Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Advances by a subsidiary, as a business venture on profit share basis, for strategic investments to be made by the holding company not dividends under section
2(22)(e)
October 21, 2019
In brief
The Indore bench of the Income-tax Appellate Tribunal (Tribunal)1, while dealing with the issue of deemed dividend, held that the amount received as loan/ advance from a subsidiary for making further strategic investments will not be covered under section 2(22)(e) of the Income-tax Act, 1961 (Act). In addition, in view of peculiar facts of the case, the Tribunal held that for calculating the amount of deemed dividend, the opening balance of accumulated profits needs to be considered.
In detail
Facts
• The taxpayer is a domestic company engaged in the business of making
strategic investments across various industry sectors.
• The taxpayer had some good investment
opportunities and was in need of funds. One of its subsidiaries, which had surplus funds decided to find investment
opportunities for investing its idle funds. A
memorandum of
understanding (MOU) was entered between the taxpayer and the aforesaid subsidiary as per which the
1 ITA No. 936/ Ind/ 2018
subsidiary agreed to provide funds to the tune of INR 8.5bn to the taxpayer for further investment in identified options in consideration for sharing of profits subject to minimum assured returns.
• During the previous year relevant to the assessment year (AY) 2015-16, the taxpayer received INR 4.29bn from this subsidiary in 51 tranches (as and when required) for making further investments. In the taxpayer’s balance sheet, the said advance was shown under long-term
borrowings, however, in the related party schedule of the financial statements this
amount was reported as a trade advance.
• During the financial year (FY) 2017-18 the
investment was sold at a profit of INR 0.58bn which was equally shared between the taxpayer and its
subsidiary, and accordingly taxed.
The Tax Officer (TO) alleged that this amount was an unsecured loan from the subsidiary which was deemed dividend in terms of section 2(22)(e) of the Act. After considering the accumulated profits on 31 March 2015 (i.e. on the last day of the relevant FY) of the subsidiary, the TO made
Tax Insights
2 pwc
an addition to the taxpayer’s income.
Issues before the Tribunal
• Whether the funds received from the subsidiary for making strategic investments is liable to be taxed as deemed dividend under section 2(22)(e) of the Act in the hands of the taxpayer?
• Which is the relevant date for ascertaining the accumulated profits for the purpose of deemed dividend under section 2(22)(e) of the Act?
Taxpayer’s contentions
• The funds received from the subsidiary were for a business venture and not as a loan simplicitor or loan/ advance in lieu of dividend.
• Advance of money in the normal course of trade for a commercial purpose is outside the purview of section 2(22)(e) of the Act. In the instant case the subsidiary that had transferred the funds was benefitting from the contribution provided.
• ‘Loans and advance’
mentioned in section 2(22)(e) of the Act cover only those loans or advances which a shareholder enjoys solely on account of being the
beneficial owner of such shares. Where loans and advances are given to a shareholder in consequence of any further consideration which is beneficial to the company giving such funds, then such loans or advances cannot be considered as deemed dividend.
• Reliance was also placed on Central Board of Direct Taxes (CBDT) circular2 wherein the it was provided that trade advances in the nature of
2 Circular no. 19 of 2019 dated 12 February 2017
commercial transactions would not be covered under section 2(22)(e) of the Act.
• The subsidiary did not directly make the investment due to various reasons including the fact that it was not having investment expertise and did not want to take risk of adverse outcome of the investment.
• Even otherwise the TO can’t question as to why the investment was not directly made by the subsidiary. The courts have held that commercial decisions are to be taken by the taxpayer and the TO is not authorised to make additions based on such decisions taken. The TO is not authorised to step into the shoes of the businessman.
• As regards accumulated profit for the purpose of section 2(22)(e) of the Act, as held in various decisions, the
accumulated profit on the opening date, i.e. 1 April 2014 and not the closing date of 31 March 2015 should be considered.
Revenue’s contentions
• The impugned transaction was nothing, but an
unsecured loan given by the subsidiary to the taxpayer, which is squarely covered under section 2(22)(e) of the Act.
• The balance sheet of the taxpayer recorded this transaction under the head
“long-term borrowings” and not as a trade payable/
advance.
• The amount received from the subsidiary is not trade advance as it carries an obligation to repay. A trade advance is normally adjusted
3 Tapadia Tools Limited v. JCIT [2015] 55 taxmann.com 361 (SC)
against trading transactions, whereas a loan carries an obligation for repayment.
• Reliance placed by the taxpayer on the CDBT circular2 was distinguished since the nature of
transaction involved in the instant case cannot be treated as a normal trade advance.
• After receipt of loan, the amount was mainly transferred to the group companies and was not utilised for any business activity. Thus, the taxpayer’s plea that the funds was utilised for making strategic investments is not valid.
• As regards the relevant date for determining the extent of accumulated profits, the Revenue relied on the TO’s order. Even during the appellate proceedings, the taxpayer could not share details of accumulated profits on the dates when the
payments were made.
Tribunal’s ruling
Issue 1: Is the transaction in the nature of deemed dividend or not?
• The fact that the taxpayer had shown the alleged amount as an unsecured loan in the balance sheet cannot be the sole reason for determining its true nature in light of the principle laid down by the Supreme Court3.
• On one hand the amount received is appearing under the head “long-term borrowing” as a loan
repayable on demand and on the other hand, in the very same set of audited financial statements, the same amount is shown as a trade advance
Tax Insights
3 pwc
in the related party disclosures.
• Provisions of section 2(22) of the Act provide certain exceptions. One such
exception is that if a company makes any loan/ advance to a shareholder in the ordinary course of its business, where the lending of money is a substantial part of the business of the company, the amount would not be treated as dividend.
• Provisions of section 2(22)(e) of the Act were introduced to counter the practice of diverting accumulated reserves and earnings to select substantial shareholders. Where the amount is advanced to a shareholder in the ordinary course of business, provisions of deemed dividend are not attracted.
• Considering entire transaction, which
commenced in FY 2012-13 and culminated in FY 2017-18 (when the investments were eventually sold and profit was shared), it was held that the transaction was a commercial transaction which was carried out in the ordinary course of business. As the contributor directly benefited from the utilisation of funds, in line with the agreed business plan, the transaction cannot be considered as a
contribution in lieu of dividend.
• According to the law, when the retained earnings/
4 Commissioner of Income-tax v. Farida Holding (P) Limited [2016] 76
taxmann.com 30 (SC), CIT v. Creative Dyeing & Printing Private Limited [2009]
accumulated surplus funds are diverted to the substantial shareholders as loans or advance and not as dividend at a fixed rate per equity share to avoid paying dividend distribution tax, then the provision of section 2(22)(e) of the Act comes into play. But in case where the amount is advanced to the substantial interested shareholder as a part of the business transaction then the situation changes as such advance or loan given by the company to its shareholder in its ordinary course of
business which cannot be treated as dividend.
• It is a judicial settled law that the businessmen should not be taught how to carry its business affairs.
• Relying on various judgements4 and CBDT circular2, the Tribunal held that provisions of section 2(22)(e) of the Act should be invoked when loans and advances are given to a substantial shareholder in the garb of avoiding dividend distribution tax or with the intention of not sharing the dividend with minority shareholders.
• Revenue authorities should refrain from using the provisions of section 2(22)(e) of the Act as a tool for maximising the tax collection rather they should use the powers to keep a check of such distribution of
accumulated reserves which are not for the ordinary
184 taxmann.com 483 (Delhi), M.
Amareswara Rao v. DCIT [2016] 67 taxmann.com 15 (Visakhapatnam), CIT v.
course of business and are intentionally entered into for the benefit of substantial shareholders.
• Therefore, the addition for deemed dividend under section 2(22)(e) of the Act was deleted.
Issue 2: Computation of deemed dividend
• As per section 2(22)(e) of the Act any advance to a
substantial shareholder is considered as deemed dividend to the extent of accumulated profits. As held by the Tribunal5 the amount of accumulated profit should be worked out on the date of payment/ advancement of the loan.
• In the instant case the amount has been advanced to the taxpayer on multiple occasions. Had it been the case wherein a single transaction was involved, it would have been feasible to compute the amount of accumulated reserves on the date of advancement.
However, considering the large number of transactions involved and the fact that the first transaction took place on 2 April 2014, the opening balance of the accumulated profits should have been considered for computing the amount of deemed dividend.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
Gayatri Chakraborty [2018] 94 taxmann.com 244 (Calcutta)
5 M.P. Stock Holding Private Limited v.
ACIT [2003] 84 ITD 542 (Ahmedabad)
Tax Insights
For private circulation only
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwCPL, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of PwCPL, this publication may not be quoted in whole or in part or otherwise referred to in any documents.
© 2019 PricewaterhouseCoopers Private Limited. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity.
About PwC
At PwC, our purpose is to build trust in society and solve important problems. We’re a network of firms in 157 countries with over 276,000 people who are committed to delivering quality in assurance, advisory and tax services.
Find out more and tell us what matters to you by visiting us at www.pwc.com.
In India, PwC has offices in these cities: Ahmedabad, Bengaluru, Bhopal, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai, Pune and Raipur. For more information about PwC India’s service offerings, visit www.pwc.in
PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.
© 2019 PwC. All rights reserved
Follow us on:
Our Offices
Ahmedabad Bengaluru Chennai
1701, 17th Floor, Shapath V, Opp. Karnavati Club, S G Highway,
Ahmedabad – 380051 Gujarat
+91-79 3091 7000
6th Floor
Millenia Tower ‘D’
1 & 2, Murphy Road, Ulsoor, Bengaluru – 560 008 Karnataka
+91-80 4079 7000
8th Floor
Prestige Palladium Bayan 129-140 Greams Road Chennai – 600 006 Tamil Nadu
+91 44 4228 5000
Hyderabad Kolkata Mumbai
Plot no. 77/A, 8-2-624/A/1, 4th Floor, Road No. 10, Banjara Hills, Hyderabad – 500034
Telangana
+91-40 44246000
56 & 57, Block DN.
Ground Floor, A- Wing Sector - V, Salt Lake Kolkata – 700 091 West Bengal
+91-033 2357 9101/
4400 1111
PwC House Plot No. 18A,
Guru Nanak Road(Station Road), Bandra (West), Mumbai – 400 050 Maharashtra
+91-22 6689 1000
Gurgaon Pune For more information
Building No. 10, Tower - C 17th & 18th Floor,
DLF Cyber City, Gurgaon – 122002 Haryana
+91-124 330 6000
7th Floor, Tower A - Wing 1, Business Bay, Airport Road, Yerwada, Pune – 411 006 Maharashtra
+91-20 4100 4444
Contact us at
