2015 (10) TMI 755 - HC - Income Tax

Deemed dividend u/s 2(22)(e) - as per revenue alleged loan taken by the appellant was a deemed dividend and, therefore an income from other sources - Whether the loan/advance given by the Finance Company to the assessee, who is a share holder in the Finance Company was made in the ordinary course of its business, hence outside the scope of Section 2(22)(e)? - Held that - It is not possible to give a fixed definition of the word substantial in relation to a substantial business of a Company. We are of the opinion that any business of a Company which is not trivial or inconsequential as compared to the whole of the business would be termed as substantial part of the business. In the instant case, the assessing officer has held that the business of giving loans and advances by Sarnath Finance Company constituted less than 20% of the total investment and, therefore, the same is not a substantial part of the business of the Company. In our view, such reasoning is per se misconceived. We find from a perusal of the order of the Tribunal that Sarnath Finance Co. is admittedly engaged in the business of loans and advances, as is clear from the memorandum of association. The Tribunal picks holes from the balance sheet of the Sarnath Finance Co. contending that under the heading Loans and Advances the Company had made sub groups, namely, Loans and Advances and stocks on hire including hire purchase . The Tribunal, therefore, concluded that a substantial part of the business of the said Finance Company was hire purchase. In our view, the Tribunal has side tracked the issue without realising that stocks on hire was also shown under the heading of Loans and Advances in the balance sheet of the Finance Company. The break up of different kinds of loans and advances indicated by the said Finance Company in its balance sheet was for its convenience. The fact remains that the Finance Company was substantially carrying on the business of lending money which was its main business. We are of the view that the Tribunal and the authorities below committed a manifest error in holding that the loan and advance given by the Sarnath Finance Company to the appellant was a deemed dividend. In fact, it was covered by the exclusionary clause (ii) of Section 2(22)(e) of the Act. - Decided in favour of assessee.

Issues Involved:
1. Whether the loan/advance given by the Finance Company to the assessee, who is a shareholder in the Finance Company, was made in the ordinary course of its business and hence outside the scope of Section 2(22)(e) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Nature of Loan and Deemed Dividend under Section 2(22)(e) of the Income Tax Act:
The appellant, a 15% shareholder in Sarnath Finance Limited, took a loan of Rs. 21.20 lacs from the company. The assessing authority treated this loan as a deemed dividend under Section 2(22)(e) of the Income Tax Act, classifying it as income from other sources. The Finance Company was primarily engaged in hire purchase of transport vehicles, with only 10.79% of its business in loans and advances, which the assessing authority did not consider substantial. The appellant's appeal was dismissed by the Tribunal, which held that the loan was not covered by the exclusionary clause (ii) of Section 2(22)(e).

2. Tribunal's Rejection of Additional Ground and Subsequent High Court Appeal:
During the pendency of the appeal, the appellant's application to add an additional ground was rejected. An application under Section 254 of the Act was also rejected, leading to an appeal before the High Court. The High Court remanded the matter to the Tribunal to reconsider whether the exclusionary clause (ii) of Section 2(22)(e) applied. The Tribunal again rejected the appeal, maintaining that the loan was not in the ordinary course of business and not covered by the exclusionary clause.

3. Tribunal's Findings and Balance Sheet Analysis:
The Tribunal noted that the Finance Company's memorandum of association indicated its business of lending money. However, the balance sheet grouped loans and advances under different heads, with Rs. 426.32 lacs as "stocks on hire" and Rs. 56.23 lacs as "loans and advances." The Tribunal concluded that hire purchase transactions were the substantial business, not loans and advances.

4. Legal Question and Interpretation of "Substantial Part of Business":
The legal question was whether the loan/advance given by the Finance Company to the assessee was in the ordinary course of business and outside the scope of Section 2(22)(e). The provision excludes loans made in the ordinary course of business if lending money is a substantial part of the company's business. The term "substantial part of business" is not defined in the Act.

5. Reference to Bombay High Court's Interpretation:
The Bombay High Court in Commissioner of Income Tax, Panaji, Goa vs. Parle Plastics Ltd. explained "substantial part of business" as not necessarily exceeding 50% of the whole. It emphasized quality over quantity and various factors like turnover, profit contribution, and capital employed to determine substantiality.

6. Assessment of Sarnath Finance Company's Business:
The High Court found the Tribunal's reasoning flawed, as it did not consider the overall context. The Finance Company was engaged in the business of loans and advances, and the categorization in the balance sheet was for convenience. The substantial business of the company included lending money, which was its main business.

7. Conclusion and Judgment:
The High Court concluded that the Tribunal and authorities erred in treating the loan as a deemed dividend. The loan was covered by the exclusionary clause (ii) of Section 2(22)(e) of the Act. The appeal was allowed, and the question of law was answered in favor of the assessee and against the Department.

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