Deemed dividend under section 2(22)(e) is not applicable in the absence of actual payment of sum directly by the company to its shareholder

In an interesting decision by Bangalore ITAT, it has been held that deemed dividend (i.e. section 2(22)(e)) provisions are not applicable in the absence of actual payment of sum directly by the company to its shareholder (owning not less than ten per cent of the voting power).

Let us have a short overview of the case:

Mukka Sea Food Industries Pvt Ltd (‘MSFIPL’) had invested INR 1,95,37,070 in Sopromer S.A.R.L (‘Sopromer’), an entity based in Guinea. Further, INR 76,47,500 was paid by MSFIPL as an advance towards supplies by Sopromer. The investments went bad, while the advance payments towards supplies were returned but the investments by MSFIPL in Sopromer were not recovered.

Mr. Mohamed Maou Elainine (‘Mr. Mohammed’) was instrumental and had negotiated the investments by MSFIPL in Sopromer. Since it went bad/ could not be recovered, Mr. Mohammed had to transfer his certain other personal investments in a Dubai based company which were in equivalent value (i.e. investments by MSFIPL) to Mr. Haris Kalandan Mohammed (‘Assessee’) without any consideration – Assessee held 41% in MSFIPL and was a managing director of MSFIPL.

Tax officer noted that there is a direct link between investments by MSFIPL in Sopromer which went bad/ not recovered and the shares of equivalent value transferred by Mr. Mohammed to Assessee, who owned 41% in MSFIPL, director of MSFIPL – hence triggered an adjustment under sec 2(22)(e) of the Income Tax Act, 1961 (‘Act’) on Assessee for receiving a benefit. CIT(A) upheld the order of tax officer.

On appeal, Bangalore ITAT held:

For investments by MSFIPL, it has been allotted shares in Sopromer, thus there is no benefit accruing to the Assessee and the advances towards supplies were returned to MSFIPL.

Section 2(22)(e) of the Act does not speak about indirect benefit to the shareholder. It only covers direct benefit received by the shareholder on account of payments made by the company, there were no direct payment from MSFIPL to the Assessee.

Double deeming or fiction on fiction is not allowed as per the settled position of law. Legal fictions are only for a definite purpose & should not be extended beyond such purpose.

Further, there was no movement of accumulated profit from MSFIPL to the Assessee, even the money moved from MSFIPL to Sopromer were during FY15, and cannot be considered as a deemed dividend during FY18, the year of transfer of shares by Mr. Mohammed to the Assessee.

MSFIPL has been recording the investments in Sopromer and has a legal right to recover such amounts. Hence, without writing off, it cannot be said that any benefit has been passed to the assessee from MSFIPL.

Conclusion:

Judgement brings out a principle that deemed dividend provisions (sec 2(22)(e)) are applicable only on actual payment of sum directly by the company to its shareholder and cannot be applied for any indirect benefit received from any other source.

The copy of the order is as under:

1723464757-ITA 878 OF 2024 SRI HARIS KALANDAN MOHAMMED MANGALORE