Section 2(22)(e) Income Tax Act | Capital Contribution Cannot Be Treated As Advance Or Loan: Delhi HC

The Delhi High Court, in the context of Section 2(22)(e) of the Income Tax Act, 1961, held that capital contribution should not be construed as an advance or loan.

The Court noted that payments, whether direct loans or advances to shareholders or affiliated concerns, or indirect payments on behalf of the shareholder from a third party, up to the extent of accumulated profits, are deemed dividends.

The Court rejected an appeal against the Income Tax Appellate Tribunal's decision in favour of the Assessee. The Tribunal noted that the Commissioner of Income Tax (CIT) couldn't simultaneously identify specific issues and directed the Assessing Officer (AO) to reframe the assessment order.

The Bench comprising Justice Rajiv Shakdher and Justice Girish Kathpalia observed, “the capital contribution on a plain reading of the section cannot be treated as a 'loan' or 'advance'”.

Senior Advocate Zoheb Hossain appeared for the Appellant and Senior Advocate S. Ganesh appeared for the Respondent.

This appeal pertained to Assessment Year (AY) 2006-07. The Appellant/revenue sought to challenge the order, issued by the Income Tax Appellate Tribunal (Tribunal).

During the initial litigation phase, the Respondent appealed to the Tribunal against the Commissioner of Income Tax (CIT)'s order under Section 263 of the Act. The CIT set aside the assessment order, citing errors and prejudice to revenue interests, focusing on issues related to mutual fund gains and the taxation of capital contributions as deemed dividends under Section 2(22)(e) of the Act.

In the subsequent appeal, the Tribunal acknowledged the CIT's identification of issues. Still, it allowed the Respondent's appeal, contending that the CIT couldn't both find specific issues and direct the Assessing Officer to reframe the assessment order. Consequently, the Tribunal modified the CIT's order, instructing the AO to reframe the assessment order independently. This led to a fresh assessment order where gains from mutual fund redemption and capital contributions were added as deemed dividends. The Respondent appealed to the Commissioner of Income Tax (Appeals) [CIT(A)], resulting in a common order partly allowing appeals for AY 2006-07 and AY 2009-10.

The CIT(A) concluded that gains from mutual fund transfers should be treated as capital gains, not business income, directing the deletion of the AO's addition. In the second round of appeals, the Tribunal upheld the CIT(A)'s order, affirming the treatment of mutual fund gains as capital gains and rejecting the categorization of capital contributions as deemed dividends. Additionally, the Tribunal refused to interpret the CIT(A)'s observations as a direction under Section 150(1) of the Act, stating that such authority rested with the CIT(A) rather than the Tribunal, and refrained from interfering with the observations, suggesting examination in the context of specific actions against the concerned individuals.

The Court framed the issue: “Whether the transactions carried out by the Respondent/assessee concerning mutual funds were in the nature of investment or stock-in-trade, is an aspect which is fact-centric, juxtaposed with the law enunciated qua like transactions”.

The Court noted the Adjudicating Authority's responsibility in determining the assessee's intent, considering factors such as transaction magnitude, frequency, shareholding duration, purpose, and disclosure. It highlighted that the acquisition of shares did not inherently indicate a trade motive over an investment one, as clarified in various judicial decisions. On the first issue, the Court observed that both the CIT(A) and the Tribunal deemed the mutual fund transactions as of an investment nature, a conclusion unchallenged by the Appellant. No questions were proposed under Section 260A, leading the Court to conclude that no substantial question of law arose.

Turning to the second issue, the Bench observed that the Respondent accepted capital contributions from KPFSE and KICIPL, leading the AO to determine Rs.21,08,38,530/- as deemed a dividend. However, the Bench noted that Pradeep Wig (HUF) and Neera Wig, despite having shares in the profit, did not contribute capital and were not liable for any losses, which were borne by the partner companies.

The Court noted that Pradeep Wig and Neera Wig's substantial equity stakes in KPFSE and KICIPL and supported the CIT(A)'s observation that the capital contributions were not akin to a loan or advance, preventing their categorization as deemed dividends in the Respondent's hands.

Considering Section 2(22)(e) of the Act, the Bench emphasized that any payment made by a company not substantially interested by the public, as a loan or advance to a shareholder with substantial interest, is treated as deemed dividends. The objective is to uncover the distribution of accumulated profits to registered shareholders or beneficial owners.

The Court noted that factual findings indicated that KPFSE and KICIPL contributed capital without extending any loan or advance to the Respondent. Since the Respondent was neither a registered shareholder nor a beneficial owner, the addition could not be justified in its hands. Any potential addition should be considered in the hands of Pradeep Wig and Neera Wig, only by their respective AO, affording them an opportunity for a hearing.

Additionally, the Court observed that the Tribunal's conclusion that the CIT(A)'s observations could not be treated as a direction under Section 150(1) of the Act was deemed appropriate, emphasizing that any potential addition concerning Pradeep Wig and Neera Wig should be addressed by their respective AO, providing them an opportunity to present their case.

Accordingly, the Court dismissed the Appeal.

Cause Title: Pr. Commissioner Of Income Tax- 18 v M/S Wig Investment (2024:DHC:299-DB)

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