Deemed Dividend

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 shareholders, to the extent of accumulated profits.

Section 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 shareholders of all or any part of the assets of the company.
• Issuing bonus equity shares to equity shareholders does not result in release of assets to the shareholders thereby does not alter the asset position and hence it is not taxable as dividend. While issuing bonus shares, the accumulated profits simply get converted into share capital of the company.
• If a company offers shareholders an option to accept bonus shares or cash and the shareholders accept cash, then such act leads to outflow of assets from the company to shareholders. In such cases, it would be taxable as dividend in the hands of the shareholder.
• If accumulated profits are capitalised and redeemable preference shares are issued as bonus to equity shareholders, then on redemption of such bonus preference shares there would be release of assets in favour of the shareholders; 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 shareholders become entitled to receive dividend [CIT vs. 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 shareholders of shares by way of bonus, to the extent of accumulated profits, whether capitalised or not.

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

• 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.
• Distribution by a liquidator by itself does not trigger taxability as dividend income, unless the company had accumulated profits before it went into liquidation.
• Shareholders are subject to capital gains tax under section 46(1) on assets distributed on liquidations. Capital Gain is calculated after deducting from consideration price or market value, the deemed dividend under section 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 capitalised or not. Distribution to shareholders on account of reduction of share capital attracts tax implications under section 2(22)(d) of the Act and also capital gains taxation under section 45 of the Act. [Kartikeya Sarabhai vs. CIT (228 ITR 163) SC]

Section 2(22)(e): Loan or advance to shareholder

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

• Payment of any sum (whether representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder (and payment to concerns in which such shareholder holds substantial interest);
• Any payment on behalf of a shareholder;
• 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 an equity shareholder who beneficially owns at least 10 per cent of the equity capital or to a concern in which he is a member/partner and is beneficially entitled to not less than 20% of income of the concern;
• 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 an HUF, a Firm, AOP, BOI, LLP or Company. If loan or advance is given to a concern, such amount shall be treated as deemed dividend in hands of shareholder and not the concern. [ACIT vs. Bhaumik Colour Pvt. Ltd. 27 SOT 270 Mum (SB) and CIT vs. Universal Medicare (P) Ltd. 324 ITR 263 (Bom.), CIT vs. Jignesh P. Shah 372 ITR 392 (Bom.)]

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

Exclusions from deemed dividend:

1. 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 shareholder 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 shareholder on liquidation or reduction of capital shall not be treated as deemed dividend.
2. In case where money lending is a substantial part of the business of a company, any advance or loan made to a shareholder or the concern by the company in the ordinary course of business is not taxable as dividend. [CIT vs. Sivasubramaniam (231 ITR 656)]
3. Any subsequent dividend paid by the company is not taxable as deemed 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. vs. CIT 204 ITR 146 (Bom.)]
4. Any payment made by a company listed on any RSE for buyback of its own shares in accordance with provisions of section 68 of the Companies Act, 2013 is not to be taxed as dividend. It will be taxable as capital gains/loss to shareholders as per section 46A of the Income Tax Act.
5. Distribution of shares pursuant to a demerger by the resulting company to the shareholders 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.
6. Inter-corporate deposits are not ‘loans and advances’ and are not assessable to tax as deemed dividend. [IFB Agro Industries Ltd. vs. JCIT 63 SOT 207 (Kol.).]

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 vs. Damodaran 121 ITR 572 & CIT vs. 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 or liquidation.

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

Building & Machinery Depreciation fund not to be included in accumulated profits. [CIT vs. Jaldu Rama Rao 140 ITR 168 (Andhra Pradesh)].

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

Share premium is not a part of accumulated profits. [DCIT vs. Maipo India Ltd. 116 TTJ 791 (Delhi)].

Finance Act, 2018 has inserted Explanation 2A with effect from 1-4-2018 stating that in case of amalgamation, the accumulated profits, whether capitalised or not, or loss, as the case may be of amalgamated company shall be increased by accumulated profits, whether capitalised or not of the amalgamating company on the date of amalgamation.

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 shareholders 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). Deemed dividend under section 2(22)(e) of the Act is to be taxed at the rate of 30 per cent in the hands of company. Deemed dividend u/s 2(22)(a) to (d) is exempt in hands of shareholder under section 10(34) r.w.s. 115BBDA to the extent it does not exceed ₹ 10 lakhs.

Applicability of Tax Deduction at Source – As per section 194, provisions of tax deduction at source are applicable to deemed dividend under section 2(22) except section 2(22)(e) and the company is bound to deduct tax if the payment is made other than by an account payee cheque and if the amount is more than ₹ 2,500/-.

Position with respect to dividend received on or after 01st April 2020

Provisions of Dividend Distribution Tax (DDT) have been made inapplicable by Finance Act 2020 and consequently, exemption u/s. 10(34) available to shareholders will not be available in respect of any income by way of dividend received on or after 01st April 2020.