S. 2(22)(e): Any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be “dividend” on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance. However, the legal fiction in s. 2(22)(e) does not extend to, or broaden the concept of, a “shareholder”

In CIT vs. Ankitech Pvt Ltd (2012) 340 ITR 14, the Delhi High Court was concerned with a case where the assessee, a company, received advances of Rs. 6.32 crores by way of book entry from Jacksons Generators Pvt. Ltd, a closely held company. The shareholders having substantial interest in the assessee company were also having 10% of the voting power in Jacksons Generators. The AO & CIT(A) held that as the shareholders who held substantial interest in Jacksons Generators also also had substantial interest in the assessee company, for purposes of s. 2(22)(e), the amount received by the assessee from Jacksons constituted “advances and loans” and was assessable as deemed dividend. On appeal, the Tribunal, relying on Bhaumik Colour 313 ITR 146 (Mum) (SB), deleted the addition on the ground that though the amount received by the assessee by way of book entry was “deemed dividend” u/s 2(22)(e), it was not assessable in the hands of assessee company as it was not a shareholder of Jacksons Generators. On appeal by the department to the High Court, the High Court dismissed the appeal on the basis that:

(i) U/s 2(22)(e), any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be “dividend” on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance.

The legal fiction in s. 2(22)(e) enlarges the definition of dividend but does not extend to, or broaden the concept of, a “shareholder”. As the assessee was not a shareholder of the paying company, the “dividend” was not assessable in its hands (Bhaumik 313 ITR 146 (Mum) (SB), approved in Universal Medicare 324 ITR 363 (Bom) & Hotel Hilltop 313 ITR 116 (Raj) followed);

(ii) As the conditions stipulated in s. 2(22)(e) treating the loan and advance as deemed dividend are established in these cases, it is open to the Revenue to take corrective measure by treating this dividend income at the hands of the shareholders and tax them accordingly as otherwise it amounts to escapement of income at the hands of those shareholders.