Shabari Constructions, Hyderabad vs Department Of Income Tax

These are appeals by assessee and Revenue against the directions of Ld. Commissioner of Income Tax(Appeals)-IV, Hyderabad dated 14-08-

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2014, while granting relief to assessee in appeal. Both the parties are aggrieved.

2. Briefly stated, assessee is a partnership firm with two partners Sri M. Satchidananda Rao and Smt. M.Jyothi with 50% share each. The two partners were directions in M/s. Navaketan Constructions Pvt. Ltd., (NCPL). During the year, NCPL had given the following loans to the assessee:

S.No. Date Amount (Rs.) 1. 18-05-2005 9,15,000 2. 20-05-2005 10,00,000 3. 17-10-2005 10,00,000 Total 29,15,000

2.1 The Assessing Officer (AO) noted that as per the Balance Sheet, NCPL was reflected as a loan creditor to the appellant for a sum of Rs.33,74,557/- (including the sum of Rs.29,15,000/- received during the year). AO further noted that the two partners Sri M. Sachidananda Rao and Smt. M. Jyothi were directors of NCPL with more than 10% voting rights therein and more than 20% share in the assessee-firm. AO directed assessee to explain why the sum of Rs.29,15,000/- should not be treated as deemed dividend in the hands of assessee u/s. 2(22)(e) of the Income Tax Act [Act] and in the absence of any reply from the assessee brought the same to tax.

3. It was submitted to the Ld.CIT(A) in appeal that assessee is not shareholder in NCPL and therefore provisions of Section 2(22)(e) of the Income Tax Act [Act] are not applicable. It relied on the decision of Hon'ble Madras High Court in the case of CIT Vs. TPSH Sokkalal [163 CTR 352 (Mad)]. Further, it was submitted that sum of Rs.29,15,000/- was an advance made for purchase during the course of business and so advances made in the course of business could not be deemed as I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 3 -: Shabari Constructions

dividend u/s. 2(22)(e). It relied on the decision of Hon'ble Bombay High Court in the case of CIT Vs. Nageendas M. Kapadia [75 CTR 161 (Bom)]. It also filed the following documents as evidence in support of the claim.

i. Agreement for purchase of land by M/s. Navketan Constructions from Dr. M. Satchidananda Rao;

ii. Ledger copy of M/s. Shabari Constructions in the books of M/s. Navketan Constructions for the AY.2005-06;

4. Ld.CIT(A) did not admit the additional evidence but accepted the first contention that the amount cannot be brought to tax as deemed dividend as assessee is not a shareholder of NCPL. However, Ld.CIT(A) held that the amount is taxable in the hands of partners. The order of Ld.CIT(A) in para 6.3 and 6.4 is as under:

"6.3 However, it is also seen that in arriving at its decision in the case of Venkat Ramana Automobiles, the ITAT relied on the decision in the case of CIT Vs. Hotel Hilltop [2009] 313 ITR 116 (Raj). In this case the loan had similarly been given by a company to the assessee which was not a shareholder in the company but whose partners were shareholders with substantial interest. While holding that the deemed dividend u/s. 2(22)(e) with regard to the loan from the company to the assessee could not be assessed in the hands of the assessee, the High Court also held that such loan would be deemed dividend in the hands of the individuals, on whose behalf, or on whose individual benefit, being such shareholder, the amount was paid by the company to the firm.

6.4 Following this decision, it can be concluded that the loan amount should be assessed as deemed dividend in the hands of the shareholder, i.e., the two partners, Sri M. Satchidananda Rao and Smt. M. Jyothi. The Assessing Officer is, therefore, directed to take necessary action as per law and in accordance with sec.150 in this regard".

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5. Assessee is aggrieved on the direction u/s. 150. It was submitted that Ld.CIT(A) exceeded the jurisdiction in directing as above as those persons are not in dispute before Ld.CIT(A) and they are third parties in whose case the jurisdiction does not extend as they are assessees before another officer. Additional ground was also raised that Ld.CIT(A) has not given any opportunity to explain the facts and the additional evidence in support of the facts were not admitted. Ld. Counsel relied on the decision of Hon'ble Madhya Pradesh High Court in the case of Mrs. Banoo E. Cawasji Vs. CIT [10 Taxman 97 (MP)], Nagpur Bench of Hon'ble High Court of Bombay in the case of Shri Inderjit Singh Sial Vs. CIT [028 ITR 0121] and co-ordinate bench decision of ITAT, Mumbai in the case of Shri Vijay Kumar Sarda Vs. DCIT in ITA No.3435/Mum/2012 dt. 04-10-2013 and other decisions for the proposition that Ld.CIT(A) has exceeded the powers granted under the Act in directing AO to assessee the amounts in third persons hand without even examining the facts nor giving an opportunity.

6. Ld. DR however, defended the action of Ld.CIT(A). It was admitted that Revenue has come in appeal on the deletion made by CIT(A). It was submitted that Ld.CIT(A) ought to have appreciated the fact that post amendment to the provisions of Section 2(22)(e) of the Act, 1961 w.e.f. 01-04-1988, the concern in which the share holder is having substantial interest is also covered in the ambit of the provisions of Section 2(22)(e) of the Act and Ld.CIT(A) ought to have appreciated the facts that the amendment to provisions of Section 2(22)(e) w.e.f. 01-04-1988, specifically brought down the condition that 'any concern in which shareholder holding not less than 10% of voting power in the company (in which public are not substantially interested) is a member or partner and in which he has a substantial interest' is liable to tax under the said provisions.

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7. We have considered the rival contentions. As far as the relief

granted by the CIT(A) in deleting the deemed dividend, we agree with the finding that the provisions of Section 2(22)(e) does not apply to assessee in regard to the sum of Rs.29,15,000/- received from NCPL as assessee is not a shareholder. This issue was elaborately considered in the co- ordinate bench decision in the case of M/s. Margadarshi Marketing (P) Ltd., in ITA No. 689, 690 & 1234/Hyd/2010 & 1849/Hyd/2011 dt. 30- 09-2013, it was held that:

"7. Having heard the submissions of the parties and perused the orders of the revenue authorities as we ll as other materials on record, we do not find any infirmity in the order of the CIT(A). The fact that the assessee is not a shareholder of M/s Ushodaya Enterprises Ltd. has not been controverted by the department. Therefore, as per the provision contained u/s 2(22)(e) of the Act the advances cannot be considered as deemed dividend in the hands of the assessee. The Hon'ble Delhi High Court in case of CIT Vs. Ankitech P. Ltd. 340 ITR 14, while considering identical issue approved the decision of the ITAT, Mumbai Special Bench in case of Bhaumic Colours (P) Ltd., 313 ITR (AT) 146 and held as under:

"22. Insofar as the provisions of Section 2(22)(e) are concerned, we have already extracted this provision and taken note of the conditions/requisites which are to be established for making provision applicable. In Commissioner of Income Tax Vs.C.P.Sarathy Mudaliar[1972] 83 ITR 170, the Supreme Court had traced out the assessee of this provision in the following manner:

―Any payment by a company, not being a company in which the public are substantially interest, of any sum (whether as representing a part of the assets of the company or otherwise) made after 31.05.19987 by way of advance or loan.

First limb

a) to a shareholder, being a person who is the beneficial 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 percent of the voting power, I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 6 -: Shabari Constructions

Second limb

b) or to my 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)

Third limb

c) or any payment by any such company on behalf, or for the individual benefit, or any such shareholder, to the extent to which the company in either case possesses accumulated profits.

23. It is rightly pointed out by the Bombay High Court in Universal Medicare (P) Ltd.(supra)that Section 2(22)(e) of the Act is not artistically worded. Be as it may, we may reiterate that as per this provision, the following conditions are to be satisfied:

(1) The payer company must be a closely held company.

(2) It applies to any sum paid by way of loan or advance during the year to the following persons:

(a) A shareholder holding at least 10 of voting power in the payer company.

(b) A company in which such shareholder has at least 20% of the voting power.

(c) A concern (other than company) in which such shareholder has at least 20% interest.

(3) The payer company has accumulated profits on the date of any such payment and the payment is out of accumulated profits.

(4) The payment of loan or advance is not in course of ordinary business activities.

24. The intention behind enacting provisions of Section 2(22)(e) is that closely held companies (i.e. companies in which public are not substantially interested), which are controlled by a group of members, even though the company has accumulated profits would not distribute such profit as I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 7 -: Shabari Constructions

dividend because if so distributed the dividend income would become taxable in the hands of the shareholders. Instead of distributing accumulated profits as dividend, companies distribute them as loan or advances to shareholders or to concern in which such shareholders have substantial interest or make any payment on behalf of or for the individual benefit of such shareholder. In such an event, by the deeming provisions, such payment by the company is treated as dividend. The intention behind the provisions of Section 2(22)(e) of the Act is to tax dividend in the hands of shareholders. The deeming provisions as it applies to the case of loans or advances by a company to a concern in which its shareholder has substantial interest, is based on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance.

25. Further, it is an admitted case that under normal circumstances, such a loan or advance given to the shareholders or to a concern, would not qualify as dividend. It has been made so by legal fiction created under Section 2(22)(e) of the Act. We have to keep in mind that this legal provision relates to 'dividend'. Thus, by a deeming provision, it is the definition of dividend which is enlarged. Legal fiction does not extend to 'shareholder'. When we keep in mind this aspect, the conclusion would be obvious, viz., loan or advance given under the conditions specified under Section 2(22)(e) of the Act would also be treated as dividend. The fiction has to stop here and is not to be extended further for broadening the concept of shareholders by way of legal fiction. It is a common case that any company is supposed to distribute the profits in the form of dividend to its shareholders/members and such dividend cannot be given to non-members. The second category specified under Section 2(22)(e) of the Act, viz., a concern (like the assessee herein), which is given the loan or advance is admittedly not a shareholder/member of the payer company. Therefore, under no circumstance, it could be treated as shareholder/member receiving dividend. If the intention of the Legislature was to tax such loan or advance as deemed dividend at the hands of "deeming shareholder", then the Legislature would have inserted deeming provision in respect of shareholder as well, that has not happened. Most of the arguments of the learned counsels for the Revenue would stand answered, once we look into the matter from this perspective.

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26. In a case like this, the recipient would be a shareholder by way of deeming provision. It is not correct on the part of the Revenue to argue that if this position is taken, then the income "is not taxed at the hands of the recipient". Such an argument based on the scheme of the Act as projected by the learned counsels for the Revenue on the basis of Sections 4, 5, 8, 14 and 56 of the Act would be of no avail. Simple answer to this argument is that such loan or advance, in the first place, is not an income. Such a loan or advance has to be returned by the recipient to the company, which has given the loan or advance.

27. Precisely, for this very reason, the Courts have held that if the amounts advanced are for business transactions between the parties, such payment would not fall within the deeming dividend under Section 2(22)(e) of the Act.

28. Insofar as reliance upon Circular No. 495 dated 22.09.1997 issued by Central Board of Direct Taxes is concerned, we are inclined to agree with the observations of the Mumbai Bench decision in Bhaumik Colour (P) Ltd. (supra) that such observations are not binding on the Courts. Once it is found that such loan or advance cannot be treated as deemed dividend at the hands of such a concern which is not a shareholder, and that according to us is the correct legal position, such a circular would be of no avail.

29. No doubt, the legal fiction/deemed provision created by the Legislature has to be taken to 'magigical conclusion' as held in Andaleeb Sehgal (supra). The Revenue wants the deeming provision to be extended which is illogical and attempt is to create a real legal fiction, which is not created by the Legislature. We say at the cost of repetition that the definition of shareholder is not enlarged by any fiction.

30. Before we part with, some comments are to be necessarily made by us. As pointed out above, it is not in dispute that the conditions stipulated in Section 2(22)(e) of the Act treating the loan and advance as deemed dividend are established in these cases. Therefore, it would always be 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 would amount to escapement of income at the hands of those shareholders."

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8. The same view has also been expressed by the Hon'ble Delhi High Court again in case of CIT Vs. Navyug Promoters P. Ltd. (203 Taxman 618) and Hon'ble Bombay High Court in case of CIT Vs. Universal Medicare (P) Ltd., (324 ITR 263).

9. The ITAT, Hyderabad Bench in case of MARC Manufacturers Pvt. Ltd. Vs. ACIT in ITA No. 555/Hyd/2008 dt. 31/08/2009 while considering identical issue of advancement of loan to one company, which is not a shareholder of the lender company following the decision of ITAT Mumbai Special Bench in case of Bhaumik Colour P. Ltd. (supra) and other decisions held as under:

"5. It can be seen from the circular that the provisions of amended section 2(22)(e) are to be applied only to the payments made to the shareholders and not to any other person or concern other than the shareholders. The Allahabad High Court in the case of CIT vs. H.K. Mittal reported in 219 ITR 420 held that the chief ingredient of dividend as defined in sub clause (e) of clause (22) of section 2 of the I T Act is that the recipient should a shareholder on the day the loan was advanced. If that fact is not established, there cannot be a deemed dividend. Therefore, the provisions of sec. 2(22)(e) cannot be applied to MARC as it is not a shareholder in MTAR Technologies Pvt. Ltd. (Hereinafter called as MTAR). In this regard, the assessee relies on the declslon of the ITAT Mumbai Bench "G" in the case of Seamist Properties Pvt. Ltd. vs. ITO reported in (2005) 1 SOT page 142. The assessee further submits that the provisions of sec. 2(22)(e) mention 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-

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extent to which the company in either case possesses accumulated profits"

6. The intention of the legislature is clarified in circular issued by the CBIT as at the time of amendment of clause (e) of sub section (22) of sec. 2 is further fortified by the fact that for deduction of tax at source. Sec. 194 provide that such deduction of tax has to be made in the case of the payments of the nature mentioned in clauses (a), (b), (c), (d) and (e) of sub section (22) of Section 2 only in a case where such payments were made to a shareholder. Section 199 also indicates that adjustment of TOS would be provided in the assessment of shareholder only. The very fact that the provision for deduction of tax at source and adjustment of tax is only in respect of the payments to the' shareholder would clearly indicate that even after the amendment, the effect of clause (e) of sub section (22) of Sec. 2 would apply only when the payment is made to shareholder. Wherever, the tax is to be deducted at source from a dividend or deemed dividend and the consequential effect of giving effect to such deduction of tax at source, etc., reference was made only to the payments to the shareholder. This would indicate clearly that clause (e) would apply only in case of payments to the shareholder and not to others."

Therefore, considered in the light of the ratios laid down as aforesaid the advances cannot be treated as deemed dividend coming within the ambit of section 2(22)(e) of the Act.

8. Respectfully following the same, as the fact that assessee is not a shareholder in NCPL was not controverted by the Revenue, we uphold the order of Ld.CIT(A) to that extent and dismiss the Revenue appeal.

9. Coming to the grievance of assessee, we agree with the contentions of assessee. In the case of Mrs. Banoo E. Cawasji Vs. CIT (supra), Hon'ble M.P. High Court has held as under:

"It is well settled law that the Commissioner (Appeals) cannot, while deciding an appeal preferred by an assessee, pass order with regard to the assessments made by the ITO in the case of others. Therefore, in the instant case, while deciding the question whether I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 11 -: Shabari Constructions

the reopening of assessment by the ITO in the assessee's case was justified, the Commissioner (Appeals) was not competent to issue direction to cancel the assessments made in the case of deceased".

9.1. Further, co-ordinate bench in the case of Shri Vijay Kumar Sarda Vs. DCIT (supra), also considered the same issue and held as under:

"8. We have carefully considered the rival submissions and perused the record. Under section 251 of the Income Tax Act the first Appellate Authority has the powers to confirm, reduce, enhance or annual the assessment. He can also initiate penalty proceedings and in any other case he may pass such orders in the appeal as he thinks fit. The expression 'may pass such orders in the appeal' was subject matter of consideration by various Courts. While deciding the appeal the Appellate Authority may give appropriate directions to' the AO either in regard to the assessee in appeal before him or otherwise. However, these directions cannot travel outside the assessment year to which the appeal relates. In the same way the directions cannot relate to a third person, whose appeal is not pending before him. The policy of law is that there must be a point of finality in all legal proceedings, that stale issues should not be reactivated beyond a, particular stage, as observed by the Hon'ble Apex Court in the case of Parashuram Pottery Workers Co. Ltd. 106 ITR 1 at page 10. In the instant case no addition was made in the hands of Smt .. Kalpana Vijay Sarda though she has filed the return by specifying that she has purchased the property. At the same time it is not in dispute that the AO has taken a consistent stand that a sum of ~16,51,000/- was paid for purchase of the said property but consciously took a view that she has no wherewithal to make such payment and hence no addition can be made under section 69A of the Act. This finding has become final and this was not in dispute before the Appellate Authority. In the appeal filed by the assessee's husband the only issue was as to whether he paid a sum of Rs.16,51,000/- to the tenant on behalf of his wife and it is not the case of either the AO or the assessee that the payment was made by assessee's wife. Such being the case, an issue which is not before the first Appellate Authority cannot be subject matter of consideration while disposing of an appeal, in exercise of the powers vested in the first Appellate Authority under section 251 of the Income Tax Act. In the case of A.S. Parikh vs. Income Tax Officer 203 ITR 186 the Hon'ble Gujarat High Court had considered identical issue with regard to extension of time I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 12 -: Shabari Constructions

limit by virtue of provisions of section 150(1) of the Income Tax Act and in that regard the Court observed that in order to issue such directions, which would amount to enhancing the assessment of a third party, such person must have been put on notice, as otherwise, it is not permissible to give such direction. The first ingredient is that there must be a finding that the income excluded from the total income of one person is the income of another person. The second ingredient is that the order must be one which has come to be passed after the other person was given an opportunity of being heard. The person concerned must be put on notice that the consequence of the income being held as her income is likely to adversely affect her tax liability.

9. In the instant case the learned CIT(A) has not called for any record either from the AO or from the affected parties before coming to the conclusion as to why the alleged payment was made from the undisclosed sources of income, more particularly when the AO was firmly of the opinion that she would not have been in a position to pay such huge amount since she had no other income to make such payment. The expression 'may be deemed to be the income' under section 69A of the Act implies that even after coming to the conclusion that a sum of Rs.16,51,000/- would have been paid for surrender of tenancy rights it is not automatic that such addition should be made under section 69A of the Act unless it is shown that she was capable of having so much of income in the year under consideration. The first Appellate Authority has not made any comment in that regard and, in fact, has not given any opportunity to Smt. Kalpana Vijay Sarda, which shows the fallacy in the direction given by him.

10. In the case of Mrs. Banoo E. Cowasji 138 ITR 686 the Hori'ble Indore Bench of the Madhya Pradesh High Court observed that there was no provision of law under which the CIT(A) , while deciding an appeal preferred by the assessee, can pass orders with regard to assessments made by the AO in the case of a third party.

11. In the case of Peico Electronics and Electricals Ltd. 210 ITR 991 the Honble Calcutta High Court observed that though the powers of the first Appellate Authority are co-terminus with that of the Aa and has powers to enhance the assessment but that is confined to the assessee and a finding or direction, while disposing of the appeal, must be a finding necessary for giving I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 13 -: Shabari Constructions

relief in respect of the assessment year in question. In other words, the conclusion reached by the AO in the case of a third party should not be disturbed without giving such assessee an opportunity of being heard and when it is not a necessary finding or direction in the case of the assessee whose appeal is pending and the issue therein is subject matter of dispute before the CIT(A).

12. In the case of CIT Vs. Banwari Lal & Sons P. Ltd., 257 ITR 518 at page 522 the Hon'ble Delhi High Court approved the findings of the Appellate Tribunal by observing as under:

"Before closing, we would like to say a word about the direction of the learned Appellate Assistant Commissioner to the Income-tax to bring the amount in question to tax under the head 'Income from property' in the respective assessment years to which the income. relates. This direction of the leaned Appellate Assistant Commissioner has to be construed in the light f the decision of the Supreme Court in the case of Rajinder Nath u. err [1979J 120 ITR

14. It was not a necessary for the disposal of the assessee's appeal for this year to give such a direction and, therefore, the same could not be treated as a direction given by the learned Appellate Assistant Commissioner as contemplated in section 153(3)(ii). "

It deserves to be noticed that the expression 'in consequence of or to effect to any finding or direct ion contained in an order under section 2 ..... ' is akin to the expression used in section 150(1) i.e. 'any finding direction contained in an order passed by any authority in any proceeding under this Act by way of an appeal'. In other words, in order to extend the time limit under section 148 of the Act, by taking aid of section 150 or 153, of the Act, the first Appellate Authority has to take into consideration the fact that the finding or direction should be relevant for the subject matter of dispute and, when it affects a third party, principles of natural justice demands that such third party shc.uld have been given an opportunity as otherwise such direction deserves to be set aside as invalid.

13. Similar view was taken by the ITAT Hyderabad Bench m the case of Pennar Electronics P. Ltd. 308 ITR (AT) 192. At page 203 the ITA' Hyderabad Benches had taken support of the view taken by the Hori'ble Patna High Court in the case of Gauri Shankar Choudhary 234 ITR 865 to observe that resort to sub-section (1) of section 150 of the Act can be take] only in cases where it becomes I.T.A. Nos. 1905 & 1645/Hyd/2014 :- 14 -: Shabari Constructions

necessary to make assessment or reassessment or recomputation and such direction must relate to the assessee in question and not any direction or assessment made in appeal reference or revision or any other assessee or any proceedings in which the assessee in question is not a party. Thus, on a conspectus of the matter, we are of the firm view that the direction given by the first Appellate Authority under section 150(1) is not in accordance with law. We order accordingly".

10. Since, co-ordinate bench considered the existing law on the issue elaborately, respectfully following the same, we hold that the directions given by Ld.CIT(A) in para 6.3 and 6.4 are not warranted and so the two paras are deleted from the order. We make it clear that directions given are not binding on the AO, but he is free to take independent steps if required on facts and permitted as per the provisions of law. With these observations, assessee's grounds are allowed.

11. In the result, Revenue's appeal is dismissed and assessee's appeal is allowed.

Order pronounced in open Court on 17th April, 2015

Sd/- Sd/-

(ASHA VIJAYARAGHAVAN) (B. RAMAKOTAIAH) JUDICIAL MEMBER ACCOUNTANT MEMBER

Hyderabad, Dated 17th April, 2015

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Copy to :

1. Shabari Constructions, C/o. P. Murali & Co., Chartered Accountants, 6-3-655/2/3, 1st Floor, Somajiguda, Hyderabad.

2. ITO, Ward-10(1), Hyderabad

3. ITO, Ward-6(2), Hyderabad

4. CIT(Appeals)-IV, Hyderabad

5. CIT-III, Hyderabad

6. D.R. ITAT, Hyderabad