ORDER
P. Madhavi Devi, J.M.
1. In this appeal the assessee has raised the following grounds of appeal:
1. The learned CIT(A)-IV on the facts and in the circumstances of the case erred in confirming the order passed under Section 143(3) of the Act by the AO assessing total income at Rs. 1,19,13,449 and determining speculation loss of Rs. 1,27,26,924.
2. The learned CIT(A)-IV on the facts and in the circumstances of the case erred in upholding the additions made by the AO of Rs. 65,56,631 being deemed dividend in terms of Section 2(22)(e) of the Act.
3. The learned CIT(A)-IV on the facts and in the circumstances of the case erred in confirming that the assessee company is engaged in the business of trading in shares and Explanation to Section 73 of the Act is applicable and allocating an amount of Rs. 1,27,26,924 to the speculation business by apportioning an amount of Rs. 1,38,51,924 being interest paid to bank and claimed as deduction from business income.
4. The learned CIT(A)-IV on the facts and in the circumstances of the case erred in upholding the addition of Rs. 11,25,000 being interest on interest-free advances to Shri Gaurang Gandhi of Rs. 75,00,000.
2. Brief facts of the case are that the assessee is a company who filed its return of income declaring a total loss of Rs. 84,95,102 on 1st Dec, 2003. During the assessment proceedings under Section 143(3), the AO noticed from the perusal of the audit report that the assessee has received a loan of Rs. 14,69,893 from M/s Pioneer Intermediaries (P) Ltd. (PIPL) which is the balance as on 31st March., 2003. He observed that the maximum loan outstanding during the year was at Rs. 19,80,333. The AO called for the list of the shareholders of the assessee company as well as of PIPL. He observed that one Shri Gaurang Gandhi held more than 20 per cent of the equity share capital of the assessee company and also held more than 10 per cent of equity share capital of PIPL. Thus, he came to the conclusion that provisions of Section 2(22)(e) are applicable to the assessee company and, therefore the assessee was required to explain as to why the amount of Rs. 19,80,333 should not be brought to tax in the hands of the assessee company as deemed dividend under Section 2(22)(e) of the Act. The assessee vide letters dt. 19th Sept., 2005., 30th Sept., 2005 and 18th Nov., 2005 submitted that (i) the assessee company has taken the loan from PIPL and not given the loan to it; (ii) the assessee company is not a shareholder of PIPL and (iii) the assessee company had two types of account of M/s PIPL, a trading and financial transaction account and as far as trading account is concerned, provisions of Section 2(22)(e) are not applicable and as far as the financial transaction account, even if the question of applicability of Section 2(22)(e) is considered, it should not apply except in respect of one instance appearing on 28th March, 2003 when there was a credit balance of Rs. 1,04,391.57 in the books of the assessee company. The AO after considering the assessee’s submissions held that Shri Gandhi being a shareholder of more than 10 per cent of equity shares of PIPL and more than 20 per cent of equity shares of assessee company, the provisions of Section 2(22)(e) are applicable to the facts of the case. He further considered the trading account of the assessee company and observed that it contains entries which are properly speaking relatable to the financial transaction account. He interpolated these into the financial transaction account and served that a credit balance appears in the account reflecting a loan from PIPL to the assessee company. On the recasting of entries of the account he found that as on 28th March., 2003 there is a receipt of Rs. 51,90,168 and as on 29th March, 2003 and 30th March, 2003 the assessee has received Rs. 10,80,000 and Rs. 2,98,000 respectively from PIPL. Accordingly, he held that during the asst. yr. 2003-04 the assessee company has received advances of a total of Rs. 65,66,631 (Rs. 51,90,168 + Rs. 10,80,000 + Rs. 2,86,463) from PIPL. He brought this amount to tax in the hands of the assessee under Section 2(22)(e) of the Act as deemed dividend. Aggrieved, assessee filed an appeal before the CIT(A) who confirmed the order of the AO. The assessee is in second appeal before us.
3. The learned Counsel for the assessee Shri Salil Kapoor submitted that the assessee and PIPL were the clients of each other. He submitted that PIPL was a share broker of Bombay Stock Exchange and the assessee was a stock broker of National Stock Exchange and was into the broking of Government securities also and upto 2002 PIPL was the client of the assessee company. In view of the same, the assessee was maintaining two accounts with PIPL i.e. trading account and current account i.e. financial transaction account. He drew our attention to pp. 13 to 15 of the paper book which contain the entries relating to the trading account and pp. 17 to 19 of the paper book which relate to the financial transaction account. He submitted that in September, 2002 the assessee surrendered NSE card and some of the assessee’s liabilities were discharged by PIPL and the assessee’s account was debited. He submitted that the AO has picked up only four entries from the trading account and put them in the current account and treated them as deemed dividend under Section 2(22)(e). He submitted that it is not open to the AO to treat such entries in his own fashion. According to him, the entries should be understood as the parties understood in their business relationships and in the case on hand as both the parties treated them as trading account, it is not open to the AO to treat them in any other way. He submitted that the provisions of Section 2(22)(e) refer to actual payments and not to deemed payments. He submitted that the assessee had not received any payment from PIPL but the payment was made on behalf of the assessee and, therefore, the deemed payment cannot be brought under the purview of the loans and advances under Section 2(22)(e) of the Act. Another proposition put forward by him was that when mutual, open and current account is operated between the parties, it will not come under the purview of Section 2(22)(e). In support of this contention, he relied upon the unreported decision of the Tribunal in the case of N.H. Securities in ITA No. 2322/Mum/2002 for the asst. yr. 2000-01 dt. 27th Jan., 2006. He submitted that the assessee was doing running business with PIPL and any advances made to the assessee for the services to be rendered by the assessee company cannot be treated as loans and advances without prejudice to the challenge of treating the advances received as deemed dividend under Section 2(22)(e). The learned Counsel further submitted that only net figures of advances have to be taken into consideration while calculating the deemed dividend and not gross of the figures. He submitted that the AO has taken net of only one figure i.e. item (4) dt. 31st March, 2002 while he has taken the gross figure of all other items, which is not permissible in law.
4. The learned Departmental Representative, on the other hand, supported the orders of the authorities below and submitted that Sub-clause (ii) of Section 2(22)(e) excludes any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, only where the lending of money is substantial part of the business of the company. In this case the substantial part of the business of PIPL was not lending of money and, therefore, the advances given to the assessee to discharge its liabilities are loans and liabilities and deemed dividend under Section 2(22)(e) of the Act. He placed reliance upon the decision of the Supreme Court in the case of Smt. Tandata Shyam and Ors. v. CIT wherein it has been held that the assessee’s income was taxable on the sums received by him as loans and advances during the relevant period from the profit of the company of which he was a shareholder, even though at the end of the relevant year, no advance and loan were due to the company by the assessee, as a result of credit made in his favour in his account. He also placed reliance upon the decision of the Bombay High Court in the case of CIT v. P.K. Badiyani , wherein the Hon’ble High Court while interpreting the phrase “accumulated profits” in Section 2(6A)(e) of 1922 IT Act held that the accumulated profit means profits which have been accumulated before beginning of the accounting year where the account being a mutual, open and current account, every debit, i.e. every payment by a company to the assessee may not be a loan and to be treated as a loan, every amount paid must make a company a creditor of the assessee for that amount. It was further held that the position as regards each debit will have to be individually considered, because it may or may not be a loan and the two basic principles are that only a loan which would include the other payments mentioned in Section 2(6A)(e) of 1922 Act can be deemed to be dividend and that too only to the extent that the company has at the date of payment accumulated profits after deduction there from all items legitimately deductible there from. What has to be considered is not a balance in account but the position of every payment and, therefore, the debit balance of the assessee with the company at any point of time could not be taken to represent an advance or loan by the company to the assessee, nor the amount outstanding at the end of the accounting year to be alone taken as loan within the meaning of Section 2(6A)(e) of 1922 Act. He drew our attention to the assessment order wherein the AO has recorded that PIPL has accumulated profits of Rs. 1,21,15,644 out of which the advances have been made and, therefore, the provisions of Section 2(22)(e) are applicable to the facts of the case. For the said proposition, he also placed reliance upon the following decisions:
(i) CIT v. K. Srinivasan and Ors. ;
(ii) M.D. Jindal v. CIT .
wherein it has been held that Section 2(22) creates a legal fiction and legal fictions are created only for a definite purpose and they are limited to the purpose for which they are created and should not be extended beyond legitimate field. But the legal fiction has to be carried to its logical conclusion within the framework of the purpose for which it is created.
(iii) CIT v. P. Sharda .
As regards the decision of the Tribunal in the case of N.S. Securities (cited supra) relied upon by the learned Counsel for the assessee, the learned Departmental Representative submitted that the Tribunal had relied upon the decision of the Calcutta High Court in the case of Mukundray K. Shah which has been reversed by the Supreme Court in its decision reported in (2007) TIOL p. 57. Thus, the said decision cannot be applied to the facts of the case before us.
5. Having heard both the parties and having considered their rival contentions and the material on record, the basic question that falls for our consideration is whether the provisions of Section 2(22)(e) are attracted at all? Let us then examine the provisions of Section 2(22)(e).
Section 2(22)(e) is reproduced as under:
(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 (hereinafter 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
6. From the above, it is seen that any payment made by a company in which public are not substantially interested, out of its accumulated profits, to a shareholder or to any concern in which such a shareholder is a member or partner and has substantial interest, by way of loan or advance is deemed dividend income of the recipient. In this case, undisputedly assessee is the recipient of the loan from M/s PIPL. It is also not disputed that M/s PIPL has accumulated profits. The assessee is not the shareholder of M/s PIPL, but it is the concern in which the shareholder of M/s PIPL, Mr. Gaurang Gandhi holds more than 20 per cent of equity share capital. Therefore, the provisions of Section 2(22)(e) are very much applicable.
7. Now comes the question as to whether the AO was empowered to interpolate the entries of the trading account in the current account? Section 145 entrusts the AO not only with the right but also a duty to consider whether or not the books disclose the true state of accounts and whether the correct income can be deduced there from and to proceed according to his judgment on this question. The Hon’ble Supreme Court in the case of CIT v. British Paints India Ltd. , has held that Section 145 confers sufficient power upon the officer-nay it imposes a duty upon him to make such computation in such manner as he determines for deducing the correct profits and gains. In view of the same, we uphold the action of the AO in treating the entries of the trading account as entries of financial transaction account after considering the nature of transactions.
8. The next question for our consideration is whether these credit balances were part of the mutual, open and current account operated between the parties and whether they will come under the purview of Section 2(22)(e)? The learned Counsel for the assessee had placed reliance upon the unreported decision of this Tribunal in the case of N.H. Securities Ltd. (supra) wherein the Tribunal was dealing with a situation where the assessee therein was having regular transactions with another company as a broking business by purchasing and selling shares and securities on behalf of the other company. The Tribunal had considered the facts of the case and had come to the conclusion that the provisions of Section 2(22)(e) were applicable as far as the relationship between the parties is concerned. As regards the application of the provisions of Section 2(22)(e) are concerned where the transactions are reflected in the accounts of the related concerns, and as to what is the amount of payment by way of loans and advances and what is the accumulated profit for the purpose of Section 2(22)(e), the Tribunal also considered (a) whether the payment made by PIPL i.e. other company reflected in the accounts maintained by the assessee company was a mutual, open and current account and if so, would come under the provisions of Section 2(22)(e) and even if the account between the assessee and PIPL is not outside the purview of Section 2(22)(e) whether the amount paid by PIPL against outstanding debts are to be considered as loans and advances; (b) whether the payments in respect of regular business transactions reflected in the said accounts are to be held as loans; (c) whether the occasional excess payment made by PIPL on account of the assessee company could be treated as in the nature of loans and advances; (d) whether the business profits of the current year need to be treated as part of accumulated profit as business profits cannot be computed on the day-to-day basis; (e) whether the statutory reserve maintained under the Reserve Bank of India Act, 1934 could be treated as part of the accumulated profits; and (f) whether the successive loans/advances paid by PIPL to the assessee company need to be successively reduced from the accumulated profits or not? The Tribunal after considering the facts of the case and the judicial precedents has held that payment made by a company through a running account in discharge of its existing debts or against purchases or for availing services, such payments made in the ordinary course of business carried on by both the parties could not be treated as deemed dividend for the purpose of Section 2(22)(e). For coming to this conclusion, the Tribunal relied upon the decision of the Bombay High Court in the case of CIT v. Nagindas Kapadia .
9. The learned Departmental Representative, however, submitted that the Tribunal had referred to the decision of the Kolkata High Court in the case of Mukundray K. Shah of its order and this decision of the Kolkata High Court ” has been reversed by the Hon’ble Supreme Court as reported in 2007-TIOL-57-SC-IT [reported as CIT v. Mukundray K. Shah (2007) 209 CTR (SC) 97–Ed.] and, therefore, the decision of the Tribunal cannot be followed. We find that in the case of N.H. Securities (supra), the reference to the decision of the Kolkata High Court in the case of Mukundray K. Shah cited supra, was only as a submission made by the counsel for the assessee to explain the characteristic of the provisions of law contained in Section 2(22)(e). The Hon’ble Supreme Court in the case of Mukundray K. Shah (supra) differed with the High Court’s decision on the finding that the amount did not amount to undisclosed income and also with regard to the finding of facts that the Tribunal has erred in holding that MKF and MKI were conduits for routing the money from MKSEPL through the two firms to the assessee and that the said amount was deemed dividend under Section 2(22)(e) in the hands of the assessee. As far as the finding of the High Court as to the category of cases to which the definition of deemed dividend applies, the Supreme Court has not given any adverse finding. In view of the same, the decision of the Supreme Court in the case of Mukundray K. Shah (supra) will not adversely affect the decision of the Tribunal in the case of N.H. Securities Ltd. (supra). However, we find that the facts and circumstances of the case in N.H. Securities (supra) and the case on hand are different. In the case of N.H. Securities Ltd. (supra) there was a running account between the parties and on certain days there was excessive sales, whereas in the case on hand it is an admitted fact that M/s PIPL had advanced amounts for meeting the liabilities of the assessee company and not as excessive advances for the services and, therefore, it was outside the regular business activity of the assessee company. The decision of the Tribunal in the case of N.H. Securities Ltd. (supra) would apply to only those transactions which are entered into the books of accounts as regards regular business transactions and even if any excess payment is made on account of regular business, the claim cannot be considered as loans and advances. In the case on hand the assessee had received payment in excess of the regular transactions with PIPL in order to discharge its liabilities and therefore the transactions would fall within the purview of Section 2(22)(e) of the IT Act. However, we are in agreement with the learned Counsel for the assessee that only the net amount and on the days when the credit is in excess has to be considered for the purpose of deemed dividend under Section 2(22)(e) of the IT Act and only that part of the amount which has been paid by PIPL to discharge the liability of the assessee company in excess of what it is due to pay to the assessee company for its regular business transactions, is to be considered as deemed dividend under Section 2(22)(e) of the Act. We, accordingly, direct the AO to recompute the deemed dividend under Section 2(22)(e) in accordance with our observations above. The assessee’s ground of appeal is therefore partly allowed.
10. As regards ground No. 3, the learned Counsel for the assessee submitted that this issue is covered in favour of the assessee by the decision of the ‘A’ Bench of this Tribunal dt. 10 April, 2004 in the assessee’s own case for the asst. yr. 2002-03. A copy of the said order is also placed on record. The learned Departmental Representative, on the other hand, relied upon the orders of the authorities below.
11. Brief facts of the case are that the assessee had declared receipts from brokerage and interest from bank deposits but did not reflect any receipt from the trading activities and the entire opening stock has been carried forward as closing stock at the end of the year. The assessee was asked to furnish the details of stock-in-trade. The assessee submitted that the stock-in-trade consisted of eleven lakhs shares of M/s Shonkh Technologies Ltd. During the course of assessment proceedings, assessee submitted that the stock is financed by bank loan secured by shares of M/s Shonkh Technologies Ltd. and it had debited Rs. 1,38,51,924 on account of bank interest to the P & L a/c. The assessee’s explanation as to why the provisions of Explanation to Section 73 should not be applied in its case and the interest expenses should not be treated as expenses towards speculation activity was called for. The assessee submitted that during the year it had neither purchased nor sold any shares and, therefore, there was no loss or profit from the share trading activity and Explanation to Section 73 applies only to a company whose business consists of purchase and sale of shares. However, the AO was not satisfied with the said explanation and held that the shares of M/s Shonkh Technologies Ltd. were shown by the assessee as its business stock and were not held as investment and, therefore, there need not be a series of transactions as long as the business is in existence. Thus, he held that Explanation to Section 73 is applicable to the facts of the case. Thereafter, he proceeded to examine the P&L a/c of the assessee and observed that the entire interest of Rs. 1,38,51,924 was towards the loan taken for purchase of shares of M/s Shonkh Technologies Ltd. and, therefore, there is a direct nexus between the amount borrowed and the investment in shares and hence this amount is to be given as a deduction out of the profits from speculation business only and as the assessee has not declared any profit or loss from the speculation business, the bank interest debited to the P&L a/c is assessed as speculation loss. Aggrieved assessee filed an appeal before the CIT(A), who confirmed the order of the AO by relying upon the decision of his predecessor in the assessee’s own case for the asst. yr. 2002-03.
12. Having gone through the material on record as well as the decision of the Tribunal in the assessee’s own case for the asst yr. 2002-03 cited supra, we find that the Tribunal has considered the fact that the assessee has only a single transaction of purchase of shares without any further trading activity at all and, therefore, the provisions of Explanation to Section 73 do not apply. It was held that no material has been brought on record by the Revenue that the purchase of shares in question constituted a separate, independent business of the assessee and even if it is accepted that the purchase of shares by the assessee on its own account constituted a different line of business, from that fact alone, it does not follow that there were two independent and separate businesses and not a single integrated business carried on by the assessee. Accordingly, the disallowance was deleted. We find that the facts and circumstances for this year are exactly the same and the decision of the co-ordinate Bench in the assessee’s own case cited supra is in favour of the assessee. In view of the same, this ground of appeal of the assessee is allowed.
13. As regards ground No. 4, brief facts are that the assessee had given an interest-free advance of Rs. 75 lakhs to Shri Gaurang Gandhi even though it had incurred interest expenses of Rs. 1,38,51,924. The AO came to the conclusion that the advances have been given for non-business purposes and, therefore, interest @ 15 per cent on the advance of Rs. 75 lakhs amounting to Rs. 11,25,000 was disallowed. Aggrieved, assessee filed an appeal before the CIT(A) who confirmed the addition following the decisions of the High Courts in the following cases:
(a) CIT v. H.R. Sugar Factory (P) Ltd. (1990) 87 CTR (All) 132 : (1990) 187 ITR 363 (All);
(b) CIT v. Motor General Finance Ltd. (2002) 173 CTR (Del) 123 : (2002) 254 ITR 449 (Del);
(c) Indian Metals & Ferro Alloys Ltd. v. CIT ;
(d) Pathan Sugar Works Ltd. v. CWT (1995) 127 CTR (Bom) 359 : (1995) 208 ITR 989 (Bom).
14. The learned Counsel for the assessee submitted that the AO has found that the interest payment of Rs. 1,38,51,954 was on account of bank interest towards loans taken for purchase of shares of Shonkh Technology Ltd. and that there is a direct nexus between the amount borrowed and investment in shares which is stock-in-trade of the share trading business. He submitted that having held so, it cannot be said that interest-free advance is out of interest-bearing funds. He placed reliance upon the decision of the Bombay High Court in the case of CIT v. Bombay Samachar Ltd. that the view taken by the AO that the assessee could have decreased the extent of its borrowing by calculating its outstanding and, therefore, would not be entitled to claim interest paid by it on borrowed capital is not capable of being sustained and further in view that the assessee had diverted the capital borrowed by it for making advances to its sister concern is squarely wrong on the facts of the case and is not capable of being sustained.
15. The learned Departmental Representative, on the other hand, strongly supported the orders of the authorities below.
16. We find that both the AO as well as the CIT(A) have held that the interest paid was towards the loan taken for purchase of shares. As long as the nexus between the interest-bearing funds and the interest-free advances is not established, the disallowance cannot be made. We find that this issue is covered by the decision of the Bombay High Court in the case of Bombay Samachar Ltd. (supra) and the assessee is entitled to succeed. This ground of appeal is, therefore, allowed.
In the result, assessee’s appeal is partly allowed.