2016 (12) TMI 1297 - HC - Income Tax

Deemed dividend addition u/s 2(22)(e) - Held that - In the instant case, the loan advanced is found to be gratuitous inasmuch as, the loan advanced was not in return to an advantage conferred upon the closely held company by the assessee company and thus, none of the decisions cited by the learned counsel referred to hereinabove help the appellant in any manner. In view of the conclusion arrived at by us after due consideration of the facts situation emerging in the present case that money lending cannot be treated to be substantial part of the business of the closely held company, the decision of the Bombay High Court in Parle Plastic Ltd. s case (2010 (9) TMI 726 - BOMBAY HIGH COURT), also does not help the appellant. Accordingly, the question no.1 framed is answered in terms that the ITAT has committed no error in construing the provision of Section 2 (22)(e) of the Act of 1961 while arriving at the conclusion that the loan advanced by M/s Sun Polytex Pvt. Ltd. shall be treated to be deemed dividend liable to be taxed in the hands of the assessee. Income by way of dividends being exempt in the hands of shareholder in view of the provisions of Section 10(34) read with Section 115-O - Held that - A bare perusal of Section 10(34) read with Section 115-O makes it abundantly clear that by virtue of said provisions, only the amount declared, distributed or paid by the domestic company by way of dividends whether out of current or accumulated profits made chargeable to additional income tax in the hands of the company, stands excluded from the computation of the income of any person and not the deemed dividend in terms of provisiosn of Section 2 (22)(e) of the Act of 1961. Thus, the loan or advance by closely held company to the shareholder, which is treated to be deemed dividend by virtue of provisions of Section 2 (22)(e) of the Act of 1961, continues to remain liable to be taxed in the hands of the recipient.

Summary

Issues Involved:
1. Applicability of Section 2(22)(e) of the Income Tax Act, 1961.
2. Interpretation of "deemed dividend" under Section 2(22)(e).
3. Exception under sub-clause (ii) of Section 2(22)(e).
4. Taxability of deemed dividend under Section 10(34) read with Section 115-O.

Detailed Analysis:

1. Applicability of Section 2(22)(e) of the Income Tax Act, 1961:
The case revolves around whether the loans received by the assessee company from Sun Polytex Pvt. Ltd. and Sisarama Plastics Pvt. Ltd. should be treated as "deemed dividend" under Section 2(22)(e) of the Income Tax Act, 1961. The assessee company held more than 10% of the shares in these companies, which is a critical factor for the application of this section.

2. Interpretation of "deemed dividend" under Section 2(22)(e):
The court examined whether the loans received by the assessee company could be considered "deemed dividend." The Assessing Officer (AO) added the loan amounts to the income of the assessee company, treating them as deemed dividends. The CIT(A) initially deleted these additions, considering them as inter-corporate deposits, but the ITAT reversed this decision, reinstating the AO's order.

3. Exception under sub-clause (ii) of Section 2(22)(e):
The assessee argued that the loans should be excluded from the definition of "deemed dividend" under sub-clause (ii) of Section 2(22)(e), which excludes loans made in the ordinary course of business where money lending is a substantial part of the company's business. The court found that money lending was not a substantial part of Sun Polytex Pvt. Ltd.'s business, as the company primarily engaged in manufacturing PP/HDPE Fabric. The court upheld the ITAT's decision that the loan did not qualify for the exception under sub-clause (ii).

4. Taxability of deemed dividend under Section 10(34) read with Section 115-O:
The assessee contended that deemed dividends should be exempt under Section 10(34) read with Section 115-O, which exempts dividend income from tax in the hands of the shareholder since the company pays tax on the dividend. However, the court clarified that "deemed dividend" under Section 2(22)(e) is not covered by this exemption. Therefore, deemed dividends remain taxable in the hands of the recipient.

Conclusion:
The court concluded that the loans received by the assessee company from Sun Polytex Pvt. Ltd. and Sisarama Plastics Pvt. Ltd. should be treated as deemed dividends under Section 2(22)(e) of the Income Tax Act, 1961. The exception under sub-clause (ii) did not apply as money lending was not a substantial part of the lender's business. Additionally, deemed dividends are not exempt under Section 10(34) read with Section 115-O and are taxable in the hands of the recipient. The appeals were dismissed, and the ITAT's order was upheld.