2016 (1) TMI 931 - AT - Income Tax

Deemed dividend u/s 2(22)(e) - applicability of clubbing provision for deemed income - whether the exempt capital gain is to be excluded from accumulated profits for the purpose of section 2(22)(e)? - whether the provisions of section 2(22)(e) of the Act could be invoked on the family members of the assessee who are not shareholders in the lending company and accordingly whether clubbing provision would be applicable for deemed income? - Held that - The legal fiction created in the Explanation 2 to section 2(22) of the Act that accumulated profits shall include all profits of the company upto the date of distribution or payment should be understood to include the current year profits of the company and not otherwise. For reckoning the accumulated profits, apart from the opening balance of accumulated profits, the profits earned in the current year also are to be added and then the total accumulated profits should be considered for the purpose of calculation of dividend out of accumulated profits, if any. The said Explanation nowhere contemplates to bring within the ambit of expression accumulated profits , any capital profits which are not liable to capital gains tax. Accordingly, even going by the provisions of the statute, it can safely be concluded that the capital gains could be included for reckoning the accumulated profits only when the said capital gains has been duly subjected to tax. In the instant case, the capital gains derived by the company to the tune of ₹ 197.20 lacs is exempt and hence the same should not be included in accumulated profits and if the same is excluded, then there is only negative accumulated profits available with the company. Admittedly, the provisions of section 2(22)(e) could be invoked only to the extent of the company possessing accumulated profits. In the absence of accumulated profits, there is no scope for making any addition towards deemed dividend. Thus we hold that the exempted capital gains shall not enter the stream of the expression accumulated profits and the company BKFCPL has got only negative accumulated profits after exclusion of exempted capital gains and hence the provisions of section 2(22)(e) of the Act cannot be invoked in the facts and circumstances of the case.- Decided in favour of assessee.

Issues Involved:
1. Whether the exempt capital gain is to be excluded from accumulated profits for the purpose of section 2(22)(e) of the Income Tax Act.
2. Whether the provisions of section 2(22)(e) of the Income Tax Act could be invoked on the family members of the assessee who are not shareholders in the lending company and whether clubbing provision would be applicable for deemed income.

Issue 1: Exclusion of Exempt Capital Gain from Accumulated Profits for Section 2(22)(e)
The primary issue in the assessee's appeal was whether the exempt capital gain should be excluded from accumulated profits for the purpose of section 2(22)(e) of the Income Tax Act. The assessee argued that the accumulated profits figure as on 31.3.2007 of Rs. 128.21 lakhs included exempted long-term capital gains of Rs. 197.20 lakhs. If these gains were excluded, there would be negative accumulated profits, and therefore, the provisions of section 2(22)(e) could not be invoked. The assessee cited various judicial precedents, including CIT vs Mangesh J Sanzgiri (119 ITR 962), which held that "accumulated profits" do not include capital gains that are not chargeable to tax.

The tribunal agreed with the assessee, stating that the legal fiction created in the Explanation 2 to section 2(22) should include only profits that have been subjected to tax. Since the capital gains in question were exempt, they should not be included in accumulated profits. Consequently, with negative accumulated profits, the provisions of section 2(22)(e) could not be invoked. The tribunal allowed the assessee's appeal on this ground.

Issue 2: Applicability of Section 2(22)(e) to Non-Shareholder Family Members
The revenue's appeal questioned whether the provisions of section 2(22)(e) could be invoked on the family members of the assessee who were not shareholders in the lending company, and whether clubbing provisions under section 64 could be applied. The tribunal noted that the Assessing Officer (AO) had exceeded the jurisdiction vested by the order of the CIT u/s 263 by treating the amounts overdrawn by the son and daughter of the assessee as deemed dividend. The tribunal cited judicial precedents, including CIT vs Hindustan Coconut Oil Mill (255 ITR 428) and CIT vs Howrah Flour Mills Ltd (236 ITR 156), which established that the AO could not go beyond the directions of the CIT.

Furthermore, the tribunal emphasized that the provisions of section 2(22)(e) create a deeming fiction and must be construed strictly. Since the son and daughter were not shareholders in the lending company, the deemed dividend could only be assessed in the hands of the shareholders. The tribunal dismissed the revenue's appeal, holding that the provisions of section 2(22)(e) could not be invoked for amounts paid to the non-shareholder family members.

Conclusion:
The tribunal concluded that the exempt capital gains should not be included in accumulated profits, resulting in negative accumulated profits, and thus, the provisions of section 2(22)(e) could not be invoked. Additionally, the tribunal held that the provisions of section 2(22)(e) could not be applied to non-shareholder family members. The assessee's appeal was allowed, and the revenue's appeal was dismissed.

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