Seamist Properties (P.) Ltd. v. Income-tax Officer

A.D. Jain, Judicial Member.—By this appeal, the assessee is challenging the CIT(A)’s order dated 21-11-2000, for the assessment year 1997-98.

2. The assessee has raised the following grounds in this appeal :

"1.The CIT(A) erred in confirming the order of the Assessing Officer in respect of addition of Rs. 11,06,475 under section 2(22)(e) of the Act. The appellant submits that provisions of section 2(22)(e) do not apply to sum of Rs. 2,33,31,427 received by the appellant from Silvasa Estates Pvt. Limited in pursuance of understanding dated 9th February, 1997 between the appellant company and the said Silvasa Estates Pvt. Ltd. On following amongst other grounds :

(a )amount received by the appellant company was a deposit in terms of the aforesaid MOU, dated 9th February, 1997 and provisions of section 2(22)(e) only apply to either a loan or advance and deposit is neither a loan or advance.

(b)provisions of section 2(22)(e) are deeming provisions and therefore have to be interpreted strictly."

3. The assessee is engaged in the business of letting out of bungalow for film shooting etc. During the year, it had shown Rs.2,25,00,000 as loans and advances. It received an amount of Rs. 2,33,31,427 from M/s. Silvasa Estate Pvt. Ltd. in pursuance of Memorandum of Understanding dated 9-2-1997. As per this Memorandum of Understanding, the assessee and M/s. Silvasa Estate Pvt. Ltd. wanted to start a new company with a view to carry out editing, shooting, dubbing, recording and allied business in the name and style of M/s. Silvasa Entertainment Private Limited.

4. The Assessing Officer noted that the intended new business did not start and the amount of Rs. 2,33,31,427 given to the assessee remained with the assessee. It is stated on behalf of the assessee that the amount had been advanced in pursuance of the said Memorandum of Understanding. M/s. Silvasa Estate Pvt. Ltd. showed accumulated profits/reserves and surplus of Rs. 11,06,475 in its balance-sheet as on 31-3-1997. The Assessing Officer also found that Mr. Premchand Godha was holding about 50 per cent of the total shares of the assessee and about 36 per cent of the shares of M/s. Silvasa Estate Pvt. Ltd. One Mr. Nirmal Jain had about 50 per cent holding of the total shares of the assessee and about 43 per cent holding of M/s. Silvasa Estate Pvt. Ltd. In view of these facts, the Assessing Officer observed that it could be concluded that both the above persons had substantial interest in the said two companies and that the provisions of section 2(22)(e) were clearly applicable in this case. The amount of Rs. 11,06,475 was, thus, held taxable.

5. Before the learned CIT(A), it was submitted on behalf of the assessee that the assessee-company and another company in which the Directors were interested. The said deposit was accepted in the ordinary course of business and not as a loan or advance. Hence, it cannot be considered as "Dividend" under section 2(22)(e) of the Act. This amount was returned in the immediately succeeding year.

6. The learned CIT(A), in the order, dated 21-11-2000, observed that Mr. Nirmal Jain and Premchand Godha held/owned most of the shares of the two companies. M/s. Silvasa Estate Pvt. Ltd. had accumulated profits to the extent of Rs. 11,06,475. As per the Memorandum of Understanding entered into between the two companies, a new company was to be created, which was not done. The huge amount of Rs. 2,33,31,427 was lying with the assessee company during the year. In view of this, the dominant intention appears to be to avoid distribution of dividend. section 2(22)(e) was enacted to take care of just such a situation. The addition was therefore, upheld.

7. The contentions on behalf of the assessee before us, broadly, are that the amount received by the assessee company was a "deposit" in terms of the MOU dated 9-2-1997 whereas the provisions of section 2(22)(e) only apply to either a loan or advance, which the deposit is definitely not. It is further submitted that the provisions of section 2(22)(e) are deeming provisions, which have to be construed strictly.

8. The learned counsel for the assessee has sought to place reliance on paragraph 7 of the MOU, copies whereof have been placed before us. The said paragraph 7 of the MOU reads as under :

"7. . . As evidence of his willingness to carry on the business the party of the second part will deposit a sum of Rs. 2.25 crores with the party of the First part immediately on signing of this MOU."

9. The stress is on "deposit". It is submitted that from this paragraph 7 of the MOU, the intention of the parties is clear that the amount was to be given as "deposit". The deposit was given in pursuance of the agreement. The assessee had shown the amount under the head of "current liability and provisions". When it was felt that the project was not feasible, the agreement was cancelled and the deposit of Rs. 2.25 crores was returned. section 2(22)(e) applies to loan and advances, and not to deposit like the one in question here. The provisions of section 2(22)(e) comprise a deeming fiction, where loan or advance is treated as dividend. The objective of the legislature in enacting the deeming provisions was to prevent evasion of tax on dividend by closely held companies by resorting to loans to substantially interested shareholders, instead of paying dividend. This view was expressed by the Hon’ble Supreme Court in the case of Navnit Lal C. Javeri v. K.K. Sen AACIT [1965] 56 ITR 198. The object of section 2(22)(e), as per the Hon’ble Allahabad High Court in the case of Commissioner Of Income-Tax v. H.K Mittal [1996] 219 ITR 420¹, is to tax shareholders avoiding dividend tax. Non-shareholders cannot be taxed. In the assessee’s case, the assessee company is not a shareholder of M/s. Silvasa Estate Pvt. Ltd. Hence, the provisions of section 2(22)(e) cannot be applied. A deeming fiction should be carried to its logical end and according to the purpose for which it has been enacted. It cannot be extended further and interpreted to go beyond the legislative intent in creating it. Provisions relating to deemed dividend relate to taxing notional income. So, these provisions require strict interpretation. When two views are possible, that supporting the assessee must be adopted. A deposit is not a loan or advance. Advance is something which is paid to a person before it is due.

10. The Hon’ble Supreme Court, in Navnit Lal C. Javeri’s case (supra) has held by a majority view, inter alia, that if the legislature realizes that private controlled companies generally adopt the device of making advances or giving loans to their shareholders with the object of evading tax, it can step in to meet this mischief and create a fiction by which the amount ostensibly and nominally advanced to a shareholder as a loan is treated in reality for tax purposes as the payment of dividend to him. In making the fiction the legislature does not travel beyond the legislative field assigned to it by entry 82 in List I of Schedule VII of the Constitution of India. Bringing in a deeming fiction in a taxing statute has thus been held to be within legislative competence, in order to avoid tax evasion on dividends by closely-held companies.

11. The amended section 2(22)(e) which we are presently concerned with, was brought on the statute by virtue of the Finance Act, 1987. The CBDT, vide its Circular No. 495, dated 22-9-1987 : [1987] 168 ITR (St.) 87, has in the Explanatory Notes on provisions relating to direct taxes contained in the Finance Act, 1987, explained, inter alia, the provisions of section 2(22)(e). It states that sections 104 to 109, which related to levy of additional tax on certain closely-held companies (other than those in which the public are substantially interested) if they failed to distribute a specific percentage of their distributable profits as dividends, had lost much of their relevance with the introduction the maximum marginal rate of personal tax to 50 per cent, which was lower than the rate for corporation tax on closely-held companies. Therefore, sections 104 to 109 stood omitted by the Finance Act, 1987. However, due to such deletion, there was a likelihood of closely-held companies not distributing their profits to shareholders by way of dividends, but by way of loans or advances so that these be not taxed in the hands of the shareholders. It was to forestall this manipulation that section 2(22)(e) was amended suitably. Under the extant provisions of the said section, payments by way of loans or advances to shareholders having substantial interest in a company to the extent to which the company possessed accumulated profits, were treated as dividend. The shareholders having substantial interest were those having a shareholding carrying not less than 20 per cent voting power as per the provisions of section 2(32). The amendment of the definition extended its application to payments made to a shareholder holding not less than 10 per cent of the voting power, or to a concern in which the shareholder was having substantial interest.

12. The amended provisions of section 2(22)(e) are, thus, to apply in a case where a shareholder has 10 per cent or more of the equity capital, so explains the Board in the said Circular. Further, deemed dividend is to be taxed in the hands of a concern where all the following conditions are satisfied :

(i)where the company makes the payment by way of loans or advances to a concern;

(ii)where a member or a partner of the concern holds 10 per cent of the voting power in the company; and

(iii)where the member or partner of the concern is also beneficially entitled to 20 per cent of the income of such concern.

"Concern" as per section 2(22) Explanation 3(a) means an HUF or a firm or an association of persons or a body of individuals or a company. A shareholder having a substantial interest in a concern as per the said Explanation 3 part ( b) is deemed to be one beneficially entitled to not less than 20 per cent of the income of such concern.

13. section 2(22)(e) as explained by the CBDT in the said Circular, is clearly not attracted to the facts of the present case. As per the agreement between the assessee and Silvasa the assessee was to lease its bungalow to a new company to be formed. Silvasa agreed to contribute Rs. 2.50 crores in the said proposed new company, for purchasing machinery and equipment and setting up a studio at the said bungalow. Silvasa further agreed to deposit Rs. 2.25 crores with the assessee immediately on signing the MOU, to show its bona fides. As per paragraph 8 of the agreement, in the event of the proposed project not coming through, the MOU was to stand cancelled and the assessee was to refund the deposit of Rs. 2.25 crores to Silvasa. It did so happen. All these facts remain unrebutted. From this factual matrix, it is evident that the provisions of section 2(22)(e) are, in no way, applicable.

14. It is the objective of section 2(22)(e) to tax shareholders intending to avoid dividend tax. Non-shareholders cannot be taxed taking recourse to this section. The Hon’ble Allahabad High Court in H.K. Mittal’s case (supra) has held that the chief ingredient of dividend as defined in section 2(22)(e) is that the recipient should be a shareholder on the date the loan was advanced and if such fact does not stand established, the advance (sic) deemed dividend. In that case the fact that the assessee was not a shareholder had not been challenged. As such, no question of law was held to have arisen. Likewise, in the present case, the assessee is not a shareholder of Silvasa. So, section 2(22)(e) is inapplicable.

15. In the following cases, it has been held to the effect that a deeming fiction should be carried to its logical end, in accord with the purpose of its enactment and no further :

(i) CIT v. P.K. Badiani [1970] 76 ITR 369 (Bom.)

(ii) CIT v. Hindustan Petroleum Corpn. Ltd. [1991] 187 ITR 1¹ (Bom.)

(iii) CIT v. Amarchand B. Doshi [1992] 194 ITR 56² (Bom.),

(iv) Caltex Oil Refining (India) Limited v. Commissioner Of Income-Tax. [1993] 202 ITR 375 ³ (Bom.)

(v) Commissioner Of Income-Tax v. Shrishakti Trading Co. [1994] 207 ITR 442⁴ (Bom.)

In the case before us, however, the taxing authorities have stretched the deeming fiction, contained in section 2(22)(e) beyond its outer reaches in applying the said provision to the assessee who clearly does not come within its four-corners.

16. The Hon’ble Supreme Court has held in CIT v. Shaan Finance (P.) Ltd. [1998] 231 ITR 308¹, inter alia that in interpreting a fiscal statute, the Court cannot proceed to make good the deficiencies if there be any. It must interpret the statute as it stands and in case of doubt, in a manner favourable to the taxpayer. So, while taxing notional income, the provisions relating to deemed dividend, like the ones comprised in section 2(22)(e) of the Income-tax Act, need to be interpreted not loosely, as the lower authorities have chosen do to, but strictly.

17. That deposits are not loans stands well settled by the following judicial pronouncements, amongst others :

(i) A. M. Shamsunder v. Union of India [2000] 244 ITR 266² (Mad.)

(ii) CIT v. Eetachi Agencies [2001] 248 ITR 525³ (Bom.)

(iii) Baidya Nath Plastic Industries (P.) Ltd. v. K.L. Anand, ITO [1998] 230 ITR 522 (Delhi)

(iv) ITO v. Pradip Kumar Rathi [2003] 85 ITD 309 (Gauhati)

(v) Industrial Enterprises v. Dy. CIT [2000] 73 ITD 252 (Hyd.)

(vi) Balaji Traders v. Dy. CIT [2001] 78 ITD 368 (Pune).

The subordinate authorities have erred in interpreting the deposit in question to mean a loan.

18. It is also well established in the following decisions that a deposit is not an advance :

(i) CIT v. K. Srinivasan [1963] 50 ITR 788 (Mad.); and

(ii) M.A. Jindal v. CIT [1987] 164 ITR 28⁴ (Cal.)

An advance, as opposed to a deposit, is something paid to a person before it is due. Here, however, the amount in question was certainly not paid before it was due. The agreement between the assessee and Silvasa is categorical in this regard. Also, the factum of such payment in the manner alleged is not refuted by the Revenue. The authorities have just dubbed it as an advance which by no means it is.

19. Still further, the Department has not made out any case of avoidance of tax at the hands of the assessee. That being so, the decision in McDowell [1985] 154 ITR 148 (SC) has no application. There is no colourable devise or subterfuge contrived by the assessee.

20. So, the case looked at from any angle, the provisions of section 2(22)(e) have been misconstrued and misapplied. The amount of Rs. 2,33,31,427 was received by the assessee company from M/s. Silvasa Estates Pvt. Ltd. in pursuance of the Memorandum of Understanding arrived at between them on 9-2-1997, as a deposit and not as a loan or an advance.

21. For the above discussion, the appeal of the assessee deserves to succeed.

22. Resultantly, the appeal is allowed.