Supreme Court Interprets “Beneficial Owner” under Section 2(22)(e) of the Income Tax Act: National Travel Services vs. Commissioner of Income Tax (18 January 2018)

Introduction

Date of the Judgment: 18 January 2018

Citation: 2018 INSC 44

Judges: Justice R.F. Nariman and Justice Navin Sinha.

Can a loan given to a partnership firm be considered a dividend if the firm’s partners are also shareholders in the lending company? The Supreme Court of India grappled with this question while interpreting Section 2(22)(e) of the Income Tax Act, 1961. The core issue revolves around whether the term “shareholder” in the context of deemed dividends includes only registered shareholders or also beneficial owners of shares. This judgment analyzes the implications of the 1988 amendment to the definition of “dividend” under the Income Tax Act, specifically focusing on the inclusion of “beneficial owners” of shares and its impact on loans to concerns where such shareholders are partners. The bench comprised of Justice R.F. Nariman and Justice Navin Sinha.

Case Background

National Travel Services, a partnership firm, consisting of three partners: Mr. Naresh Goyal, Mr. Surinder Goyal, and M/s Jet2 Enterprises Private Limited, with profit sharing ratios of 35%, 15%, and 50% respectively, took a loan of Rs. 28,52,41,516 from M/s Jetair Private Limited. Mr. Naresh Goyal and Mr. Surinder Goyal held 48.19% of the total shareholding in Jetair Private Limited, registered in their names, but on behalf of the firm, which was the beneficial shareholder. The central question was whether this loan to the firm could be deemed as a dividend under Section 2(22)(e) of the Income Tax Act, 1961, given that the partners held shares in the lending company.

Timeline

Legal Framework

The judgment primarily revolves around the interpretation of Section 2(22)(e) of the Income Tax Act, 1961, and its amendments.

The Income Tax Act, 1922, defined “dividend” under Section 2(6A)(e) as:

“2. (6A) `dividend’ includes- …
(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 by any such company on behalf or for the individual benefit of a shareholder, to the extent to which the company in either case possesses accumulated profits;”

The Income Tax Act, 1961, initially defined “dividend” under Section 2(22)(e) as:

“Section 2. Definition – In this Act, unless the context otherwise requires,-
(22) “dividend” includes-
(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) by way of advance or loan to a shareholder, being a person who has a substantial interest in the company or any payment by any such company on behalf or for the individual benefits, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;”

The 1988 amendment to Section 2(22)(e) of the Income Tax Act, 1961, redefined “dividend” as:

“Section 2. Definition – In this Act, unless the context otherwise requires,-
(22) “dividend” includes-
(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 percent 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’”

Explanation 3 of Section 2(22) of the Income Tax Act, 1961, defines:

(a) “concern” means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company;

(b) a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern;”

Arguments

Appellant’s Arguments:

• The appellant argued that the term “shareholder” should continue to mean a registered shareholder, even after the 1988 amendment to Section 2(22)(e) of the Income Tax Act, 1961.
• The appellant cited the judgment in C.I.T. vs. Ankitech Private Limited [2012] 340 ITR 14 (Del), where a Division Bench of the Delhi High Court held that “shareholder” means a registered shareholder.
• The appellant also referred to an order in C.I.T., Delhi-II vs. Madhur Housing and Development Company, where the Supreme Court affirmed the reasoning of the Ankitech judgment.
• Since the firm was not a registered shareholder, Section 2(22)(e) should not apply to the loan given to the firm.

Respondent’s Arguments:

• The respondent argued that the impugned judgment correctly distinguished the facts of Ankitech (supra) from the present case.
• The respondent contended that the impugned judgment referred to the second limb of the amended definition, which deals with concerns in which a shareholder is a member, and not to the first limb, which deals with a shareholder being a beneficial owner.
• The respondent supported the impugned judgment’s conclusion that a partnership firm can be treated as a shareholder without being a registered shareholder.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues:

1. To attract the first limb of Section 2(22)(e) of the Act, is it necessary that the person who has received the advance or loan is a shareholder and also beneficial owner? To put it otherwise, whether both the conditions are required to be satisfied will depend upon the interpretation to be given to the words “being a person who is a beneficial owner of shares…..” which was inserted by amendment in the aforesaid provision carried out by the Finance Act, 1987 w.e.f. 1st April, 1988.
2. Whether the assessee who is a partnership firm can be treated as `shareholder’ because of the reason that it has purchased the shares in the name of the two partners.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

Cases Relied Upon:

Legal Provisions Considered:

• Section 2(6A)(e) of the Income Tax Act, 1922: Definition of “dividend” including loans to shareholders.
• Section 2(22)(e) of the Income Tax Act, 1961: Definition of “dividend” including loans to shareholders with substantial interest.
• Section 2(22)(e) of the Income Tax Act, 1961 (as amended in 1988): Definition of “dividend” including loans to beneficial owners of shares and concerns in which such shareholders have a substantial interest.
• Explanation 3 of Section 2(22) of the Income Tax Act, 1961: Definition of “concern” and “substantial interest”.

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Supreme Court discussed C.I.T., Andhra Pradesh vs. C.P. Sarathy Mudaliar, (1972) 4 SCC 531 and M/s Rameshwari Lal Sanwarmal vs. Commissioner of Income Tax, Assam (1980) 2 SCC 371 to highlight that under the unamended provision, the term “shareholder” referred to a registered shareholder.
• The Supreme Court held that the judgment in C.I.T. vs. Ankitech Private Limited [2012] 340 ITR 14 (Del), which stated that the expression “shareholder” would continue to mean a registered shareholder even after the amendment, was wrongly decided.
• The Supreme Court referred to Mathalone vs. Bombay Life Assurance Co. Ltd., [1954] SCR 117 to support the view that a beneficial shareholder can compel the registered owner to vote in a particular way.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to prevent tax evasion by closely held companies. The court found that the 1988 amendment to Section 2(22)(e) of the Income Tax Act, 1961, was intended to broaden the definition of “shareholder” to include beneficial owners, thus preventing companies from avoiding dividend tax by routing profits through loans to related parties. The court emphasized that the term “shareholder” in the amended provision should not be restricted to registered shareholders, as this would defeat the purpose of the amendment.

Fact:Law Ratio

Logical Reasoning:

The court rejected the interpretation that both registered and beneficial ownership are required, stating that this would be contradictory and incorrect. The court noted that the addition of “beneficial owner” holding not less than 10% of voting power indicates that the amendment speaks only of a beneficial shareholder who can compel the registered owner to vote in a particular way. The court also noted that Ankitech’s case was wrongly decided.

The court stated that, “The whole object of the amended provision would be stultified if the Division Bench judgment were to be followed.”

The court further stated that, “One cannot be a registered owner and beneficial owner in the sense of a beneficiary of a trust or otherwise at the same time.”

The court also stated that, “To state, therefore, that two conditions have to be satisfied, namely, that the shareholder must first be a registered shareholder and thereafter, also be a beneficial owner is not only mutually contradictory but is plainly incorrect.”

The court concluded that the term “shareholder” in Section 2(22)(e) should be interpreted to include beneficial owners of shares, and not just registered shareholders.

Key Takeaways

• The term “shareholder” in Section 2(22)(e) of the Income Tax Act, 1961, includes beneficial owners of shares, not just registered shareholders.
• Loans or advances to a concern (like a partnership firm) where a beneficial shareholder is a partner with a substantial interest can be deemed as a dividend.
• The 1988 amendment to Section 2(22)(e) was intended to prevent tax evasion by closely held companies.
• The judgment in C.I.T. vs. Ankitech Private Limited was deemed wrongly decided and requires reconsideration.

Directions

The court referred the appeals to the Hon’ble Chief Justice of India to constitute an appropriate Bench of three learned Judges in order to have a relook at the entire question, including whether the facts of the present case would fit the second limb of the amended definition clause.

Specific Amendments Analysis

(Not Applicable)

Development of Law

The ratio decidendi of this case is that the term “shareholder” in Section 2(22)(e) of the Income Tax Act, 1961, as amended in 1988, includes beneficial owners of shares and not just registered shareholders. This is a change from the previous position of law, which was based on the interpretation that “shareholder” meant only a registered shareholder. The court held that the judgment in C.I.T. vs. Ankitech Private Limited, which stated that the expression “shareholder” would continue to mean a registered shareholder even after the amendment, was wrongly decided.

Conclusion

In this case, the Supreme Court addressed the interpretation of “shareholder” under Section 2(22)(e) of the Income Tax Act, 1961, as amended in 1988. The court held that the term “shareholder” includes beneficial owners of shares, not just registered shareholders. This interpretation was crucial in determining whether a loan given to a partnership firm, where the partners were also beneficial shareholders in the lending company, could be deemed a dividend. The court found that the 1988 amendment was intended to prevent tax evasion by closely held companies and expanded the definition of “shareholder” to include beneficial owners. The court also noted that the judgment in C.I.T. vs. Ankitech Private Limited was wrongly decided and required reconsideration. The case was referred to a larger bench for a relook at the entire question.