Deemed Dividend

‘Dividend’, generally, means the sum paid to or received by a share holder in proportion to his shareholding in a company out of the total profit distributed. The word ‘deemed’ has not been defined anywhere in the Act.

The sub-clauses (a) to (e) of section 2 (22) of the Income-tax Act bring into the ambit of dividend certain distributions / outflows which would otherwise not have been considered as dividend in the ordinary sense. ‘Dividend’ includes following disbursements by the company to the share holders, to the extent of accumulated profits.

Sec. 2 (22) (a): Distribution entailing the release of assets of the company

…any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its share holders of all or any part of the assets of the company…

Issuing bonus equity shares to equity share holders does not result in release of assets in the hands of the share holders and hence it is not taxable as dividend. While issuing bonus shares, the accumulated profits simply get converted into share capital of the company. Issue of bonus shares in no way alters the asset position of the company.

If a company offers shareholders with an option to accept bonus shares or cash and the share holders accept cash, then such act leads to outflow of assets from the company to share holders. In such cases, it would be taxable as dividend in the hands of the share holder.

If accumulated profits are capitalised and redeemable preference shares are issued as bonus to equity share holders, then on redemption of such bonus preference shares there would certainly be release of assets in favour of the share holders; such pay off of bonus share would be taxable as dividend. Shashibala Navnitlal (54 ITR 478) Guj. & Dalmia Investment (52 ITR 567) SC. Where assets are distributed as dividend, amount of dividend is taken to be the market values of the property on the date on which the share holders become entitled to receive dividend CIT v. Central India Industries Ltd. 82 ITR 555 (SC)

Section 2 (22) (b): Distribution not involving the release of assets of the company

…any distribution to its shareholders by a company of debentures, debenture-stock, or deposit certificates in any form, whether with or without interest, and any distribution to its preference share holders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalised or not…

Section 2(22) (c): Distribution on liquidation

…any distribution made to the share holders 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…

Note that distribution by a liquidator by itself will not trigger taxability as dividend income, unless the company had accumulated profits before it went into liquidation.

Share holders are subject to capital gains tax u/s 46 (1) on assets distributed on liquidations. Capital Gain is calculated after deducting from consideration price or market value, the deemed dividend u/s 2 (22) (c).

Section 2(22) (d): Distribution on reduction of capital

…any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits whether such accumulated profits have been capitalised or not…

Distribution to share holders on account of reduction of share capital attracts tax implications u/s 2(22) (d) of the Act and also capital gains taxation u/s. 45 of the Act. Kartikeya v. Sarabhai v. CIT (228 ITR 163) SC.

Section 2(22) (e): Loan or advance to share holder

Following types of payments made by a company are treated as dividend under this clause.

Any payment 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 (extended to payment to concerns in which share holder holds substantial interest);
Any payment on behalf of a share holder;
Any payment for the individual benefit of a shareholder.
Any of the above referred payments would be taxed under this sub-clause if following three conditions are fulfilled:
The company should not be one in which the ‘Public are substantially interested’ within the meaning of Section 2(18); In other words this provision applies to closely held companies.
The advance or loan is made to a equity shareholder who beneficially owns at least 10 per cent of the equity capital, or to a concern in which he is member/partner and is beneficially entitled to not less than 20% of income of the concern or to any person on behalf or for the individual benefit of such share holder. ( Share holder means beneficial owner of shares holding not less than 10% voting power )
The company should possess accumulated profits at the time it makes the payment. The payment can be deemed to be dividend only to the extent of such profits.

Here ‘concern’ means a HUF, a firm, AOP, BOI or company. If loan or advance is given to a concern, such amount shall be treated as deemed dividend in hands of share holder and not concern. ACIT v. Bhaumik Colour Pvt. Ltd. 27 SOT 270 Mum (SB)

When a loan is deemed to be dividend, the same amount when repaid/relent cannot once again deemed to be dividend. The accumulated profits should be notionally reduced by amount of loans once deemed to be dividend. CIT v. G. Narasimhan 236 ITR 327 (SC)

Exclusions from deemed dividend

Distribution to shareholders in the event of liquidation or on reduction of share capital, to the extent of the accumulated profits of the company is included as dividend. But any such distribution in respect of any share issued for full consideration, where the share holder is not entitled to participate in the surplus assets in event of liquidation is excluded from the definition of dividend. In other words distribution to preference share holder on liquidation or reduction of capital shall not be treated as deemed dividend.
In case where money lending is a substantial part of the business of a company, any advance or loan made to a share holder or the concern by the company in the ordinary course of business is not taxable as dividend. CIT v. Sivasubramaniam (231 ITR 656)
Any subsequent dividend paid by the company is not taxable as dividend to the extent to which it is set off by the company against any loan or payment that has been earlier treated as dividend within the meaning of sub-clause (e). However if the dividend paid is not set off against earlier deemed dividend, then in absence of set off such dividend will be taxable. Walchand & Co. Pvt Ltd v. CIT 204 ITR 146 (Bom)
Any payment made by a company for buyback of its own shares in accordance with provisions of section 77A of the Companies Act, 1956 is not to be taxed as dividend. There will be capital gains / loss to share holders as per section 46A.
Distribution of shares pursuant to a demerger by the resulting company to the share holders of the demerged company (whether or not there is reduction of capital in the demerged company) is to be excluded from the definition of dividend.

Accumulated profits

“Accumulated profits” mean commercial profits and not profits as assessed for income-tax purposes. From accumulated profits all “disbursements legitimately attributable to it by way of expenses, development, dividends and deemed dividends” must be reduced.

SC in CIT v. Damodaran & CIT v. Ashokbhai Chimanbhai 56 ITR 42 held that ‘accumulated profits’ cannot include current profits. However, Explanation 2 to section 2 (22) provides that the expression “accumulated profits” shall include all profits of the company up to the date of distribution or payment so, however, as regards sub-clause (c) which deals with distribution on liquidation, the expression shall include the profits up to the date of liquidation. Smt Meena Talukdar v. ITO 15 TTJ 379. (Cal)

These would include development rebate & investment allowance reserve. P. K. Badiani v. CIT (105 ITR 642) SC. It will even include income which is exempt from tax. Tea Estate v. CIT (103 ITR 785) SC.

If any deemed dividends are repaid they will not augment accumulated profits. “once an amount goes out of accumulated profits as a loan and the loan is to be deemed to be dividend, the same amount when repaid cannot again be capable of attracting the fiction and be deemed to be dividend.” P. K. Badiani v. CIT (105 ITR 642) SC.

Provision for tax & dividend will not form part of accumulated profits. CIT v. Damodaran (85 ITR 590).

Building & Machinery Depreciation fund is not profits and canot be included in accumulated profits. CIT v. Jaldu Rama Rao 140 ITR 168

Depreciation calculated at income tax rates should be deducted in computing accumulated profits even if lower depreciation has been provided for in accounts. CIT v. Jamnadas (92 ITR 105)

Share premium is not a part of accumulated profits. DCIT v. Maipo India Ltd. ITAT, Delhi 116 TTJ 791.

Taxability

Due to the operation of section 8 of the Act, dividend income becomes taxable in the year in which it is declared, distributed or paid even if it relates to an earlier year in respect of which it is declared. The right of the share holders to dividend crystallizes only when the dividend is declared.

Dividend Distribution Tax (DDT) is payable by an Indian company on deemed dividend arising u/ss. 2 (22) (a) to (d). DDT is not leviable on deemed dividend u/s 2 (22) (e). As a result, deemed dividend u/s 2 (22) (e) is taxable in the hands of share holder. Deemed Dividend u/s 2(22) (a) to (d) is exempt in hands of shareholder u/s 10 (34).

Applicability of Tax Deduction at source – As per section 194, provisions of tax deduction at source are applicable to deemed dividend and the company is bound to deduct tax whenever the payment made to share holder falls within the provisions of section 2 (22)(e).