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Facts
The assessee, a director in Saraf Yarn Pvt. Ltd., received a loan of Rs. 25,58,638/- from the company. The Assessing Officer (AO) treated this loan as deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961, considering the assessee's shareholding at certain points during the financial year. The CIT(A) upheld the AO's order.
Held
The Tribunal held that Explanation 3 to Section 2(22)(e) is applicable only to 'concerns' other than companies. For companies, the test of shareholding percentage for deeming a loan as dividend should be at the relevant point of time in the previous year. Since the assessee's shareholding fell below 10% at the end of the financial year, Section 2(22)(e) was not attracted.
Key Issues
Whether a loan received by a director from a company can be treated as deemed dividend under Section 2(22)(e) when shareholding falls below the prescribed threshold at the end of the financial year, and if Explanation 3 to Section 2(22)(e) applies to companies.
Sections Cited
2(22)(e), 250, 271(1)(c)
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Income Tax Appellate Tribunal, “SMC” BENCH, MUMBAI
Before: SHRI PAWAN SINGH, JM &
(Assessment Year: 2013-14) Vinita Pawankumar Saraf, ITO, Ward-42(1)(5), 1207-B, Green park, Raheja Estate, Kautilya Bhavan, G Block, Vs. Borivali East, Mumbai-400066. Bandra Kurla Complex, PAN: AAZPS4472P Bandra (East), Mumbai-400051. Appellant) : Respondent) Appellant /Assessee by : Shri Krupa Jimit Shah, CA (Virtually) Revenue / Respondent by : Shri Surendra Mohan, Sr. DR : 07.07.2025 Date of Hearing : 16.07.2025 Date of Pronouncement O R D E R Per Padmavathy S, AM:
This appeal by the assessee is against the order of the Commissioner of Income Tax (Appeals)/ National Faceless Appeal Centre (NFAC), Delhi [In short 'CIT(A)'] passed under section 250 of the Income Tax Act, 1961 (the Act) dated 31.01.2025 for Assessment Year (AY) 2013-14. The assessee raised the following grounds of appeal:
“1. The Ld. CIT (A), NFAC, Delhi, erred in law and on facts in upholding an addition of Rs. 25,58,638/- made by the Assessing Officer under section 2 (22) (e) of the I. T. Act, 1961, as deemed dividend in the hands of the Appellant Vinita Pawankumar Saraf wrongly invoking clause (b) of Explanation 3 to section 2 (22) (e) of the I. T. Act which is not applicable in the Appellant's case.
2. The Ld. CIT (A) erred in law and on facts in ignoring the fact that all the loans received by the Appellant from Saraf Yarn Pvt. Ltd. were only when the shareholding of the Appellant in the said company was below 10% of the Total Shareholding i.e. below the threshold limit prescribed to attract the provisions of section 2 (22) (e) of the I. T. Act.
3. The Ld. CIT (A) erred in law and on facts in relying on clause (b) of Explanation 3 to section 2 (22) (e) of the I. T. Act without appreciating that the percentage of shareholding "at any time during previous year" is required to be taken in respect of a "concern" and not in respect of a closely held private limited company. The Appellant prays that reliefs on the aforesaid grounds be allowed and the Appellate Order of Ld. CIT (A) be modified accordingly.”
The assessee is an individual and is a Director of M/s Saraf Yarn Pvt. Ltd. The assessee filed the return of income for the AY 2013-14 on 31.03.2014 declaring a total income of Rs. 14,39,900/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. During the course of assessment proceedings, the Assessing Officer (AO) noticed that the assessee has taken unsecured loans from various parties which included loan taken from M/s Saraf Yarn Pvt. Ltd. to the tune of Rs. 25,58,668/-. Since the assessee is a Director holding 22% of the shares in M/s Saraf Yarn Pvt. Ltd. the AO was of the view that the provisions of section 2(22)(e) of the Act would get attracted and issued a show- cause notice to the assessee in this regard. The assessee submitted that the shareholding in M/s Saraf Yarn Pvt. Ltd. is less than 10% and therefore the provisions of section 2(22)(e) will not be applicable. The AO did not accept the submissions of the assessee and treated the loan amount of Rs. 25,58,638/- as deemed dividend under section 2(22)(e) of the Act. The relevant portion of the AO are extracted as below:
Vinita Pawankumar Saraf “The share holding pattern is changed to 9% during the financial year 2012-13 The submission was duly considered but not found acceptable because it is seen that assessee's shareholding in the company is reduced to 9% from 22% during the F.Y 2012-13. However, as per explanation 3 of clause (b) of section 2(22)(c) 'A person shall be deemed to have a substantial interest in a concern, other than a company, If he is, at any time during the previous year, beneficially entitled to not less than twenty percent of the income of such concern.' Since the share holding of the assessee in the above said company in which public are not substantially interested exceeding 20% on any time during the previous year i.e. F.Y. 2012-13 relevant to A.Y. 2013-14, it can be said that the assessee is having substantial interest in the company. In the backdrop of the assessee's case squarely gets covered by the provisions of section 2(22)(e) in as under: (i) The company is a company in which public are not substantial interested. (ii) The assessee is having substantial interested in the company. (iii) The company is having reserves of Rs. 1,73,89,054/- (iv) The assessee has taken loan of Rs. 25,58,638/- In the backdrop of assessee, facts needless to mentioned that the provision of section 2(22)(e) squarely attached in assesee's case calling thereby taxation of deemed dividend u/s. 2(22)(e) in the hands of the assessee to the extent of loan taken of Rs. 25,58,638/ is less than the reserves/accumulated profit of Rs. 1,73,89,054/-, the quantum and deemed divided which is taxable in the hands of the assessee is Rs. 25,58,638/-. In view of this circumstances, sum of Rs. 25,58,638/- is brought to tax in the assessee's hand as deemed dividend u/s. 2(22)(e) of the I.T. Act. (Addition: 25,58,638) Penalty proceedings u/s. 271(1)(c) are initiated separately for furnishing inaccurate particulars of income and thereby concealed the same.”
In further appeal, the CIT(A) confirmed the addition made by the AO.
The ld. AR submitted that in assessee's case as per clause (b) of explanation-3 to section 2(22) cannot be applied since the said explanation is applicable only to concerns not being companies. The ld. AR further submitted that the AO has applied Vinita Pawankumar Saraf the said explanation to test the shareholding of the assessee at any time during the financial year relevant to the AY and said application is incorrect for the reason that M/s Saraf Yarn Pvt. Ltd. is a company. The ld. AR took the bench through the facts pertaining to the shareholding of the assessee wherein the assessee was holding 22.06% of the shares as a Financial Year 2011-12 has transferred 7,25,000 shares as on 01.05.2012 (page no. 38 & 39 of PB) during FY 2012-13 which brought down the percentage holding at the end of year to circa 8%. Accordingly, the ld. AR submitted that the explanation which the AO has invoked is not applicable to assessee's case and that since the shareholding percentage of the assessee at the end of the FY is less than 10% the provisions of section 2(22)(e) are not applicable to the assessee.
The ld. DR on the other hand vehemently argued that the assessee has transferred the shares in order to bring down the shareholding percentage so that the loan could not be treated as deemed dividend. Accordingly, the ld. DR relied on the orders of the AO and the CIT(A).
We heard the parties and perused the material on record. The provisions of section 2(22)(e) and explanation-3 read as under:
any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits; Vinita Pawankumar Saraf Explanation 3.—For the purposes of this clause,— (a) concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company ; (b) a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern.”
From the above provisions it is clear that when any loan or advances is extended to the shareholder having beneficial ownership of more than 10% then the same shall be deemed as dividend income in the hands of the shareholders to the extent of the accumulated profits. Explanation-3 provides that a person is deemed to have a substantial interest in a concern other than a company if he holds not less than 20% at any time during the previous year. The contention of the assessee is that the test of substantial interest for a company has to be done at the end of the year and not at any time during the year since explanation-3 is applicable only to other than companies. We notice that the assessee was holding 12,00,000 shares as of 30.04.2012 which is 22.06% of the total shareholding of the company. We further notice that on 01.05.2012 the assessee has transferred 7,25,000 shares and accordingly the assessee's shareholding came down to 8.73% which remained as it is till the end of the FY. We also notice that this factual position has not been disputed by the revenue. The AO has invoked section 2(22)(e) for the reason that the percentage holding "at any time during the previous year" should be tested for applicability of section 2(22)(e) and that in assessee's case during the year the assessee was holding 22.06%. Further the AO has made the addition for the reason that the shareholding of the assessee is reduced with an intention to circumvent section 2(22)(e). We have already held from the plain reading of explanation 3 clause (b) that the said explanation is applicable to a concern other than a company and therefore testing of the percentage of holding for the purpose of section 2(22)(e) at any time during the year is applicable only to concerns other than companies.
Vinita Pawankumar Saraf Accordingly, we see merit in the argument of the ld. AR that the percentage holding of the assessee for the year end relevant to AY 2013-14 is less than 10% and therefore treating the loan extended by the company to the assessee cannot be treated as deemed dividend under section 2(22)(e) of the Act. We therefore direct the AO to delete the addition made in this regard.
In result, appeal of the assessee is allowed.