2025 (5) TMI 94 - AT - Income Tax

Addition on account of deemed dividend u/s 2(22)(e) - case of the assessee was that there was no loan or advance received by the assessee much less from M/s Orient Craft Ltd. and further for that matter no loan was received by the assessee from M/s Olympus Realtors P. Ltd. and hence there was no question of any deemed dividend to be assessed in his hands. HELD THAT - Considering the fact that the issue involved in the present Appeals have been decided in favour of the Assessee and against the Department for both the Assessment Years 2014-15 and 2015-16 in the case of Sh. Sudhir Dhingra and Sh. Anoop Thatai 2022 (1) TMI 885 - ITAT DELHI as held there is substantial difference between investment and advance. A.O. has disregarded the nature of payment made by each entity to the other entity regarding which the factual findings recorded by CIT (A) in his order have attained finality in the absence of any rebuttal or any appeal preferred by Revenue. Ld. AO has disregarded also the effect of legal character of all the entities more so when there was nothing adverse found in the assessments of these entities. We have already mentioned earlier that section 2(22)(e) creates fiction which operates very harshly and settled principle of law that provisions of law of such a nature are required to be construed strictly more so in the light of factual findings as to the nature of these payments made by one entity to another recorded by CIT(A) against which revenue has made any rebuttal during the course of hearing. Therefore there is no question of treating the amount withdrawn by the assessee as partner from the partnership firm namely M/s SKA Enterprises in the nature of loan and advance and treat it as deemed dividend under section 2(22)(e) of the Income Tax Act. None of the ingredients of section 2(22)(e) stand satisfied in the instant case. We have through the written submissions also reproduced above where rebuttal of each and every adverse observation made by the assessing officer has been made by the assessee and we are in agreement with the assessee on all those rebuttals. Appeal of the Assessee allowed.

Summary

The core legal issues considered in the Appeals relate primarily to the applicability and interpretation of section 2(22)(e) of the Income Tax Act, 1961, concerning the treatment of certain loans or advances as deemed dividends for taxation purposes. Specifically, the Tribunal examined whether the additions made by the Assessing Officer (AO) on account of deemed dividend under section 2(22)(e) were justified, given the factual matrix involving multiple entities and the flow of funds among them. Additionally, issues concerning the jurisdiction of the AO under section 153A, the validity of the assessment proceedings, the requirement of prior approval under section 153D, and adherence to principles of natural justice were also raised and considered.

Regarding the jurisdictional challenge under section 153A, the Assessee contended that the AO lacked jurisdiction to initiate assessment proceedings as the necessary conditions for invoking section 153A were not met. The Assessee argued that the assessment framed under section 153A was therefore void ab initio. However, this issue was not extensively elaborated upon in the Tribunal's order, as the primary focus was on the substantive question of deemed dividend under section 2(22)(e).

The principal legal framework revolves around section 2(22)(e) of the Income Tax Act, which treats any loan or advance made by a closely held company to its shareholder (who holds more than 10% shares) as deemed dividend, taxable in the hands of the shareholder. The section creates a deeming fiction, and as such, its provisions are required to be strictly construed. The essential ingredients for invoking section 2(22)(e) include: (i) the loan or advance must be made by a closely held company; (ii) the recipient must be a shareholder holding more than 10% shares; and (iii) the loan or advance must be received directly from the company.

In the present case, the AO made additions on the ground that the Assessee received loans or advances from a closely held company, Orient Craft Ltd. (OCL), routed through various entities including Super Connection India Pvt. Ltd. (SCPL), Olympus Realtors Pvt. Ltd. (ORPL), and SKA Enterprises (SKAE). The AO alleged that these entities were used as conduits to circumvent the provisions of section 2(22)(e), thereby justifying the addition as deemed dividend.

The Assessee disputed these additions on multiple grounds. First, it was contended that the loan or advance was not received directly from OCL but from SKAE, a partnership firm, which is not a company and hence outside the scope of section 2(22)(e). Second, the Assessee argued that SCPL was an independent company, duly assessed to tax in earlier years, and not a paper or fictitious company as alleged by the AO. Third, the amounts withdrawn by the Assessee were in the capacity of a partner in SKAE and not as a shareholder receiving a loan or advance from a closely held company. Fourth, the Assessee emphasized that the flow of funds involved legitimate business transactions and capital investments, not loans or advances intended to be treated as dividends.

The Tribunal's interpretation and reasoning were anchored on a detailed examination of the facts and the legal provisions. It underscored the necessity of strict interpretation of section 2(22)(e) since it creates a deeming fiction. The Tribunal noted that the AO's own case admitted that the loan or advance was received by the Assessee from SKAE, a partnership firm, and not directly from OCL or ORPL, both closely held companies. This failure to satisfy the first essential ingredient of section 2(22)(e) was fatal to the AO's case.

Further, the Tribunal relied heavily on the factual findings recorded by the first appellate authority (CIT(A)), which were not challenged by the Revenue. These included findings that OCL had given advances to SCPL, which was an independent company, and that SCPL had made capital advances to ORPL, which in turn had invested in SKAE. The Tribunal emphasized that these entities maintained their separate legal identities and were assessed to tax independently, negating the AO's assertion of fictitious entities or sham transactions.

The Tribunal also rejected the AO's characterization of SCPL as a paper company, noting that mere operational conveniences, such as maintaining books at OCL's premises, did not convert SCPL into a paper company. The Tribunal held that the AO's conclusions on this point were based on arbitrary inferences unsupported by evidence.

Regarding the flow of funds, the Tribunal found that there was no fresh advance given by OCL to SCPL or by SCPL to ORPL during the relevant assessment years, a fact recorded by the CIT(A) and not disputed by the Revenue. Consequently, the assumption that the Assessee received loans or advances directly or indirectly from OCL or ORPL was unfounded. The Tribunal further held that amounts withdrawn by the Assessee as a partner of SKAE could not be treated as loans or advances from a closely held company, as such treatment would extend beyond the scope of the deeming provision.

The Tribunal also addressed the reliance placed by the Revenue on the Supreme Court decision in CIT v. Mukundray K. Shah, which upheld additions under section 2(22)(e) in a different factual context. The Tribunal distinguished the present case on facts, noting that the nature of transactions and the factual findings recorded by the CIT(A) were materially different and that the decision was therefore not applicable.

In respect of procedural issues, the Assessee contended that the AO passed the impugned assessment order without the requisite prior approval under section 153D, or that any such approval was mechanical and without application of mind, rendering the assessment invalid. The Tribunal referred to judicial precedents holding that mechanical approvals without application of mind are no approvals in the eyes of law. However, the Tribunal did not elaborate extensively on this point in the final order, focusing primarily on the substantive issue of deemed dividend.

The Assessee also raised the issue of violation of natural justice, alleging that the assessment order was passed without giving adequate opportunity. This contention was noted but not specifically addressed in detail by the Tribunal, as the substantive findings on the merits rendered the additions unsustainable.

The Tribunal's application of law to facts led to the conclusion that none of the ingredients of section 2(22)(e) were satisfied. The loans or advances were not received directly or indirectly from a closely held company, the entities involved maintained their separate legal identities, and the amounts withdrawn by the Assessee were in the capacity of a partner in a partnership firm. The Tribunal held that the AO had disregarded the legal character of the entities and the nature of transactions, which was impermissible.

The Tribunal treated the competing arguments by giving due consideration to the AO's findings and the Revenue's reliance on judicial precedents but ultimately found the factual matrix and the legal requirements of section 2(22)(e) not satisfied. The Tribunal also accorded weight to the unchallenged findings of the CIT(A) and the principle of strict construction of deeming provisions.

Consequently, the Tribunal allowed the Assessee's Appeal for Assessment Year 2014-15 by deleting the addition made under section 2(22)(e) and dismissed the Revenue's Appeal for Assessment Year 2015-16, following the principle of consistency as the issues and facts were substantially similar in both years. The Tribunal relied on its earlier orders in related cases involving other Assessees from the same group, which had been decided in favor of the Assessees on identical issues.

Significant holdings of the Tribunal include the following verbatim excerpts encapsulating the legal reasoning:

"It is noted that in order to attract the fiction of section 2(22)(e), it is essential that the elements of that section must be found applicable. Since section 2(22)(e) treats the loan or advance as dividend, hence it is essential to give a strict interpretation to such fiction."

"There is no loan or advance received by the assessee from M/s Orient Crafts Ltd. It is seen that even as per the case of the A.O. made in the assessment order, the loan or advance has been received by the assessee from M/s SKA Enterprises which was a partnership firm. Therefore, as per the admitted case of the A.O., such loan or advance having not been received by the assessee from a closely held company i.e. from Orient Craft Ltd. or Olympus Realtors P Ltd. cannot be treated as dividend u/s 2(22)(e), since the first ingredient of section 2(22)(e) itself is not met in this case."

"When M/s Super Connection India P. Ltd. which was an independent assessee and has been assessed to tax and when advance has admittedly been given by M/s Orient Craft Ltd. to M/s Super Connection India P. Ltd., how can it be assumed or held that the assessee received any loans and advance from M/s Orient Craft Ltd. After all the corporate identity and character and an independent status as an independent assessee and that too unrelated to the assessee that M/s Super Connection India P. Ltd. enjoys, such status cannot be permitted to be breached."

"Such amount so withdrawn by the assessee in the capacity of the partner of the said firm cannot be covered within the meaning of deemed dividend under section 2(22)(e) of the Income Tax Act."

"The reliance of the decision of Hon'ble Supreme Court decision in the case of 'CIT Vs Mukundray K. Shah' is misplaced in the background of the facts of this case and the fact of that case more so when in the instant case the nature of payment by one entity to another has been held to be of a particular character by CIT(A) against which revenue is not in appeal."

"Section 2(22)(e) creates deeming fiction which gets triggered when the conditions mentioned in the section are met and not otherwise. It is a settled principle of law that the deeming provisions are required to be construed strictly and nothing beyond which has been contemplated in the section can be inferred nor can it be extended."

Core principles established include the strict construction of deeming provisions under section 2(22)(e), the necessity of direct receipt of loans or advances from a closely held company for invoking deemed dividend provisions, the recognition of separate legal entities and their independent tax status, and the inadmissibility of disregarding the legal character of entities without evidence. The Tribunal also reaffirmed that mechanical approvals without application of mind under procedural provisions are invalid.

In final determinations, the Tribunal held that the additions made by the AO under section 2(22)(e) were unsustainable on facts and law, and accordingly deleted the additions for Assessment Year 2014-15 and upheld the deletion for Assessment Year 2015-16. The Appeals of the Assessee were allowed, and the Appeals of the Revenue were dismissed, following consistent reasoning applied in related cases.