Meaning is paid by a company out of its profits. Thus, a share of profit received by a shareholder out of the profits of the company, proportionate to his shareholding, is termed as “dividends”. But the legislature in defining dividend has added certain other receipts which otherwise may not have been called dividends. According to Sec.2 (22) of Income-tax Act, receipts which are deemed to be dividends are described as following:
Distribution of Accumulated profits, Entailing the Release of Company’s Assets [sec.2 (22) (a)]. Any distribution of accumulated profits, whether capitalized or not, by a company to its shareholders is deemed to be dividend if it entails the release of all or any part of its assets. Distribution of accumulated profits may be in cash or in kind.
If accumulated profits are distributed in cash, it is dividend within the meaning of the Act as it had reduced the assets of the company.
Where accumulated profits are distributed in kind, market value of asset, to the extent of accumulated profits, is deemed to be dividend, [CIT. Central India Industries LTd.(1971) 82 ITR555(SC]. For example, the company distribution, to the extent of accumulated profits, is liable to be taxed as dividend in the hands of a shareholder.
Renunciation of Right Shares, covered by Accumulated profits. Where a company becomes entitled to “right shares” of a company in which it is itself a shareholder and instead of taking up these” right shares” it renounces its rights in favor of its shareholders in proportion to their shareholding, such distribution of the right amounts to dividend[Kantilal Manilal .CIT(1961)41 ITR 275 (SC]
If a company applies its accumulated profits for buying the share of another company and then distributes those shares among its own shareholders, there would be distribution of accumulate profits entailing release of the company’s assets. In such a case the shareholders arte deemed to have received dividends in money’s worth.
Shares Distributed as Dividend must be valued at Market value. When shares are distributed as dividend, amount of dividend should be taken to be the market value of those shares as on date on which person concerned becomes entitled to those shares; the fact that shareholder retains them and does not sell them is irrelevant. It would be wrong to say that when shares are distributed as dividend, the person who receives them gets only their face value in terms of money. What he really receives is the market value of those shares as on the date he became entitled to those shares [CIT .Central India Industries Led. [1971]82 ITR 555(SC
Capitalization of profit in case of Equity shareholders not treated as Deemed Dividend. Capitalization of accumulated profits does not entail the release of the company’s assets. A company may capitalize its accumulated profits by issuing bonus shares to its equity shareholders. These bonus shares may either be ordinary or preference shares on one hand, or redeemable preference shares on the other. Capitalization of the accumulated profits keeps the assets of the company intact. Assets which were represented by the accumulated profits continue to remain as part of a company’s assets, the only difference being that instead of the assets being profits they are capitalized and become part of the capital of the company. There is thus no deemed dividend to be included in the total income of a shareholder.
But whenever such bonus shares ate paid off, the distribution to the holders of bonus shares is deemed to be dividend as it entails the release of the company redeems such shares, the amount received on redemption, including premium, if any, is taxable as dividend in the hands of he purchaser. It is to be noted that the purchaser cannot deduct the cost of purchasing such shares as no capital expenditure is allowed in computing the taxable income from dividends.
Distribution of Bonus shares to preference shareholders [Sec.2 (22)].Where a company capitalizes its accumulated profits and issues bonus shares to preference shareholders, the market value of such shares is assessable as dividend. Preference shareholders are entitled to the refund of their capital and nothing more. Issue of bonus shares would entitle them to claim more amount than what they invested. Thus, issue of bonus shares to preference shareholder is deemed to be dividend even though it does not entail a release of company’s assets. Therefore, the market value of such bonus shares is taxable as dividend in the hands of a preference shareholder
Scope of Accumulated Profits [under Explanation 1 and Explanation 2 to Sec. 2(22)].Accumulated profits include all profits of the company whether capitalize or not up to the date of such distribution or payment but any capital gain arising before 1 April 1946, and 1 April 1948 to 31 March 1956 is excluded from tax during this period.
Thus, accumulated profits include the balance standing to the credit of profit and loss account + current profits of the year in which the distribution or payment is made up to the date of such distribution or payment + general reserve + investment allowance/ development rebate reserve + capitalised profits, i.e. bonus shares issued out of profits + tax-free profits, i.e. agricultural income + capital gains chargeable to tax [Tea Estate India (P) LTd. CIT (1976) 103 ITR 785 (SC)].
Provision for depreciation or taxation is not included in accumulated profits.
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Deemed Profit not to be treated a part of Accumulated Profit. “balancing charge” under Sec. 41(2), being fictionally a withdrawal of excess depreciation allowed, does not represent accumulated profits.
Similarly, deemed dividend cannot be included in accumulated profits. For example, B Ltd. Holds shares in C Ltd. B Ltd. Takes loan from C Ltd. The loan is assessed as deemed dividends in the hands of B Ltd. Under Sec. 2 (22) (e). Such deemed dividend, fictionally assessed, cannot be included in the accumulated profits within the meaning of that expression in Sec. 2(22) [CIT. Urmila Ramesh [1998]96 Taxman 533 (SC)].
Profit to be understood in the Commercial Sense. The expression’ accumulated profits’ means profit in the commercial sense and not assessable or taxable profits liable to tax as income [P.K Badiani .CIT (1976) 105 ITR 642 (SC)]. For example, expenses actually disbursed but disallowed in assessment, say, expenditure disallowed for the purposes of assessment, the money has, commercially, gone out of the hands of the assessee. However, this does not apply to bogus or fraudulent expenses because these have not been incurred as such [Rajpal Bros. Pvt.Ltd. CIT (1971) 80 ITR 463 (Bom.)].
Similarly, surplus on revaluation of assets, arising by mere book entries, cannot be considered as profits in the commercial sense. Therefore, the same cannot be treated as part of accumulated profits.
Distribution of Debentures or Debenture Certificate by a Company to its Shareholders to the extent of Accumulate Profits [Sce.2 (22) (b)]. If a company distributes debentures or debenture stock or debenture certificate in any form, i.e. in the form of a promissory note or a post-dated chaque to its shareholders; whether with or without interest such distribution to the extent it possesses accumulated profits is deemed to be dividend though there is no release of company’s asset in this case. The accumulated profits have the same meanings as already discussed.
The certificates are valued at the market rate and if there is no market rate, they should be valued according to well-known principles of valuation, e.g. the solvency of the debtor company, the rate of interest as compared to market rate and the period of redemption. Such income would be the income of the year in which such certificates arte issued.
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Distribution in Liquidation [Sec. 2(22) (c)]. Any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not, is deemed to be dividend income. Thus, any distribution made out of the profits of the company after the date of liquidation cannot be deemed to be dividends. It is a repayment towards capital.
Distribution can be less Than Capital Invested. There is no warrant for the proposition that the distribution in a winding up does not attract tax even if it is out of accumulate profits unless the capital has been repaid in full. The shareholder may have made al loss by subscribing to the capital of the company and may have, in the distribution, receiver much less than the capital subscribed. Yet, such receipt is taxable.
Scope of Accumulated Profits in case of Compulsory Acquisition.Accumulated profits include all profits of the company up to the date of liquidation whether capitalised or not. But where liquidation is consequent on the compulsory acquisition of an undertaking by the government or any corporation owned or controlled by the government, the accumulated profits do not include any profits of the company prior to the three successive previous years immediately proceeding the previous year in which such acquisition took place.
Exceptions. Any distribution attributable to accumulate profits as on the date of liquidation is deemed to be dividend. However, there are two exceptions to this:
(1) Distribution to preference shareholders in respect of shares issued for full cash consideration: Any distribution on the date of liquidation to the extent of accumulate profits is not deemed to be a dividend if the distribution is made in respect of shares issued for full cash consideration and the holder is not entitled to participate in the surplus assets in the event of liquidation. Preference shareholders are not entitled to participate in the surplus assets in the event of liquidation. They are only entitled to a return of their share money which they had paid either in full or in part, as the case may be, but to no more. Therefore, the return to such a shareholder either in liquidation proceeding or on reduction of capital of the company would really be in the nature of a return of capital.
The exception applies in respect of preference shares which have been issued for full cash consideration. Where, on the other hand, the shares in question have been only partially paid up and the shareholder gets from the liquidator the full nominal value of the share, then the difference between the amount partly paid up and full face value is regarded as dividend within the meaning of this definition.
(2) Distribution to equity shareholder who has been issued bonus shares after 31 March 1964 but before 1 April 1965: Where distribution is made to equity shareholders in respect of bonus shares which were issued by capitalisation of the profits after 31 March 1964 and before 1 April, it is not deemed to be dividend. The exception has been granted because during this period there was a tax on notional capital gains arising on allotment of bonus shares. Hence the exemption has been provided.
From 1 April 1965 and onwards, there is no tax on notional gains on the allotment of bonus shares. Hence, the exemption does not apply from 1 April 1965.
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