Quest

ABC … … Querist

CA Chetan Karia

“M/s. ABC Private Limited (“the Company”) is a closely held single family owned company having substantial accumulated profits, within the meaning of Section 2 (22)(e) of the Income Tax Act, 1961 (“the Act”), on and from 1st April, 2006.

The Company’s capital structure is as under:

It may be noted that Section 187 C of the Companies Act, 1956, required every person to declare to a company that he does not have beneficial interest in the shares which as per the register of members are in his name. Further, a company was also required to file a declaration of such beneficial interests to the ROC. The provisions of section 187 C have been made ineffective w.e.f. 13th December, 2000 and therefore, there is no requirement at present to declare beneficial interest, etc. Therefore, such beneficial interest is not declared in the register of the Company or with ROC.

Therefore, as per the register of members of the Company, the shares are in the name of the respective shareholders and there is no note taken of their divestment of beneficial interest.

The Shareholders are contending that since they are not the beneficial owner of the shares held as trustees, these shares should not be included for computing the limit of 10 % for the purpose of section 2 (22)(e) of the Act.

Query

In the above circumstances, kindly let us know, whether loans given by the Company to these shareholders would be covered by the provisions of section 2 (22)(e) of the Act or not?”

Opinion

1. The undisputed facts of the case are as follows:

i) The two individuals, A and B are registered holders of shares in excess of 10% of total shareholding in the company;
ii) However, their beneficial ownership of shares in the company is less than 10% of total shareholding in the company;
iii) The company has accumulated profits;
iv) The company has advanced loans to the two individuals, A and B.

2. The provisions of S. 2(22)(e) of the Act as applicable reads as follows:

“(e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits.”

3. The provisions of S. 2(22)(e) were amended by Finance Act, 1987 w.e.f. 01.04.1988 and the words “made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern)” were substituted for the words “by way of advance or loan to a shareholder, being a person who has a substantial interest in the company”. The term “person who has a substantial interest in the company” is defined by S. 2(32) of the Act as a person who is beneficial owner of shares in excess of prescribed limit. Under Indian Income Tax Act, 1922 (1922 Act) S. 2(6A)(e) provided for taxation of deemed dividend in similar terms as S. 2(22)(e) of the 1961 Act. S. 2(6A)(e) of the 1922 Act read as follows:

“(e) any payment by a company, not being a company, in which the public are substantially interested within the meaning of section 23A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or any payment ………………”

4. Under the 1922 Act, the words used were loan or advance to a shareholder and the term shareholder was not defined. Under the 1961 Act, though the word shareholder was still used, but it was qualified by words “being a person who is a beneficial owner of shares”. In so far as it is relevant to the facts of the present case, the words “being a person who is the beneficial owner of the shares” has been inserted in S. 2(22)(e) of 1961 Act which were absent in S. 2(6A)(e) of the 1922 Act.

Provisions of S. 2(6A)(e) of 1922 Act

5. Let us first examine the provisions of the section 2(6A)(e) of 1922 Act.

6. Law recognizes dual ownership of property – a person may be a registered owner of a property but the property may belong to another, called beneficial owner. Hindu Undivided Family (HUF) and trusts are two common examples of such dual ownership. In case of a trust, though the property is registered in names of trustees they are not entitled to them personally and the benefit of such property accrues to beneficiaries under the trust.

Dividend chargeable to tax in hands of beneficial owner

7. Under the Act, income arising from a property is chargeable to income tax in the hands of person who is entitled to enjoy the income, i.e. the beneficial owner. Though income is received by registered owner, the trustee, as the same is for benefit of the beneficiary under the trust, it is chargeable to tax in the hands of the beneficiary, the beneficial owner. The same principle applies to dividend received on shares – though it is received by the registered owner, the trustees, the same is chargeable to tax in the hands of the beneficial owner, the beneficiary. The said principle has been laid down by the Hon’ble Supreme Court in case of K. L. Bajaj vs. CIT (1966) 50 ITR 500 (SC).

Even deemed dividend chargeable to tax in hands of beneficial owner

8. In context of deemed dividend u/s. 2(6A)(e) of the 1922 Act, the same principle has been followed by Hon’ble Supreme Court in CIT vs. Rameshwarlal Sanwarmal (1971) 82 ITR 628 (SC) and it has been held that even deemed dividend is assessable in the hands of the beneficial owner of shares and not registered owner.

9. Therefore, the law is well settled that as far as chargeability to tax is considered, dividend including deemed dividend is chargeable to tax in hands of beneficial owner of shares.

Reference to shareholder under the Act – means registered owner

10. As far as chargeability to tax is considered, as discussed above, the law is well settled that it is the beneficial owner of shares who is chargeable to tax, both of dividend and deemed dividend. However, at varying points of time, the 1922 Act and the 1961 Act have provided for special provisions relating to companies and its shareholders.

11. S. 23A of the 1922 Act provided that undistributed profits of specified companies shall be deemed to be income of the shareholder. In CIT vs. Shankuntala & ors (1961) 43 ITR 352 (SC) it was held that as the term used is shareholder, which has not been defined, it is only the registered owner of shares as per Companies Act who has to be considered. As the Companies Act does not recognize beneficial owner as shareholder, whenever the Income Tax Act uses the term Shareholder, it is the registered owner who has to be considered. It was accordingly held that u/s. 23A, it is the registered owner of shares who is liable to tax.

12. S. 16(2) of the 1922 Act provided for rebate against dividend income of amount of tax paid by company. In Howrah Trading Co (1959) 36 ITR 215 (SC) it was held that though dividend is taxed in the hands of beneficial owner, rebate u/s. 16(2) is allowable only to a registered owner and not beneficial owner of shares.

13. Provisions of S. 2(6A)(e) of the 1922 Act provided for deemed dividend in similar terms as in S. 2(22)(e) of the 1961 Act. It also provided for treating loan advanced to a shareholder as deemed dividend. As the word used was loan to shareholder, issue arose, whether loan to registered shareholder has to be considered or loan to beneficial owner has to be considered. In CIT vs. C P Sarathy Mudaliar (1972) 83 ITR 170 (SC) it was held that as word shareholder is used, it would mean registered shareholder and not beneficial owner, who is not recognized as shareholder under Companies Act.

14. Therefore, under the provisions 1922 Act, it is loan to registered shareholder which has to be considered as deemed dividend for the purposes of S. 2(6A)(e) and for chargeability to tax of such deemed dividend, it is the beneficial owner of such shares who is liable to tax. The above proposition was clarified and laid down by Hon’ble Supreme Court in Rameshwarlal Sanwarmal (1980) 122 ITR 1 (SC).

Provisions of S. 2(22)(e) of 1961 Act

15. As discussed earlier, after the word “shareholder”, words “being a person who is the beneficial owner of shares” has been added in S. 2 (22) (e) of the 1961 Act. Under the 1922 Act, it was loan to registered shareholder which was to be considered, but under the 1961 Act, the term shareholder has been qualified by the words: “Person who is beneficial owner of shares”.

16. One view would be that the Legislature intends by the amendment to substitute the condition in 1922 Act of loan to registered shareholder to be changed to loan to beneficial owner of shares. That is under the 1961 Act, loan to beneficial owner of shares has to be considered and not registered owner.

17. The issue was referred to Special Bench of Hon’ble Income Tax Appellate Tribunal (ITAT) in ACIT vs. Bhaumik Colour Pvt. Ltd, ITA no 5030/M/04, A Y 1997-98 and the Hon’ble Special Bench vide order dated 19-11-2008 held that post amendment, dual condition has been prescribed and it is loan to a person who is both registered owner as well beneficial owner of shares which is covered by provisions of S. 2(22)(e).

18. In so far as facts of the present case are concerned, as discussed in detail hereinafter, it is sufficient to say that Legislature itself has clarified that under S. 2(22)(e) of the Act, it is only loan to beneficial owner of shares which is deemed to be dividend u/s. 2(22)(e).

Facts of the case of the querist

19. It is undisputed in the present case that two individuals, A and B are entitled to beneficial ownership of shares, which is less than 10% of total shareholding in the company. Their individual shareholding in the company as beneficial owner is less than 10%.

Therefore, any loan to each of them in their individual capacity is not to be considered for the purposes of deemed dividend u/s. 2(22)(e). Though they are registered shareholders in respect of shares held as trustees, as they are not entitled to beneficial ownership of such shares, shareholding as trustees has to be ignored for the purposes of S. 2(22)(e) in view of specific provisions of 1961 Act. Though it is possible to argue, relying on judgment of Special Bench of ITAT in case of Bhaumik Colour, discussed above, that shareholding as trustee have to be completely ignored; as far as the present facts are concerned, as the individuals, who have received loans, are beneficially entitled to shares, which is less than 10% of total shareholding in the company, the provisions of S. 2(22)(e) are not attracted.

Reply to query raised

20. In view of the fact narrated to me and discussion above, my answer to the query raised is that the querist has a good case to contend that loans given by company to Individuals A and B are not hit by provisions of S. 2 (22) (e) as their shareholding in the company to which they are beneficially entitled, is less than 10% of total shareholding.