VINITA PAWANKUMAR SARAF,MUMBAI vs. INCOME TAX OFFICER WARD 42(1)(5), MUMBAI

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.

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 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: “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.'

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 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:

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. 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.