1. This appeal has been filed by the department against the order dated 29-2-1980 of the Commissioner (Appeals). The assessee is an individual.
The assessment year involved in this appeal is 1973-74 with the year ended 31-3-1973 as the relevant previous year. The assessee is a director of Fouress Engg. (1)(P.) Ltd. and also a person who is substantially interested in that company. The assessee was also a member of HUF which had a proprietary concern styled as Sameer Finance Corporation. Further, the assessee was the sole proprietor of another concern styled as Bombay Engineering Industries, 2. The business carried on by Fouress Engg. (I) (P.) Ltd. was formerly carried on by a partnership firm consisting of the assessee and her husband. That business was taken over as a running concern by the aforesaid company from 1-7-1971. The accounts of the said company were closed for the first time on 30-6-1972 relevant to the assessment year 1973-74. The balance sheet of the company as on 30-6-1972 showed development rebate reserve of Rs. 4,09,798 and unappropriated credit balance in the profit and loss account amounting to Rs, 1,14,450. This was the position as at the end of the first year of the business carried on by the company. It may be stated that the brought forward development rebate from the earlier, partnership firm amounted to Rs. 3,08,112. The balance development rebate of Rs, 1,01,686 was created out of the profits of the first year. Similar is the case with the credit balance of Rs. 1,14,450 which represented the profits of the first year of business of the assessee.
3. On 18-7-1972, the aforesaid company gave a loan of Rs. 30,000 to Sameer Finance Corporation. On 30-6-1972, another loan of Rs. 40,000 was given. Thus, the aforesaid company gave a loan of Rs. 70,000 to Sameer Finance Corporation. Sameer Finance Corporation gave a loan of Rs, 73,000 in two instalments on 14-9-1972, to Bombay Engineering Industries. The ITO held the view that the aforesaid private limited company ultimately gave a loan to the assessee indirectly through Sameer Finance Corporation. He invoked the provisions of Section 2(22)(e) of the Income-tax Act, 1961, and held the sum of Rs. 70,000 as deemed dividend in the hands of the assessee and assessed the same as such.
4. The assessee appealed to the Commissioner (Appeals) and contended that the action of the ITO was not justified. The Commissioner (Appeals) found that the loans were given by the company in the very first year of its existence and so they could not have come out of any accumulated profit. He relied on the decision in the case of CIT v.Damodaran  121 ITR 572 (SC). Secondly, he observed that "shareholder" envisaged under Section 2(22)(e) means a registered shareholder and not a benami shareholder, in view of the decision in the case of Damodaran (supra). Further, he held that the development rebate brought forward from the earlier partnership concern could not be said to be accumulated profits of the private limited company because it was of a hereditary nature and it had to be kept intact for eight years and was not available for distribution of dividends.
According to him, the development rebate of the current year could not form part of the accumulated profits. Finally, he observed that an artificial provision like Section 2(22)(e) has to be strictly construed and its scope could not be widened. In this view of the matter, he deleted the sum of Rs. 70,000 from the total income of the assessee holding that the same cannot be treated as deemed dividend under Section 2(22)(e).
5. Shri T.S. Srinivasan, the learned representative for the department, urged before us that the Commissioner (Appeals) erred in his decision.
He stated that the assessee-company had enough development rebate brought forward from the earlier partnership concern and they constituted the accumulated profits of the company itself. He relied on the decision in the case of CIT v. P.K. Badiani  76 ITR 369 (Bom.) in support of the proposition that such development rebate forms part of the accumulated profits. Then, he contended that the aforesaid company gave the loan ultimately to the assessee who is the registered shareholder and also a director of the company. All that the, company did was to give the money indirectly through the conduit pipe of Sameer Finance Corporation. He, however, stated that the case of the department was not that Sameer Finance Corporation was a benami concern of the assessee, but that the said Corporation was used as a mere intermediary to pass on the loan to the assessee. Hence, he urged that the decision of the Commissioner (Appeals) deserve to be reversed and that of the ITO deserve to be restored.
6. Shri S.P. Mehta, the learned representative for the assessee, on the other hand, supported the order of the Commissioner (Appeals). He stated that the legal position regarding Section 2(22)(e) is quite well settled. As it is a deeming provision, it has to be strictly construed and, as held in the case of Damodamn (supra), the shareholder referred to therein must be the registered shareholder and none else. The assessee-company came into existence for the first time during the year under consideration and did not have any accumulated profits of its own. The loan given by the company to Sameer Finance Corporation was in the ordinary course of its business and there was a gap of about three months between the date of loan received by Sameer Finance Corporation and the date on which it gave loan of a different amount to the assessee in the ordinary course of its own business. Under the circumstances, he contended that the decision of the Commissioner (Appeals) was quite justified.
7. We have considered the contentions of both the parties as well as the facts on record. Section 2(22)(e) enacts a legal fiction inasmuch as it directs to treat certain amounts as dividends under certain circumstances, which would not otherwise be regarded as dividends. It is now well settled that such deeming provisions creating legal fictions, especially in taxing statute, have to be strictly construed vide the decisions in the case of CIT v. Kexhavlal Lallubhai Patel  55 ITR 63 (SC), Smt. Mohini Thapar v. CIT  83 ITR 208 (SC), CIT v. C.P. Sarathy Mudaliar  83 ITR 170 (SC) and CIT v.Vadilal Lallubhai  86 ITR 2 (SC), In the case of CIT v. Vadilal Lallubhai (supra), it has been held that legal fictions, created for a definite purpose should be limited to that purpose and cannot be extended beyond their legitimate needs. In particular, no words which are not there can be read into the statute. Similar is the decision in the cases of CIT v. Maharaj Kumar Kamal  89 ITR 1 (SC), CED v. R.Kanakasabai  89 ITR 251 (SC) and CIT v. P.S.S. Investments (P.) Ltd.  107 ITR 1 (SC). In the case of CIT v. National Taj Traders  121 ITR 535 (SC), it has been held that the court should not supply an omission in a statute unless it is necessary for avoiding an absurdity. Hence, the position is quite clear that Section 2(22)(e) had to be strictly construed in accordance with the language appearing therein without adding anything to it. In our opinion, this provision has been enacted to bring into the tax-net certain amounts which would not be taxed as dividends otherwise. Hence, the conditions neccessary to apply the said provisions should be strictly fulfilled.
8. In the case of Rameshwarlal Sanwarmal v. CIT 122 ITR 1 (SC), the HUF through its karta was found to be the registered shareholder of a company. Hence, the loan given by the company to the HUF was held to be deemed dividend. On the other hand, in the case of Sarathy Mudaliar (supra) the members of an HUF were the registered shareholders of a company. But there was no finding by the Tribunal that the members were holding the shares on behalf of the HUF. Hence, the loan given by the company to the HUF was held to be not taxable as deemed dividend. The above position is further clarified in the case of Rameshwarlal Sanwarmal (supra) which clearly lays down the proposition that Section 2(22)(e) applies only to a registered shareholder and not to a beneficial one. Hence, there is no doubt that the recipient of the loan must himself be a registered shareholder in order to be taxed under Section 2(22)0).
9. As stated earlier, the case of Damodaran (supra) lays down the proposition that for purposes of deemed dividend, accumulated profits do not include current profits. No decision has been brought to our notice on the question as to whether the profits taken over from an earlier concern by the limited company can constitute its accumulated profits in its very first year of existence. The language of Section 2(22)(e) merely refers to "accumulated profits" which normally means the accumulated profits of the assessee-company. In our opinion, it can be argued that the accumulated profits envisaged under Section 2(22)(e) cannot extend to accumulated profits of a predecessor-in-business which is not a company. In any case, the matter is not free from doubt and two reasonable interpretations are possible. In such a situation, the decision of CIT v. Vegetable Products Ltd.  88 ITR 192 (SC) says that the matter has to be decided in favour of the assessee.
10. Applying the above principles to the facts of this case, we find that the company in which the assessee was a shareholder did not give any loan to the assessee. In the absence of the phrase "directly or indirectly" in Section 2(22)(e), it is not permissible to read the same into it vide the decision in the case of Nandlai Kanoria v. CIT  122 ITR 405 (Cal.). Further, the assessee-company cannot be said to have any accumulated profits in the very first year of its existence.
There is a gap of about three months between the loan by the company to Sameer Finance Corporation and the loan given by the latter to a concern belonging to the assessee and the amounts are also not identical. Under the circumstances, we agree with the Commissioner (Appeals) that the sum of Rs. 70,000 could not be treated as deemed dividend under Section 2(22)(e), Hence, we uphold his order.