reversed on the same day or the very next day, without the assessee using the funds.

2.11 A certificate from the bank confirming that the said debits from the company's account and credits to the assessee's account were erroneously made and reversed immediately was on record. The Tribunal noted that, even if these entries were not purely inadvertent errors but were passed intentionally by the bank for its own purposes (targets/technical requirements), the essential factual position remained that: (i) the entries were temporary and reversed almost immediately; (ii) the assessee neither requested such transfer nor used the money; and (iii) there was no intention or arrangement of a loan or advance by the company to the assessee.

2.12 The Tribunal reasoned that section 2(22)(e) contemplates a real "loan or advance" by the company to a shareholder for the shareholder's benefit. Where the transfer of funds is merely a book entry initiated by the bank for its own operational purposes, immediately reversed, and not at the instance of or for the benefit of the shareholder, such transactions do not partake the character of a loan or advance to the shareholder.

2.13 On this basis, the Tribunal rejected the approach of the first appellate authority in disregarding the bank certificate on the ground that such mistakes could not be repeated time and again, and instead accepted the substance of the transaction as not being a loan or advance.

Conclusions

2.14 The Tribunal held that, on merits, the impugned credits in the assessee's bank account did not constitute "loans or advances" by the company to the assessee, that the assessee derived no benefit and did not use the funds, and that there was no transaction of the nature contemplated by section 2(22)(e).

2.15 Consequently, even apart from the jurisdictional defect in the limited scrutiny assessment, the addition of Rs. 1,95,00,000 as deemed dividend under section 2(22)(e) was held to be unsustainable on merits and ordered to be deleted.

---