Contributions for Business and Commercial Purposes Not Considered Deemed Dividend u/s 2(22)(e): ITAT [Read Order]

The Surat Bench of Income Tax Appellate Tribunal ( ITAT ) held that contributions made for business and commercial purposes do not qualify as deemed dividend under Section 2(22)(e) of Income Tax Act,1961.

International Creations Pvt. Ltd.,appellant-assessee, was issued an information notice by the ITO, Ward-1(2)(2), Surat, alleging failure to deduct Tax Deducted at Source ( TDS ) under Section 194 of the Income Tax Act. It was stated that the company had advanced ₹39,50,000 during FY 2014-15 to M/s. Gulmohar Knitting without charging interest.

Since a director of M/s. Gulmohar Knitting held 33.36% shareholding in the assessee-company, the amount was considered as deemed dividend under Section 2(22)(e), on which TDS at 10% was required to be deducted and deposited with the Government.

As the assessee had not deducted TDS, the Assessing Officer (AO) issued show cause notices proposing action under Sections 201(1) and 201(1A). The assessee contended that the payment was not a loan or advance but a capital contribution towards partnership in M/s. Gulmohar Knitting, formed to install knitting machinery.

It further stated that the firm admitted the assessee as a partner on 02.06.2014 and that the assessee retired from the partnership on 27.03.2015. Hence, the amount was shown as partners’ capital and not a loan, and therefore, provisions of Section 194 were inapplicable since the recipient was not a shareholder.

The AO, however, did not accept the explanation, observing that the director had substantial interest in the firm. Referring to the unsecured loan confirmation and the company’s reserves of ₹6,04,35,062, the AO held that ₹39,50,000 was a deemed dividend and that TDS of ₹3,95,000 should have been deducted. Consequently, the assessee was treated as in default under Section 201(1) and interest of ₹3,31,800 was charged under Section 201(1A), creating a total demand of ₹7,26,800.

On appeal, the Commissioner of Income Tax (Appeals)[CIT(A)] upheld the AO’s decision, holding that deemed dividend under Section 2(22)(e) attracted TDS under Section 194, and dismissed the appeal.

Aggrieved by the CIT(A)’s order assessee appealed before the tribunal.

The two member bench comprising Dinesh Mohan Sinha (Judicial Member) and Bijayananda Pruseth (Accountant Member) heard both sides and reviewed the material on record along with the case laws cited by the authorised representative.

It noted that Section 2(22)(e) treated certain loans or advances made by a closely held company to a concern in which a substantial shareholder had interest as deemed dividend, provided such payment was not in the ordinary course of business.

On examining the partnership deed dated 26.09.2014, the tribunal found that the assessee-company had been admitted as a partner in M/s. Gulmohar Knitting and that ₹39,50,000 had been credited as partner’s capital, not as a loan.

The retirement deed dated 27.03.2015 also confirmed that the withdrawal made by the company was part of its retirement proceeds and not repayment of any loan. The tribunal observed that the AO had ignored these documents while treating the amount as deemed dividend.

It further referred to the order of the CIT(A) in the case of Shri Ashok Kumar Jindal, where similar transactions were held to be capital contributions and not loans or advances, and noted that the departmental representative had not brought any contrary evidence.

Relying on judicial precedents such as Creative Dyeing & Printing Pvt. Ltd. and Pradip Kumar Malhotra, the tribunal held that amounts contributed for commercial or business purposes did not fall within the ambit of deemed dividend.

Based on the facts and precedents, the appellate tribunal concluded that the amount of ₹39,50,000 represented capital contribution towards the partnership firm and not a loan or advance. The transaction was carried out for business purposes to facilitate a bank loan.

Therefore, no TDS was deductible under Section 194, and the assessee could not be treated as in default under Section 201(1) or made liable for interest under Section 201(1A). The Tribunal, accordingly, deleted the demand and interest, holding that the AO’s action was not in accordance with law.

Accordingly the appeal was allowed.

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