From: CABHUPENDRASHAH <ca.bhupendrashah@...>
Subject: [globalIndianCAs] I-T - Sec 2(22)(e) - Deemed dividend can be taxed only in hands of person who is
To: globalIndianCAs@yahoogroups.com
Date: Monday, 22 December, 2008, 9:27 PM

I-T - Sec 2(22)(e) - Deemed dividend can be taxed only in hands of
person who is shareholder of lender company and not in hands of non-
shareholders; Word shareholder refers to both registered as well as
beneficial - if a person is registered shareholder but not
beneficial, provisions of Sec 2(22)(e) will not apply: ITAT SB

MUMBAI, DEC 22, 2008 : SECTION 2(22)(e) in the Income Tax Act is
related to dividend income. From the AY 1988, the CBDT also
introduced the concept of deemed dividend. And the objective was to
curb the mischief of closely-held group companies making loans and
advances to another concern only to benefit the shareholders having
substantial interest in that. However, for the assessing officer it
became a rampant practice to invoke the deeming fiction to bring all
sorts of payments under the tax net. One such case was referred to
the Special Bench which has in an interesting and lucidly explained
decision, held that deemed dividend can be assessed only in the
hands of a person who is a shareholder of the lender company and not
in the hands of a person other than a shareholder.

The Bench also observed that the expression shareholder referred to
in Sec.2(22)(e) refers to both a registered shareholder and
beneficial shareholder. If a person is a registered shareholder but
not the beneficial shareholder then the provisions of Sec 2(22)(e)
will not apply. Similarly if a person is a beneficial shareholder
but not a registered shareholder then also the provisions of Sec 2
(22)(e) will not apply.

Let's take a look at the matrix of facts

The Assessee, Bhaumik Colour Pvt. Ltd. (BCPL) is a company engaged
in the business of manufacture of pencil-paints. BCPL took an
interest bearing loan of Rs. 9 lakhs from M/s Umesh Pencils Pvt.
Ltd. (UPPL). It was observed by the Assessing Officer that though
BCPL is not a shareholder of UPPL, both the companies had one common
shareholder i.e. Narmadaben Nandlal Trust(NNT). The said trust was
holding 20% shares in BCPL i.e., holding substantial interest and
10% shares in UPPL. The Assessing Officer was of the view that the
said transaction was covered by the second limb of provisions of
section 2(22) (e).

According to the Assessee the shares were held in the name of three
trustees for and on behalf of the Trust NNT and that the
beneficiaries of the trust were five in number and none of the
trustees were beneficiaries of the trust. The Assessee contended
that to invoke the second limb of the provisions of section 2(22)(e)
the primary condition was that NNT must be both a registered
shareholder arid also beneficial shareholder. Since the Trustees of
NNT held the shares on behalf of the Trust only as legal owners and
were not the beneficial owners of the shares, the provisions of Sec.2
(22)(e) could not be invoked. The AO however did not agree with the
contentions on behalf of the Assessee and taxed Rs. 9 lakhs in the
hands of BCPL as deemed dividend.

On appeal by the Assessee the CIT(A) deleted the addition made by
the AO for the reason that NNT was not beneficial shareholder of
shares in BCPL or UPPL and therefore the second limb of the
provisions of Sec.2(22)(e) could not be applied vis-a-vis the
Assessee.

Aggrieved by the order of CIT(A) the revenue has preferred an appeal
before the Tribunal which observed that,

++ Section 2(6A)(e) of the Income Tax Act, 1922 as introduced by the
Finance Act, 1955 corresponds to Section 2(22)(e) of the Income Tax
Act, 1961;

++ Under the 1922 Act, two categories of payment were considered as
Dividend viz., (a) any payment by way of advances or loan to a
shareholder was considered as dividend paid to shareholder or (b)
any payment by any such company on behalf or for the individual
benefit of a shareholder was considered as dividend.

++ In the 1961 Act, the very same two categories of payment were
considered as Dividend but an additional condition that payment
should be to a shareholder being a person who is the beneficial
owner of shares and who has a substantial interest in the company
viz., shareholding which carries not less than twenty percent of the
voting power, was introduced.

++ By the 1987 amendment w.e.f. 1.4.88, the condition that payment
should be to a shareholder who is the beneficial owner of shares
(not being shares entitled to a fixed rate of dividend whether with
or without a right to participate in profits) holding not less than
ten percent of the voting power was substituted. By the very same
amendment a new category of payment was also considered as dividend
viz., payment to any concern in which such shareholder is a member
or a partner and in which he has a substantial interest. Substantial
interest has been defined to mean holding of shares carrying 20% of
voting power.

++ The provisions of Sec.2(22)(e) creates a fiction bringing in
amounts paid otherwise than as dividend into the net of dividends.
Therefore this clause must be given a strict interpretation.

++ The words "Shareholder" alone existed in the Definition of
Dividend in the 1922 Act. The expression "Shareholder" has been
interpreted under the 1922 Act to mean a registered shareholder.
This expression "Shareholder" found in the 1961 Act has to be
therefore construed as applying only to registered shareholder.

++ In the 1961 Act the word "Shareholder" is followed by the
following words "being a person who is the beneficial owner of
shares". This expression used in Sec.2(22(e) both in the 1961 Act
and in the amended provisions w.e.f. 1.4.88 only qualifies the
word "Shareholder" and does not in any way alter the position that
the shareholder has to be a registered shareholder. These provisions
also do not substitute the aforesaid requirement to a requirement of
merely holding a beneficial interest in the shares without being a
registered holder of shares.

++ The expression "being" is a present participle. A participle is a
word which is partly a verb and partly an adjective. In Section 2(22)
(e), the present participle "being" is used to describe the noun
shareholder like an Adjective. The expression "being a person who is
the beneficial owner of shares" is therefore a further requirement
before a shareholder can be said to fall within the parameters of
Sec.2(22)(e) of the Act.

++ In the 1961 Act, Sec.2(22)(e) imposes a further condition that
the Shareholder has also to be beneficial owner of shares (not being
shares entitled to a fixed rate of dividend whether with or without
a right to participate in profits) holding not less than ten per
cent of the voting power.

++ The expression "shareholder being a person who is the beneficial
owner of shares" referred to in first time of Sec.2(22)(e) refers to
both a registered shareholder and beneficial shareholder. If a
person is a registered shareholder but not the beneficial
shareholder than the provisions of Sec.2(22)(e) will not apply.
Similarly if a person is a beneficial shareholder but not a
registered shareholder then also the first limb of provisions of
Sec.2(22)(e) will not apply.

++ In this case, NNT held shares in UPPL and BCPL only as a legal
and registered owner but not as a beneficial owner. In the case of
the Assessee it is seen that the three trustees of NNT held shares
in UPPL and BCPL only as a legal and registered owner. They held
shares for and on behalf of 5 beneficiaries of the trust who are
different individuals. They were therefore not beneficial owners of
the shares.

++ Trust ownership is a peculiar instance of duplicate ownership.
Trust property is, in fact, owned by two persons simultaneously in
the sense that one is under an obligation to use the property for
the benefit of the other. The ownership of the trustee called trust
ownership is nominal rather than real. The beneficiary interest is
called the beneficial interest. The trustee is to administer the
property of another person but the ownership right in the trustee is
to be used only on behalf of the real owner. As between trustee and
third party ownership conferred on the trustee fictitiously by law
prevails, that is, the trustee is clothed with the rights of the
beneficiary and is so enable to personate or represent him in
dealings with the world at large. The main purpose of Trusteeship is
to protect the rights and interest of person who for any reason are
unable effectively to protect them for themselves. Such protection
is required for four classes of people. (a) unborn persons; (b)
infants, lunatics, or other disqualified persons; (c) a large number
of persons who are interested in common and (d) persons having
conflicting interest in the same property, i.e., an owner and an
encumbrancer or different kinds of encumbrancers. Therefore the
first requirement of holding of shares both as a legal registered
owner and beneficial owner of such shares is not satisfied in the
case of the Assessee. Therefore provisions of Sec.2(22)(e) would not
be applicable at all to the case of the Assessee.

++ The expression shareholder referred to in Sec.2(22)(e) refers to
both a registered shareholder and beneficial shareholder. If a
person is a registered shareholder but not the beneficial
shareholder than the provisions of Sec.2(22)(e) will not apply.
Similarly if a person is a beneficial shareholder but not a
registered shareholder then also the provisions of Sec.2(22)(e) will
not apply.

++ provisions of Sec.2(22)(e) which brought in a new category of
payment which was to be considered as dividend as introduced by the
Finance Act 1987 w.e.f. 1.4.88 viz., payment by a company "to any
concern in which such shareholder is a member or a partner and in
which he has a a substantial interest" do not say as to in whose
hands the dividend has to be brought to tax, whether in the hands of
the "concern" or the "shareholder" .

++ The intention behind enacting provisions of Sec 2(22)(e) are that
closely held companies, which are controlled by a group of members,
even though the company has accumulated profits would not distribute
such profit as dividend because if so distributed the dividend
income would become taxable in the hands of the shareholders.
Instead of distributing accumulated profits as dividend, companies
distribute them as loan or advances to shareholder or to concern in
which such shareholders have substantial interest or make any
payment on behalf of or for the individual benefit of such
shareholder.

++ In such an event, by the deeming provisions such payment by the
company is treated as dividend. The intention behind the provisions
of section 2(22)(e) is to tax dividend in the hands of shareholder.
The deeming provisions as it applies to the case of loans or
advances by a company to a concern in which it's shareholder has
substantial interest, is based on the presumption that the loan or
advances would ultimately be made available to the shareholders of
the company giving the loan of advance. The intention of the
legislature is therefore to tax dividend only in the hands of the
shareholder and not in the hands of the concern.

++ The basis of bringing in the amendment to Sec.2(22)(e) of the Act
by the Finance Act, 1987 is to ensure that persons who control the
affairs of a company as well as that of a firm can have the payment
made to a concern from the company and the person who can control
the affairs of the concern can draw the same from the concern
instead of the company directly making payment to the shareholder as
dividend. The source of power to control the affairs of the company
and the concern is the basis on which these provisions have been
made. It is therefore proper to construe those provisions as
contemplating a charge to tax in the hands of the shareholder and
not in the hands of a non-shareholder viz., concern. A loan or
advance received by a concern is not in the nature of income. In
other words there is a deemed accrual of income even u/s.5(1)(b) in
the hands of the shareholder only and not in the hands of the payee
viz., non-shareholder (Concern). Sec.5(1)(a) contemplates that the
receipt or deemed receipt should be in the nature of income.
Therefore the deeming fiction can be applied only in the hands of
the shareholder and not the non-shareholder viz., the concern.

++ The definition of Dividend u/s 2(22)(e) of the Act is an
inclusive definition. Such inclusive definition enlarges the meaning
of the term "Dividend" according to its ordinary and natural meaning
to include even a loan of advance. Any loan or advance cannot be
dividend according to its ordinary and natural meaning. The ordinary
and natural meaning of the term dividend would be a share in profits
to an investor in the share capital of a limited, company. To the
extent the meaning of the word "dividend" is extended to loans and
advances to a shareholder of to a concern in which a shareholder is
substantially interested deeming them as Dividend in the hands of a
shareholder the ordinary and natural meaning of the word "Dividend"
is altered. To this extent the definition of the term "Dividend can
be said to operate.

++ If the definition of "Dividend" is extended to a loan or advance
to a non shareholder the ordinary and natural meaning of the word
dividend is taken away. In the light of the intention behind the
provisions of Sec.2(22)(e) and in the absence of indication in Sec.2
(22)(e) to extend the legal fiction to a case of loan or advance to
a non-shareholder also, we are of the view that loan or advance to a
non-shareholder cannot be taxed as Deemed Dividend in the hands of a
non-shareholder.