Holding

The Tribunal’s finding that the payments were for the benefit of the assessee and constitute a deemed dividend under Section 2(22)(e) is correct, and the block assessment under Chapter XIV‑B is valid.

Summary

The Income Tax Department searched MKSEPL and seized a diary showing that Mukundra Y.K. Shah invested Rs.26.35 crore in RBI relief bonds. The Assessing Officer concluded that MKSEPL paid Rs.5.99 crore to two firms (MKF and MKI), which then routed the money to Shah, enabling the bond purchase; the payment was treated as a deemed dividend under Section 2(22)(e). The Tribunal upheld this view and the block assessment under Chapter XIV‑B, but the Calcutta High Court set it aside, holding that the case did not involve undisclosed income. The Supreme Court reinstated the Tribunal’s findings, holding that the payments were for Shah’s benefit, that the block assessment was proper, and that the High Court could not interfere with factual findings under Section 260A. Consequently, the appeal was allowed and the block assessment of Rs.5.99 crore as deemed dividend was affirmed.

Issues considered

Whether the payments made by MKSEPL to MKF and MKI were for the benefit of the assessee and thus constitute a deemed dividend under Section 2(22)(e) of the Income Tax Act.
Whether a block assessment under Chapter XIV‑B is maintainable when undisclosed income is discovered solely through a search.
Whether the merger of SCPL with MKSEPL affects the treatment of accumulated profits for the purpose of deemed dividend.
Whether the High Court could interfere with the Tribunal’s factual findings under Section 260A.
Whether the amount of deemed dividend should be limited to Rs.5.99 crore after eliminating known company sources.

Legislation cited

Income Tax Act, 1961s. 132(1), s. 132(4), s. 158BC, s. 2(22)(e), s. 260A, s. Chapter XIV-B

Subjects

deemed dividendblock assessmentChapter XIV-Bundisclosed incomemergeraccumulated profitscircular tradingIncome Tax ActSection 2(22)(e)high court interferencefactual findings

Judgment

A COMMISSIONER OF INCOME TAX, KOLKATA
v.
MUKUNDRA Y K. SHAH

APRIL I 0, 2007

B [S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.]

c
Income Tax Act, 1961

Section 2(22)(e)-Deemed dividend-
}

-
Diary belonging to assessee, seized by department during search of
premises of a company, MKSEPL, indicating investment by him in bonds-
Assessing Officer finding that bonds were purchased from money received
from two firms in which assessee was partner, and their books of accovnt
D showed repayment of loans and advances from three companies, including
MKSEPL, which were closely related private limited companies, wherein
assessee had controlling interest and considerable voting power-Assessing
Officer concluding that MKSEPL had accumulated profits but deliberately
refused .to distribute them as dividends to its shareholders, and money paid
by it to two firms was for purchase of bonds by assessee which was assessable
E as deemed dividend in his hands under Section 2(22)(e)-Correctness of-
Held-Entries discovered during search had direct co-relation with payment
by MKSEP L to two firms and payments by said two firms to assessee who used
-
it to buy bonds; said funds were not repayment of loans.;_ Timing of so-called
repayments by company to those firms and immediate withdrawal offunds by
assessee and timing of purchase of bonds was around same time-It was
F noteworthy that in MKSEPL assessee was not only a shareholder having
more than 10% of total voting power, but was also its Director, and said
company was partner in the two firms; also withdrawal of money by assessee
were debited in capital account of firm leading to a debit balance.

G Merger of companies-Effect of-Held-Reserves had to he taken on
basis of merged account.

Chapter XIV-B dealing with block assessment-Invocation of-
Undisc/osed income in nature of deemed dividend detected wholly and A. ..-.

exclusively as a result of a search by department and not from any scrutiny
H 1104
I

COMMISSIONEROFINCOMETAX, KOLKATA v. MUKUNDRAYK. SHAH 1105
proceedings, tax evasion petitions, surveys, information receivedfrom ext._rnal A
agency etc.-Case of circular trading wherein funds were routed through
conduits and clear picture emerged only after seeing cash flow statements-
Held-Department was right in invoking provisions of Chapter XIV-B.

Section 260A-Appeal to High Court-Interference with fir.ding of
facts of Tribunal-Held-Question as to whether payment by company is for B
benefit of assessee is a question offact-Conclusions of Tribunal that it was
routed through other firms for benefit of assessee, on date of payment there
existed accumulated profits and all withdrawals were debited in cupital
account offirm leading to debit balance, were findings of facts-These were
not perverse and could not be interfered by High Court-Section 2(22)(e). C

Words and phrases-Circular trading-In the context of Chapter XIV-
B of Income Tax Act, 1961.

Appellant, the Income Tax Department, searched the premises of a
company, MKSEPL and seized a diary titled "ML-20" belonging to respondent- D
assessee. The diary indicated investment ofRs.26.35 crores by the respondent
in 9% RBI Relief Bonds between 17.11.99 and 11.2.2000 during the
accountir.g year ending 31.3.2000. The Assessing Officer found that the said
Bonds were purchased from the money received from two firms, MKF and
MKI, in which the respondent was partner. In the books of account, the said
two firms were shown to have received back the loans and advances from three E.
companies viz. MKTPL, SCPL and MKSEPL, which were closely related
private limited companies, wherein the respondent had controlling interest
and considerable voting power. On the basis of the said diary and the cash
flow chart, the Assessing Officer concluded that (i) MKSEPL had accumulated
profits but deliberately refused to distribute them as dividends to its F
.. Shareholders; (ii) Rs.Y.99 crores was paid by MKSEPL (including SCPL) in
the Accounting Year 1999-2000 to MKF and MKI respectively for the
purchase of 9% RBI Relief Bonds by the respondent, and assessed the said
sum as deemed dividend in the hands of the respondent under Section 2(22)(e)
of the Income Tax Act, 1961. It was more so as SCPL stood merged with
MKSEPL with effect from 18.5.98 G
Aggrieved by the Assessment Order, the respondent filed an appeal
before Commissioner of Income Tax (Appeals), which was allowed. Against
this appellant appealed to the Tribunal. The Tribunal held that (i) Section
2(22)(e) was attracted to facts of the case since disbursement was made by
MKSEPL; (ii) all payments should be taken to have originated from MKSEPL H
1106 SUPREME COURT REPORTS [2007) 4 S.C.R.

A (iii) in January/February 2000 when payments were made by MKI and MKF
to the respondent, SCPL had no independent existence in law having merged
with MKSEPL with effect from 18.5.98; therefore shareholding of respondent
in SCPL and its accumulated profits were liable to be taken into account; (iv)
though the respondent had bought the Bonds for Rs.26.35 crores, restriction
of deemed dividend amount to Rs.5.99 crores was correct since known
B company sources had to be eliminated. Accordingly, the Tribunal allowed the
appeal

Aggrieved by the decision of the Tribunal, the respondent appealed to
the High Court. The High Court held that (i) as the respondent had declared
C the primary facts in the returns, it was not a case of undisclosed income, but
of regular assessment which did not fall under Chapter XIV-B of the Act; (ii)
none of the Authorities below had held that the entries in the books of accounts
were fictitious; (iii) all payments were made by cheque; (iv) moneys were lent
and advanced by MKSEPL to MKF and MKI in normal course of business; (v)
the Tribunal erred in holding that MKF and MKI were conduits for routing
D the money from MKSEPL to the respondent as there was no evidence in that
regard; (vi) there was no evidence to show that payments were made by
MKSEPL for the individual benefit of the respondent; (vii) when Rs.26.35
crores was invested in the above financial year, there was no reason to treat
Rs.5.99 crores as deemed dividend. For the above reasons the High Court set
E aside ~the judgment of the Tribunal. Hence present appeal.

Appellant contended that under Section 260A of the Act the High Court
should not have interfered with the findings of facts recorded by the Tribunal
as there was neither a substantial question of law nor any perversity in its
findings.
F
Respondent contended that the appellant was wrong in treating the
accumulated profits of MKSEPL as accumulated profits of SCPL merely
because the merger became effective retrospectively with effe~t from 18.5.98.
It was more so as MKSEPL had not merged with SCPL but SCPL had merged
withMKSEPL
G
Allowing the appeal, the Court

HELD 1.1. The Tribunal was right in holding, on examination of the
cash flow statement, that MKSEPL had made payments to MKF and MKI for
the benefit of the assessee which enabled the assessee to buy 9% RBI Relief
H Bonds in the F.Y. 1999-2000. It is in this sense that the Tribunal was right in
COMMISSIONEROFINCOMETAX,KOLKATAv.MUKUNDRAYK.SHAH 1107

holding that the two firms were used as conduits by the assessee. It is not in A
dispute that the assessee had more than 10% ofvoting power in MKSEPL
during the block period. It is not in dispute that the assessee had substantial
interest of about 16% in MKF. It is not in dispute that the three companies
were the controlled companies. (Para 12) (1118-A-C)

Commissioner of Income-Tax, Madras-Iv. L. Alagusundaram Chettiar, B
(1977) I 09 ITR 508, approved.

1.2. The timing of so-called repayments by the company to MKF and
MKI and the immediate withdrawal of the funds by the a~um-Director
cum-shareholder-cum-partner and the timing of investmer.t in purchase of C
Bonds were around the same time. Moreover, in MKSEPL the assessee is not
only a shareholder having more than 10% of total voting power, he is also a
Director of that company. The said company is also a partner in MKF and
MKI which explains why the amount ofRs.5.99 crores was routed by splitting
the said amount into two parts ofRs.2.79 crores and Rs.3.20 crores.
(Para 12) (1118-C-D) D

1.3. The most important aspect, which has not been considered by the
High Court, was that withdrawal of money by the assessee from his capital
account, in the books ofMKI, during F.Y.1999-2000 led to a debit balance of
Rs.8.18 crores as on 31.3.2000. To this extent, the finding given by the A.O.
and by the Tribunal remains unchallenged. [Para 12) (1118-D-E] E
2.1. On the maintainability of the block assessment, the Department
was right in assessing the said amount as deemed dividend in the hands of
the assessee under Section 2(22)(e) of the Act. The impugned Assessment
Order was passed under Section 158BC. That assessment originated on
account of a search conducted under Section 132(1) of the Act. In that search F
the diary "ML-20" was identified. That identification was the starting point
of connected enquiries resulting in the detection of undisclosed income of
Rs.5.99 crores. In other words, undisclosed income, in the nature of deemed
dividend, did not arise from any scrutiny proceedings, tax evasion petitions,
surveys, information received from external agency etc. The undisclosed G
income was detected by the A.O. wholly and exclusively as a result of a search
and, therefore, the Department was right in invoking the provisions of Chapter
XN-B. [Para 12) (1118-E-G)

2.2. The Department has established a sort of circular trading in this
case. One of the important features of circular trading is to route the funds H
1108 SUPREME COURT REPORTS [2007) 4 S.C.R.

A through conduits. In such cases the picture emerges only after seeing the
cash Dow statem~nts. In the present case, ML-20 made the A.O. to hold
enquiries and in that enquiry the cash flow statement emerged, therefore,
the Department was right in invoking the provisions of Chapter XIV-B in the
present case. The five payments had direct co-relation with Rs.5.99 crores
B paid by MKSEPL to MKF and MKI and payments by the said two firms to the
assessee who used the said money to buy 9% RBI Relief Bonds. Therefore,
the said payment by the company through the two firms was for the benefit of
the assessee. Therefore, the said funds were not repayment of loans, they were
for purchase of 9% RBI Relief Bonds by the respondent. (Para 12)
(1118-G-H; 1119-A-B)
c 3. The A.O. was correct ·in expressing the view )hat on merger the
accounts of the two companies had merged and, therefore, the reserves had to
be taken on the basis of merged account. Moreover, the assessee had
substantial interest in MKSEPL right from the inception. (Para 13) (1119-C)

D 4.1. The question as to whether payment made by the company is for the
benefit of the assessee is a question of fact. In this case, the Tribunal has
concluded that the payment routed through MKF and MKI was for the benefit
ofthe assessee. This was a finding of fact. It was not perverse. Therefore, the
High Court should not have interfered with the said finding.
[Para 16) (1121-D)
E
Nandlal Kanoria v. Commissioner of Income-Tax, Central, Calcutta,
(1980) 122 ITR 405 and Commissioner of Income-Tax (Central), Bombay v.
P.K Badiani, (1970) 76 ITR 361, approved.

4.2. The concept·of deemed dividend under Section 2(22)(e) of the Act
F postulates two factors, namely, whether payment is a loan and whether on the
date of payment there existed "accumulated profits". These two factors have
. to be correlated. This correlation has been done by the Tribunal coupled with
the fact that all withdrawals were debited in the capital account of the firm
leading to the debit balance of Rs.8.18 crores. The High Court has e.rred in
G disturbing the findings offact. (Para 16) (1121-E]
5. The companies having accumulated profits and the companies in
which substantial voting power lies in the hands of the person other than the
public (controlled companies) are required to distribute accumulated profits
as dividends to the shareholders. In such companies, tht controlling group
H can do what it likes with the management of the company, its affairs and its
COMMISSIONER OF INCOMETAX, KOLKATA v. MUKUNDRAYK. SHAH [KAPADIA, J.) 1109

profits. It is for this group to decide whether the profits should be distributed A
as dividends or not. The declaration of dividend is entirely within the discretion
of this group. Therefore, the legislature realized that though funds were
available with the company in the form of profits, the controlling group refused
to distribute accumulated profits as dividends to the shareholders but adopted
the device of advancing the said profits by way of loan to one of its shareholders B
so as to avoid payment of tax on accumulated profits. This was the main reason
for enacting Section 2(22)(e) of the Act. [Para 11) (1117-D-F]
CIVIL APP ELLATE JURISDICTION : Civil Appeal No. 1873 of 2007.
From the Judgment and Order dated 12.05.2005 of the High Court of
Calcutta in G.A. No. 321 of2005 and ITA No. 21 of2005. C
Mohan Parasaran, A.S.G., Chidananda, Gaurav Dhingra, K.K. Senthilvelan
and B.V. Balaram Das for the Appellant.
N.K. Poddar and Rakha Rangaswamy for the Respondent.
The Judgment of the Court was delivered by D
KAPADIA, J. 1. Leave granted.

2. A short question which arises for determination in this civil appeal
filed by the Department: whether payments made by M. K. Shah Exports Pvt.
Ltd. (for short, 'MKSEPL') during the Accounting Year ending 3 l.3.2000 E
(Assessment Year 2000-01) amounting to Rs.5.99 crores was made to the two
finns M/s. M.K. Foundation (for short, 'MKF') and Mis. M.K. Industries (for
short, 'MKJ') for the benefit of respondent-assessee herein, Mukundrai K.
Shah.

3. Department sought to tax the said amount of Rs.5.99 crores as F
undisclosed income in the hands of the assessee. On 24.8.2000, the Department
searched the premises of the assessee under Section 132 of Income Tax Act,
196l(for short, 'the Act'). During the search apart from cash and jewellery a
diary titled "ML-20" was seized. On 16.11.2000, during the search the statement
of Kalpesh Shah, son of the assessee, was also recorded under Section 132(4)
of the said Act. Statement of the assessee was also recorded on that date. G
The diary indicated investment of Rs.26.35 crores by the assessee in 9% RBI
Relief Bonds during the accounting year ending 31.3.2000. By the Assessment
Order dated 29 .11.2002, the said amount of Rs.5 .99 crores was assessed as a
deemed dividend under Section 2(22)(e) of the said Act. The A.O. took into
consideration the income of the assessee for the block period, under Chapter H
1110 SUPREME COURT REPORTS [2007] 4 S.C.R.

A XIV-Bat Rs.65.77 crores. This was for the block period 1.4.90 to 24.8.2000 (for
short, "block period"). The diary was seized from the premises of MKSEPL.
It belonged to the assessee. The assessee was asked to explain the sources
of investment ofRs.26.35 crores in purchase of9% RBI ReliefBonds during
Financial Year 1999-2000. The said Bonds were purchased between' 17.11.99
B and 11.2.2000. The A.O. found that the said Bonds were purchased from the
money received from MKF and MKI (for short, 'two finns') in which the
assessee was the partner. In the books of account the said two finns were
shown to have received back the loans and advances from three companies
M.K. Tea (P) Ltd. (for short, 'MKTPL'), Safari Capital (P) Ltd. (for short,
'SCPL') and MKSEPL, which three companies were closely related companies,
C in which the assessee had controlling interest. All three companies were
private limited companies in which the assessee had considerable voting
power. However on the basis of the said diary and the cash flow chart, the
A.O. concluded that Rs.5.99 crores was paid by MKSEPL (including SCPL)
and Rs.94 lakhs by MKTPL in the Accounting Year 1999-2000 toMKF and
MKI respectively for the purchase of 9% RBI Relief Bonds by the assessee.
D In the circumstances, by the Assessment Order, the Department assessed the
said sum as deemed dividend in the hands of the assessee under Section
2(22)(e) of the Act. It was held that MKSEPL, SCPL and MKTPL (for short,
'three companies') we~e the companies in which the public was not substantially
interested; that the assessee was one of the shareholders having morj:: than
E l 0% total voting rights of MKSEPL and SCPL; that in MKTPL the total
shareholding of the assessee was 9.3% and, therefore, he was not the beneficial
owner of the shares of the said companies. It was further held by the A.O.
that SCPL stood merged with MKSEPL with effect from 18.5.98. This was by
the Order of the Calcutta High Court dated 5.7.2001. Therefore, according to
the Order of Assessment, the alleged repayments by MKSEPL including
F SCPL were not repayments but they were payments made by MKSEPL
(including SCPL) to MKF and MKl for the individual benefit of the assessee
amounting to Rs.5.99 crores which was held to be a deemed dividend under
Section 2(22)(e) of the Act. Before the A.O. the assessee contended that
during the financial year 1999-2000, his shareholding in MKTPL was only
G 9.3% and, therefore, he was not having substantial interest in the said company;
that similarly he was not having substantial interest in SCPL in which his
shareholding in the F.Y 1999-2000 was only 0.2%; that the assessee was one
of the partners in MKF and MKI and that the said two finns did not have
substantial interest in MKSEPL, SCPL and MKTPL; that reserves and surplus
of MKSEPL cannot be taken as reserves and surplus of SCPL which was
H merged with the company with effect from 18.5.98; that MKl had advanced
COMMISSIONER OF INCOMETAX, KOLKATA v. MUKUNDRAYK. SHAH (KAPADIA, J.) J111

loan to SCPL which was repaid; that payment made by MKSEPL to MKF was A
through the current account and that the withdrawal made by the assessee
from the two firms were debited to his capital account in the books of MKF
and MKI and, therefore, the assessee contended that the said payments were
not made to the said two firms for his individual benefit. These arguments
were rejected by the A.O. It was held that the assessee had substantial
interest in MKSEPL in which SCPL stood merged with effect from 18.5.98; that B
there was no merit in the contention of the assessec that the two firms, in
which he was the partner, were not beneficial owner of shares of MKSEPL
and SCPL; that the only relevant criteria was whether payments made to the
said two firms was for the individual benefit of the assessee, who was the
shareholder in MKSEPL. This point, according to the A.O., became relevant C
since the only issue which arose for det<!rmination in this case was the issue
of deemed dividend under Section 2(22)(e) of the Act. According to the A.O.,
the said two firms-MK! and MKF, were the conduits enabling the assessee
to take out the money from the company by using the said two firms as
conduits. According to the A.O., payment of Rs.5.99 crores was not made
directiy to the assessee by MKSEPL but through the above-mentioned two D
firms-MKF and MKI. At this stage, it needs to be mentioned that there is no
dispute that 9% RBI Relief Bonds were purchased by the assessee out of the
funds available with MKI and MKF who in tum were funded by MKSEPL
including SCPL. It is also not in dispute that the assessee had the majority
of the voting power in MKSEPL. It is not in dispute that the said company, E
MKSEPL, had accumulated profits but according to the A.O. the said company
deliberately refused to distribute the said accumulated profits as dividends to
its shareholders and instead adopted the device of a~vancing the said
accumulated profits as loan to the assessee who was the shareholder of the
said company. According to the A.O., it was a device to evade payment of
tax on accumulated profits. F
4. Aggrieved by the Assessment Order dated 29.11.2002, the assessee
went in appeal to Commissioner oflncome Tax (Appeals) {for short, 'CIT (A)')
under Section 158BC(c) read with Section 143(3) of the Act. By the Order
dated 21.2.0J,r it was held by CIT (A) that the assessee did not possess any G
substantial interest in MKTPL or in SCPL during F.Y 1999-2000; that MKF and
MKI had no substantial interest in MKSEPL, SCPL and MKTPL during F.Y.
1999-2000; that SCPL did not make any loan to MKI during the financial year
1999-2000; that SCPL had borrowed money from MKI and all payments made
by SCPL during F.Y. 1999-2000 were repayments ofloans advanced by MKI;
that the assessee had 16% share in MKF; that MKSEPL had a current H

•
1112 SUPREME COURT REPORTS [2007) 4 S.C.R.

A account in the books of MKF and that in most cases MKF had advanced
loans to MKSEPL. According to CIT(A), MKSEPL have repaid those loans
to MKF in which the assessee had substantial interest. According to CIT(A),
the nature of transactions between MKF and MKSEPL consisted of a running
account; it consisted of giving of loans and repayments thereof. According
to CIT(A), none of the two firms had any substantial interest in MKSEPL,
B SCPL and MKTPL. According to CIT(A): all withdrawals made by the assessee
from MKF and MKI including the impugned sum were debited to the
assessee's capital account in the books of MKF and MKI. According to
CIT(A), MKSEPL and SCPL had a regular account in MKF and MKI even
before the purchase of the said Bonds and that the said two firms had
C advanced loans to MKSEPL and SCPL even in the earlier years as well as in
the financial year 1999-2000 and, therefore, there was no motive iQ the debtor
companies repaying their debts to MKF and MKI. According to CIT(A),
merely because repayments were made by MKSEPL and SCPL through MKF
a'nd MKI in January/February 2000 and merely because the said amounts were
partly utilized by the said two firms in making payments to the assessee who
D bought 9% RBI Relief Bonds therefrom, did not necessarily mean that the
assessee had routed the funds of MKSEPL through MKF and MKI for his
individual benefit. .According to CIT(A), MKF and MKI were two separate
entities; that there was no material to show that MKF and MKI were used
as conduits for routing the money from MKSEPL to the assessee. According
E to CIT(A), while the total investment made by the assessee in purchase of
Bonds during F.Y. 1999-2000 was Rs.26.35 crores, the Department has sought
to assess only Rs.5.99 crores as deemed dividend and, therefore, according
to CIT, the allegation made by the A.O. was baseless. According to CIT(A)
there was no material to show that MKSEPL and SCPL had made payments
to the said two firms for the benefit of the assessee enabling him to purchase
F the said Bonds in F.Y. 1999-2000. According to CIT(A), MKSEPL and SCPL
were the debtors of MKF and MKI in the regular course of business and,
therefore, payments made by MKSEPL to MKF and MKI were repayments of
loans and that the said payments were not for purchase of Bonds by the
assessee. Accordingly, the appeal was allowed by CIT(A).
G 5. Aggrieved by the decision dated 21.2.03, the matter was carried in
appeal by the ·Department to the Tribunal. By the judgment dated 28.1.05, the
Tribunal held that in this case Section 2(22)(e) was attracttd since disbursement
was made by MKSEPL (company); that SCPL had no independent existence
in law in January/February 2000 when payments were made by MKI and MKF
H to the assessee who bought the said Bonds; that SCPL disbursed Rs.2.04
COMMISSIONEROFINCOMETAX,KOLKATAv. MUKUNDRAYK.SHAH[KAPADIA,J.] 1113

crores and Rs.75 lakhs in January 2000; that SCPL stood merged in MKSEPL A
vide Order of the High Court dated 5.7.2001 with retrospective effect, i.e.
18.5.98; that in January 2000 SCPL had no legal existence since the merger had
taken place with effect from 18.5.98; that merger had taken place under a
voluntary scheme in which every shareholder of the two companies agreed;
that, therefore, there was no merit in the contention of the assessee that his
shareholding in SCPL and the accumulated profits of SCPL were not liable to
B
be taken into account; according to the Tribunal, in the aforestated
circumstances, all payments should be taken to have originated from MKSEPL;
the Tribunal further found that the accumulated reserves of MKSEPL was
Rs.55 crores, nearly ten times in excess of Rs.5.99 crores taxed as deemed
dividend It is not in dispute that the assessee had more than 10% of the total C
voting power in MKSEPL. In the circumstances, the Tribunal took the view
that MKSEPL made payment to the said two firms for the benefit of the
assessee who thereafter bought the said Bonds. According to the Tribunal,
MKSEPL was the only company which made the disbursement through MKF
and MKI. According to the Tribunal, it is true that the assessee bought the
said Bonds for Rs.26.35 crores but the A.O. had taxed only ~ fraction of D
Rs.5.99 crores. However, according to the Tribunal, for the purposes of
applicability of Section 2(22)(e) of the said Act payment has to originate from
a company. After excluding known company sources, according to the Tribunal,
the A.O. was right mrestricting the deemed dividend amount to Rs.5.99 crores
since known company sources had to be eliminated. According to the Tribunal, E
the A.O. was right in identifying MKSEPL as the originating company, the
identity of the ultimate beneficiary, the amount to be taxed, that is, Rs.5.99
crores and the sufficiency of accumulated profits of MKSEPL in which the
assessee had more than I 0% voting power. Accordingly the Tribunal allowed
the Department's appeal.
F
6. Aggrieved by the decision of the Tribunal dated 28.1.05, the assessee
carried the matter in appeal to the High Court under Section 260A of the said
Act. By the impugned judgment the High Court held in favour of the assessee
on two counts. According to the High Court, the assessee had declared the
primary facts in the Returns. According to the High Court, the present case
did not fall under Chapter XIV-B of the said Act. According to the High
G·
Court, this was not the case of undisclosed income. According to the High
Court, this was a matter of regular assessment. According to the High Court,
none of the Authorities below have held that the entries in the books of
accounts were fictitious. According to the High Court, full details were
disclosed during the block period in the Returns filed by the assessee. H
1114 SUPREME COURT REPORTS [2007) 4 S.C.R.

A According to the High Court, all payments were made by cheque. According
to the High Court, moneys were lent and advanced by MKSEPL to MKF and
MKI in normal course of business. According to the High Court, the Tribunal
had erred in holding that MKF and MKI were conduits for routing the money
from MKSEPL through the two firms to the asses'see; that there was no
B evidence in that regard; that the two firms did not have substantial interest
in MKSEPL; that there was no evidence to show that payments were made
by MKSEPL for the individual benefit of the assessee and to enable him to
purchase 9% RBI Relief Bonds; that CIT(A) was right in holding that when
Rs.26.35 crores was invested in the above financial year then A.O. had no
reason to treat Rs5.99 crores as deemed dividend under Section 2(22)(e) and
C for the above reasons the High Court set aside the judgment of the Tribunal
dated 28.1.05. Hence this civil appeal.

7. According to Mr. Mohan Parasaran, learned Additional Solicitor
General appearing for the appellant (Department), the High Court should not
have interfered with the findings of facts recorded by the Tribunal; that there
D was no substantial question of law; that no perversity in the findings recorded
by the Tribunal so as to warrant interference under Section 260A of the Act;
that the Department had searched the premises, it had seized the diary "ML-
20" which contained entries subsequently corroborated by cash flow chart
which indicated that money had originated from MKSEPL to the two firms
E through which it had gone to the assessee and, therefore, the Department was
right in assessing Rs.5.99 crores· as deemed dividend in the hands of the
assessee under Section 2(22)(e). Learned counsel urged that the five entries
discovered in the search represented five transactions/payments for purchase
of 9% RBI Relief Bonds. These, according to the learned counsel, were not
repayment of loans, they were payments for purchase of the said bonds
F during the F.Y. 1999-2000.

8. On behalf of the assessee (respondent), Mr. N.K. Poddar, learned
senior counsel,· submitted that the impugned block assessment was wholly
without jurisdiction having regard to the fact that the alleged deemed dividend
of Rs.5.99 crores relate to transactions recorded and reflected in the regular
G books and tax records even before the search; that no incriminating document
or evidence was found by the Department during the search which falsify
such transactions entered into by the· assessee in the normal course; that the
expression "undisclosed income" has been defined in Section I 58B(b) of the ' -
said Act and since block assessment was relatable to such evidence recovered
H during search in the present case Section l58BB(l) was not applicable in this
\
,.__ •
COMMISSIONER OF INCOME TAX, KOLKATA v. MUKUNDRAYK SHAH [KAPADIA, J.] lllS
case since no such evidence was recovered during the search. Learned A
·--..1.
counsel submitted that Chapter XIV-B was put on the Statute Book to enable
assessment of undisclosed income detected on evidence found during the
search. According to the learned counsel, the block assessment was intended
to be an assessment in addition to the regular assessment. Learned counsel
submitted that in the present case for want of such evidence, the Department
was not entitled to make additions on account of deemed dividend to the tune B
ofRs.5.99 crores. During the search, according to the learned counsel, nothing
except a cash flow chart giving details of investments made by the assessee
.,,. in purchase of the said Bonds of the value of Rs.26.35 crores was furnished .
According to the learned counsel, the diary "ML-20" was the ledger copy of
the investment account in 9% RBI Relief Bonds which copy was a print-out c
from the regular accounts of the assessee; that the investment of Rs.26.35
crores, reflected in ML-20, was made by the assessee out of his disclosed
funds and through regular books of accounts, and that the seized diary did
not contained any incriminating information. Learned counsel urged that in
the course of block assessment proceedings the A.O. directed the assessee
to furnish details as to the source of funds out of which Rs.26.35 crores was D
made and when it was explained to the A.O. that the assessee had made such
• ~ investments in 9% RBI Relief Bonds out of the moneys withdrawn from MKF
and MKI and that books of accounts maintained regularly by the said two
firms indicated such withdrawals the A.O. directed the authorized
representatives of the assessee to prepare a statement indicating the source E
from which moneys came in the hands of the two firms and out of which
withdrawals were made by the assessee to make investment in the 9% RBI
Relief Bonds, therefore, according to the learned counsel, no incriminating
material whatsoever was found in the course of the search which could enable
the A.O. to invoke Section 2(22)(e) of the Act. According to the learned
counsel, in the above circumstance, Chapter XIV-B dealing with block F
. ..,.. assessment was wrongly invoked by the A.O .

9. On the nature of the transactions, learned counsel urged that during
the F.Y. 1999-2000, the assessee had invested Rs.26.35 crores in the purchase
of bonds; that the said investment was made out of the disclosed sources
through cheques and that the said investment was mentioned in the bank
G
accounts and in the tax records of the assessee long before the search.
Learned Counsel urged that the immediate source of investment was the
:..- _,. withdrawal of Rs.26.35 crores from the partners' capital account with MKF
....,
and MKI. It was urg~d that the cash flow statement was not an admission
on the part of the assessee and, therefore, it was not open to the Department H
·-
~
1116 SUPREME COURT REPORTS [2007) 4 S.C.R.

A to invoke Chapter XIV-B. Learned counsel submitted that the Tribunal had \.--~
erred in holding that the fact that SCPL had a running current account with
MKI in the usual course of business, was irrelevant. Learned counsel submitted
that SCPL had borrowed substantial amounts from MKI and in January 2000
SCPL repaid Rs.2.79 crores to MKI which were not on behalf of or for the
benefit of the assessee. It was urged that MKI had never borrowed money
B from SCPL at any time. Learned counsel urged that the Tribunal was wrong
in holding that the fact that MKI had never borrowed money from SCPL, was
irrelevant. Learned counsel urged that Rs.2.79 crores were withdrawn by the
assessee from his firm styled MKI on 28. I .2000 and such withdrawal was :r
debited by MKI to the capital account of the assessee. It was urged that
c MKSEPL had borrowed substantial amounts from MKF; and MKSEPL had
made repayments to MKF during the F.Y. 1999-2000 against the earlier debt
owed by MKSEPL to MKF. Learned counsel submitted that the assessee had
a credit balance of Rs.6. 72 crores in his capital account standing in the books
of partnership firm of MKF as on 1.4. I 999. Learned counsel urged that the
withdrawals made by the assessee from MKF were only out of his capital
D account with MKF and that the said withdrawals were debited by MKF to the ._
capital account of the assessee. Learned counsel further urged· that there was
.;._
no evidence on record to show that payments by SCPL to MKI and/or the ;;
payment by MKSEPL to MKF was for the benefit of the assessee. Leamed
counsel submitted that payments were made by each of the two companies,
E namely, SCPL and MKSEPL to MKI and MKF respectively in liquidation of
their respective dues owed by each of the two companies to the said two
firms. Learned counsel urged that no payment was ever made by SCPL and
MKSEPL to the assessee. Learned counsel urged that the existence ofreserves

F
in the balance-sheet of MKSEPL in the sum of Rs.55 crores as on 31.3. I 999
is wholly irrelevant for the purposes of Section 2(22)(e) of the Act. Learned ...
counsel urged that similarly the fact that the assessee owed Rs.8.18 crores
to MKI as on 31.3.2000, was wholly irrelevant for the purposes of Section ..,.,..,~

2(22)(e) of the Act. Learned counsel submitted that Section 2(22)(e) had no
application in the matter of the above two facts. Learned counsel urged that
the Tribunal failed to appreciate that the assessee did not hold any shares
G in SCPL on or after 1.4. I 999 and, therefore, he did not have ariy interest in
f
SCPL on the dates when Rs.2.79 crores were repaid by SCPL to MKI.

I 0. Learned counsel contended that the accumulated profits of MKSEPL
,_
could not be treated in law as the accumulated profits of SCPL in spite of the ,...._ ~
Order dated 5. 7.200 I passed by the High Court approving the merger of SCPL
H with MKSEPL, even when such merger was made effective from 18.5.98.
.
COMMISSIONER OF INCOMET AX, KOLKATA v. MUKUNDRA YK. SHAH [KAPADIA, J.] 1117

Learned counsel submitted that the Tribunal had failed to appreciate that A
MKSEPL had not merged with SCPL but it is SCPL which had merged with
MKSEPL. As a result of the said merger the accumulated profits ofMKSEPL
did not vest in SCPL. Learned counsel, therefore, submitted that the
subsequent event of the Court's Order dated 5.7.2001 approving merger of
SCPL with MKSEPL can not enable the Revenue to treat the accumulated
profits of MKSEPL as part of the accumulated profits of SCPL. Learned B
counsel further submitted that MKF never held any shares in MKSEPL.
~
Learned counsel urged that Rs.2.04 crores were paid on 11.1.2000 and Rs.75
were paid on 28.1.2000 by SCPL to MKI. Therefore, according to the learned
counsel, if SCPL wanted to declare dividends it could have done so only to
the extent of accumulated profits in its own hands and since SCPL on the c
above two dates could not have declared dividends in excess of its accumulated
profits, the. Department was wrong in treating the accumulated profits of
MKSEPL as accumulated profits of SCPL merely because the merger became
effective retrospectively with effect from 18.5.98.

11. We find merit in this civil appeal. The companies having accumulated D
.. ~
profits and the companies in which substantial voting power lies in the hands
of the person other than the public (controlled companies) are required to
distribute accumulated profits as dividends to the shareholders. In such
companies, the controlling group can do what it likes with the management
of the company, its affairs and its profits. It is for this group to decide whether
E
the profits should be distributed as dividends or not. The declaration of
dividend is entirely within the discretion of this group. Therefore, the legislature
realized that though funds were available with the company in the form of
profits, the controlling group refused to distribute accumulated profits as
dividends to the shareholders but adopted the device of advancing the said
profits by way of loan to one of its shareholders so as to avoid payment of F
''¥ tax on accumulated profits. This was the main reason for enacting Section
2(22)(e) of the Act.

12. In the case of Commissioner of Income.Tax, Madras·! v. L.
Alagusundaram Chettiar ( 1977) I 09 ITR 508, the Madras High Court held that
the word "payment" in the said section means the act of paying and, therefore, G
in that case it was held that payment by the company to Karuppiah Chettiar
was for the benefit of the assessee, the Managing Director of the company,
~ ·L. Alagusundaram Chettiar, and was therefore assessable as dividend in the
hands of the assessee. In the said judgment it has been held that the basic
test to be applied in such cases is not whether loan given is a benefit but H
1118 SUPREME COURT REPORTS [2007] 4 S.C.R.

A whether payment by the company to Karuppiah Chettiar was for the benefit
of the assessee who was the Managing Director of the paying company.
Applying the above test to the facts of the present case, we are of the view
that the Tribunal was right in holding, on examination of the cash flow
statement, that MKSEPL had made payments to MKF and MKI for the benefit
of the assessee which enabled the assessee to buy 9% RBI Relief Bonds in
B the F.Y. 1999-2000. It is in this sense that the Tribunal was right in holding
that the tWo firms were used as conduits by the assessee. It is not in dispute
that the assessee had more than l 0% of voting power in MKSEPL during the
block period. It is not in dispute that the assessee had substantial interest
of about 16% in MKF. It is not in dispute that the three companies were the
C controlled companies. There is ODe more point which needs to be mentioned.
The timing of so-called repayments by the company to MKF and MKI and
the immediate withdrawal of the funds by the assessee-cum-Director-cum-
shareholder-cum-partner and the timing of investment in purchase of Bonds
were around the same time. Moreover, in MKSEPL the assessee is not only
a shareholder having more than 10% of total voting power, he is also a
D Director of that company. The said company is also a partner in MKF and
MKI which explains why the amount ofRs.5.99 crores was routed by splitting
)
the said amount into two parts of Rs.2.79 crores and Rs.3.20 crores. In the
present case, the most important aspect, which has not been considered by
the High Court, was that withdrawal of money by .the assessee from his
E capital account, in the books of MKI; during F.Y. 1999-2000 led to a debit
balance ofRs.8.18 crores as on 31.3.2000. To this extent, the finding given by
the A.O. and by the Tribunal remains unchallenged. Lastly, on the
maintainability of the block assessment, we are of the view that the Department
was right in assessing the said amount as deemed dividend in the hands of
the assessee under Section 2(22)(e) of the Act. The impugned Assessment
F Order was passed under Section 158BC. That assessment originated on account
of a search conducted under Section 132(1) of the Act. In that search the
diary "ML-20" was identified. That identification was the starting point of
connected enquiries resulting in the detection of undisclosed income of
Rs.5.99 crores. In other words, undisclosed income, in the nature of deemed
G dividend, did not arise from any scrutiny proceedings, tax evasion petitions,
surveys, information received from external agency etc. The undisclosed
income was detected by the A.O. wholly and exclusively as a result of a
search and, therefore, the Department was right in invoking the provisions of
Chapter XIV-B: There is 'one more aspect in this regard. From the facts,
indicated above, the Department has established a sort of circular trading in
H this case. One of the important features of circular trading is to route the
COMMISSIONEROFINCOMETAX,KOLKATA v. MUK.UNDRAYK. SHAH[KAPADIA,J.] 1119
funds through conduits. In such cases the picture emerges only after seeing A
the cash flow statements. In the present case, ML-20 made the A.O. to hold
enquiries and in that enquiry the cash flow statement emerged, therefore, the
Department was right in invoking the provisions of Chapter XIV-B in the
present case. The five payments had direct co-relation with Rs.5.99 crores
paid by MKSEPL to MKF and MKI and payments by the said two firms to
the assessee who used the said money to buy 9% RBI Relief Bonds. Therefore, B
the said payment by the company through the two firms was for the benefit
of the assessee. Therefore, the said funds were not repayment of loans, they
were for purchase of 9% RBI Relief Bonds by the respondent.

13. As regards the contention advanced on behalf of the assessee that C
the accumulated profits of MKSEPL could not be treated as the accumulated
profits ofSCPL in spite of the Order of merger with effect from 18.5.98, we
agree with the view expressed by the A.O. that on merger the accounts of
the two companies had merged and, therefore, the reserves had to be taken
on the basis of merged account. Moreover, the assessee had substantial
interest in MKSEPL right from the inception. Lastly, in the present case, we D
- ... are concerned with the block assessment which covers the period l.4.1990 to
24.82000.

14. Before concluding, we quote hereinbelow the relevant paragraphs
from the judgment of the Calcutta High Court in the case of Nandlal Kanoria
v. Commissioner ofIncome-Tax, Central, Calcutta reported in (1980) 122 ITR E
405 at p. 415:

"The only question which remains to be considered is that whether
the said company made the payments of the said sum of Rs. 75,000
and Rs. 4,80,000 to Indira & Co. for the benefit of the assessee. So F
far as Rs. 75,000 is concerned it is found by the Tribunal, though not
very clearly, that this amount was received by Indira & Co. from the
said company and the same amount was given to the assessee by
Indira & Co. The Tribunal inferred from the said facts that this was
a payment by the said company meant for the benefit of the assessee .
.This conclusion involves two findings offact, namely, the factum of G
payment by the company and the motive or intention of the company
making such payment, namely, a benefit accruing to the assessee.
These are essentially findings of fact and have not been challenged
by the assessee by an appropriate question."

(emphasis supplied) H
1120 SUPREME COURT REPORTS [2007] 4 S.C.R.

A 15. We also quote hereinbelow para 19 and para21 of the judgment of
the Bombay High Court in the case of Commissioner t>jlncome:..Tax (Central),
Bombay v. PX Badiani, reported in{l970) 76 ITR 361:

"19. Now, the assessee's account for 1st April, 1957, to 31st March,
1958, shows that there are credits as well as debits. What has to be
B ascertained is whether the debits are "loans", so that they can be
deemed as dividends. The account is a mutual,. open, and current
account. Every debit, i.e., every payment by the company to the
assessee, may not be a loan. To be treated as a loan, every amount
paid must make the company a creditor of the assessee for that
amount. If, however, at the time when the payment is made by the
c company is already a debtor of the assessee, the payment would be
merely a repayment by the company towards its already exisiting debt.
. It would be a loan by the company only if the payment exceeds the
amount of its already existing debt and that too only to the extent
of the excess. Therefore, the position as regards each debit will have
D to be individually considered, because it may or may not be a loan.
The two basic principles are, that only a loan; which would include
the other payments mentioned in section 2(6A)(e),'.can· be deemed to
be dividend and that foo only to the extent that the company has at
the date of the payment "accumulated profits" after deducting
therefrom all items legitimately deductible therefrom.
E
xxx xxx xxx

21. As regards questions Nos. 3 and 4, Mr. Rajgopal conte4ded that
the debit balance, if any, at the last date of the assessee' s accounting
year lst April, 1957 to 31st March, 1958, should be taken as the
F amount to be treated as dividend and as the assessee;s··accoimt is on ;
the last dayto his credit, no amount can be deemed to be dividend.
As already pointed out, the position has to be ascertained at' the date
of each payment by the company to the assessee and this contention
must, therefore, be rejected. If Mr. Rajgdpal's contentiOn was to be
G a
accepted, the' result would be that if a shareholder borrows large
amount during the year, but repays it on the last day of the year, it
would not be considered to be a loan_, though ·the facts show that he
did borrow a loan. Such a contradiction ofth.e·real factwould result ·
if Mr. Rajgopal's contention were to be accepted. Mr,:Rajgopal further
contended that in any event the highest amount to the assessee's
H debit on any day of the year should be the amount to be deemed to
COMMISSIONEROFINCOMETAX, KOLKATAv. MUKUNDRAYK. SHAH[KAPADIA,J.] 1121

be dividend. This argument, again, ignores the principle laid down by A
us, that the position at the date of each payment must be considered.
Moreover, there is another reason and that is that if it were to be so
done, it would not enable the position of the balance of th-::
"accumulated profits" being taken into account, as more than one
shareholder may have borrowed loans from the company in an account
similar to that of the assessee. All these contentions of Mr.Rajgopal B
ignore the basic fact that section 2(6A)(e) uses the words "any
payment" which means, every payment, and section 2(6A)(e) requires
the determination of two factors, viz., whether the payment is a loan
and whether at the date when the payment is made there were
"accumulated profits" and that these two factors are to be correlated C
and the result must be ascertained at the date of each such payment."

(emphasis supplied)

16. The above two judgments indicate that the question as to whether
payment made by the company is for the benefit of the assessee is a question D
of fact. In this case, the Tribunal has concluded that the payment routed
through MKF and MKI was for the benefit of the assessee. This was a
finding of fact. It was not perverse. Therefore, the High Court should not
have interfered with the said finding. Further, the above two judgments lay
down that the concept of deemed dividend under Section 2(22)(e) of the Act
postulates two factors, namely, whether payment is a loan and whether on the E
date of payment there existed "accumulated profits". These two factors have
to be correlated. This correlation has been done by the Tribunal coupled with
the fact that all withdrawals were debited in the capital account of the firm
leading to the debit balance of Rs.8.18 crores. The High Court has erred in
disturbing the findings of fact. p
17. For the above reasons, we set aside the impugned judgment of the
High Court. Accordingly, the appeal stands allowed with no order as to costs.

vs Appeal allowed.