Court rules no deemed dividend for shareholder with debenture account balance exceeding loans

Case Name:

Anil Kumar Agrawal v. Income-tax Officer, 14(2)(1) (ITAT Mumbai)

Key Takeaways:

- The court clarified that a debenture is essentially a loan account, and the debenture account balance should be considered along with other accounts to determine the net outstanding balance. - If the consolidated balance across all accounts shows that the assessee did not owe any money to the company, the provisions of Section 2(22)(e) cannot be invoked. - The court also held that share premium cannot be included in accumulated profits for the purpose of applying Section 2(22)(e). **Issue:** Whether the debenture account balance should be considered along with the personal and proprietorship accounts to determine if the assessee had taken any loans or advances from the company, thereby attracting the provisions of Section 2(22)(e) of the Income Tax Act, 1961. **Facts:** - The assessee was a shareholder of more than 10% in M/s. Star Synthetics Pvt. Ltd. - The Assessing Officer found that the assessee had received unsecured loans of Rs. 23,65,000 from the company through personal and proprietorship accounts. - The Assessing Officer invoked Section 2(22)(e) and treated the amount as deemed dividend, considering the company's accumulated profits of Rs. 64,28,793. - The assessee argued that the debenture account balance should also be considered, which would show that the assessee did not owe any money to the company. **Arguments:** - Assessee's Argument: The debenture account balance should be considered along with the personal and proprietorship accounts to determine the net outstanding balance. If all accounts are considered, the assessee did not owe any money to the company, and Section 2(22)(e) cannot be invoked. - Revenue's Argument: The debenture account is different from loans or advances and should not be considered for the purpose of Section 2(22)(e). **Key Legal Precedents:** - Dy. CIT v. MAIPO India Ltd. [2008] 116 TTJ 791 / 24 SOT 42 (Delhi): Share premium cannot be included in accumulated profits for the purpose of applying Section 2(22)(e). **Judgement:** The court allowed the assessee's appeal, ruling that: 1. A debenture is essentially a loan account, and the debenture account balance should be considered along with other accounts to determine the net outstanding balance. 2. If the consolidated balance across all accounts shows that the assessee did not owe any money to the company, the provisions of Section 2(22)(e) cannot be invoked. 3. Share premium cannot be included in accumulated profits for the purpose of applying Section 2(22)(e), following the precedent in MAIPO India Ltd.'s case. **FAQs:** Q1. What is the significance of the court's decision? A1. The court's decision clarifies that the debenture account balance should be considered along with other accounts to determine the net outstanding balance for the purpose of Section 2(22)(e). It also reiterates that share premium cannot be included in accumulated profits for this purpose. Q2. What is the impact of this decision on the assessee? A2. The assessee's appeal was allowed, and no addition can be made under Section 2(22)(e) for the transactions and balances with M/s. Star Synthetics Pvt. Ltd. Q3. Can the debenture account balance be ignored for the purpose of Section 2(22)(e)? A3. No, the court held that the debenture account balance, being a loan account, should be considered along with other accounts to determine the net outstanding balance. Q4. What is the reasoning behind excluding share premium from accumulated profits for Section 2(22)(e)? A4. The court followed the precedent in MAIPO India Ltd.'s case, which held that considering Section 78 of the Companies Act, 1956, share premium cannot be included in accumulated profits for the purpose of applying Section 2(22)(e). Q5. Can the provisions of Section 2(22)(e) be invoked if the consolidated balance across all accounts shows that the assessee did not owe any money to the company? A5. No, the court ruled that if the consolidated balance across all accounts shows that the assessee did not owe any money to the company, the provisions of Section 2(22)(e) cannot be invoked.

This appeal filed by the assessee is against the addition made under section 2(22)(e) of the IT Act, 1961 (in short "Act") which was confirmed by the learned CIT(A).

2. Short facts apropos are that assessee is a shareholder of more than 10 per cent in one company called M/s. Star Synthetics (P.) Ltd. During the course of assessment proceedings, Assessing Officer found that assessee had taken certain loans from M/s. Star Synthetics Pvt. Ltd. through his personal account therein and also through an account of his proprietor-ship concern called M/s. S.A. Fabrics. Clubbing the personal account and the account of M/s. S.A. Fabrics. In M/s. Star Synthetics Pvt. Ltd., Assessing Officer worked out that assessee had received unsecured loans of Rs. 23,65,000 from M/s. Star Synthetics Pvt. Ltd. during the relevant previous year. Finding that M/s. Star Synthetics Pvt. Ltd. was having a reserve balance of Rs. 64,28,793, Assessing Officer invoked section 2(22)(e) of the Act and treated the sum of Rs. 23,65,000 as deemed dividend in assessee's hands.

3. In its appeal before the CIT(A), assessee mainly advanced two fold contention. First was that he had a closing credit balance of Rs. 51,79,000 in the debenture account with the said company, which amount was due from the said company and if this was also considered along with the two accounts aforesaid, there would not be any loan balance warranting the application of section 2(22)(e) of the Act. Second contention was that the accumulated profit of M/s. Star Synthetics Pvt. Ltd. considered by the Assessing Officer at Rs. 64,28,793 was including share premium amount of Rs. 40 lakhs which had to be excluded. According to the assessee, it was against the debenture account with the said company that he was given various amounts. Further it was assailed by the assessee that the account of the proprietorship concern M/s. S.A. Fabrics in M/s. Star Synthetics (P.) Ltd. was not a loan or advance, but, only a running account. Crux of his contention was that if the account were all considered i.e., the account in his personal name, the account in the name of M/s. S.A. Fabrics and the debenture account, then, the said company was always a borrower and not the other way round. One more argument was taken, that, a proprietorship concern was different from an individual and shares being held by the assessee in his personal name, the balance and the dealings that the proprietorship concern had with M/s. Star Synthetics Pvt. Ltd. could not be taken into account for application of section 2(22)(e) of the Act. However, learned CIT(A) did not accept any of these contentions. It was held by him that the amount of unsecured loans received by the assessee from M/s. Star Synthetics (P.) Ltd. was undisputed and there was also no dispute regarding the accumulated profit balance of Rs. 64,28,793 in that company. According to the learned CIT(A), proprietorship concern cannot be deemed as a distinct or separate from an individual as per the contention of the assessee that debenture balance should also be considered while working out the outstanding loan if any. Learned CIT(A) was of the opinion that debentures were for a fixed period with fixed interest and by nature were totally different from unsecured loans. Thus, he confirmed the addition of deemed dividend.

4. Now before us, it is submitted by the learned A.R. that assessee had based on resolution dated 20th March, 2001 of the Board of Directors of M/s. Star Synthetics Pvt. Ltd., subscribed to non-convertible unsecured debentures bearing 4 per cent interest for Rs. 50 lakhs. He pointed out from the copy of the said resolutions placed at paper book page Nos. 25 and 26 that debenture holders were allowed to maintain a current account against the said debentures with a condition that they could not draw a sum in excess of the debentures amount. Therefore, according to him, when assessee's personal account with the said company placed at paper book page No. 10 and that of proprietorship concern placed at PB Pages 11 to 143 were to be clubed, it was necessary to club the debenture account also, copy of which was placed at paper book page No. 9. Learned counsel for the assessee pointed out the consolidated account taking all the three together viz., personal account in the name of the assessee, account in the name of M/s. S.A. Fabrics and debenture account in the name of the assessee, all in M/s. Star Synthetics Pvt. Ltd. placed at paper book 15 to 19. According to him, this consolidated account clearly proved that at no point of time, assessee owed any amount to that company, but, it was vice versa. Learned counsel for the assessee also, relied on the audited final accounts of M/s. Star Synthetics Pvt. Ltd. placed at paper book page Nos. 1 to 8 to buttress his contention that debentures were shown by it as unsecured loans. According to him, though the Assessing Officer had relied on a number of judicial precedents, these were all on the extent and applicability of section 2(22)(e) of the Act. But, he never adjudicated why debenture account also could not be considered for working out the balances of loan/advances. Ld. Counsel pointed out that assessee was allowed to withdraw money as per the terms of the debenture issue and at no point of time he owed any money to the said company, for application of section 2(22)( e) of the Act. As for the plea that accumulated profits should exclude share premium balance, he relied on the decision of Delhi Bench of this Tribunal in Dy. CIT v. MAIPO India Ltd. [2008] 116 TTJ 791 / 24 SOT 42 (Delhi).

5. Per contra the learned Departmental Representative supported the Orders of the authorities below.

6. We have perused the orders and heard the rival contentions. There is no dispute that assessee had an account with M/s. Star Synthetics Pvt. Ltd. in his personal name and another account in the name of M/s. S.A. Fabrics of which he was the proprietor. There is also no dispute that assessee was having more than 10 per cent of the shareholding in M/s. Star Synthetics Pvt. Ltd. and therefore for any loans and advances taken by the assessee from the said company, provisions of section 2(22)(e) of the Act necessarily applied, if other conditions set out therein were satisfied. Assessee's contention is that when the account in his personal name and that in the name of M/s. S.A. Fabrics were considered by the Assessing Officer, it should have been done after including the debenture account balances as well. According to the assessee, though the Assessing Officer clubbed the personal account in his personal name and in the name of the proprietorship concern for working out the peak loan amount of Rs. 23,65,000, he completely ignored the debenture account. So the short question that arise is whether all the three accounts, i.e., debenture account in assessee's name, personal account in assessee's own name and account in the name of the proprietorship concern of the assessee, were to be considered together or only the latter two accounts were to be considered for working out the peak credit in order to see whether assessee had loaned any amount from M/s. Star Synthetics Pvt. Ltd. No doubt section 2(22)(e) of the Act uses the terms 'advance or loans'. The question is whether to exclude the debenture account from such workings, considering it to be not in the nature of loan or advance as maintained by learned CIT(A) and the Assessing Officer. For this purpose, it is required to understand what is meant by a debenture.

7. In Law Lexicon at page 290 by P. Ramanatha Aiyar, 'debenture' is defined as a document or a certificate signed by the officer of a corporation or company acknowledging indebtedness for money lent and guaranteeing repayment with interest; a security for a loan of money issued by a public company, usually creating a charge on the whole or a part of the company's stock and property, though not necessarily in the form of a mortgage. Section 137 of the Transfer of Property Act regards debentures as the subject-matter of a transfer and not as constituting a transfer by itself. A debenture means a document which either creates a debt or acknowledges it, and any document which fulfils either of these conditions is a debenture. Although an instruments called debentures may be described with comparative case studies, a judicial definition of a debenture or at any rate an accurate one has not been obtained and is perhaps not urgently required. In the Accountancy Text Book by William Pickles, "debenture" is defined as a document, acknowledging a loan to a company and is generally executed under the seal of the company, usually (but not necessarily) containing provisions as to payment of interest and the repayment of the principal and giving a charge on the assets of such company, and may give security for the payment over some or all of the debts and undertaking of the company.

8. In Halsbury's Laws of England, 4th Edn., 7th Vol., in paragraph 813, the meaning of "debenture" is stated as under:

"No precise definition of 'debenture' can be found, but various forms of instrument are called debentures. A debenture is a document which either creates or acknowledge a debt. A document may be a debenture even though under its terms, the debt is only to be repaid out of a part of the profits. The term 'debenture' is usually associated with a company of some kind, and most debentures are securities given by companies, but they are often granted by clubs and occasionally by individuals."

9. In Narendra Kumar Maheshwari v. Union of India AIR 1989 SC 2138, a "debenture" was defined to mean essentially as an acknowledgement of debt with a commitment to repay the principal with interest.

In India Cements Ltd. v. CIT [1966] 60 ITR 52 (SC), it was held that obtaining a capital by issue of shares is different from obtaining loan by debentures. A loan obtained cannot be treated as an asset or advantage for the enduring benefit of the business of the assessee.

10. In Director General of Investigation & Registration v. Deepak Fertilizers & Petrochemicals Corpn. Ltd. [1994] 1 SCL 239 (Delhi), it was held that a "debenture" is simply an acknowledgement of debt by the company whereby it undertakes to repay the amount covered by it and till then it undertakes further to pay interest thereon to the debenture holder. Except where debentures are secured by mortgage of immovable property or hypothecation or pledge of movable property, they constitute actionable claims. It was further held that a debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.

11. Thus, the above exposition would clearly show that debenture is only a loan account. Hence, both the CIT and the learned Assessing Officer fell in error when they consolidated only two accounts of the assessee with M/s. Star Synthetics Pvt. Ltd. ignoring its debenture account therein. We find from paper book page Nos. 18 to 19 that if all those three accounts are taken together, assessee at no point of time owed any money to the company and therefore, assessee cannot be considered to have taken any loan or advance from the said company. Therefore, there is no question of any deemed dividend arising in its hand.

12. As for the contention of the assessee that accumulated profits would not include share premium account. We find that this decision of the Delhi Bench of this Tribunal in MAIPO India Ltd.'s case (supra) is clearly in assessee's favour. It was held therein that considering section 78 of the Companies Act, 1956 share premium account could not be taken as part of accumulated profits for the purpose of applying section 2(22)(e) of the Act.

13. Therefore, we find that assessee has to succeed in his appeal. No addition can be made under section 2(22)(e) of the Act on the assessee in the impugned assessment year for its transactions and balances with M/s. Star Synthetics (P.) Ltd.

14. Appeal of the assessee, therefore, stands allowed.