The company and I have a mutual, open and current account with money moving both ways. Is the deemed dividend the closing debit balance, the highest debit balance during the year, or something else? And can the Department tax money that reached me through a firm rather than directly?
Neither the closing balance nor the peak. The Supreme Court, adopting the Bombay High Court's reasoning in P.K. Badiani, held that the position must be ascertained at the date of each payment: every debit is examined individually, it is a loan only to the extent it exceeds the company's existing debt to the shareholder, and it is taxable only to the extent of accumulated profits existing on that date. The Court also upheld the taxing of money routed to the shareholder through partnership firms used as conduits, as a payment for his individual benefit.
Decided by the Supreme Court (S.H. Kapadia J (author); the print view does not reproduce the coram) on 2007-04-10, reported as Civil Appeal No. 1873 of 2007 (arising out of S.L.P. (C) No. 13570 of 2006); the indiankanoon print view carries no equivalent-citation line. It bears on section 2(22)(e), section 158BC, section 132, section 260A of the Income Tax Act 1961, in Assessment & Scrutiny, Search, Survey & Block Assessment and How Tax Law Is Read matters.
This is the decision that answers the quantum question on a running account, and the answer is unwelcome to both sides. The assessee's argument that a nil or credit closing balance means nothing is taxable was rejected — otherwise a shareholder who borrowed heavily and repaid on 31 March would escape entirely. But the alternative argument that only the highest debit balance during the year should be taxed was rejected too, and for a reason worth knowing: taking the peak would prevent the balance of accumulated profits being properly tracked where more than one shareholder has borrowed on a similar account. So each debit stands or falls on its own date, correlated against the accumulated profits then available. The second half of the decision is the conduit point: the last limb of s.2(22)(e) catches any payment by the company on behalf, or for the individual benefit, of the shareholder, and the Court accepted that payments made to two firms in which the shareholder was a partner, immediately withdrawn by him and used to buy RBI Relief Bonds, were payments for his benefit. The timing of the payments, the immediate withdrawal and the resulting debit balance of Rs 8.18 crores in his capital account were the facts that carried it, and the Court treated the question as one of fact which the High Court should not have disturbed under s.260A.
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The assessee had controlling interests in three closely held companies — M.K. Shah Exports Pvt. Ltd. (MKSEPL), Safari Capital Pvt. Ltd. (SCPL) and M.K. Tea Pvt. Ltd. — and was a partner in two firms, M.K. Foundation and M.K. Industries. On 24 August 2000 the Department searched his premises under s.132 and seized a diary titled 'ML-20' showing investment of Rs 26.35 crores in 9% RBI Relief Bonds during the year ended 31 March 2000, the bonds having been bought between 17 November 1999 and 11 February 2000. The money had come to the assessee from the two firms, which in turn had received it from the companies; the companies' books showed the payments as repayments of loans and advances. By a block assessment order dated 29 November 2002 under s.158BC read with s.143(3) the Assessing Officer treated Rs 5.99 crores as deemed dividend under s.2(22)(e), holding the two firms to be conduits and the payment to have been made for the individual benefit of the assessee, who had more than ten per cent of the voting power in MKSEPL. SCPL had merged into MKSEPL under a scheme sanctioned by the Calcutta High Court on 5 July 2001 with effect from 18 May 1998. The CIT(A) allowed the assessee's appeal on 21 February 2003, holding among other things that MKSEPL had a current account in the books of M.K. Foundation consisting of loans and repayments and that there was no material to show the firms were conduits. The Tribunal restored the addition on 28 January 2005, noting that MKSEPL's accumulated reserves were about Rs 55 crores, nearly ten times the amount taxed. The High Court set the Tribunal's order aside, holding that this was not a case of undisclosed income and that there was no evidence that the firms were conduits. The Department appealed.
The Department's appeal was allowed and the High Court's judgment set aside. The concept of deemed dividend under s.2(22)(e) postulates two factors — whether the payment is a loan, and whether accumulated profits existed on the date of the payment — and the two must be correlated. Whether a payment made by the company is for the benefit of the shareholder is a question of fact; the Tribunal's finding that the payment routed through the two firms was for the assessee's benefit was not perverse and the High Court should not have interfered with it. On merger, the accounts of the two companies merged and the reserves had to be taken on the merged basis. The block assessment was validly made under Chapter XIV-B because the undisclosed income was detected wholly and exclusively as a result of the search, the seized diary having been the starting point of the enquiries that produced the cash flow statement.
The Court began with the purpose of the provision: in a controlled company the controlling group decides whether profits are distributed, and the legislature enacted s.2(22)(e) because such a group might refuse to declare dividends and instead advance the accumulated profits by way of loan to a shareholder so as to avoid tax. It applied the test in CIT v. L. Alagusundaram Chettiar (1977) 109 ITR 508 (Madras), that the question is not whether the loan given is a benefit but whether the payment made by the company to the intermediate recipient was for the benefit of the shareholder. On the facts it pointed to the timing of the so-called repayments, the immediate withdrawal of the funds by the assessee, who was director, shareholder and partner, the timing of the bond purchases, and above all to the debit balance of Rs 8.18 crores that his withdrawals left in his capital account with M.K. Industries as at 31 March 2000. It then quoted the Calcutta High Court in Nandlal Kanoria v. CIT (1980) 122 ITR 405 for the proposition that the factum of payment and the intention that a benefit accrue to the assessee are findings of fact, and set out paragraphs 19 and 21 of the Bombay High Court's judgment in P.K. Badiani. That passage, which the Court treated as laying down the governing principle, holds that in a mutual, open and current account not every debit is a loan; a payment is a loan only if it makes the company a creditor of the assessee, so that where the company is already the assessee's debtor the payment is merely a repayment and is a loan only to the extent of the excess; that the debit balance at the last date of the accounting year cannot be the measure, since otherwise a shareholder who borrows a large amount and repays it on the last day would escape; and that the highest amount standing to the assessee's debit on any day of the year cannot be the measure either, both because the principle requires the position at the date of each payment to be considered and because taking the peak would not allow the balance of accumulated profits to be taken into account where more than one shareholder has borrowed on a similar account. On the block assessment the Court held that the undisclosed income did not arise from scrutiny proceedings, tax evasion petitions, surveys or information from an external agency but wholly and exclusively from the search, and that the Department had established a form of circular trading in which funds were routed through conduits, a picture that emerges only from the cash flow statements.
Further, the above two judgments lay down that the concept of deemed dividend under Section 2(22)(e) of the Act postulates two factors, namely, whether payment is a loan and whether on the date of payment there existed "accumulated profits". These two factors have to be correlated.
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Handle my notice → Ask a CA on WhatsAppNeither the closing balance nor the peak. The Supreme Court, adopting the Bombay High Court's reasoning in P.K. Badiani, held that the position must be ascertained at the date of each payment: every debit is examined individually, it is a loan only to the extent it exceeds the company's existing debt to the shareholder, and it is taxable only to the extent of accumulated profits existing on that date. The Court also upheld the taxing of money routed to the shareholder through partnership firms used as conduits, as a payment for his individual benefit. This was decided by the Supreme Court (S.H. Kapadia J (author); the print view does not reproduce the coram) and bears on section 2(22)(e), section 158BC, section 132, section 260A of the Income Tax Act 1961. It is reported as Civil Appeal No. 1873 of 2007 (arising out of S.L.P. (C) No. 13570 of 2006); the indiankanoon print view carries no equivalent-citation line. This is the decision that answers the quantum question on a running account, and the answer is unwelcome to both sides. The assessee's argument that a nil or credit closing balance means nothing is taxable was rejected — otherwise a shareholder who borrowed heavily and repaid on 31 March would escape entirely. But the alternative argument that only the highest debit balance during the year should be taxed was rejected too, and for a reason worth knowing: taking the peak would prevent the balance of accumulated profits being properly tracked where more than one shareholder has borrowed on a similar account. So each debit stands or falls on its own date, correlated against the accumulated profits then available. The second half of the decision is the conduit point: the last limb of s.2(22)(e) catches any payment by the company on behalf, or for the individual benefit, of the shareholder, and the Court accepted that payments made to two firms in which the shareholder was a partner, immediately withdrawn by him and used to buy RBI Relief Bonds, were payments for his benefit. The timing of the payments, the immediate withdrawal and the resulting debit balance of Rs 8.18 crores in his capital account were the facts that carried it, and the Court treated the question as one of fact which the High Court should not have disturbed under s.260A. If it applies to you, the first step is this: Prepare a date-wise working: for each debit, the amount, the company's balance owed to the shareholder immediately before it, and the company's accumulated profits on that date. That schedule is the case.
The assessee had controlling interests in three closely held companies — M.K. Shah Exports Pvt. Ltd. (MKSEPL), Safari Capital Pvt. Ltd. (SCPL) and M.K. Tea Pvt. Ltd. — and was a partner in two firms, M.K. Foundation and M.K. Industries. On 24 August 2000 the Department searched his premises under s.132 and seized a diary titled 'ML-20' showing investment of Rs 26.35 crores in 9% RBI Relief Bonds during the year ended 31 March 2000, the bonds having been bought between 17 November 1999 and 11 February 2000. The money had come to the assessee from the two firms, which in turn had received it from the companies; the companies' books showed the payments as repayments of loans and advances. By a block assessment order dated 29 November 2002 under s.158BC read with s.143(3) the Assessing Officer treated Rs 5.99 crores as deemed dividend under s.2(22)(e), holding the two firms to be conduits and the payment to have been made for the individual benefit of the assessee, who had more than ten per cent of the voting power in MKSEPL. SCPL had merged into MKSEPL under a scheme sanctioned by the Calcutta High Court on 5 July 2001 with effect from 18 May 1998. The CIT(A) allowed the assessee's appeal on 21 February 2003, holding among other things that MKSEPL had a current account in the books of M.K. Foundation consisting of loans and repayments and that there was no material to show the firms were conduits. The Tribunal restored the addition on 28 January 2005, noting that MKSEPL's accumulated reserves were about Rs 55 crores, nearly ten times the amount taxed. The High Court set the Tribunal's order aside, holding that this was not a case of undisclosed income and that there was no evidence that the firms were conduits. The Department appealed. The matter was decided on 2007-04-10 by the Supreme Court (S.H. Kapadia J (author); the print view does not reproduce the coram). On those facts the Supreme Court held as follows. The Department's appeal was allowed and the High Court's judgment set aside. The concept of deemed dividend under s.2(22)(e) postulates two factors — whether the payment is a loan, and whether accumulated profits existed on the date of the payment — and the two must be correlated. Whether a payment made by the company is for the benefit of the shareholder is a question of fact; the Tribunal's finding that the payment routed through the two firms was for the assessee's benefit was not perverse and the High Court should not have interfered with it. On merger, the accounts of the two companies merged and the reserves had to be taken on the merged basis. The block assessment was validly made under Chapter XIV-B because the undisclosed income was detected wholly and exclusively as a result of the search, the seized diary having been the starting point of the enquiries that produced the cash flow statement.
The Court began with the purpose of the provision: in a controlled company the controlling group decides whether profits are distributed, and the legislature enacted s.2(22)(e) because such a group might refuse to declare dividends and instead advance the accumulated profits by way of loan to a shareholder so as to avoid tax. It applied the test in CIT v. L. Alagusundaram Chettiar (1977) 109 ITR 508 (Madras), that the question is not whether the loan given is a benefit but whether the payment made by the company to the intermediate recipient was for the benefit of the shareholder. On the facts it pointed to the timing of the so-called repayments, the immediate withdrawal of the funds by the assessee, who was director, shareholder and partner, the timing of the bond purchases, and above all to the debit balance of Rs 8.18 crores that his withdrawals left in his capital account with M.K. Industries as at 31 March 2000. It then quoted the Calcutta High Court in Nandlal Kanoria v. CIT (1980) 122 ITR 405 for the proposition that the factum of payment and the intention that a benefit accrue to the assessee are findings of fact, and set out paragraphs 19 and 21 of the Bombay High Court's judgment in P.K. Badiani. That passage, which the Court treated as laying down the governing principle, holds that in a mutual, open and current account not every debit is a loan; a payment is a loan only if it makes the company a creditor of the assessee, so that where the company is already the assessee's debtor the payment is merely a repayment and is a loan only to the extent of the excess; that the debit balance at the last date of the accounting year cannot be the measure, since otherwise a shareholder who borrows a large amount and repays it on the last day would escape; and that the highest amount standing to the assessee's debit on any day of the year cannot be the measure either, both because the principle requires the position at the date of each payment to be considered and because taking the peak would not allow the balance of accumulated profits to be taken into account where more than one shareholder has borrowed on a similar account. On the block assessment the Court held that the undisclosed income did not arise from scrutiny proceedings, tax evasion petitions, surveys or information from an external agency but wholly and exclusively from the search, and that the Department had established a form of circular trading in which funds were routed through conduits, a picture that emerges only from the cash flow statements. In the words reproduced by the source cited on this page: "Further, the above two judgments lay down that the concept of deemed dividend under Section 2(22)(e) of the Act postulates two factors, namely, whether payment is a loan and whether on the date of payment there existed "accumulated profits". These two factors have to be correlated." The decision followed or applied Commissioner of Income-Tax, Madras-I v. L. Alagusundaram Chettiar (1977) 109 ITR 508 (Madras) — applied; Commissioner of Income-Tax (Central), Bombay v. P.K. Badiani (1970) 76 ITR 361 (Bombay), paras 19 and 21 — set out and adopted; Nandlal Kanoria v. Commissioner of Income-Tax, Central, Calcutta (1980) 122 ITR 405 (Calcutta) — quoted with approval.
It was decided by the Supreme Court on 2007-04-10 and is reported as Civil Appeal No. 1873 of 2007 (arising out of S.L.P. (C) No. 13570 of 2006); the indiankanoon print view carries no equivalent-citation line. Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On section 2(22)(e), section 158BC, section 132, section 260A, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the department, and it appears in this library for that reason — you need to know what the Assessing Officer will cite against you. The Department's appeal was allowed and the High Court's judgment set aside. The concept of deemed dividend under s.2(22)(e) postulates two factors — whether the payment is a loan, and whether accumulated profits existed on the date of the payment — and the two must be correlated. Whether a payment made by the company is for the benefit of the shareholder is a question of fact; the Tribunal's finding that the payment routed through the two firms was for the assessee's benefit was not perverse and the High Court should not have interfered with it. On merger, the accounts of the two companies merged and the reserves had to be taken on the merged basis. The block assessment was validly made under Chapter XIV-B because the undisclosed income was detected wholly and exclusively as a result of the search, the seized diary having been the starting point of the enquiries that produced the cash flow statement. It arises in Assessment & Scrutiny, Search, Survey & Block Assessment and How Tax Law Is Read matters, on section 2(22)(e), section 158BC, section 132, section 260A of the Income Tax Act 1961, and was decided by S.H. Kapadia J (author); the print view does not reproduce the coram. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Do not offer the closing balance or the peak as the measure — both were argued in Badiani and both were rejected in the passage the Supreme Court adopted. Where the company was already the shareholder's debtor when it paid, say so: on that reasoning the payment is a repayment of the company's own debt and is a loan only to the extent of the excess. On a conduit allegation, meet the timing head on. Show that the intermediate entity had an independent commercial reason for the receipt, that it was not withdrawn by the shareholder immediately, and that the shareholder's capital account with it did not go into debit. Where the deemed dividend is charged on an amalgamated company's reserves, note that the Court accepted that on merger the accounts merge and the reserves are taken on the merged basis, even where the merger was sanctioned later with retrospective effect. Remember that these are findings of fact. Win them at the Tribunal; s.260A will not reopen them.
Validity check could not be completed. Validity check could not be completed: no citator search was run and later treatment was not checked. Note that the passage carrying the quantum rule is the Bombay High Court's, quoted and adopted here; the library already carries the Supreme Court's own decision in P.K. Badiani on the separate question of what 'accumulated profits' means in a commercial sense. This entry is about which figure on a current account is taxable and about the 'individual benefit' limb, not about the identity of the assessee under the section; on that separate question the library carries Ankitech and National Travel Services and the reference to a larger Bench there is still undisposed so far as this pass could establish. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The indiankanoon print view carries no paragraph numbers, so passages are located by position. The assessee's first name is printed as 'Mukundrai K. Shah' in the opening paragraph and 'Mukundray K. Shah' in the cause title. The print view names only the author, Kapadia J; it does not reproduce the coram, so the other member or members of the Bench are not stated here. The Bombay High Court decision quoted at length is reported in the judgment as 'Commissioner of Income-Tax (Central), Bombay v. P.K. Badiani (1970) 76 ITR 361' — this is the High Court stage of the case the library already carries at Supreme Court level under the slug pk-badiani-v-cit-accumulated-profits-commercial-sense. I read paragraphs 19 and 21 of that Bombay judgment only as they are set out inside this Supreme Court judgment; I did not retrieve the Bombay judgment itself. The Calcutta High Court decision in Nandlal Kanoria v. CIT (1980) 122 ITR 405 is likewise quoted but was not separately retrieved. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The Department's appeal was allowed and the High Court's judgment set aside. The concept of deemed dividend under s.2(22)(e) postulates two factors — whether the payment is a loan, and whether accumulated profits existed on the date of the payment — and the two must be correlated. Whether a payment made by the company is for the benefit of the shareholder is a question of fact; the Tribunal's finding that the payment routed through the two firms was for the assessee's benefit was not perverse and the High Court should not have interfered with it. On merger, the accounts of the two companies merged and the reserves had to be taken on the merged basis. The block assessment was validly made under Chapter XIV-B because the undisclosed income was detected wholly and exclusively as a result of the search, the seized diary having been the starting point of the enquiries that produced the cash flow statement.
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