2014 (8) TMI 866 - AT - Income Tax

Deemed dividend u/s 2(22)(e) Closely held company or not - substantial interest - nature of transaction, loan or otherwise Held that - The assessee was holding 15% shares in SFL besides being one of the directors of the company - the assessee has beneficial interest in SFL as required u/s 2(22)(e) of the Act - Though the loan has been squared up during the year along with the interest but these facts are not relevant to decide whether the provisions of section 2(22)(e) can be invoked on a loan given by the company to the shareholder. As per this Schedule to the balance sheet, SFL (the company) has obtained secured loan from Bank of Baroda against hypothecation of stock on hire - stock on hire is shown separately and loan and advances are shown separately, which means stock on hire is not loans and advances. In fact, stock on hire is owned by SFL and only then, SFL can hypothecate the same to Bank and Bank had accepted stock on hire under hypothecation to Bank. - These facts go to show that in the present case, hire purchase transaction conducted by SFL is not in the nature of loan, but SFL is owning assets given on hire by it and therefore, as per the judgment of the Hon ble Apex Court rendered in the case of Sundaram Finance Ltd. vs. State of Kerala and Other (1965 (11) TMI 123 - SUPREME COURT OF INDIA), these hire purchase transactions cannot be regarded as loan transaction, particularly when SFL is also claiming and showing assets given on hire as its own assets and such claim of the assessee is accepted by Bank of Baroda. When SFL is not engaged in the business of money lending, the transaction of the assessee by way of receiving loan of ₹ 21.02 lakhs from SFL has to be treated as deemed dividend in the hands of the present assessee Decided against Assessee. Interest paid on loan obtained from persons u/s 40A(2)(b) Held that - The AO has allowed rate of interest @14% and the balance interest was disallowed - even the bank interest rate was more than 14% and the assessee has obtained the loan @15% without furnishing any security it should be allowed keeping in view the commercial expediencies - the interest paid at 15% is allowed to the persons covered u/s 40A(2)(b) of the Act Decided in favour of assessee. House hold expenses Held that - The assessee family comprised of himself, wife and two sons studying in good school of Bareilly - AO has estimated the house hold expenses at ₹ 10,000/- per month and made the addition of ₹ 42,000/- as the assessee has declared house hold expenses at ₹ 78,000/ - Keeping in view the standard of living of the assessee, ₹ 78,000/- cannot be sufficient to meet the house hold expenses Decided against Assessee.

Summary

Issues Involved:

1. Application of provisions of section 2(22)(e) of the Income Tax Act, 1961.
2. Calculation of accumulated profit for applying section 2(22)(e).
3. Addition of interest paid on loans obtained from Sarnath Finance Limited.
4. Addition of interest paid on loans obtained from persons covered under section 40A(2)(b) of the Act.
5. Addition under the heading "Unexplained Household Expenses."
6. Overall validity of the assessment order.

Detailed Analysis:

1. Application of Provisions of Section 2(22)(e) of the Income Tax Act, 1961:

The primary issue was whether the loan of Rs. 21,20,000/- received by the assessee from Sarnath Finance Limited (SFL) should be treated as deemed dividend under section 2(22)(e) of the Act. The assessee argued that the loan was given in the ordinary course of business as SFL was engaged in the finance business. However, the Assessing Officer (AO) and the CIT(A) concluded that SFL was a closely held company and not engaged in the money lending business as a substantial part of its business. The Tribunal upheld this view, stating that the hire purchase business of SFL could not be equated with money lending, and thus, the loan was deemed dividend.

2. Calculation of Accumulated Profit for Applying Section 2(22)(e):

The AO calculated the accumulated profits of SFL to determine the quantum of deemed dividend. The assessee contested the inclusion of certain reserves and the method of calculation. However, the AO's method, which included general reserves and pro-rata profits, was upheld. The Tribunal confirmed that the accumulated profits were correctly calculated, leading to the addition of Rs. 21,20,000/- as deemed dividend.

3. Addition of Interest Paid on Loans Obtained from Sarnath Finance Limited:

The assessee paid Rs. 11,245/- as interest on the loan from SFL. Since the loan was treated as deemed dividend, the interest paid was not considered a business expense and was disallowed. The Tribunal upheld this disallowance, affirming that the interest on deemed dividend is not deductible.

4. Addition of Interest Paid on Loans Obtained from Persons Covered Under Section 40A(2)(b) of the Act:

The assessee paid interest at 15% on loans from persons covered under section 40A(2)(b) and 18% to Anand Lok Finance Limited. The AO allowed only 14% interest, disallowing the excess. The Tribunal found the 15% interest rate reasonable given the market conditions and allowed it but restricted the interest paid to Anand Lok Finance Limited to 15%, disallowing the excess 3%.

5. Addition Under the Heading "Unexplained Household Expenses":

The AO estimated household expenses at Rs. 10,000/- per month, adding Rs. 42,000/- to the declared expenses of Rs. 78,000/-. The Tribunal found the AO's estimation reasonable given the assessee's standard of living and upheld the addition.

6. Overall Validity of the Assessment Order:

The assessee challenged the overall validity of the assessment order on grounds of natural justice and factual errors. However, the Tribunal found no merit in these arguments, upholding the assessment order except for the partial relief granted on the interest rate issue.

Conclusion:

The Tribunal partly allowed the appeal, granting relief on the interest rate issue but upholding the major additions, including the deemed dividend and household expenses. The order was pronounced in the open court on 2.5.2014.