Deemed dividend under section 2(22)(e) & Determination of accumulated profits vis a vis Treatment of deferred tax liability

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Deemed dividend under section 2(22)(e) & Determination of accumulated profits vis a vis Treatment of deferred tax liability

 

 

Short Overview  Reversal of Deferred tax liability is nullifying the effect of provision created earlier, meaning thereby, the net monetary effect would be nil, when it is reversed. For example, if Rs. 100 is transferred to Deferred tax liability in any of the earlier years and if the same is reversed now, then both the transactions get neutralised and hence the same shall not have any effect on “accumulated profits”. Accordingly, no adjustment need be made in the year of reversal to arrive at accumulated profits.

Assessee received loan of Rs. 8 crores from its subsidiary named M/s. ‘A’ (P) Ltd, in which assessee held 99.99% of shares. AO noticed that M/s. ‘A’ (P) Ltd. had reserves to the tune of Rs. 22 crores as at the beginning of year, which included “Surplus profit & loss” balance of Rs. 4 crores. Hence, AO took the view that provisions of section 2(22)(e) relating to deemed dividend was applicable to the loan taken by assessee. Assessee’s case was that transactions were in furtherance of business objective and business needs of both the companies. AO noticed that “Reserves & Surplus” of Rs. 22 crores included “Surplus in profit & loss account” of Rs. 4 crores. Accordingly, AO held that loan to the extent of Rs. 4 crores was assessable as deemed dividend income under section 2(22)(e). Assessee submitted that the opening balance of “Surplus in profit & loss account” was Rs. 4,42,41,971. During the year ending 31-3-2013, i.e., in the immediately preceding previous year, the assessee has credited profit and loss account with “Deferred Tax liability reversal amount” of Rs. 8,59,35,099. He submitted that “Deferred tax liability amount” is a notional reserve, which is created in compliance with the requirements of Accounting Standards. Accordingly, he submitted that the “Deferred Tax liability amount” and its reversal should be ignored for determining “accumulated profits”. He submitted that the Mumbai bench of Tribunal has held in the case of ACIT v. Shri Narayan J Pagrani (ITA No. 7480/Mum/2011, dated 13-8-2014) that the deferred tax liability amount is a notional reserve and it need not be deducted from the “Profits of the year” and hence could not be allowed to be deducted from “accumulated reserves”. Accordingly, if Rs. 8,59,35,009 is excluded from the “Surplus in profit & loss account” as on 31-3-2013, the above said company shall not have any “accumulated profits”. Hence the addition made by assessing officer under section 2(22)(e). Revenue submitted that the term “accumulated profits” have been defined under Explanation 2 to section 2(22)(e) of the Act. The said definition does not allow deduction of any amount from accumulated profits. 

It is held that  The expression “accumulated profits” would refer to the “Reserves and Surplus” accumulated over the years as per the accounts prepared under Companies Act. Further, the term “accumulated profits” has been defined under Explanation 2 to section 2(22)(e). Reversal of Deferred tax liability is nullifying the effect of provision created earlier, meaning thereby, the net monetary effect would be nil, when it is reversed. For example, if Rs. 100 is transferred to Deferred tax liability in any of the earlier years and if the same is reversed now, then both the transactions get neutralised and hence the same shall not have any effect on “accumulated profits”. Accordingly, no adjustment need be made in the year of reversal. Accordingly, the accumulated profit amount determined by the AO at Rs. 4,42,41,971 was justified and accordingly the AO was justified in assessing the same as deemed dividend under section 2(22)(e) of the Act.

Decision: Against the assessee.

 

IN THE ITAT, BANGALORE “C” BENCH

N.V. VASUDEVAN, V.P. & B.R. BASKARAN, A.M.

Assetz Infrastructure (P) Ltd. v. Dy. CIT

ITA Nos. 563 & 983/Bang/2019

A.Y. 2014-15

2 December, 2020

Appellant by: B. Sudheendra, Authorised Representative

Respondent by: Sunil Kumar Agarwal, Departmental Representative

ORDER

B.R. Baskaran, A.M.

These cross appeals are directed against the Order, dated 28-1-2019 passed by learned Commissioner (Appeals)-1, Bengaluru and they relate to the assessment year 2014-15.

2. The assessee is in appeal in respect of the following issues:–

(a) Disallowance of interest expenses under section 36(1)(iii) of the Income Tax Act,1961 (‘the Act’ for short).

(b) Addition of deemed dividend under section 2(22)(e) of the Act partially sustained by learned Commissioner (Appeals). Remaining grounds are either general in nature or consequential in nature.

3. The revenue is in appeal in respect of the following issues: —

(a) Disallowance made under section 14A of the Act.

(b) Partial relief granted in respect of addition of deemed dividend under section 2(22)(e) of the Act.

4. The assessee company is engaged in the business of construction, development and sale of all types of housing projects, commercial projects and related activities.

5. The first issue contested by the assessee relates to the disallowance of interest expenditure under section 36(1)(iii) of the Act. The assessing officer noticed that the assessee has taken interest bearing loans from various persons to the tune of Rs. 29.16 crores. It was also noticed that the assessee has given interest free loans to related concerns to the tune of Rs. 10.26 crores. Further, he assessee had also claimed interest expenditure of Rs. 1,54,10,932. Hence the assessing officer proposed to disallowed a part of interest expenditure. When questioned, the assessee offered following explanations:–

(a) The interest free loans were given to subsidiary companies, which are also engaged in the real estate development activities only. Hence it is in furtherance of business activities of the assessee.

(b) The assessee has got interest fee funds in the form of “Advances from customers” and it has been used to give interest fee loans. Hence it should be presumed that interest free funds have been used to give interest free loans.

The assessing officer held that that loan given to/investment made in subsidiaries cannot be termed as a business activity of the assessee. The assessee could not prove the nexus between the business purpose and advancing of loans. Accordingly, the assessing officer rejected the contentions of the assessee. Accordingly, he disallowed proportionate interest expenses of Rs. 43,13,634.

5.1 The learned Commissioner (Appeals) also held that there is no business purpose in given interest free advances to the subsidiaries. He also noticed that the assessee has invested funds in JDA projects, in purchase of lands etc., and hence the interest free advances from customers could have been used for the above said purposes. Since the assessee was having small amount of share capital, the learned Commissioner (Appeals) took the view that the interest bearing loans have been diverted to the subsidiary companies in the form of interest free loans. Accordingly, he confirmed the addition made by the assessing officer.

5.2 We heard the parties on this issue and perused the record. There is no dispute with regard to the fact that the interest free advances received from customers was available with the assessee to the tune of Rs. 16.96 crores as noticed by learned Commissioner (Appeals) at page 28 of his order, i.e., Rs. 14.22 crores under Schedule V and Rs. 2.74 crores under Schedule X, both aggregating to Rs. 16.96 crores. The interest free loans given to subsidiary companies stand at Rs. 10.26 crores. Hence the assessee has contended that the interest free funds available with it has been used to make interest free loans to the subsidiaries. The learned Authorised Representative placed his reliance on the decision rendered by Hon’ble Bombay High Court in the case of CIT v. HDFC Bank Ltd. (2014)(49 taxmann.com 335)(Bom) : 2014 TaxPub(DT) 3351 (Bom-HC). Following observations made by the Hon’ble High Court would show that, if the own funds and “interest free funds” available with the assessee is more than the investment in tax free securities, then it should be presumed that the said investments have been made out of interest free funds available with the assessee:–

“5. We find that the facts of the present case are squarely covered by the judgment in the case of Reliance Utilities & Power Ltd. (supra)**. The finding of fact given by the ITAT in the present case is that the Assessee’s own funds and other non-interest bearing funds were more than the investment in the tax-free securities. This factual position is not one that is disputed. In the present case, undisputedly the Assessee’s capital, profit reserves, surplus and current account deposits were higher than the investment in the tax-free securities. In view of this factual position, as per the judgment of this Court in the case of Reliance Utilities & Power Ltd. (supra), it would have to be presumed that the investment made by the Assessee would be out of the interest-free funds available with the Assessee. We therefore, are unable to agree with the submission of Mr. Suresh Kumar that the Tribunal had erred in dismissing the Appeal of the Revenue on this ground. We do not find that question (A) gives rise to any substantial question of law and is therefore rejected.”

(** 313 ITR 340)

It may be noticed that the above said decision was made in the context of the disallowance made under section 14A of the Act. However, the Hon’ble Bombay High Court has followed the decision rendered by it in the case of Reliance Utilities and Power Ltd., wherein the question was disallowance made under section 36(1)(iii) of the Act. It may also be noticed that the decision rendered in the case of HDFC Bank Ltd. (supra) has been followed by the jurisdictional Hon’ble Karnataka High Court in the case of CIT v. Micro Labs Ltd. (2017) 79 taxmann.com 365 (Kar). The decision rendered by Hon’ble Bombay High Court in the case of Reliance Utilities Power Ltd. (supra) has been followed by the Hon’ble Karnataka High Court in the case of CIT v. Brindavan Beverages (P) Ltd. (2017) 88 taxmann.com 477 (Kar.) : 2017 TaxPub(DT) 1187 (Karn-HC) in the context of disallowance made under section 36(1)(iii) of the Act.

5.3 Since the interest free funds available with the assessee is more than the interest free loans given to subsidiaries, it should have to be presumed that the loans have been given out of interest free funds. Accordingly, following the decision rendered by the Hon’ble jurisdictional Karnataka High Court (referred supra), we set aside the order passed by learned Commissioner (Appeals) on this issue and direct the assessing officer to delete this disallowance.

6. The next issue relates to the addition made by the assessing officer under section 2(22)(e) of the Act. Since the learned Commissioner (Appeals) has given partial relief in respect of this addition, both the parties are in appeal before us on this issue.

6.1 The assessing officer noticed that the assessee has received loan of Rs. 8,99,11,142 from its subsidiary named M/s. Assetz Property Services (P) Ltd, in which the assessee held 99.99% of shares. The assessing officer noticed that M/s. Assetz Property Services (P) Ltd. had reserves to the tune of Rs. 22,66,94,775 as at the beginning of the year, which included “Surplus profit & loss” balance of Rs. 4,42,41,971. Hence the assessing officer took the view that the provisions of section 2(22)(e) relating to deemed dividend is applicable to the loan taken by the assessee.

6.2 The assessee submitted that it is having running account with its subsidiary company (referred to by the assessee as “Assetz Property Management Services (P) Ltd. (APMS).). The learned Authorised Representative submitted that this subsidiary company was earlier known as “Bearing Point Property Services (P) Ltd. Hence all the three names refer to the same subsidiary. There were financial transactions of both deposits and receipts in the running account. The assessee had received advances of Rs. 5,11,38,000 and paid advances of Rs. 5,20,91,533. It was submitted that these transactions were in furtherance of business objective and business needs of both the companies. Accordingly, it was submitted that the provisions of section 2(22)(e) are not attracted. The assessee placed its reliance on the decision rendered by Hon’ble Karnataka High Court in the case of Bagmane Constructions (P) Ltd. (2015) 57 taxmann.com 120 (Kar) : 2015 TaxPub(DT) 2337 (Karn-HC) and CIT v. M/s. Shree Balaji Glass Manufacturing (P) Ltd. (2016) 72 taxmann.com 118 (Cal.) : 2016 TaxPub(DT) 3695 (Cal-HC)

6.3 The assessing officer did not accept the contentions of the assessee. As noticed earlier, the “Reserves & Surplus” of Rs. 22.66 crores included “Surplus in profit & loss account” of Rs. 4,42,41,971. Accordingly, the assessing officer held that the loan to the extent of Rs. 4,42,41,971 is assessable as deemed dividend income under section 2(22)(e) of the Act. Accordingly he assessed the same as deemed dividend.

6.4 The learned Commissioner (Appeals) noticed that the assessee has received loans from APMS to the extent of Rs. 5,11,38,000 and repaid a sum of Rs. 4,99,88,354. Accordingly, the learned Commissioner (Appeals) held that the net amount of Rs. 11,49,646 only as deemed dividend under section 2(22)(e) of the Act. Aggrieved, by the decision so rendered by learned Commissioner (Appeals), both the parties are in appeal before us.

6.5 We notice that the decision taken by learned Commissioner (Appeals) to give set off amounts repaid is against the decision rendered by Hon’ble Supreme Court in the case of Miss P Sarada v. CIT (1998) 229 ITR 444 (SC) : 1998 TaxPub(DT) 1048 (SC). In the above said case, Hon’ble Supreme Court held that the loan or advance taken from the company may have been ultimately repaid or adjusted but that will not alter the fact that the assessee, in the eye of law, had received dividend from the company during the relevant accounting period. Hence the order passed by learned Commissioner (Appeals) on this issue requires to be set aside.

6.6 The learned Authorised Representative contended that the Reserves & Surplus of M/s. Assetz Property Management Services (P) Ltd. included Share Premium account and the Share Premium amount shall not fall under the definition of “accumulated profits”. However, we have noticed earlier that the assessing officer has assessed the “Surplus in profit & loss account” of Rs. 4,42,41,971 only as deemed dividend under section 2(22)(e) of the Act, i.e., the assessing officer himself has not taken Share premium account as part of accumulated profits.

6.7 The learned Authorised Representative submitted that the opening balance of “Surplus in profit & loss account” was Rs. 4,42,41,971. During the year ending 31-3-2013, i.e., in the immediately preceding previous year, the assessee has credited profit and loss account with “Deferred Tax liability reversal amount” of Rs. 8,59,35,099. He submitted that “Deferred tax liability amount” is a notional reserve, which is created in compliance with the requirements of Accounting Standards. Accordingly, he submitted that the “Deferred Tax liability amount” and its reversal should be ignored for determining “accumulated profits”. He submitted that the Mumbai bench of Tribunal has held in the case of ACIT v. Shri Narayan J Pagrani (ITA No. 7480/Mum/2011, dated 13-8-2014) that the deferred tax liability amount is a notional reserve and it need not be deducted from the “Profits of the year” and hence could not be allowed to be deducted from “accumulated reserves”. Accordingly, if Rs. 8,59,35,009 is excluded from the “Surplus in profit & loss account” as on 31-3-2013, the above said company shall not have any “accumulated profits”. Hence the addition made by assessing officer under section 2(22)(e) of the Act is liable to be deleted.

6.8 On the contrary, the learned Departmental Representative submitted that the term “accumulated profits” have been defined under Explanation 2 to section 2(22)(e) of the Act. The said definition does not allow deduction of any amount from accumulated profits as contended by learned Authorised Representative.

6.9 On a careful consideration of the arguments of learned Authorised Representative, we are of the view that the same is liable to be rejected on two grounds, viz.,

(a) The expression “accumulated profits” would refer to the “Reserves and Surplus” accumulated over the years as per the accounts prepared under the Companies Act. Further, the term “accumulated profits” has been defined under Explanation 2 to section 2(22)(e) of the Act. As submitted by learned Departmental Representative, the said definition does not provide for exclusion of any amount from the “accumulated profits”.

(b) Reversal of Deferred tax liability is nullifying the effect of provision created earlier, meaning thereby, the net monetary effect would be nil, when it is reversed. For example, if Rs. 100 is transferred to Deferred tax liability in any of the earlier years and if the same is reversed now, then both the transactions get neutralised and hence the same shall not have any effect on “accumulated profits”. Accordingly, no adjustment need be made in the year of reversal.

6.10 Accordingly, the accumulated profit amount determined by the assessing officer at Rs. 4,42,41,971 is justified and accordingly we hold that the assessing officer was justified in assessing the same as deemed dividend under section 2(22)(e) of the Act. Accordingly, we reverse the order passed by learned Commissioner (Appeals) on this issue.

7. The remaining issue contested by the revenue relates to the addition made under section 14A of the Act.

7.1 The assessing officer noticed that the assessee has made investment of Rs. 14,72,66,000. However, it did not disallow any amount in terms of section 14A of the Act read with rule 8D of Income Tax Rules. The assessee submitted that it did not earn any dividend income during the year under consideration and hence no exemption was claimed. Accordingly it submitted that no disallowance under section 14A is called for. The assessee placed its reliance on the decision rendered by co-ordinate bench in the case of M/s. Kingfisher Finvest India Ltd. v. Addl. CIT (ITA No. 1368/B/2012 dated 17-10-2014), CIT v. M/s. Shivam Motors (P) Ltd. (2014) 272 CTR 277 (All) : 2014 TaxPub(DT) 4333 (All-HC). The assessing officer did not accept the contentions of the assessee and disallowed a sum of Rs. 44,89,934 under section 14A of the Act.

7.2 However, the learned Commissioner (Appeals) accepted the contentions of the assessee and accordingly, he deleted the disallowance made under section 14A of the Act by following the decision rendered by co-ordinate bench in the case of M/s. Kingfisher Finvest India Ltd. (supra). Revenue is aggrieved.

7.3 We heard the parties on this issue. We notice that the Hon’ble Delhi High Court, in the case of Cheminvest Ltd. v. CIT (2015) 61 taxmann.com 118 (Delhi) : 2015 TaxPub(DT) 3520 (Del-HC), held as under:–

“23. In the context of the facts enumerated hereinbefore the Court answers the question framed by holding that the expression “does not form part of the total income” in section 14A of the Act envisages that there should be an actual receipt of income, which is not includible in the total income, during the relevant previous year for the purpose of disallowing any expenditure incurred in relation to the said income. In other words, section 14A will not apply if no exempt income is received or receivable during the relevant previous year.” Identical view has been expressed by Hon’ble Madras High Court in the case of CIT v. Chettinad Logistics (P) Ltd. (2017) 80 taxmann.com 221 (Mad) : 2017 TaxPub(DT) 1144 (Mad-HC). We also notice that the appeal filed before the Hon’ble Supreme Court by the revenue in the case of Chettinad logistics (P) Ltd. has been dismissed on the ground of delay as well as on merits. It is reported in (2018) 95 taxmann.com 250 (SC) : 2018 TaxPub(DT) 4126 (SC).

7.4 In view of the above, we do not find any infirmity in the decision taken by learned Commissioner (Appeals) on this issue.

8. In the result, the appeal filed by the assessee and revenue are partly allowed.

 


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