Court rules deemed dividend under Section 2(22)(e) can only be taxed in hands of shareholder, not recipient of loan.

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Case Name:

Commissioner of Income Tax Vignesh P. Shah (High Court of Bombay)

Income Tax Appeal No. 197 of 2013

Key Takeaways:

- Section 2(22)(e) of the Income Tax Act, 1961, which deals with deemed dividends, can only be applied if the assessee is a shareholder of the company lending the money.

- The court upheld the principle of strict interpretation of tax laws, stating that any ambiguity must be resolved in favor of the taxpayer.

- The court cited the Supreme Court's decision in CIT v/s. Vatika Township 2015 (1) SCC 1, which emphasized that tax laws cannot be extended beyond the clear language used in the statute.

Issue:

The central legal question in the case is whether the assessee, who received a loan from a company can be taxed on the loan as a deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961, especially when this loaning company took loan from another company in which assessee was 50% shareholder?

Facts:

The assessee received a loan from a company called M/s. NS Fincon Pvt. Ltd.

M/s. La-fin Financial Services Pvt Limited had advanced money to M/s. NS Fincon Pvt. Ltd. who in turn advanced money to the Respondent­ Assessee.

The Respondent ­Assessee a 50% shareholder of M/s. La­fin Financial Services

Pvt. Limited.

The Income Tax Department sought to tax this loan as a deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961.

The assessee appealed to the Income Tax Appellate Tribunal (ITAT), which ruled in favor of the assessee, holding that the issue was covered by the decision of the Special Bench of the Tribunal in Bhaumik Colours Pvt. Ltd. 313 ITR 146 (AT) and the Bombay High Court's decision in CIT v/s. Universal Medicare Pvt. Ltd. 324 ITR 263. The Income Tax Department then appealed to the Bombay High Court.

Arguments:

- The Income Tax Department argued that the substance of the transaction should be considered, and if looked at from that perspective, the assessee should be taxed on the loan as a deemed dividend.

- The assessee's position, as upheld by the ITAT and the Bombay High Court, was that Section 2(22)(e) can only be applied if the assessee is a shareholder of the lending company, which was not the case here.

Key Legal Precedents:

- Bhaumik Colours Pvt. Ltd. 313 ITR 146 (AT) (Special Bench of the Tribunal)

- CIT v/s. Universal Medicare Pvt. Ltd. 324 ITR 263 (Bombay High Court)

- CIT v/s. Impact Containers Pvt. Ltd. 367 ITR 346 (Bombay High Court)

- CIT v/s. Vatika Township 2015 (1) SCC 1 (Supreme Court)

These precedents established that Section 2(22)(e) of the Income Tax Act, 1961, cannot be applied or invoked where the assessee is not a shareholder of the lending company.

Judgement:

The Bombay High Court upheld the decision of the Income Tax Appellate Tribunal (ITAT) and ruled in favor of the assessee.

The court held that Section 2(22)(e) of the Income Tax Act, 1961, which deals with deemed dividends, can only be applied if the assessee is a shareholder of the company lending the money.

Since the assessee was not a shareholder of M/s. NS Fincon Pvt. Ltd., the company from which he received the loan, the court found no fault with the ITAT's decision to follow the precedents set by the Bombay High Court in Universal Medicare Pvt. Ltd. and Impact Containers Pvt. Ltd.

The court emphasized the principle of strict interpretation of tax laws, citing the Supreme Court's decision in CIT v/s. Vatika Township 2015 (1) SCC 1, which stated that any ambiguity in tax laws must be resolved in favor of the taxpayer.

FAQs:

Q1: What is the significance of the court's decision?

A1: The court's decision reinforces the principle that tax laws must be interpreted strictly, and any ambiguity should be resolved in favor of the taxpayer. It also clarifies that Section 2(22)(e) of the Income Tax Act, 1961, which deals with deemed dividends, can only be applied if the assessee is a shareholder of the lending company.

Q2: What are the implications of this case for taxpayers?

A2: This case provides clarity for taxpayers who receive loans from companies in which they are not shareholders. Such loans cannot be taxed as deemed dividends under Section 2(22)(e) of the Income Tax Act, 1961.

Q3: Can the Income Tax Department appeal this decision?

A3: The provided content does not mention the possibility of further appeals. However, in general, the Income Tax Department may have the option to appeal the decision to a higher court, such as the Supreme Court, if they believe there are grounds for challenging the Bombay High Court's ruling.

Q4: What is the reasoning behind the court's decision to strictly interpret tax laws?

A4: The court cited the Supreme Court's decision in CIT v/s. Vatika Township 2015 (1) SCC 1, which emphasized that tax laws are in derogation of personal rights and property interests, and therefore, any ambiguity must be resolved against the imposition of tax. This principle is based on the doctrine of fairness, ensuring that taxpayers are not burdened with tax liabilities unless the law clearly prescribes such liability.

1. This Appeal under Section 260­A of the Income Tax Act, 1961 (the Act), challenges the order dated 8th May, 2012 passed by the Income Tax Appellate Tribunal (the Tribunal) for the Assessment Year 2007­-08.

2. The Revenue has formulated the following re­framed question of law for our consideration:

“ Whether the facts and in the circumstances of the case and in law, the Tribunal is right in placing reliance on the judgment in the case of ACIT v/s. M/s. Bhaumik Colours Pvt. Ltd. whereas in the instant case, the assessee is a registered and beneficial share holder of a company that has given loans to a third company that lent these, monies to the Assessee?”.

3. We find that the impugned order has upheld the order of the

CIT(A) dated 28th March, 2011, holding that the issue arising before it

was covered by the decision of the Special Bench of the Tribunal in

Bhaumik Colours Pvt. Ltd. 313 ITR 146 (AT) read with decision of this

Court in CIT v/s. Universal Medicare Pvt. Ltd. 324 ITR 263. It is pertinent

to note that in paragraph 6 of the impugned order, Tribunal recorded as

under:­

“6:­ At the time of hearing, no one appeared on behalf of

assessee in spite of giving notice. However, ld. D. R. fairly

conceded that the issue involved is covered in favour of assessee

by the decision of ITAT (SB) in the case of Bhaumik Colours P

Ltd (supra). Further, ld. D. R. referred to the decision of

Hon'ble Apex Court in the case of L Alagusundaram Chettiar vs.

CIT 252 ITR 893 (SC) but when it was pointed out that the

said decision pertains to section 2(6A) (e) of 1922 Act, and

whereas the decision by ITAT in the case of Bhaumik Colours

(supra) is under 1961 Act and similar view has been taken by

Hon'ble Bombay High Court in the case of Commissioner of

Income Tax vs. Universal Medicare Private Limited 324 ITR 263

(Bom.), ld. D. R. submitted that she dutifully relies on the

decision of Assessing Officer.”

4. In view of the above, we indicated to Mr. Pinto, learned

Counsel appearing for the Revenue that it appears that the Revenue had

conceded before the Tribunal that the issue involved in the Appeal before

it is covered by the Special Bench of the Tribunal. However, Mr. Pinto

submitted that if paragraph 6 is read in its entirety it would be evident

that Departmental Representative appearing for the Revenue had relied

upon the decision of the Assessing Officer and not upon the decision

referred to earlier. Although we do not agree with the above submission

as our reading of the above paragraph is that Departmental

Representative placed reliance upon the decision of the Assessing Officer

in support of her submission that the decision of the Supreme Court in

L Alagusundaram Chettiar vs. CIT 252 ITR 893 supports the case of the

Revenue. At that time, the Tribunal pointed out that same deals with

deemed dividend under Income Tax Act, 1922 while the decision of this

High Court in Universal Medicare Pvt. Ltd. (supra) deals with Act.

5. Be that as it may to avoid needless controversy, we have

considered the challenge of the Revenue to the impugned order

independently and not shut out the Revenue because of the concession

made by it before the Tribunal.

6. The undisputed facts are that the assessee received loan from

one M/s. NS Fincon Pvt. Ltd. The Revenue seeks to tax this loan as

deemed dividend. The case of the Revenue before us is that one M/s. La-

fin Financial Services Pvt. Limited had advanced money to M/s. NS Fincon

Pvt. Ltd. who in turn advanced money to the Respondent­ Assessee. The

Respondent ­Assessee a 50% share holder of M/s. La­fin Financial Services

Pvt. Limited and in view thereof, loan advanced by M/s. NS Fincon Pvt.

Ltd. to the Respondent­Assessee is to be treated as a dividend in the hands

of Respondent­Assessee. It is also an admitted position that the

Respondent­Assesee is not a share holder in M/s. NS Fincon Pvt. Ltd. The

Assessing Officer brought to tax the amount of loan received by the

Respondent­Assesee from M/s. NS Fincon Pvt. Ltd. as deemed dividend

under Section 2 (22)(e) of the Act.

7. On Appeal, the CIT(A) held that the loan given by M/s. NS

Fincon Pvt. Ltd to the Respondent ­Assessee is not the payment made by it

to its share holder. Thus, Section 2 (22)(e) of the Act could have no

application. The CIT(A) further held that Section 2 (22)(e) of the Act

creates a fiction by bringing to tax an amount as dividend when the

amount so received is otherwise then dividend. Therefore, Section 2(22)

(e) of the Act has to be strictly read.

8. On further appeal to the Tribunal by the Revenue, the

impugned order placed reliance upon the decisions of this Court in

Universal Medicare (P) Ltd. (supra) read with its decision in Bhaumik

Colours (P) Ltd. (supra) and the decision of Rajasthan High Court in CIT

v/s. Hotel Hilltop 313 ITR 116 to uphold the order of the Commissioner

of Income Tax (Appeals). Thus upholding the conclusion that deemed

dividend can be assessed only in the hands of a shareholder of the lender

company. In this case, the Respondent­Assessee is admittedly not the

shareholder of M/s. NS Fincon (P) Ltd.

9 This Court in the case of Universal Medicare (supra) while

approving the decision of the Special Bench of the Tribunal in Bhaumik

Colours (supra) inter alia observed that:

“ All payments by way of dividend have to be taxed in hands of

the recipient of the dividend namely the share holder.

Consequently, the effect of clause (e) of Section2 (22) is to

broaden the ambit of the expression 'dividend' by including

certain payments which the company has made by way of a

loan or advance or payments made on behalf of or for the

individual benefit of a share holder. The definition does not

alter the legal position that dividend has to be taxed in the

hands of the shareholder.”

10 Further, this Court in the case of CIT v/s. Impact Containers

Pvt. Ltd. ­ 367 ITR 346 while dealing with the issue of deemed dividend

categorically held that Section 2(220(e) of the Act cannot be applied/

invoked where the assesee is not a shareholder of the leading company.

The objective of Section 2(22)(e) of the Act is only to ensure that the

Company in which the public are not substantially interested would not

distribute its prosperity amongst shareholders by calling them the loan/

advances, as tax would be payable if the same were distributed as

dividend.

11. The submission on behalf of the Revenue made before us is

that one has to look at the substance of the transaction and that if one

looks at the substance, then the Respondent ­Assessee would be chargeable

to tax. This is not acceptable as fiscal status have to be interpreted strictly.

We can do no better then meet the submission of the Revenue by inviting

attention to the decision of the Supreme Court in CIT v/s. Vatika

Township 2015 (1) SCC 1 wherein it has been observed as under:­

“41.2:­ At the same time, it is also mandated that

there cannot be imposition of any tax without the authority of

law. Such a law has to be unambiguous and should prescribe

the liability to pay taxes in clear terms. If the provision

concerned of the taxing statue is ambiguous and vague and as

susceptible to two interpretations, the interpretation which

favours the subjects, as against the Revenue, has to be preferred.

This is a well­established principle of statutory interpretation, to

help finding out as to whether particular category of assessee is

to pay a particular tax or not. No doubt, with the application

of this principle, the courts make endeavour to find out the

intention of the legislature. At the same time, this very principle

is based on “fairness” doctrine as it lays down that if it is not

very clear from the provisions of the Act as to whether the

particular tax is to be levied to a particular class of persons or

not, the subject should not be fastened with any liability to pay

tax. This principle also acts as a balancing factor between the

two jurisprudential theories of justice – Libertarian theory on

the one hand and Kantian theory along with Egalitarian theory

propounded by John Rawls on the other hand.

41.3 Tax laws are clearly in derogation of personal

rights and property interests and are, therefore, subject to strict

construction, and any ambiguity must be resolved against

imposition of the tax.

41.4 Again as United States v. Merraim, the Supreme

Court clearly stated at US pp. 187.88

“ On behalf of the Government it is urged that taxation is a

practical matter and concerns itself with the substance of the

thing upon which the tax is imposed, rather than with legal

forms or expressions. But in statutes levying taxes the literal

meaning of the words employed is most important, for such

statutes are not to be extended by implication beyond the clear

impost of the language used. If the words are doubtful, the

doubt must be resolved against the Government and in favour of

the taxpayer. Gould v. Gould L Ed p. 213: Usp 153.

41.5 As Lord Carins said many years ago in Partington

v. Attorne General (LR p. 122)

“.... as I understand the principle of all fiscal legislation it is this: if the person sought to be taxed comes within the letter

of the law he must be taxed, however great the hardship may

appear to the judicial mind to be. On the other hand, if the

Crown, seeking to recover the tax, cannot bring the subject

within the letter of the law, the subject is free, however,

apparently within the spirit of the law the case might otherwise

appear to be.”

Thus on strict interpretation of Section 2(22)(e) of the Act, unless

the Respondent­ Assessee is the shareholder of the company lending him

money, no occasion to apply it can arise.

12. In the present facts, it is an admitted position that

Respondent­ Assessee is not a shareholder of M/s. NS Fincon Pvt. Ltd. from

whom he has received loan. Therefore, no fault can be found with the

decision of the Tribunal in having followed the decision of the High Court

in Universal Medicare (supra). This view has been further reiterated by

another Division Bench of this Court in Impact Containers (supra)

rendered on 4th July, 2014.

13. We are of the view that as the issue raised by the Revenue

stands concluded by the order of this Court, no substantial question of law

arises for our consideration. Accordingly, Appeal dismissed. No order as

to costs.

(G.S.KULKARNI,J.) (M.S.SANKLECHA,J.)