Bombay HC holds utilization of business advance for personal purpose is considered as 'deemed dividend'; repayment is irrelevant

The Taxpayer (Jaykumar B. Patil^[1]) was the Managing Director and a substantial shareholder in Ghatge Patil Industries Ltd. (GPIL). GPIL was engaged in manufacturing castings and components and had ongoing business dealings with the Taxpayer’s proprietary concern. The two parties maintained a running account to manage their transactions. 

TELCO (Tata Engineering and Locomotives Co. Ltd.) had placed a large order with GPIL, part of which was to be executed by the Taxpayer. Based on anticipated and pending orders, the Taxpayer requested an advance of INR7.1m from GPIL on 26 December 1997, as he had to meet deadline of payment of taxes under the Kar Vivad Samadhan Scheme (KVSS). However, TELCO did not go ahead with placing of orders with GPIL and the Taxpayer repaid the advance in the same financial year. 

The tax authority treated the advance taken by the Taxpayer as deemed dividend under Section (S.) 2(22)(e) of the Income Tax Act,1961 (ITA) and same was upheld by first appellate authority. Further, Mumbai Income Tax Appellate Tribunal acknowledged that the advance was linked to job work, however concluded that the actual utilization was for personal tax payment and held that the advance qualified as deemed dividend under S. 2(22)(e). Aggrieved, the Taxpayer appealed before the Bombay High Court (HC).

The HC noted that the Taxpayer was a substantial shareholder of GPIL and had received advance of INR7.1m which was utilized for the purpose of payment of taxes under KVSS (i.e., for personal benefit). Further, the HC observed that the Central Board of Direct Taxes (CBDT) Circular No. 19/2017^[2], which was relied upon by the Taxpayer, is applicable only in the cases where the advance is actually utilized for the job work. In other words, utilization of advance for execution of a particular business transaction is a pre-requisite for exclusion of the amount of loan or advance from the ambit of S. 2(22)(e). Thus, the HC rejected Taxpayer’s contention that advance received for business transactions need not be utilized for business and can be utilized for any other purpose. The HC placed reliance on the Supreme Court decision in the case of Smt. Tarulata Shyam v. CIT [[1997] 108 ITR 345 (SC)], and affirmed that mere repayment of advance within the same financial year does not protect the Taxpayer from the trigger of deemed dividend under S. 2(22)(e) and, accordingly, ruled that the advance paid was in the nature of deemed dividend in the hands of the Taxpayer. It further observed that maintaining a running account or having business relations is not sufficient to conclude that the amount of advance was actually utilized for execution of a business transaction.

^[1] [TS-1043-HC-2025(BOM)]
^[2] Which provides for exclusion of advances made to shareholders, which are granted for business purposes, from being treated as deemed dividend