Loan advanced to shareholder for availing credit facility from banks can’t be treated as ‘deemed dividend’ u/s 2(22)(e) of I-T Act: Karnataka HC

Read judgment: Commissioner of Income Tax & Anr vs. Sri N S Narendra

LE Staff

Bengaluru, July 23, 2021: While dismissing an appeal of the Revenue Department, the Karnataka High Court ruled that the loan advanced to a shareholder with the intention of availing credit facility from banks on the name of such shareholder, cannot be treated as ‘deemed dividend’ under section 2(22)(e) of Income Tax Act. 

The Division bench of Justice Alok Aradhe and Justice Hemant Chandangoudar observed that the loan was not advanced to the assessee by the Company merely because he was a shareholder with substantial interest, but with an intention to avail loan from the bank for business purposes. 

Thus, reiterating that the Company derived the benefit from getting a loan/advance, the High Court upheld the findings of the Tribunal that such advancement of loan cannot be termed as ‘deemed dividend’. 

Going by the background of the case, the managing director of M/s. Firepro Systems Pvt. Ltd. borrowed loans worth Rs. 200 crores for purpose of capital requirements of its business, and out of the same paid certain amounts to the assessee for purchasing an apartment in Bengaluru which was disclosed under recoverable advances in the accounts of the Company. The said amounts were paid to the assessee in recognition of his contribution to the business of the Company. In the course of assessment, this advance was added as ‘deemed dividend’ u/s 2(22)(e) to the income of assessee. 

When the matter went in appeal, the CIT(A) held that payments received by assessee from the Company could not be termed as deemed dividends as the payments were not for the benefit of the assessee and in fact the Company was benefited by availing loans for furtherance of its business. This finding of the FAA was upheld by the Income tax appellate Tribunal. 

“In the instant case, the Commissioner of Income Tax (Appeals) has held that the loan was not advanced to the assessee by the Company merely because he was a shareholder with substantial interest, but the Company allowed the assessee to avail the advance/loan as it wanted to obtain the loan from the Bank for business purpose. Thus, the Company derived the benefit of getting a loan/advance. Therefore, advance of loans granted by the Company to the assessee cannot be treated as deemed dividend u/s 2(22)(e) of the Act,” said the High Court. 

The Division Bench also noted that the assessee was managing director of the Company and holding more than 10% of the voting power. Further, the assessee is the owner of an apartment which was offered as a collateral security in the form of mortgage to the Bank, and in lieu thereof, the Company availed of credit facility from the Banks to the extent of Rs. 266.45 crores. 

In short, the Company derived the benefit from the assessee and therefore, granted the loan/advance to the assessee, reiterated the Bench. 

Therefore, affirming the findings of the CIT(A) as well as the Tribunal which was based on the division bench decision of Calcutta High Court in Pradip Kumar Malhotra vs. CIT, the Karnataka HC ruled the substantial question of law in favour of the assessee.