The law must not be stretched to tax what is not legislatively intended. Section 2(22)(e) is not a charging section for taxing loans to non-shareholders.”
— Delhi High Court in CIT v. Ankitech Pvt. Ltd.
1. Statutory Provision: Section 2(22)(e) – What the Law Says
Section 2(22) of the Income-tax Act, 1961 expands the definition of “dividend” to include certain payments made by a company, apart from actual dividend declared.
Section 2(22)(e) reads as follows:
“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 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 10% 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 (i.e., not less than 20% share in income of the concern),
to the extent to which the company possesses accumulated profits.
Key Definitions:
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Concern: As per Explanation 3 to Section 2(22)(e), includes an HUF, firm, AOP, BOI, or company.
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Substantial Interest: Explanation 3(b) – 20% or more beneficial interest in the income of the concern.
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Closely Held Company: i.e., a company in which the public are not substantially interested (Private Ltd. Companies).
2. Essential Ingredients for Applicability
To invoke Section 2(22)(e), all the following must be fulfilled:
| S. No. | Condition | Legal Requirement |
|---|---|---|
| 1 | Loan/Advance is given by a closely held company | Not a company in which public are interested |
| 2 | Loan is given to: (a) a shareholder, or (b) a concern | Shareholder must hold ≥10% voting power |
| 3 | If paid to a concern, shareholder must hold ≥20% beneficial interest | In the income of the concern |
| 4 | Loan is paid out of accumulated profits | Profits up to the date of payment |
| 5 | Payment is for the individual benefit of the shareholder | Must not be a business loan |
3. Interpretation & Judicial Evolution
A. Core Principle – Only a Shareholder Can Be Taxed
Multiple courts have held that deemed dividend under Section 2(22)(e) can be taxed only in the hands of a registered shareholder, not in the hands of a non-shareholder concern.
ACIT v. Bhaumik Colour Pvt. Ltd.
(2009) 313 ITR (AT) 146 (SB) (Mumbai)
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Special Bench held that:
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The recipient must be both registered and beneficial shareholder.
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A non-shareholder concern cannot be taxed directly under 2(22)(e), even if a shareholder has interest in it.
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CIT v. Ankitech Pvt. Ltd.
(2011) 340 ITR 14 (Del.)
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Delhi High Court affirmed Bhaumik Colour.
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Recipient of loan must be a shareholder of the lender company for deemed dividend to apply.
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Held: Concern (LLP or firm) receiving loan is not taxable, even if a shareholder has interest in it.
B. Concern Must Receive the Loan for Shareholder’s Personal Benefit
CIT v. Madhur Housing & Development Co.
(2011) 337 ITR 445 (Del.)
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Loan to a concern (firm/LLP) is not deemed dividend unless it can be shown that the loan was for the benefit of the shareholder.
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The burden is on the Revenue to establish shareholder-beneficiary relationship.
4. Case Illustration: Windlass Engineers Case – LLP Not Shareholder
Facts:
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Assessee was an LLP (earlier a partnership firm), received loan from Windlass Engineers and Services Pvt. Ltd. (WESPL).
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AO taxed it under Section 2(22)(e) because partners of LLP (Sudhir & Pradeep Windlass) held 45% and 50% shares in WESPL.
Assessee's Argument:
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The LLP is not a shareholder in WESPL.
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The amounts were commercial advances for business purposes, not loans for private gain.
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Funds were repaid in the same financial year.
Held:
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Section 2(22)(e) not applicable as:
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LLP was not a registered shareholder.
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No evidence of personal benefit to the shareholders.
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Loan was part of running business account.
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Addition deleted.
Assessment Year: 2014–15
Ratio: Reiterates that for Section 2(22)(e) to apply:
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The recipient must be a shareholder, and
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The loan must be for personal benefit of such shareholder.
5. Compliance Guidance and Strategic Notes
| Observation | Professional Insight |
|---|---|
| LLP/firm receiving loan from closely-held Co. | Not taxable unless LLP itself is a shareholder |
| Substantial interest of partner in lender Co. | Not sufficient — beneficial ownership of shares required |
| Trade advances vs. Loans | Commercial transactions in business course are excluded |
| Accumulated profits exhausted | No deemed dividend can arise |
| Personal benefit of shareholder not shown | Section 2(22)(e) cannot be invoked |
Conclusion: A Provision of Caution, Not Overreach
Section 2(22)(e) is an anti-avoidance provision designed to prevent tax-free distributions of profits. However, it is not a charging section to tax legitimate business transactions.
Indian jurisprudence now firmly holds that:
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Only shareholders can be taxed on deemed dividend;
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Concerns cannot be taxed unless the shareholder relationship is legally proven;
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And that commercial substance overrides form.
✅ Tax professionals must carefully examine the shareholding structure, nature of transactions, and the end use of funds before invoking or defending under Section 2(22)(e).
Key Cases Cited
| Case Name | Citation | Principle Established |
|---|---|---|
| ACIT v. Bhaumik Colour Pvt. Ltd. | (2009) 313 ITR (AT) 146 (SB) (Mumbai) | Only shareholder can be taxed |
| CIT v. Ankitech Pvt. Ltd. | (2011) 340 ITR 14 (Del.) | Concern is not taxable; shareholder-benefit must be proved |
| CIT v. Madhur Housing | (2011) 337 ITR 445 (Del.) | Loan must be for benefit of shareholder |
| Windlass Engineers Case (Unreported) | A.Y. 2014–15 – In favour of assessee | LLP not shareholder; Section 2(22)(e) not applicable |
