MSN PHARMACHEM PRIVATE LIMITED,HYDERABAD vs. ACIT., CENTRAL CIRCLE-2(4), HYDERABAD

The assessee has more or less raised common grounds for both the assessment years, therefore, for the sake of brevity, grounds raised in for A.Y. 2019-20 read as under :

The Ld. CIT(A) erred on facts and in law in not allowing the additional claim of deduction of expenditure of Rs.4,00,38,452/- against the unaccounted cash receipts from sale of spent solvents and scrap of Rs.4,51,88,803/- as evidenced by the entries of cash outflows in the names of the employees in the seized document and notarized affidavits of the employees and labour contractors furnished as additional evidence during the appellate proceedings and in allowing such deduction on estimate basis to the extent of 10% of such unaccounted cash receipts only.

The Ld.CIT(A) erred on facts and in law in upholding the addition made in the assessment order towards deemed dividend u/s 2(22)(e) of the Act to the extent of Rs.241,82,77,339/- for the purpose of levy of dividend distribution tax. 3.1. In the facts and circumstances of the case, the Ld.CIT(A) ought to have appreciated that the transactions resulting in debit balance in the names of the recipient companies in the books of the appellant company cannot be construed as excess payments which fall under the scope of "advances or loans" within the meaning of section 2(22)(e) of the Act. 3.2. In the facts and circumstances of the case, the Ld.CIT(A) ought to have appreciated that the transactions between the appellant company and the recipient companies bear the character of current account adjustment transactions due to two-way movement of funds on a need basis and such transactions do not fall under the ambit of "advances or loans" within the meaning of section 2(22)(e) of the Act.” 3.3. In the facts and circumstances of the case, the Ld.CIT(A) ought to have appreciated that deemed dividend is not attracted when the payments to recipient companies were utilized by them for the purpose of their business and were not utilized/diverted for the benefit of the common substantial shareholder.

The Ld.CIT(A) erred in law in holding that the Assessing Officer rightly assumed jurisdiction to take the addition towards deemed dividend in an unabated assessment inspite of unavailability of incriminating seized material in respect of the said issue by erroneously construing the judgment of the Hon'ble Supreme Court in the case of Abhisar Buildwell Pvt Ltd.”

The brief facts of the case are that the appellant company is engaged in the business of manufacturing and sale of drugs and pharmaceuticals filed its return of income for assessment years 2019-20 and 2020-21 under Section 139(1) of the Income Tax Act, 1961. A search and seizure operation under Section 132 of the Income Tax Act, 1961 was carried out in M/s. MSN Group of cases on 24.02.2021. The appellant M/s. MSN Pharmachem Private Limited (hereinafter referred to as “MSN”) is one of the companies covered under Section 132 of the Income Tax Act, 1961 as part of the search. Consequent to search, notice under Section 153A of the Act dated 12-10-2021 was served on the assessee, calling for return of income for Assessment Years 2019-20 and 2020-21. In response, the assessee filed its return of income for assessment year 2019-20 on 08-11-2021 declaring total income of Rs. 251.97 crores and for assessment year 2020-21 on 02-02-2021 declared total income of Rs. 246.82 crores. The case was selected for scrutiny and the assessment was completed under Section 143(3) r.w.s. 153A of the Income Tax Act, 1961, for assessment year 2019-20 on 03-04-2023 and for assessment year 2020-21 on 31-03-2023, determining total income at Rs.495.03 crores and Rs.520.14 crores, respectively, by making additions towards deemed dividend under Section 2(22)(e) of the Act and consequent dividend distribution tax under Section 115Q of the Income Tax Act, 1961 for both the assessment years.

Aggrieved by the order of LD.CIT(A), the assessee is now in appeal before the Tribunal.

The first issue that came up for our consideration from Ground No.2 of the assessee's appeal for both assessment years is the additional claim of deduction of expenditure against the unaccounted cash receipts from sale of spent solvents / scrap. The facts with regard to the impugned dispute are that the assessee is engaged in the manufacturing and sale of bulk drugs. In the process, the assessee purchased various solvents and used them for manufacturing bulk drugs. The used solvents has to be discarded by the assessee. During the course of search at the registered office of the assessee on 24.02.2021, a Sony make pen-drive of 16 GB was found in the possession of Shri R. Buchi Reddy, Cashier, which contained various Excel sheet data. From the excel sheets, it was found that the spent solvents / scrap was sold in cash and such transactions were not recorded in the books of accounts for the relevant assessment years. A sworn statement under Section 132(4) of the Act was recorded from Shri R. Buchi Reddy on 24.02.2021, and in response to Question No.18, he has stated that details of cash generated from the sale of utilized solvents and scrap has been maintained by him in an excel work book - APRIL 19.29.04.19XZ. xls, found in the seized pen-drive, and further stated that the said cash receipts are not recorded in the books of accounts for the relevant assessment year. He has further furnished the entity-wise and financial year-wise working of the said cash receipts. As per the details furnished by Shri R. Buchi Reddy, the total cash receipts from the sale of spent solvents for the financial years 2012-13 to 2020-21, in respect of the appellant and four other group companies, were worked out at Rs.63,61,27,585/- and the total cash receipts from the sale of scrap for the financial years 2015-16 to 2020-21 were worked out at Rs. Rs.18,76,02,606/-. The sworn statement recorded from Shri R. Buchi Reddy along with the Excel sheet data found in the pen-drive was confronted to Shri MSN Reddy, the Managing Director of the appellant and other group companies, and his statement on oath was recorded on 27.04.2021. In response to a specific Question No. 5, he stated that the spent solvents / scrap used for manufacturing of bulk drugs and after such reuse are categorized as hazardous waste and the same are required to be disposed of at the earliest. He further explained that, he was given to understand that such waste is sold to local buyers, and some of the employees of the group companies have utilized such money for their own purposes, and the said money has not reached the respective companies. He further explained that the interest of the management in this regard is the quick disposal of such hazardous waste, and the management has not paid much attention to any other aspect. With regard to the sale of scrap, he explained that the same is generated out of dismantling of old building / units purchased by the companies and the proceeds from the disposal of such scrap have never reached the respective companies, since the immediate disposal of such scrap for paving the way for further construction or development, is the priority of the management. However, considering the fact that the data was found in the registered office of the appellant company and in order to put a quietus to the issue, he stated that the cash receipts from the sale of spent solvents of Rs.63,61,27,585/- and sale of scrap Rs.18,76,02,606/-, aggregating to Rs.82,37,30,191/- was offered as additional income in the hands of their respective companies for the concerned assessment years.

Aggrieved by the assessment order, the appellant preferred an appeal before the LD.CIT(A).

Aggrieved by the order of the LD.CIT(A), the assessee is in appeal before us.

The Learned Counsel for the assessee Shri M.V. Prasad, C.A. submitted that the LD.CIT(A) has erred in not allowing the additional claim of deduction of expenditure against the unaccounted cash receipt from the sale of spent solvents / scrap as represented by the entries of outflow in the name of employees in the seized documents and notarized affidavits of the employees and labour contractors without appreciating the fact that income cannot be earned without incurring any expenditure. The Learned Counsel for the assessee further submitted that the LD.CIT(A), having held that the entries in the seized material represents the cash inflow towards unaccounted cash receipts and that the cash outflow represents the amounts spent towards various expenditures as represented by the very same seized material, but erred in allowing the additional claim of expenditure only to the extent of 10% of the gross cash receipts from sale of spent solvents / scrap on estimate basis by considering only one element of cost involved in the disposal of scrap without considering the other elements of cost like transportation, handling, and disposal of hazardous waste. The learned counsel for the assessee referring to seized material found in the form of an Excel sheet, submitted that except for a few occasions, the amounts received from the sale of spent solvents / scrap have been given back for further disposal of hazardous waste, as additional wages, to employees who were involved in the disposal of said scrap. The AO conveniently ignored one part of the seized document, which contains details of expenditure incurred against unaccounted cash receipts from the sale of spent solvents / scrap, even though the Managing Director of the appellant company claimed that the management did not pay any attention to the financial aspects of the disposal of spent solvents / scrap, but only showed interest in the quick and early disposal of waste because of its hazardous nature and the impact that may be created on environment. Although, the appellant has furnished all the evidence, including the sworn affidavit from the persons employed to disburse cash expenditure to various persons, but the LD.CIT(A) has ignored all the evidence filed by the assessee and allowed 10% of receipt as expenditure incurred against unaccounted cash receipts from the sale of spent solvents / scrap. Therefore, he submitted that the deduction towards expenditure incurred for handling and disposal of spent solvents / scrap, as per the very same seized material, which was quantified as Rs.66,80,52,108/-, may be allowed as a deduction against the unaccounted cash receipts. The Learned Counsel for the assessee made an alternative claim that if at all a reasonable portion of expenditure needs to be estimated, then the same needs to be estimated by considering the various expenditures involved in handling and disposal of spent solvents / scrap, but not only the salary and wages, as considered by the LD.CIT(A).

On the other hand, Shir B. Bala Krishna, CIT-DR supporting the order of the LD.CIT(A), submitted that there is no dispute regarding the fact that the amount received from sale of spent solvents / scrap has not been accounted in the books of account for the relevant assessment years. In fact, Shri R. Buchi Reddy, Cashier, who received the amount has clearly admitted in a statement recorded under Section 132(4) of the Act during the course of search that the said receipts are not accounted for in the books of accounts of the appellant company. The statement of Shri R. Buchi Reddy has been confirmed by Shri MSN Reddy, the managing director of the assessee company, in his sworn statement recorded on 27.04.2021 and the affidavit filed on 05.07.2021 during the course of search. Further, the appellant had also offered additional income towards unaccounted cash receipts from the sale of spent solvents / scrap in all four companies for the relevant assessment years and also filed a revised return in response to notice under Section 153A of the Act and paid taxes on the said unaccounted income. Therefore, the claim of the assessee towards expenditure during the course of assessment proceedings and appellate proceedings is only an afterthought without there being any evidence to suggest that the amount received from the sale of spent solvents / scrap has been utilized for making payments to employees. Although the appellant has obtained notarized affidavits from the employees, if you go by the seized document, it clearly shows the cash inflow towards unaccounted cash receipts from the sale of spent solvents / scrap and also the cash outflow towards various payments made to MSN Reddy and other Directors of the appellant and other companies. From the above, it is very clear that the LD.CIT(A) has rightly allowed 10% of the receipt as expenditure incurred against unaccounted cash receipts, considering the nature of the material and the risk involved in the disposal of the said hazardous waste. Therefore, CIT-DR submitted that the order of the LD.CIT(A) should be upheld.

We have heard both parties, perused the material, and gone through the orders of the authorities below. There is no dispute with regard to the fact that during the course of the search in the office of the appellant and other group companies, a Sony make 16 GB pen drive was found and seized from the possession of cashier Shri R. Buchi Reddy, which was marked as Annexure A/MSN/OFF/PD1. The entries contained in the Excel workbook in the seized pen drive pertains to the cash receipts of the appellant company as well as the other group companies about the sale of spent solvents / scrap. In fact, Shri R. Buchi Reddy, the cashier, in his sworn statement recorded on 24-02-2021, has admitted unaccounted cash receipts from sale of spent solvents / scrap and also stated that the said receipts are not accounted for in the books of accounts for the relevant assessment years. The statement of Shri R. Buchi Reddy has been confirmed by the MSN Reddy, the Managing Director of the appellant company. He has further explained the process involved in handling and disbursal of spent solvents / scrap, and according to MSN Reddy, the management did not pay any attention to the financial aspects of the disposal of spent solvents / scrap, but their only interest is the early disposal of the said material, considering the hazardous nature and environmental issues involved in handling and disbursal of the said material. Further, it is also an admitted fact that the appellant and other group companies have admitted additional income received from sale of spent solvents / scrap for the respective assessment years and filed returns in response to notices issued under Section 153A of the Act and paid taxes. Therefore, the issue of the additional claim of expenditure against unaccounted cash receipts from sale of spent solvents / scrap needs to be considered in light of the incriminating material found during the course of the search, statements recorded from the persons who handled the issue, and MSN Reddy, the Managing Director of the appellant company, as well as the subsequent additional evidence filed by the assessee before the LD.CIT(A), including the notarized affidavits from the employees who are involved in the disposal of the said hazardous waste.

The next issue that came up for our consideration from Ground No. 3 of the assessee’s appeal for both assessment years is the addition made on account of deemed dividend (dividend distribution tax in the hands of the appellant). During the course of search operation at the premises of MSN Group Companies, books of accounts were found and seized vide Annexure A/MSN/Off/HD3. On verification, the AO found that there was a substantial amount of debit balance outstanding from M/s. MSN Laboratories Pvt. Ltd (hereinafter referred to as “MSNL”) and M/s. MSN Organics Pvt. Ltd (hereinafter referred to as “MSNO”) in the books of the appellant company. The AO further noted that Shri MSN Reddy is a common director in all the three companies and holds more than 10% of the voting share. During the course of search proceedings, summons u/s 131 of the Act, dated 09.04.2021 was issued to the assessee requesting him to produce the information with regard to the purchases and sales made, receipts, and also excess payments made to MSNL and MSNO. The assessee was asked to provide details of sales and purchases made to/from both the companies. The assessee was also required to produce the nature and purpose of payments made, the necessity or purpose of giving such amounts in excess of purchases made, and to provide a copy of the Board resolution passed, if any, for making payments in excess of purchases made along with details of interest charged on such excess amounts paid, if any. In response, the assessee has submitted ledger account copies of MSNL and MSNO in the books of the appellant company and also filed details of opening balance and sales made during the relevant financial year, purchases made from the above two companies, payments made and received from the above two companies and closing balances. The assessee had also explained the nature and necessity of payments made to the above two group companies and submitted that the appellant company and the other two group companies i.e., MSNL and MSNO, are engaged in the same line of business of manufacture and sale of Active Pharmaceutical Ingredients (APIs). The appellant company and the recipient company have carried out trading transactions of both purchases and sales made with each other in the course of said business. The appellant company has made payments in respect of purchases made from the above two companies and also received payments in respect of sales made to the above two companies, and submitted that these transactions are in the course of the normal business of the assessee and have business exigency or commercial expediency.

Aggrieved by the order of the LD.CIT(A), the appellant is in appeal before us.

The Learned Counsel for the assessee Shri M.V. Prasad, C.A. submitted that the LD.CIT(A) erred in sustaining additions made by the AO towards deemed dividend under Section 2(22)(e) and the consequent dividend distribution tax under Section 115Q, without appreciating the fact that the transactions between the appellant company and two other associated concerns are trade advances, which are in the nature of commercial transactions effected in the ordinary course of business and does not fall under ‘loans or advances’ for the purpose of Section 2(22)(e) of the Act. The Learned Counsel for the assessee further submitted that the LD.CIT(A) failed to appreciate that there is a two-way movement of funds between the appellant company and the recipient companies and the said transactions, which are in the nature of current adjustment account transactions, cannot be termed as loans or advances falling within the ambit of deemed dividend under Section 2(22)(e) of the Act. The Learned Counsel for the assessee further submitted that the LD.CIT(A) failed to appreciate the fact that payments made to recipient companies, who is not a shareholder of the appellant company, do not come under the purview of deemed dividend under Section 2(22)(e), since the same have been utilized for the purpose of business of the recipient companies and no part of the said payments were utilized / diverted for the benefit of substantial shareholders. The Learned Counsel for the assessee took us to relevant documents, including ledger accounts of the two companies in the books of accounts of the appellant, and argued that if you go by the nature of transactions involving purchases and sales with the above companies and against purchase and sales, the appellant received payments from these companies and also made payments for purchases. There is a series of day-to-day transactions between the two companies which are arising in the normal course of business of carrying out manufacturing of API and bulk drugs. Since all the three companies are engaged in the business of manufacturing of Active Pharmaceutical Ingredients (API) and bulk drugs, they have transactions with each other for purchases, sales, and also requirement of short-term funds for carrying out the business activities. Therefore, the Assessing Officer having accepted the fact that there are commercial transactions between the appellant and the two companies, and that these are in the nature of trade advances as per Board Circular No.19/2017 dated 12-06- 2017, but erred in coming to the conclusion that only a portion of advances paid by the appellant company falls under trade advances and rest is loans and advances.

Per contra, Shri B. Bala Krishna, CIT-DR supporting the order of LD.CIT(A) submitted that there is no dispute regarding the fact that the conditions required for invoking provisions of Section 2(22)(e) are satisfied. Further, the appellant company and the other two companies are part of the MSN Group, and Shri MSN Reddy is the common shareholder holding more than 10% voting power in all three companies. There is no dispute with regard to the fact that the appellant company has accumulated profits in excess of the amounts of loans or advances given to the two companies. Since the conditions for invoking the provisions of Section 2(22)(e) are satisfied, the reasons given by the AO to consider the transactions between the appellant company and the other two companies as loans and advances must be examined in light of the transactions between these companies. If you go by the analysis of the transactions between the Appellant Company and the other two companies, as done by the Assessing Officer, there is a clear fact to the effect that the appellant has made very minimum purchases from the above two companies, but has made substantial amounts over and above the value of purchases. Therefore, the Assessing Officer came to the conclusion that any amount paid in excess of 150% / 200% of purchases should be treated as loans and advances, and thus, rightly computed the excess amount paid by the appellant company to the two companies and invoked the provisions of Section 2(22)(e) read with Section 115Q of the Act. Therefore, he submitted that the order of LD.CIT(A) should be upheld.

We have heard both parties, perused the materials available on record and gone through the orders of the authorities below. We have also carefully considered the plethora of case laws relied upon by both sides. The addition towards deemed dividend for the purpose of levy of dividend distribution tax has been made by considering the debit balance outstanding in the accounts of two group concerns i.e., M/s MSN Laboratories Pvt. Ltd and M/s MSN Organics Pvt. Ltd, in the books of the appellant company as on 31.03.2019. The appellant company and two group companies MSN Laboratories Pvt. Ltd and MSN Organics Pvt. Ltd (referred to as recipient companies) are engaged in the same line of business of manufacture and sale of Active Pharmaceutical Ingredients (API). The appellant company and the recipient companies have carried out trading transactions of purchases and sales with each other in the course of the said business. The appellant company has made payments in respect of purchases made from the recipient companies and received payments in respect of sales made to recipient companies. During course of assessment proceedings, the AO analyzed the details of opening balance, sales, purchases, receipts, payments and closing balance in the accounts of the two recipient companies and observed that they are in receipt of excess amounts from the appellant company in comparison to the amounts receivable by them against the trading transactions of purchases and sales that took place between the appellant company and the recipient companies during the year. The AO worked out the quantum of excess payments made by the appellant company to the recipient companies by aggregating the sales and payments made to the recipient companies and subtracting the purchases made and payments received from the recipient companies. However, having regard to the Board’s Circular No.19/2017, wherein it was stated that the trade advances, which are in the nature of commercial transactions, would not fall under the ambit of the word “advance” in section 2(22)(e) and keeping in view the flexibility required in practical business situations, the AO treated the payments made by the appellant company to the extent of 150% of the purchases made from the recipient companies as the payments made in the ordinary course of business and the payments made in excess of such 150% of the purchases as payments having no nexus with the business transactions. Accordingly, the AO reduced an additional amount of 50% of the purchases from the excess payments and such balance excess payments were treated as payments made by way of ‘advances or loans’ on the reasoning that they have no relation to the trading transactions between the companies. In this connection, the AO noted that the appellant company is not engaged in the business of finance and that no interest was charged in respect of such ‘advances or loans’. The said amounts of excess payments were accordingly held to be constituting deemed dividend u/s 2(22)(e) in the hands of Sri. M.S.N.Reddy, who is the common substantial shareholder in the appellant company and the recipient companies. The deemed dividend worked out by the AO amounted to Rs.241,53,50,035/- in the case of payments made to MSN Laboratories Pvt Ltd and Rs.1,53,47,177/- in the case of payments made to MSN Organics Pvt Ltd. The aggregate deemed dividend worked out for Asst. Year 2019-20 amounted to Rs.243,66,97,212/-. Similar working has been made for Asst. Year 2020-21 and worked out deemed dividend of Rs.266,76,84,647/-. The details of the recipient companies and the payments made to them by the appellant company in excess of 150% of the purchases, which has been treated as deemed dividend u/s 2(22)(e) by the Assessing Officer for the assessment years 2019-20 and 2020-21 under consideration are summarized in the table given below:

The AO observed that the appellant company, being the payer company, is liable to pay dividend distribution tax under the provisions of section 115-O of the Act, in respect of the said deemed dividend u/s 2(22)(e) in the hands of the common substantial shareholder, in view of the amendment made to section 115Q with effect from 01.04.2018 making dividend distribution tax applicable to deemed dividend also. Since no dividend distribution tax has been paid in respect of such deemed dividend by the appellant company, the AO made addition of deemed dividend of Rs.243,06,97,212/- u/s 2(22)(e) of the Act for A.Y. 2019-20 and Rs.266,76,84,647/- for A.Y. 2020-21, in respect of which the appellant failed to pay dividend distribution tax, in the assessment order passed u/s 153A in the case of the appellant company. On first appeal filed by the assessee, the LD.CIT(A) upheld the inference of deemed dividend drawn by the AO in the assessment order. However, the LD.CIT(A) allowed partial relief with regard to the working of the quantum of deemed dividend by holding that payments made to the extent of 200% of purchases can be considered to have been made as per normal commercial 37 practice and excess payments made over and above 200% of purchases should be considered as “loans or advances” falling within the ambit of deemed dividend u/s 2(22)(e) of the Act. Accordingly, the LD.CIT(A) reduced an additional amount of 50% of the purchases from the excess payments computed by the AO and the balance excess amount has been treated as “advance or loan” constituting deemed dividend.

The provisions of section 2(22)e) of the Income Tax Act, 1961 deals with ‘Deemed Dividend’. As per the provisions of section 2(22)(e) of the Act, deemed dividend defined to mean, any payment by a company, not being a company in which the public are substantially interested, of any sum by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares holding not less than 10% of the voting power, or to any Concern in which such shareholder is member or partner and in which he has a substantial interest 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. The term ‘Concern’ has been defined which includes ‘a company’ also. Therefore, in the present case, the conditions prescribed for invoking the provisions of Section 2(22)(e) of the Act is primarily satisfied to the extent the appellant company and other two companies are having common share holder Shri MSN Reddy, who is holding more than 10% voting power in all the three companies and further, the appellant company is having accumulated profits which is in excess of the amount of advance computed by the Assessing Officer. However, whether the transactions between the appellant company and the other two companies are trade advances which are 38 carried out in the normal course of business of all the companies or any loan or advances which fall within the ambit of Section 2(22)(e) of the Act has to be seen in light of nature of transaction between the parties.

There is no dispute regarding the satisfaction of the some of the basic ingredients for inferring deemed dividend such as the payer company (appellant) being a company in which public are not substantially interested, substantial shareholding of Sri. M.S.N. Reddy in both the appellant company as well as the recipient companies as per the specified percentages of shareholding and the availability of accumulated profits in the hands of the appellant company. However, it is the contention of the appellant that the other basic ingredient for inferring deemed dividend that there should be payments by the payer company (appellant) by way of ‘advances or loans’ to the recipient company, is not satisfied in the appellant’s case and consequently, no deemed dividend arises in the hands of the common substantial shareholder and no liability to pay dividend distribution tax arises in the hands of the appellant company. Therefore, it is necessary to examine the issue in light of provisions of section 2(22)(e) of the Act, nature of transactions between two companies and the purpose of payments to two recipient companies.

The appellant has made three-fold arguments. The first and foremost argument of the appellant is that all the transactions between the appellant company and the recipient group companies 39 have been made in the ordinary course of the business carried on by them and they do not come under the purview of deemed dividend u/s 2(22)(e) of the Act, as they cannot be characterized as ‘loans or advances’. Admittedly, these group companies are engaged in the same line of business of manufacturing and sale of Active Pharmaceutical Ingredients (API). The appellant company and the recipient companies have carried out trading transactions of purchases and sales with each other in the course of the said business. These group companies have made payments in respect of purchases made by them from the other group companies and received payments in respect of sales made by them to other group companies. This is evident from the summary of transactions between the appellant company and the recipient companies, i.e., MSN Laboratories Pvt Ltd and MSN Organics Pvt Ltd for both assessment years. From the above, it is undisputedly proved that these are trade advances, which arises in the course of carrying out purchases in the normal course of the business and which result in closing debit balance in the account of the recipient company in the books of payer company and thus, these trade advances in the ordinary course of business cannot be regarded as payment of ‘loans or advances’ to the recipient company, since the same are undeniably in the nature of commercial transactions. It is a settled position of law that trade advances given in the normal course of business on account of trading transactions cannot be treated as ‘loans or advances’ so as to constitute deemed dividend u/s 2(22)(e) of the Act. This legal position is fortified by the decisions in the case of CIT Vs. India Fruits Ltd [2015] 53 taxmann.com 307 (Andhra Pradesh), where it has been held as under :

Similar view has been expressed by various Courts in CIT Vs. Creative Dyeing & Printing Pvt Ltd [2009] 318 ITR 476 (Delhi), CIT Vs. Ambassador Travels Pvt Ltd [2009] 318 ITR 376 (Delhi), CIT Vs. Raj Kumar [2009] 318 ITR 462 (Delhi), CIT Vs. Nagindas M Kapadia [1989] 177 ITR 393 (Bombay), Jamuna Vernekar Vs CIT [2021] 432 ITR 146 (Karnataka),CIT Vs. Amrik Singh [2015] 56 taxmann.com 460 (P & H),and CIT Vs Atul Engineering Udyog [2014] 51 taxmann.com 569 (Allahabad). This legal position is further fortified from the CBDT Circular No.19/2017 (Pg No.77 of PB-I), where it has been clarified that trade advances in the nature of commercial transactions would not fall within the ambit of the provisions of section 2(22)(e) of the Act and that such views have attained finality. The CBDT, therefore, stated that it is a settled position that trade advances, which are in the nature of commercial transactions, would not fall within the ambit of the word ‘advance’ in section 2(22)(e) of the Act. Though, the Assessing Officer and LD.CIT(A) have taken cognizance of the said circular and applied the same to the appellant’s case keeping in view the trading transactions between the appellant company and recipient companies, which resulted in debit balance in the account of the recipient companies at the end of the year, but both authorities have misdirected themselves in holding that payments made to the recipient companies in excess of 150% or 200% of purchases from such company cannot be treated as ‘trade advances’ in the nature of commercial transactions. The AO has wrongly treated the payments in excess of 150% of the purchases as ‘loans or advance’ and wrongly held the same to be deemed dividend u/s 2(22)(e) of the Act. Similarly, the LD.CIT(A) has wrongly treated the payments in excess of 200% of the purchases as ‘loans or advance’ and wrongly upheld the same to be deemed dividend u/s 2(22)(e) of the Act. In our considered view, the said approach of the AO/CIT(A) is arbitrary and the same is not founded on any settled principle laid down by the Courts or on any stipulation conveyed by the Board through a circular regarding the reasonableness of the quantum of trade advances. The AO/CIT(A) has not revealed the basis on which they arrived at the threshold of 150%/200% of purchases for accepting the reasonableness of the quantum of trade advances. In the absence of specification of the relevant basis by the AO/CIT(A), the same is required to be regarded as arbitrary and non- maintainable. Further, having accepted that purchases are being made regularly from the recipient companies and payments in the nature of trade advances are being made to the said companies against the purchases, the AO/CIT(A) has drawn an artificial line for segregating the payments into ‘trade advances’ which are in the nature of commercial transactions and ‘loans or advance’ which do not have such commercial character. Such an approach of the AO/CIT(A) is not permissible since the extent to which trade advances are paid is purely a commercial decision which is contingent on the business expediencies. The AO/CIT(A) cannot place himself in the arm-chair of the businessman and usurp his role for deciding what constitutes reasonable level of trade advances that can be given against the purchases. In this regard, reliance is placed on the decision of the Hon’ble Supreme Court in the case of Hero Cycles (P) Ltd Vs.CIT [2015] 379 ITR 347 (SC) (Pg No.97-99 of PB-I), wherein it was held that the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. The Hon’ble Apex Court further held that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The Hon’ble Court further held that the authorities must not look at the matter from their own viewpoint but that of a prudent businessman. The said ratio laid down by the Hon’ble Supreme Court in the context of reasonableness of the expenditure laid out for the purpose of business is applicable with equal force in respect of reasonableness of the quantum of trade advances given against purchases. We, therefore, are of the considered view that the action of the AO/CIT(A) in holding that amounts paid upto 150% / 200% of the purchases alone can be considered as reasonable quantum of trade advances in contravention of the binding decision of the Hon’ble Supreme Court cited above and the same is untenable on facts and in law. Having accepted the factum of purchases and payment of trade advances against the purchases, the AO/CIT(A) could not have imposed an imaginary and artificial limit on the quantum of payments that can be regarded as trade advances by sitting in the arm-chair of the businessman. Therefore, we are of the considered view that the entire amount of payments made against purchases has to be regarded as ‘trade advances’ without any artificial limitation on the quantum of such trade advances. As a result, the amounts paid to recipient company in excess of 200% of the purchases also have to be regarded as ‘trade advances’ which are in the nature of commercial transactions only and they cannot be characterized as ‘loans or advance’ constituting deemed dividend within the meaning of section 2(22)(e). The addition made by the AO and upheld by the CIT(A) towards deemed dividend is therefore wholly untenable and needs to be deleted.

We further noted that the transactions of payments made by the appellant to the recipient companies have arisen due to business exigencies and the said transactions therefore bear commercial character. The appellant company and the recipient companies are associate concerns of the same group with a common Managing Director and substantial shareholder Sri.M.S.N Reddy. The group companies, including the said companies, are engaged in similar line 44 of business of manufacture of Active Pharmaceutical Ingredients (API). As mentioned by the AO himself in the assessment order (Pg No. 50 and 51 of the order), the business activities of the group companies are inter-related and inter-dependent since each company is making sale of raw materials, engineering materials and intermediates to the other associate companies, in view of the fact that the manufacturing process is fragmented into different stages and different group companies are handling the manufacture at different stages. In view of existence of such inter-dependency among the associate concerns, the said companies provide funds to each other on a need basis as a measure of business expediency as and when there is requirement of funds for the purpose of business in order to provide the required support to the business of the other associate concerns. Further, this fact is also apparent from the audited financials of the appellant company that export sales constitute a significant portion of its total sales (Pg No 17 of PB-I). The appellant is making the export sales by taking marketing services from the foreign subsidiary companies promoted by MSN Laboratories Pvt Ltd namely, MSN Pharmaceuticals Inc, USA, MSN Laboratories Europe Ltd and Mega MSN Pte Ltd, Singapore (Pg No.37 of PB-I). The sales commission paid to such foreign subsidiary companies is debited to P&L A/c (Pg No.18 back side of PB-I). These facts clearly bring out the large-scale dependency of the appellant on MSN Laboratories Ltd for effecting its export sales. We further noted from the funds flow statement regarding the utilization of the funds given by the appellant company to MSN Laboratories Pvt. Ltd (page No.75 of PB-I), where there is utilization of such funds by way of investment in foreign subsidiaries of MSN Laboratories Pvt. Ltd to the extent of Rs.60 crores during the year, apart from utilization towards working capital and acquisition of fixed assets of the business (for setting up new units/expansion of existing units). The business expediency for making huge payments to MSN Laboratories Pvt. Ltd is revealed by this crucial fact also in addition to the explanation furnished in the preceding paragraph. Therefore, the payments made by the appellant to MSN Laboratories Pvt. Ltd which are evidently imbued with business expediency cannot be considered to be falling under the ambit of “advance or loans” under section 2(22)(e) so as to constitute deemed dividend. Further, the provisions of deemed dividend are not attracted in the facts of the case for the instant assessment years as the basic ingredient to invoke the said provisions that payments by way of ‘advance or loans’ have been made by the appellant company to the recipient companies in which Sri. M.S.N.Reddy is the common substantial shareholder, is non- existent. Therefore, in our considered view, the addition made by the AO, to the extent upheld by the CIT(A), towards deemed dividend u/s 2(22)(e) in the hands of the appellant for the purpose of levy of dividend distribution tax without the satisfaction of the said basic condition laid down in the section is unwarranted and untenable.

The second limb of argument of the appellant is that current adjustment account transactions do not represent ‘loans or advance’ for the purpose of deemed dividend. We, find that there is a two-way movement of funds between the appellant company and the recipient companies as per the business requirements of the said companies and the same is evident from the perusal of the respective ledger account copy of the recipient companies in the books of the appellant company, the copies of which were furnished to the AO 46 during the assessment proceedings (Pg No.62-67 and Pg No.68 of PB-I). We further observed that there is a series of debits and credits in the concerned ledger accounts, which clearly indicate that the transactions were effected in the normal course of business and the concerned group companies have given funds to and received funds from each other as and when required for the purpose of the business of the said group companies. It needs to be borne in mind that such transactions between the group companies cannot be considered to be in the nature of ‘loans or advance’ to the group companies. An account containing such series of debit and credit entries reflecting movement of funds both ways between the associate/group companies as per their business requirements has to be construed to be in the nature of a Current Adjustment Account unlike the transactions in the nature of ‘loans or advances’ to a shareholder or to a concern in which the shareholder has substantial interest, the movement of funds in a current adjustment/ accommodation account is in either direction on a need basis. Therefore, transactions which are in the nature of current adjustment account transactions cannot be termed as ‘loans or advances’ falling within the ambit of deemed dividend u/s 2(22)(e) of the Act.

The appellant, in support of the aforesaid contention places reliance on several judicial decisions. In the case of CIT Vs. Schutz Dishman Bio-tech Pvt Ltd in Tax Appeal Nos. 958 & 959 of 2015 (Pg No.100-101 of PB-I), the Hon’ble Gujarat High Court held that where there is movement of funds on a need basis, unlike transactions in the nature of loans or advances which are usually few in number, such transactions are in the form of current adjustment accommodation entries. The Hon’ble Court held that when the CIT(A) and Tribunal have concurrently held that the amounts are not in the nature of loan or deposit but merely adjustments based on large number of adjustment entries occurring in the accounts between the entities, application of section 2(22)(e) would not arise. Similarly, Hon’ble Calcutta High Court in the case of CIT Vs. Gayatri Chakraborti [2018] 407 ITR 730 (Calcutta) (Pg No.102-104 of PB-I) held that the transactions between the shareholder and the company were in the nature of current account and the provisions of section 2(22)(e) would not be applicable, where there were transactions of giving money by the company to the shareholder and vice versa in the account. Further, the ITAT, Mumbai held in the case of Ravindra R Fotedar Vs. ACIT [2017] 85 taxmann.com 314 (Mumbai) (Pg No.105-111 of PB-I) that where the movement of funds is in both ways on need basis between the two companies in which the assessee held substantial interest, the transactions are in the form of current accommodation entries and the amount in question could not be regarded as deemed dividend. In another case of Neha Home Builders Pvt Ltd Vs. DCIT [2018] 98 taxmann.com 465 (Mumbai- Trib) also (Pg No.112-116 of PB-I), the ITAT, Mumbai held that when the transactions between group companies were current and inter banking accounts containing both receipt and payment entries, same could not be regarded as loans and advance, as contemplated under section 2(22)(e) and no addition could be made as deemed dividend. Similar view was expressed by the ITAT, Delhi in the case of Saamag Developers Pvt Ltd Vs. ACIT [2018] 90 taxmann.com 20 (Delhi-Trib) (Pg No.117-131 of PB-I), wherein the Tribunal held that the amounts received from various group companies could not be considered as loans and advance, as contemplated u/s 2(22)(e) since the said transactions between the group concerns are current and inter banking accounts containing both types of entries of giving and taking of amounts. In the case of Iswar Chand Jindal Vs. ACIT [2015] 61 taxmann.com 428 (Delhi-Trib), the ITAT, Delhi held that the transactions between the two group companies are in the nature of current account transactions and the same cannot be regarded as deemed dividend under section 2(22)(e) of the Act. The sum and substance of ratio laid down by various courts and Tribunals is that current account transactions between two group companies cannot be regarded as loans or advances as defined u/s 2(22)(e) of the Income Tax Act, 1961. Therefore, we are of the considered view that the provisions of deemed dividend u/s 2(22)(e) are not applicable to the transactions between the appellant company and recipient companies, as the said transactions bear the character of current adjustment account transactions due to two-way movement of funds on a need basis. Thus, the addition made by the AO towards deemed dividend in the hands of the appellant for the purpose of levy of dividend distribution tax to the extent upheld by the LD.CIT(A) is not warranted and therefore, deleted for this reason also.

The third and final proposition canvassed by the appellant is that deemed dividend not attracted when payments to recipient company were utilized for its business and not diverted to or utilized for the benefit of the common substantial shareholder. In this regard, we find that the payments made by the appellant company to the two recipient companies during the year do not come under the ambit of deemed dividend u/s 2(22)(e), as the said funds have been 49 used by the recipient companies for the purpose of their business and they have not been diverted to or utilised in any manner for the benefit of the common substantial shareholder. The business expediency/exigencies in making the said payments to the recipient companies had already been explained in earlier part of this order. The funds received from appellant company have been wholly used by the recipient companies for meeting the working capital requirements of the business, financing the acquisition of fixed assets of the business (setting up new units/expansion of existing units), investment in subsidiaries and loans to related parties (subsidiaries). The funds have not been diverted to the common substantial shareholder or were not utilised for the benefit of said shareholder. The details of the utilisation of the funds by the two recipient companies are submitted at Pg No.75-76 of PB-I, which were submitted to the LD.CIT(A) during the appellate proceedings. The said statements are prepared on the basis of the cash flow statement forming part of the audited financial statements of the recipient companies, the copies of which were furnished to the AO during the assessment proceedings. It may be seen from the perusal of the said statements that the funds received from appellant company have been fully subsumed in the funds utilised by the recipient companies during the year for the purpose of working capital, acquisition of fixed assets of the business (setting up new units/expansion of existing units), investment in subsidiaries and loans to related parties (subsidiaries). Thus, the payments made to the recipient companies during the year were wholly used by them for the purpose of their business and such payments did not yield any benefit to the substantial common shareholder. We further noted that at para 7.19.2 of the assessment order, the AO has also accepted the factual position that the funds received from the appellant company have been utilized for financing the current assets of the recipient companies. Thus, it may be seen that there is no finding by the AO on facts that such funds have been diverted by the recipient companies for the benefit of the common substantial shareholder. On the other hand, the AO expressed his opinion that such financing of current assets of the recipient companies by the interest free funds received from the appellant company can be construed as a benefit accruing directly or indirectly to the recipient company. Since the utilization of the relevant funds for financing the working capital (current assets) of the recipient companies is an undisputed fact, it cannot be said that any part of the said funds has been diverted to the common substantial shareholder. Consequently, there is no scope for obtaining any direct or indirect benefit by the common substantial shareholder from the said funds. Therefore, in our considered view, it is not legally tenable to consider the payments made by the appellant company to the recipient companies as ‘deemed dividend’ in the hands of the common substantial shareholder for the purpose of levy of dividend distribution tax in the hands of the appellant company, in the absence of any benefit derived by such shareholder from the said payments.

In support of this contention, the appellant placed reliance on the decision of the Hon’ble Gujarat High Court in the case of Jayesh T Kotak Vs. DCIT [2020] 425 ITR 435 (Gujarat) (Pg No.140-146 of PB-I), wherein it was held in the light of the decision of the Hon’ble Supreme Court in the case of CIT Vs. Mukundray K. Shah [2007] 51 290 ITR 433 (SC) that any payment made by a company in which a shareholder has shareholding exceeding 10% of the voting power to any concern in which such shareholder has substantial interest, would be deemed to be dividend in his hands if any benefit from such transaction has been received by such shareholder. The Hon’ble High Court held that the intention of the legislature is to tax funds ultimately received by a shareholder holding not less than 10% voting power in the company, which have been routed through different modes/concerns. The Hon’ble High Court held that what needs to be taxed as deemed dividend is the amount ultimately used for the benefit of the shareholder. The relevant portion of the said decision is extracted below:

Further, the SLP filed by the Revenue against the said decision of the Hon’ble Gujarat High Court has been dismissed by the Hon’ble Supreme Court by stating that it does not find any ground to interfere with the impugned order passed by the High Court, as reported in DCIT Vs. Jayesh T Kotak [2021] 130 taxmann.com 170 (SC) (Pg No.147 of PB-I). Therefore, in our considered view, it is now a settled law that the payment made by the payer company to the recipient company, in which there is a common shareholder holding not less than 10% and 20% of the voting power respectively, would be deemed to be ‘dividend’ in the hands of such shareholder only if any benefit from such transaction has been received by such shareholder or the amount is ultimately used for the benefit of the shareholder. This settled legal principle has been judicially laid down having regard to the intention of the legislature to tax funds ultimately received by a shareholder holding not less than 10% voting power in the company, which have been routed to him through different concerns in which he holds substantial interest.

Let us now come back to the observations of the Assessing Officer. In the assessment order, the AO expressed the view that the requirement that the payment made by the payer company should result in a benefit to the shareholder so as to construe the same to be in the nature of deemed dividend is not applicable to the limb of section 2(22)(e) dealing with “payments by way of loans or advances made by a company in which the shareholder has not less than 10% voting power to a company/concern in which such shareholder has substantial interest”. The AO stated that the said condition is applicable only to another limb of section 2(22)(e) which deals with the “payments made by the payer company on behalf of or for the individual benefit of the shareholder”. However, the said view of the AO is patently contrary to the decision rendered by the Hon’ble Gujarat High Court in the case of Jayesh T Kotak (supra) which has since been affirmed by the Hon’ble Supreme Court. The decision rendered by the Hon’ble Gujarat High Court in the said case that receipt of benefit by the shareholder on account of payment made by the company in which he holds voting power of not less than 10% is a sine qua non for regarding such payment to be deemed dividend is with specific reference to the limb of section 2(22)(e) dealing with 54 “payments by way of loans or advances made by a company in which the shareholder has not less than 10% voting power to a company/concern in which such shareholder has substantial interest”. Therefore, in our considered view, the said decision is squarely applicable to the facts of the appellant’s case where the transactions forming the subject matter of examination of the applicability of provisions of deemed dividend in the assessment order are the payments made by the appellant company to the recipient company in which the appellant holds not less than 10% and 20% of the voting power respectively. In the case of the appellant, it is undisputed that the payments made by the appellant company have been used for the business purposes of the recipient companies as already discussed above. The relevant funds have not been utilized by the recipient companies for the benefit of the common substantial shareholder. In view of the said incontrovertible fact and having regard to the decisions of the Hon’ble Gujarat High Court and Hon’ble Supreme Court in the case of Jayant T Kotak (supra), we are of the considered view that the payments made by the appellant company to the recipient companies during the year do not fall under the scope of deemed dividend u/s 2(22)(e) of the Act. Therefore, the addition made by the AO towards deemed dividend in the hands of the appellant for the purpose of levy of dividend distribution tax, to the extent upheld by the LD.CIT(A) is not warranted for this reason also and thus, deleted.

In this view of the matter and considering facts and circumstances of this case and also, by following ratios of various Courts/Tribunals discussed hereinabove, we are of the considered view that the transactions between appellant Company and two other recipient Companies do not come under the provisions of section 2(22)(e) of the Income tax Act, 1961 and consequently, the AO/CIT(A) is erred in levying dividend distribution tax in the hands of the assessee for both assessment years. Thus, we set aside the order of the LD.CIT(A) on this issue, and direct the Assessing Officer to delete addition made u/s 2(22)(e) and consequent levy of Dividend Distribution Tax u/s 115-O r.w.s. 115Q of the Income Tax Act, 1961 for Asst. Years 2019-20 and 2020-21 in the hands of the assessee.

In the result, the appeals filed by the assessee for assessment years 2019-20 and 2020-21 are partly allowed.