Advances given to shareholder for business purposes not under the ambit of “Deemed Dividend” provisions

Brief Facts:

• The assessee is a private limited company engaged in the business of manufacturing of HR/CR sheets and trading of MS plates. In the course of assessment proceedings, the A.O. noticed that the assessee has availed unsecured loans from group concern M/s Krishna Sheets Processors Pvt. Ltd. (lender). It was found that the assessee is holding 21.45% shareholding in the lender company.
• The A.O. considered such loans to fall within the ambit of section 2(22)(e) of the Act as “deemed dividend” and made additions to income.

Assessee’s submissions:

• The transactions of the loan were carried out in the ordinary course of money lending, which is a substantial part of business of lending company M/s Krishna Sheet Processors Private Limited and hence, covered by the exception provided in clause (ii) of section 2(22)(e) of the Act.
• The transactions were in the nature of inter-corporate deposit (ICD) between KSPPL and appellant company and hence, it cannot be termed as loans and advances.
• However, The AO has stated that the deployment of funds in loans and advances on which interest is earned is only 10.25% of the gross turnover of lending company. Therefore, money lending cannot be considered as substantial part of business of lending company. He stated that the total turnover w.r.t deployment of funds to earn interest ratio is 10:1 in favour of turnover approximately. Hence, as per the criteria laid down by the Hon’ble Bombay High Court in its decision in the case of Parle Plastics Limited, the appellant case is not covered by exceptions of section 2(22)(e).
• To rebute the A.O.’s claim, the assessee submitted that the Hon’ble Calcutta High Court in its decision in the case of Pradipkumar Malhotra has held that not every advance or loan to a shareholder is liable to be taxed as deemed dividend u/s 2(22)(e), but, only gratuitous loans advanced by the company to shareholders can be treated as deemed dividend.

The court held as follows:

“The phrase ‘by way of advance or loan’ appearing in the section 2(22)(e) must be construed to mean those advances or loans which a shareholder enjoys for simply on account of being a person who is the beneficial owner of shares. But if such loan or advance is given to such shareholder as a consequence of any further consideration which is beneficial to the company received from such shareholder, in such case, such advance or loan cannot be said to be deemed dividend. Thus, only gratuitous loan or advance given by a company to shareholders would come within the purview of section 2(22) but not to the cases where the loan or advance is given in return to an advantage conferred upon the company by such shareholder.”

• The appellant submitted that these loans were not advanced interest free loans. The lending company has charged interest 12% on such loans and hence, these loans are not gratuitous in nature.
• The appellant has submitted that the AO himself has allowed interest paid by the appellant company to KSPPL while computing business income of the appellant company on the amount so received from KSPPL which was assessed as deemed dividend.
• The appellant further relied upon the decision in the case of ITO vs. Krishnomics Limited in which the Jurisdictional Tribunal has held that for the purpose of determining as to whether the lending company is substantially engaged in the money lending business, income criteria need not required to be followed and such aspects needs to be examined w.r.t. the deployment of funds in such activity to the total available funds. One must see the main objects and the deployment of funds of the payer-company. If it is found that the payer company had money lending as its main objects and funds deployed during the course of money lending business were substantial as compared to the total funds deployed, then the amount given by such payer company to any other company will not attract provisions of section 2(22)(e).
• As per the criteria laid down by the above ruling, the appellant submitted that the percentage of assets representing investment and financing activity of lending company is 59.51% of the entire funds.

Order by CIT(A):

Taking into account the ratios laid down by the decisions as discussed above, it is held that the lender company i.e. Krishna Sheet Processors Pvt. Ltd. had lending of money as a substantial part of its business during the F.Y. 2010-11 and the loan to the appellant has been advanced in the ordinary course of its business. Accordingly, such loan cannot be taxed as deemed dividend in the hands of the appellant. Aggrieved by the order of CIT(A), the Revenue preferred appeal before the Tribunal.

Submission of assessee before Tribunal:

• The learned counsel for the assessee broadly divided his contentions in three parts;

(a) the unsecured loan received was in the ordinary course of business and such transactions have occurred in the earlier years also when the shareholding of the assessee company in the lending company was less than the threshold limit.
(b) The lender company was substantially engaged in the money lending activity and has charged interest on the money lent to the assessee.
(c) The transactions carried out between the lender company and assessee are in the nature of deposit in contrast to loans and advances and therefore falls outside the purview of section 2(22)(e) of the Act.

• The assessee holds 21.45% shares of M/s KSPPL (lender) and the lender company also hold 40.83% in equity share capital of the appellant company. Thus, both the companies have cross shareholdings in each other.
• Both the assessee and the lender company are in the same line of business and are stated to be acting for mutual benefits/ business of each other due to cross holding and common management. Major raw materials for both concerns are steel and the same is procured from same supplier and the negotiations are made in consolidated manner to get price advantage.
• It is claimed that to get the price advantage, temporary funds were provided by the lender company to the assessee in order to make onward payments to the supplier. It is thus claimed that advancing of funds to assessee was meant for business exigencies only and in the course of business.
• The lender has been advancing funds to the assessee when assessee was not its shareholder at all right from A.Y. 2009-10 whereas the assessee acquired significant shareholding in lender company during the AY 2011-12 only. It is thus the case of assessee that transactions of borrowal in ordinary course of business to achieve economy of sale is outside the purview of section 2(22)(e) of the Act.
• The lender advances funds to the assessee in the ordinary course of business and money lending is substantial part of its business. Interest income earned in money lending activity has been offered and assessed under the head “business income” in the hands of lending company.
• As further stated, the lender advanced funds to the assessee by way of inter-corporate deposits (ICD) and the lending was done on the similar rate of interest on which funds were advanced to the unrelated parties and hence all the transactions were at arm’s length.

Tribunal’s observation & Verdict:

• We find merit in the argument advanced on behalf of the assessee that the money was lend to the assessee in the ordinary course of business for fulfilment of business supply through consolidated negotiation.
• It is also demonstrated by the assessee that similar advance was obtained in the earlier years right from A.Y. 2009-10 when the assessee was not a shareholder in the lender company at all.
• It is also the case of the assessee that the lender company was substantially engaged in the money lending activity. Furthermore, the lender company has charged interest on loans advanced to the assessee. In these facts, the case of the assessee is squarely covered by the decision of the Hon’ble Gujarat High Court in PCIT vs. Mohan Bhagwat Prasad Agrawal [2020] 115 taxmann.com 69 (Gujarat) & CIT vs. Parle Plastics Limited (2011) 332 ITR 63 (Bombay).
• Section 2(22)(e) of the Act required money so lent to be only ‘substantial part’ of business and in contracts to the ‘principal business’ as wrongly assumed by the A.O.
• Thus, seen from any angle, no addition could be made by way of deemed dividend in the case of the assessee as rightly held by the CIT(A). In result, the appeals of the Revenue are dismissed.

Read Complete Judgement: ACIT Vs. Krishna Coil Cutters Pvt. Ltd.