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The Income Tax Appellate Tribunal, Mumbai has held that a payment made by a closely held company to a substantial shareholder cannot be treated as deemed dividend under Section 2(22)(e) of the Income-tax Act, 1961 merely because money has moved from the company to the shareholder. The Tribunal emphasised that the payment must first possess the character of a loan or advance by the company to the shareholder before the deeming provision can operate.
The dispute arose in the case of Deepak Varandmal Wadhwa, who held 85% shares in M/s Dhanraj Global Corporation Pvt. Ltd. and was also its director. During the relevant year, the assessee received ₹48 lakh from the company. The Assessing Officer treated the amount as deemed dividend under Section 2(22)(e), principally on the ground that the assessee was a substantial shareholder and had received the money from the company.
The assessee, however, demonstrated through the company’s ledger and audited financial statements that the financial relationship was precisely the reverse. As on 1 April 2019, ₹42,03,475 was already standing to the assessee’s credit in the books of the company. The assessee continued to introduce funds during the year, and even after the withdrawal of ₹48 lakh, his account never became debit. At the end of the year, the company continued to owe him ₹68,91,536.
The CIT(A) accepted these factual findings, including that the assessee had advanced money to the company and that there was no debit balance in his account at any point. Nevertheless, the addition was sustained on the reasoning that Section 2(22)(e) uses the expression “any payment by a company”.
The Tribunal rejected this interpretation. It observed that the words “any payment” cannot be read in isolation and must be read together with the qualifying expression “by way of advance or loan to a shareholder”. Therefore, the mere movement of funds from a closely held company to a shareholder is insufficient. The legal and commercial character of the payment must be examined.
The ITAT made an important distinction between a shareholder borrowing money from a company and a company repaying money that it already owes to the shareholder. Where the company is already indebted to the shareholder and makes payment against an existing credit balance, the payment reduces the company’s liability; it does not create any indebtedness of the shareholder towards the company.
Accordingly, the Tribunal held that a debtor’s repayment to its creditor cannot become a loan merely because the money moves from the company to its shareholder. Where the shareholder’s running account remains in credit and does not become debit after the payment, such payment ordinarily represents discharge of the company’s existing liability.
The Tribunal also rejected the Assessing Officer’s reliance on the absence of a formal loan agreement, repayment schedule, interest terms or evidence of Board approval. Once the company’s books and audited accounts established that it was indebted to the assessee, the absence of such formalities could not alter the actual direction of indebtedness or supply the foundational requirement necessary for invoking Section 2(22)(e).
The ITAT further observed that the same running account could not be examined selectively. The cumulative movement of funds, including the opening credit balance, additional amounts introduced by the assessee, the ₹48 lakh withdrawal and the closing credit balance, showed that the assessee remained a net lender to the company throughout the relevant period.
The Tribunal therefore concluded that the ₹48 lakh represented withdrawal or repayment against money already due from the company to the assessee, and not a loan or advance by the company. The fundamental statutory ingredient for applying Section 2(22)(e) was consequently absent.
The addition of ₹48 lakh under Section 2(22)(e) was directed to be deleted, and the assessee’s appeal was allowed.
Key Takeaway
Section 2(22)(e) does not apply merely because a closely held company makes a payment to a substantial shareholder. The payment must have the character of a loan or advance by the company. Where a running account continuously remains in the shareholder’s favour and the company is merely repaying an existing liability, such repayment cannot be treated as deemed dividend.