Section 2(22)

Deemed Dividend

Constitutional validity

Deeming concept qua distribution on reduction of capital is valid - Sub-clause (d), under which any distribution on the reduction of capital is deemed as dividend, is constitutionally valid - Punjab Distilling Industries Ltd. v. CIT [1965] 57 ITR 1 (SC).

Deeming loans/advances as dividend is not violative of Constitution - Section 2(6A)(e) of 1922 Act [Section 2(22)(e) of 1961 Act] is not beyond the legislative competence of the Legislature. It also does not contravene the rights conferred under articles 19(1)(f) and 19(1)(g) of the Constitution - Navnit Lal C. Javeri v. K.K. Sen, AAC [1965] 56 ITR 198 (SC).

Dividend

Dividend is not impressed with character of profit - ‘Dividend’ in its ordinary connotation means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum distributed. Dividend distributed by a Company being a share of its profits declared as distributable among the shareholders, is not impressed with the character of the profits from which it reaches the hands of the shareholders - CIT v. Nalin Behari Lall Singha [1969] 74 ITR 849 (SC).

Meaning as understood under Company Law is relevant - Being an inclusive definition, the expression ‘dividend’ means dividend as ordinarily understood under the Companies Act, and also the heads of payment or distribution specified therein - Hari Prasad Jayantilal & Co. v. V.S. Gupta, ITO [1966] 59 ITR 794 (SC).

Receipt not falling under statutory definition may yet be included - The definition of dividend is an inclusive definition and a receipt by a shareholder which does not fall within the definition, may possibly be regarded as ‘dividend’ within the meaning of the Act unless the context negatives that view - CIT v. Nalin Behari Lall Singha [1969] 74 ITR 849 (SC).

Application of definition - A perusal of section 2(22)(e) shows that for the purpose of the Act, any payment made by a company of any sum of money by way of advance or loan to its shareholders is deemed to be a dividend. Since the Act has not provided for any other definition of the word ‘dividend’ except the ones enumerated in section 2(22), it should be construed that this definition would be applicable to all provisions which contain the term ‘dividend’ in the Act - CIT v. Mysodet (P.) Ltd. [1999] 103 Taxman 336/237 ITR 35 (SC).

Distribution/Payment

Distribution can be physical or constructive - The expression ‘distribution’ is to give each a share. It can be physical; it can also be constructive. One may distribute amounts between different shareholders either by crediting the amount due to each one of them in their respective accounts or by actually paying to each one of them amount due to him. The only difference between the expression ‘Paid’ and the expression ‘distribution’ is that the latter necessarily involves the idea of division between several persons which is the same as payment to several persons. Distribution is a culmination of a process - Punjab Distilling Industries Ltd. v. CIT [1965] 57 ITR 1 (SC).

Apportionment must be among more than one person - The expressions ‘distribution’ and ‘payment’ connote different meanings; distribution is division amongst several persons. It connotes an idea of apportionment among more than one person. In the case of ‘distribution’ the recipients would be more than one, while in the case of ‘payment’ the recipient may be a single person - CIT v. P.V. John [1990] 52 Taxman 221 (Ker.).

Distribution need not be in cash - Dividend need not be distributed in cash; it may be distributed by delivery of profit or right having monetary value - Kantilal Manilal v. CIT [1961] 41 ITR 275 (SC).

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 v. Central India Industries Ltd. [1971] 82 ITR 555 (SC).

Shareholder

Shareholder means registered shareholder and not beneficial owner - The word ‘shareholder’ as occurring of in section 2(6A) of the 1922 Act [corresponding to section 2(22) of the 1961 Act] refers to a registered shareholder and not to a beneficial owner. It is the former who is the ‘shareholder’ within the matrix and Scheme of company law, and not the latter - Rameshwarlal Sanwarmal v. CIT [1980] 122 ITR 1 (SC)/CIT v. Shakuntala [1961] 43 ITR 352 (SC).

Accumulated profits

Return of capital cannot form part of accumulated profits - The use of the expression ‘accumulated profits, whether capitalised or not’ in section 2(22) tends to show that under that provision it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of the shareholders. By using the expression ‘whether capitalised or not’, the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts should, in other words, be in the nature of profits which the company could have distributed its shareholders. This would clearly exclude return of part of a capital to the company, as the same cannot be regarded as profit capable of being capitalised, the return being of capital itself - CIT v. Urmila Ramesh [1998] 96 Taxman 533 (SC).

Profit under section 41(2) is not part of accumulated profits - The amount received by the company, which was taxed as deemed profits under section 41(2), does not represent ‘accumulated profits’ within the meaning of that expression in section 2(22) - CIT v. Urmila Ramesh [1998] 96 Taxman 533 (SC).

Where on liquidation of company assets are sold at a price less than actual cost, profits assessable by virtue of fiction under section 41(2) would not form part of the accumulated profits for purpose of section 2(22)(c) - CIT v. Express News Papers Ltd. [1998] 96 Taxman 548 (SC).

Profits must be understood in commercial sense - The expression ‘accumulated profits’ occurring in sub-clause (e) of section 2(6A) of the 1922 Act [corresponding to section 2(22)(e) of the 1961 Act] or for the matter in any other clause means profits in the commercial sense and not assessable or taxable profits liable to tax as income under the 1922 Act - P.K. Badiani v. CIT [1976] 105 ITR 642 (SC).

Accumulation can be within the same year - The word ‘accumulated’ means the profit earned hit by bit and accumulated. It does not mean that it should be carried forward from year to year. Profits can accumulate even within a single year —CIT v. Roshan Lal [1975] 98 ITR 349 (All.)

Payment must be adjusted against accumulated profits - When a loan by a company to a shareholder in the manner set out in section 2(22)(e) is treated as a deemed dividend, it is to be treated as payment out of accumulated profits of the company. Any legal fiction will have to be carried to its logical conclusion. If the payment under section 2(22)(e) is treated as a deemed dividend and is required to be so treated to the extent the company possesses accumulated profits, the logical conclusion is that this payment must be considered as adjusted against the company’s accumulated profits to the extent it is treated as deemed dividend while calculating accumulated profits of the company. Whenever accumulated profits of the company are required to be determined, such an adjustment will have to be made - CIT v. G. Narasimhan [1999] 102 Taxman 66/236 ITR 327 (SC).

Amount should be bifurcated into dividend and capital gains - The amount distributed by a company on reduction of its share capital has two components - distribution attributable to accumulated profits and distribution attributable to capital (except capitalised profits). To the extent of the accumulated profits, whether such accumulated profits are capitalised or not, the return to the shareholder on the reduction of his share capital is a return of such accumulated profits. This part would be taxable as dividend. The balance may be subject to tax as capital gains, if they accrue - CIT v. G. Narasimhan [1999] 102 Taxman 66/236 ITR 327 (SC).

Distribution entailing release of company’s assets

Issue of bonus shares does not entail release of company’s assets - When bonus shares are issued/credited as fully paid up out of capitalised accumulated profits, there is distribution of capitalised accumulated profits but such distribution does not entail release of assets of the company so as to fall within section 2(6A)(a) of the 1922 Act - Shashibala Navnitlal v. CIT [1964] 54 ITR 478 (Guj.).

Redemption of preference shares amounts to distribution of capitalised profits - Where a company has issued redeemable shares out of accumulated profits and later has redeemed those shares by paying out of general funds, the amounts which are returned to the shareholders on redemption are the amounts paid up on the preference shares and since the amounts paid up on the preference shares are capitalised accumulated profits, it must follows as a necessary consequence that capitalised accumulated profits reach the hands of the shareholders when redemption takes place and consequently there is distribution of capitalised accumulated profits on redemption - Shashibala Navnitlal v. CIT [1964] 54 ITR 478 (Guj.).

Distribution on liquidation

Liquidation followed by distribution must be present - In order that section 2(22)(c) should apply, there must be a liquidation and in such liquidation there is distribution and that distribution is attributable to the accumulated profits of the company immediately before its liquidation - Southern Agencies (P.) Ltd. v. CIT [1968] 70 ITR 838 (Mad.).

Date of dissolution is not date of liquidation - The date of liquidation under section 2(22)(c) cannot be interpreted to mean the date of dissolution - Kanhaiya Lal Bhargava v. Official Liquidator [1965] 56 ITR 393 (All.).

Amount referable to accumulated profits is taxable - The amount received by a shareholder from the liquidator which is referable to the accumulated profits of the company, is taxable as dividend by virtue of section 2(6A)(c) - Gautam Sarabhai v. CIT [1964] 52 ITR 921 (Guj.).

Accumulation need not be prior to liquidation - The words ‘attributable to the accumulated profits of the company immediately before its liquidation’ in section 2(6A)(c) of the 1922 Act cannot be read as equivalent to ‘accumulated before its liquidation’ in the sense that the company had gathered the amount in its hands before the date of liquidation. The phraseo-logy would only seem to indicate that the company had kept, collected and did not distribute, disburse or make some other similar provision in respect of the amount - CIT v. Scindia Steam Navigation Co. Ltd. [1980] 125 ITR 118 (Bom.).

Face value of shares is not deductible - The entire amount paid by the company to its shareholder will have to be treated as dividend. The face value of the shares cannot be deducted from such payment of dividend - CIT v. Jai Hind Investment Industries (P.) Ltd. [1993] 202 ITR 316 (Cal.).

Distribution must be actual, and not notional - The amount which did not reach the liquidator at any time cannot be treated as accumulated profits in his hands for the purpose of section 2(22)(c) by applying section 531A of the Companies Act - K.N. Narayana Iyer v. CIT [1993] 202 ITR 774 (Ker.).

Distribution on reduction of capital

Date of resolution, and not date of payment, is relevant - The date of the resolution for the reduction of capital and not the several dates of payments to the shareholders, is the date for ascertaining the quantum of accumulated profits under section 2(6A)(d) of the 1922 Act [corresponding to section 2(22)(d) of the 1961 Act] - Punjab Distilling Industries Ltd. v. CIT [1965] 57 ITR 1 (SC).

Payment as Loans/Advances

Provision must be strictly construed - Section 2(22)(e) creates a fiction bringing in amounts paid otherwise than as dividends, into the net of dividends. Section 2(22)(e) must, therefore, be given a strict interpretation - CIT v. P.V. John [1990] 181 ITR 1 (Ker.).

Recipient can be a corporate entity - The provisions of section 2(22)(e) are applicable also to the advance or loan made to a corporate entity - Sadhana Taxtiles Mills (P.) Ltd. v. CIT [1991] 188 ITR 318 (Bom.).

Where assessee was shareholder in a company doing only money-lending business, loan taken by assessee could not be treated as deemed dividend even though company had accumulated profits - CIT v. V.S. Sivesubramaniam [1997] 141 CTR (Mad.) 34.

Emphasis is on ‘possessing’ accumulated profits - Payments made by way of loan or advance to a shareholder or any payments made on behalf or for the benefit of a shareholder are to be treated as dividend in either case to the extent to which the company possesses accumulated profits. The emphasis in this connection must be on-the word ‘possesses’. If the company does not possess the amount, it cannot pay the same. A company can be said to have profits or to be possessed of profits when it actually possess the amount or is in its control - R. Dalmia v. CIT [1982] 133 ITR 169 (Delhi).

To determine shareholding date of registration of transferred shares is not relevant - Where because of transfer of shares by execution of transfer deeds, assessee’s shareholding in company had fallen below 20 per cent, loan taken by assessee could not be treated as dividend and in such a case date on which company registered transfer of shares was of no consequence - CIT v. Smt. S. Parvathavarthini Ammal [1996] 87 Taxman 370/219 ITR 661 (Ker.).

Payment need not be against a pre-existing liability - The ordinary dictionary meaning of the word ‘payment’ is the act of paying the money by one person to another. The word ‘payment’ in itself does not either expressly or by necessary implication, connote payments of a sum of money towards a pre-existing liability or by way of discharge of an existing obligation or by way of a payment to a person by way of hire or wages to which the payee was already entitled. Thus, if a managing director directs an employee to take a loan from the company and pass on the money to him as and when he needed money, the loans given to the employee by the company will amount to ‘payment’ of deemed dividend to the managing director - CIT v. L. Alagusundaram Chettiar [1977] 109 ITR 508 (Mad.).

Theory of direct or indirect payment will not apply - One cannot read section 2(22)(e) by importing the expression ‘directly or indirectly’ in connection with the expression ‘by way of advance or loan to a shareholder’ appearing therein. The theory of direct or indirect loans does not hold good - Nandlal Kanoria v. CIT [1980] 122 ITR 405 (Cal.).

Mere creation of debtor-creditor relationship is not enough - There should be an actual cash advance or loan from the company to the assessee and the mere creation of a debtor and creditor relationship between the company and the assessee will not be enough. There should be an outgoing or flow of money from the company to the shareholder. The director or shareholder helping himself out of the money of the company cannot be treated as lending or advancing - CIT v. G. Venkataraman [1975] 101 ITR 673 (Mad.).

Payments may be towards personal liabilities of shareholder - Section 2(6A)(e) of the 1922 Act covers not only advances and loans to shareholder but any other payments by the company on behalf of or for the individual shareholder, such as payments of shareholder’s personal expenses, income-tax dues, insurance premia, etc., to the extent of the accumulated profits of the company - CIT v. K. Srinivasan [1963] 59 ITR 788 (Mad.).

Fact of repayment of loan is not relevant - The Legislature has deliberately not made the subsistence of the loan or advance, or its being outstanding on the last date of the previous year relevant to the assessment year, a prerequisite for raising the statutory fiction. In other words, even if the loan or advance ceased to be outstanding at the end of the previous year, it can still be deemed as a ‘dividend’ if the other four conditions factually exist to the extent of the accumulated profits possessed by the company. - Smt. Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) [See also Miss P. Sarada v. CIT [1998] 96 Taxman 11 (SC)].

Deemed income under section 2(22)(e) does not become income of the shareholder - Section 2(22)(e) does not transform the character of the loan granted by the company in favour of a director or other persons as his own money. The intention of the Legislature is clear that the loan does not become the income of the shareholder and if it is otherwise, then the question of set off would not arise at all. Therefore, the view that deemed dividend under section 2(22)(e) of the Act becomes the income of the shareholder is unsustainable in law - CIT v. T.P.S.H. Selva Saroja [2000] 244 ITR 671 (Mad.).

Accumulated profits may comprise solely of agricultural income - Loan from accumulated profits consisting of only agricultural income, is taxable under section 2(22) - S. Kumaraswami v. ITO [1961] 43 ITR 423 (Mad.).

Advance paid by company to its managing director which was adjustable against rent payable to managing director - Where assessee was managing director of company and company had agreed to pay an advance of Rs. 10 lakhs when it had taken the first floor on lease from assessee for the purpose of meeting the cost of construction of the other three floors and the lease deed provided explicitly that the advance so paid was to be adjusted against the rent payable for the other three floors, advance was to be treated as deemed dividend in assessee’s hands - CIT v. P.K. Abubucker [2003] 259 ITR 507/[2004] 135 Taxman 77 (Mad.).