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Advances to shareholders/sister concerns which indirectly benefits the
company not to be regarded as deemed dividend
23 January 2015
Background
Recently, the Karnataka High Court (High Court) in the
1
case of Bagmane Constructions Pvt. Ltd. (the
taxpayer) held that loan or advance given to a
shareholder or to any sister concern as a consideration
for the goods or for purchase of a capital asset, which
indirectly would benefit the company advancing the
loan, cannot be treated as deemed dividend under
Section 2(22)(e) of the Income-tax Act, 1961 (the Act).
The High Court observed that the term ‘advance’ may
or may not include lending. The word ‘advance’ if not
found in the company or in conjunction with the word
loan, may or may not include the obligation of
repayment. If it does then it would be a loan. However,
the legislature has used the expression by way of
advance or loan. Therefore, the meaning of the word
‘advance’ is to be understood in conjunction with the
meaning of the word loan which is used immediately
thereafter. If the intention of such advance or loan is to
avoid payment of Dividend Distribution of Tax (DDT)
under Section 115-O of the Act, such payment by a
company constitutes deemed dividend.
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1
Bagmane Constructions Pvt. Ltd. v. CIT (ITA No. 473/2013, 474/2013,
475/2013, 476/2013) – Taxsutra.com
Facts of the case

The taxpayer is a closely held company. The
taxpayer advanced money to its sister concerns
including, an individual shareholder who holds 99
per cent of the equity share capital in the taxpayer.
The taxpayer advanced the said amounts for
sourcing of land on account of a joint venture
agreement.

In view of the provisions of the Karnataka Land
Reforms Act, a non-agriculturist including a
company cannot purchase or own agricultural land.
Therefore, funds were given by the taxpayer to its
sister concerns (including individual shareholder) to
procure land in the name of the directors and hold
the same in the form of capital asset and then
transfer it back to the company after the
agricultural land was converted into nonagricultural land.

The taxpayer claimed that since the funds were not
given for individual benefit of directors, deemed
dividend concept was not applicable.

The Assessing Officer (AO) held that the payment
by way of loans that were advanced to the extent
of accumulated profits is to be treated as deemed
© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
as trade advance as a consideration for the goods
received or for purchase of a capital asset which
indirectly would benefit the company advancing
the loan, such advance cannot be brought within
the word ‘advance’ used in the aforesaid
provision.
dividend under Section 2(22)(e) of the Act. The
Commissioner of Income-tax (Appeals) [CIT(A)] upheld
the order of the AO.

The Income-tax Appellate Tribunal (the Tribunal) held
that the advances made by the taxpayer to its sister
concerns would not fall within the definition of ‘dividend’
under Section 2(22)(e) of the Act and hence not
taxable.

The trade advance which is in the nature of
money transacted to give effect to commercial
transactions would not fall within the ambit of the
provisions of Section 2(22)(e) of the Act.

The Supreme Court in the case of LIC of India
has held that each word employed in a statute
must take colour from the purport and the object
for which it is used. Principle of purposive
interpretation should be taken recourse to. If a
literal interpretation is given to the said words, it
means all trade advances are to be taxed as
deemed dividend. If such an interpretation is
placed, it would lead to absurdity. That was not
the intention of the legislature in enacting the
aforesaid provision.

The High Court observed that Clause (ii) of
Section 2(22)(e) of the Act would be applicable
only when all the conditions prescribed in clause
(e) of Sub-Section (2) of Section 22 are complied
with. If a payment is made by way of trade or
business, advance or loan, Section 2(22)(e) of the
Act is not attracted and the question of applying
the aforesaid clause (ii) would not arise.

Accordingly, it has been held that under the
circumstance, the advances made by the
company to its sister concerns do not fall within
the definition of a deemed dividend under Section
2(22)(e) of the Act.
High Court’s ruling

Perusal of the provisions of Companies Act, 1956,
indicates that the only registered shareholder in a
company is entitled to dividend. Even a person who
holds shares as a trustee is treated as a registered
shareholder. The shareholder is the only person
recognised by the company, who is entitled to payment
of dividend.

On a perusal of various decisions , it indicates that the
purpose of the insertion of sub-clause (e) of Section
2(22) of the Act was to bring within the tax, net
accumulated profits which are distributed by closely
held companies to its shareholders in the form of
advances and loans to avoid payment of taxes.




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Thus, gratuitous loan or advance given by a company
to specified classes of shareholders would fall within
the purview of Section 2(22) of the Act but not the
cases where the loan or advance is given in return to
an advantage conferred upon the company by such
shareholder. The intention behind the provisions of
Section 2(22)(e) of the Act is to tax dividend in the
hands of shareholders.
The word ‘any payment’, by a company, by way of
advances or loans, has to be interpreted in the context
of the object with which said provision is introduced.
Though the legislature has introduced ‘advance’ as well
as ‘loan’ which are two different words, the meaning of
each of those words have to be understood in the
context in which they are used.
In the case of a loan, money is advanced generally on
payment of interest. In the case of an advance, the
element of repayment is there but such a repayment
may be with interest or without interest. When the said
two words are used in the provision with the purpose of
levying tax, if the intention of such advance or loan is to
avoid payment of DDT under Section 115-O of the Act,
such payment by a company certainly constitutes
deemed dividend.
If payment is made firstly not out of accumulated profits
and secondly even if it is out of accumulated profits, but
_____________
2
K.P.Varghese v. ITO [1981]131 ITR 597 (SC)
CIT v. Mother India Refrigeration Industries P. Ltd. [1985]155 ITR 711(SC)
CIT v. Rajkumar [2009] 318 ITR 462 (Del)
Pradeep Kumar v. Income Tax Officer [2011] 338 ITR 538 (Cal)
CIT v. Ankitech P. Ltd. [2012] 340 ITR 14 (Del)
CIT v. Sarva Equity Pvt. Ltd. (ITA No. 322/12)
3
4
Our comments
In typical closely held companies, generally
loans/advances are taken from sister concerns on
account of various reasons like better credit facility,
pure business transactions, etc. In such a situation,
the tax officer may seek to bring these amounts within
the ambit of section 2(22)(e) of the Act. Thus, a pure
commercial transaction may also be brought to tax.
5
The Delhi High Court in the case of Raj Kumar has
held that the trade advances which are in the nature of
money transacted to give effect to a commercial
transaction would not fall within the ambit of the
provisions of Section 2(22)(e) of the Act. The instant
decision further supports the contention that ‘advance’
in the form of a pure commercial transaction should
not be brought within the ambit of section 2(22)(e) of
the Act.
__________
3
LIC of India v. Retired LIC Officers Association [2008] (3) SCC 321
Clause (ii) of Section 2(22)(e) provides that deemed dividend does not
include any advance or loan made to a shareholder or the concern in the
ordinary course of business where the lending of money is a substantial part
of the business of the company
5
CIT v. Raj Kumar [2009] 181 Taxmann 155 (Del)
4
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
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