Section 13(2)(e) Not Same as Deemed Dividend Law: ITAT Delhi Clarifies Rules for Trust Investments in Group Companies

 

 

In an important ruling for charitable trusts and societies, the Delhi Bench of the Income Tax Appellate Tribunal has clarified that investment by a charitable institution in shares of a company cannot be treated as violation of Section 13(2)(e) merely by aggregating shareholdings of different persons or entities.

In Jan Kalyan Samiti v. ITO, the Tribunal examined whether investment made by a society registered under Section 12AA in shares of a finance company resulted in denial of exemption under Sections 11–12. The ruling provides significant clarity on how “substantial interest” should be determined and distinguishes the provisions of Section 13 from those governing deemed dividend under Section 2(22)(e).

Facts of the Case

The assessee, a charitable society registered under Section 12AA, had invested about ₹69 lakh in shares of RPL Capital Finance Ltd. The shares were acquired from another corporate entity.

During assessment, the Assessing Officer alleged:

•  The payment exceeded fair market value
•  Certain persons connected with the society indirectly controlled the company
•  By aggregating shareholdings of different entities and individuals, the threshold of substantial interest under Section 13(2)(e) was crossed

On this basis, the AO denied exemption and treated the investment itself as taxable.

The society challenged the action before the Tribunal.

Key Issue Before the Tribunal

The core questions examined were:

Whether shareholdings of different persons and entities can be combined to determine “substantial interest” under Section 13(2)(e)?
Whether investment by a charitable trust can itself be treated as taxable income?

The Tribunal answered both issues in favour of the assessee.

1.  Separate Legal Personality Must Be Respected

The ITAT stressed that each entity – the society, individuals, HUFs, and companies – is a separate taxable person.

Relying on landmark principles from corporate law jurisprudence, the Tribunal held that shareholdings of different entities cannot be aggregated unless the statute specifically allows it.

The AO’s attempt to combine holdings of multiple persons to artificially cross the threshold of substantial interest was therefore rejected.

This observation is important because many assessments attempt to infer indirect control by clubbing unrelated entities.

2.  Correct Scope of Section 13(2)(e)

The Tribunal clarified that Section 13(2)(e) applies only where:

•  A trust invests in or purchases shares from a concern, and
•  A person specified under Section 13(3) holds substantial interest in that concern

The AO’s approach of constructing indirect ownership by aggregation was found to be inconsistent with the statutory requirement.

The Tribunal held that unless the specified person individually holds the prescribed substantial interest, the provision cannot be invoked.

3.  Section 13 Does Not Automatically Create Taxable Income

Another important finding was that violation of Section 13, even if established, does not automatically convert the investment amount into taxable income.

The provision merely withdraws exemption to the extent of income that becomes ineligible.

The Tribunal held that treating the entire investment amount as income was legally unsustainable in absence of real income arising from the transaction.

This distinction is crucial for charitable trust taxation.

4.  Confusion Between Section 13(2)(e) and Section 2(22)(e)

The ITAT also observed that the Assessing Officer appeared to mix up the concept of “substantial interest” used in trust law with the deemed dividend provisions under Section 2(22)(e).

While both provisions refer to shareholding thresholds, their objectives and application are entirely different.

Applying dividend taxation logic to charitable trust investments led to an incorrect conclusion in this case.

Why This Ruling Matters

This decision is particularly relevant for charitable institutions that:

•  Invest in group entities
•  Purchase shares from related concerns
•  Have founders or trustees connected with business companies
•  Face scrutiny regarding indirect benefit or control

The ruling confirms that statutory thresholds must be applied strictly and cannot be expanded through inference or aggregation.

Practical Takeaways for Charitable Trusts and Professionals

The judgment highlights several compliance lessons:

First, documentation of investment decisions should be maintained.
Second, valuation support helps defend allegations of excessive payment.
Third, shareholding structures should be analysed entity-wise, not broadly grouped.
Fourth, denial of exemption must relate to income, not capital deployment itself.

Understanding the distinction between exemption withdrawal and income taxation is critical in trust cases.

Conclusion

The ITAT Delhi ruling in Jan Kalyan Samiti v. ITO provides valuable clarity on how Section 13(2)(e) should be interpreted in cases involving trust investments in companies.

By reaffirming the principle of separate legal personality, limiting the scope of aggregation, and distinguishing Section 13 from deemed dividend provisions, the Tribunal has strengthened the legal position of genuine charitable institutions.

For trusts navigating compliance under Sections 11 to 13, the ruling confirms that statutory safeguards cannot be overridden by assumptions of indirect control or conceptual confusion between unrelated provisions.

The copy of the order is as under:

1770379696-5tYZ8G-1-TO