Some significant cases related to deemed dividends

1. PCIT Vs. Dr. Ranjan Pai(2021)431 ITR 250 (Karnataka)

QUESTTION: Can Bonus Shares received by shareholders be taxable under head " Income from other sources" as per provisions of Section 56(2)(x) , as they are received without consideration?

ANSWER: The issue of Bonus Shares by capitalization of reserves is merely a reallocation of the company's funds. There is no inflow of fresh funds in the company by issue of Bonus Shares. There is no change in the funds available with the company and there is no addition in the share capital of the company in monetary angel. The value of shares against whose Bonus Shares are issued goes down after Bonus issue. The intrinsic value of Original and Bonus shares will be same as before issue of Bonus Shares.

 Thus any profit derived by the assessee shareholder on account of receipt of bonus shares is adjusted by depreciation in the value of equity shares originally held.

Hence , the provisions of Section 56(2)(x) would not be attracted in the hands of recipient shareholders on receipt of bonus shares.

Note;- the decision was rendered in the context of Section 56(2)(vii) however, the underlying principle emanating therefrom applies with equal force in the context of the present provisions contained in the Section 56(2)(x). Accordingly , the issue and decision has been presented with reference to Section 56(2)(x)

The Finance Act, 2017 introduced a new clause (x) in Section 56(2) of the Income Tax Act to provide that receipt of the sum of money or the property received by a person without any consideration or upon crossing a particular threshold would be liable to tax in the hands of the receiver under the head 'Income from other sources'. The taxation on gifts that are received by an Individual/ HUF is governed by the provisions of clause (x) in Section 56(2) of the Income Tax Act. Let us look in detail about Section 56(2)(x) in this article.

UNDER THE EXISTING PROVISION OF SECTION 56(2)(VII), any sum of money or any property received without any consideration by any Individuals or HUF is chargeable to income tax.

Section 56(2)(vii a) was applicable only to the Firm and Closely held company.

Whereas, 56(2)(x) is applicable to all kinds of the assessee. Clause(x) is included in section 56(2) to provide the following receipts:

a). Any sum of money that is received without consideration, in aggregate exceeding Rs.50,000 during the financial year

b). Any immovable property without any consideration, the stamp duty value of which exceeds Rs.50,000

c). Any immovable property with the consideration which is less than stamp duty value by an amount exceeding Rs.50,000

d). Any movable property (as defined and specified) without consideration where aggregate fair market value whereof exceeds Rs.50,000

e). Any movable property (as defined and specified) for consideration which is less than fair market value by an amount exceeding Rs.50,000

Exceptions to Section 56(2)(x)

Provision of 56(2)(x) would not apply to any sum of money or any property received from any relative –

• In the case of an individual.
• spouse of the individual.
• Brother or sister of the individual.
• Any inherent ascendant or descendant of the individual.
• Brother or sister of the parents of the individual.
• Any inherent ascendant or descendant of the individual.
• Brother/ sister of the spouse of the individual.
• Any inherent ascendant or descendant of the spouse of the individual.
• In case of a Hindu undivided family.
• Any member thereof.

Provision of 56(2)(x) would not be applicable to any sum of money or any property that is received under the following circumstances:

• On the occasion of an individual's marriage.
• By a will or by way of inheritance.
• In the case of death of the payer or donor, as the case may be.
• From any local authority that as defined in the Explanation to clause (20) of section 10.
• From any fund/ foundation/ other educational institution/ university/ hospital/ other medical institution/ any trust or institution referred to in under section 10.
• From any trust or institution that is registered under section 12A or section 12AA.
• By any trust or fund or any institution or university or other educational institution or hospital or any other medical institution referred to in sub-clause (iv)/ (v)/ (vi) or sub-clause (via) of clause (23C) of section 10.
• From any individual by a trust created solely for the benefit of relative of the individual.

2. CIT Vs. Sree Rama Multi Tech Ltd.(2018) 403 ITR 426 (SC)

QUESTION: is interest income from share application money deposited in bank eligible for set-off against public issue expenses or should such interest be subject to tax under head " Income from other sources?".

ANSWER:  As per provisions of the Companies Act,2013 the assessee company is required to keep all application money in a separate account till allotment of shares issued. A part of application money is required to be returned to the unsuccessful candidates /applicants, and therefore, the entire share application money would not ultimately be appropriated by the company.

The interest earned was inextricably linked with the requirement of raising share capital.

any surplus money deposited in the bank for the purpose of earning interest is liable to be taxed as " Income from other sources".

Since Share Application Money deposited in the bank make additional income, though deposit of the same is required by the statute. The company has not deposited the same in the bank account for earning income and hence the interest accrued on such deposit is mere incident.

Since issue of share related to capital structure of the company and expenses relates to issue are to be capitalised.

Accordingly , the accrued interest is not liable to be taxed as "Income from other sources", the same is eligible to be set-off against Public Issue expenses.

3. Movaliya Bhikhubhai Balabhai Vs. ITO(TDS)(2016) 388 ITR 343 (Gujarat)

QUESTION: is interest on enhanced compensation u/s 28 of the Land Acquisition Act, 1894 assessable as Capital gains or as Income from other sources?

ANSWER: The assessee has received interest u/s. 28 of the Land Acquisition Act, 1894 which represents enhanced value of land and thus, partakes the character of compensation and not interest. Hence ,interest u/s. 28 to be taxed under the head " Capital Gains" and not under " Income from other Sources".

On the other hand , interest u/s. 34 of the Land Acquisition Act,1894 if for delay in making payment after the compensation amount is determined. Such amount is liable to be taxed under head " Income from other sources".

SECTION 28 IN THE INCOME- TAX ACT, 1995

28. Profits and gains of business or profession the following income shall be chargeable to income- tax under the head" Profits and gains of business or profession",-

(i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year;

(ii) any compensation or other payment due to or received by,-

(a) any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management or the modification of the terms and conditions relating thereto;

(b) any person by whatever name called, managing the whole or substantially the whole of the affairs in India of any other company, at or in connection with the termination of his office or the modification of the terms and conditions relating thereto;

(c) any person, by whatever name called, holding an agency in India for any part of the activities relating to the business of any other person, at or in connection with the termination of the agency or the modification of the terms and conditions relating thereto;

(d) any person, for or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, under any law for the time being in force, of the management of any property or business;]

(iii) income derived by a trade, professional or similar association from specific services performed for its members;

(iiia)profits on sale of a licence granted under the Imports (Control) Order, 1955 , made under the Imports and Exports (Control) Act, 1947 (18 of 1947 );

(iiib) cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India;

(iiic) any duty of customs or excise re- paid or re- payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971 ;

(iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;

(v) any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm:

Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted. 

Explanation 1-Omitted by the Direct Tax Laws (Amendment) Act, 1987, w.e.f 1-4-1989.

Explanation - Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as" speculation business") shall be deemed to be distinct and separate from any other business.

Section 34 in The Land Acquisition Act, 1894

 Payment of interest.

When the amount of such compensation is not paid or deposited on or before taking possession of the land, the Collector shall pay the amount award­ed with interest thereon at the rate of nine per centum per annum from the time of so taking possession until it shall have been so paid or deposited: 

Provid­ed that if such compensation or any part thereof is not paid or deposited within a period of one year from the date on which possession is taken, interest at the rate of fifteen per centum per annum shall be payable from the date of expiry of the said period of one year on the amount of compensation or part thereof which has not been paid or deposited before the date of such expiry.

4. CIT Vs. Parle Plastics Ltd.(2011)332 ITR 63 (Bom)

QUESTION What are the tests for determining "Substantial part of business" of lending company for the purpose of application of exclusion provisions under Section 2(22)?

ANSWER:  U/s. 2(22) "Dividend" does not include, inter alia, any advance or loan made to a shareholder by a company in the ordinary course of its business , where lending of money is a " substantial part of the business of the company".

The percentage of turnover in relation to the whole as also the percentage of the profit in relation to the whole and sometimes even percentage of manpower used for a particular part of the business in relation to total manpower or work force of the company would be required to be taken into consideration for determining the substantial part of business.

The Capital Employed for a specific division of a company in comparison to the total Capital Employed would also be relevant to determine whether the part of the business constitutes a substantial part.

SECTION 2(22) of the Income Tax Act,1961

According to section 2(22), the following receipts are deemed to be dividend:

(a) Distribution of accumulated profits, entailing the release of company's assets - Any distribution of accumulated profits, whether capitalized or not, by a company to its shareholders is a dividend if it entails the release of all or any part of its assets.

For example, if accumulated profits are distributed

(i) in cash, it is dividend in the hands of the shareholders.

(ii) in kind, for example by delivery of shares etc. entailing the release of the company's assets, the market value of shares is deemed dividend in the hands of the shareholder.

(b) Distribution of debentures, deposit certificates to shareholders and bonus shares to preference shareholders - Any distribution to its shareholders by a company of debenture, debenture stock or deposit certificate in any form, whether with or without interest, and any distribution of bonus shares to preference shareholders to the extent to which the company possesses accumulated profits, whether capitalized or not, will be deemed as dividend.

The market value of such bonus shares is taxable in the hands of the preference shareholder. In the case of debentures, debenture stock etc., their value is to be taken at the market rate and if there is no market rate they should be valued according to accepted principles of valuation.

Note: Bonus shares given to equity shareholders are not treated as a dividend.

(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 capitalized or not, is deemed to be dividend income. Note: Any distribution made out of the profits of the company after the date of the liquidation cannot amount to the dividend. It is a repayment towards the capital.

Accumulated profits include all profits of the company up to the date of liquidation whether capitalized or not.

But where liquidation is consequent to the compulsory acquisition of an undertaking by the Government or by any corporation owned or controlled by the Government, the accumulated profits do not include any profits of the company prior to the 3 successive previous years immediately preceding the previous year in which such acquisition took place subject to certain exceptions.

(d) Distribution on the reduction of capital - Any distribution to its shareholders by a company on the reduction of its capital to the extent to which the company possessed accumulated profits, whether capitalized or not, shall be deemed to be a dividend.

SECTION 2(22)(e)

ADVANCE OR LOAN BY A CLOSELY HELD COMPANY TO ITS SHAREHOLDER

Any payment by a company in which the public are not substantially interested of any sum by way of advance or loan to any shareholder who is the beneficial owner of 10% or more of the equity capital of the company will be deemed to be a dividend to the extent of the accumulated profits.

Please Note That:

i) If the loan is not covered by the accumulated profits, it is not deemed to be a dividend.

ii) Advance or loan by a closely held company to a specified concern - Any payment by a company in which the public are not substantially interested to any concern (i.e. HUF / Firm / AOP / BOI / Company) in which a shareholder, having the beneficial ownership of at least 10% of the equity shares is a member or a partner and in which he has a substantial interest (i.e. at least 20% share of the income of the concern) will be deemed to be dividend.

iii) Also, any payments by such a closely held company on behalf of, or for the individual benefit of any such shareholder will also be deemed to be a dividend. However, in both cases, the ceiling limit of the dividend is the extent of accumulated profits.

EXCEPTIONS

The following payments or loan given would not be deemed as dividend:

I). If the loan is granted in the ordinary course of its business and lending of money is a substantial part of the company's business, the loan or advance to a shareholder or to the specified concern is not deemed to be a dividend.

II). Where a loan had been treated as a dividend and subsequently the company declares and distributes a dividend to all its shareholders including the borrowing shareholder, and the dividend so paid is set off by the company against the previous borrowing, the adjusted amount will not be again treated as a dividend.

OTHER EXCEPTIONS

Apart from the exceptions cited above, the following also do not constitute "dividend" –

I) Any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956;

II). Any distribution of shares on demerger by the resulting companies to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company).

YEAR OF ACCRUAL OF DIVIDEND

Section 8 provides that deemed dividend under section 2(22) declared by a company or distributed or paid by it shall be deemed to be the income of the previous year in which it is declared, distributed or paid, as the case may be. Any interim dividend shall be deemed to be the income of the previous year in which the amount is unconditionally made available to the member who is entitled to it.

5. CIT Vs. Vir Vikram Vaid(2014)367 ITR365 (Bombay)

QUESTION  Can repair and renovation expenses incurred by a company in respect of premises leased out by a shareholder having substantial interest in the company , be treated as Deemed Dividend?

ANSWER: The Expenditure on repair and renovation of leased premises cannot brought under definition of " Loans and Advances" given to shareholder having substantial interest in the company, through he is the owner of the premises. The repair and renovation expenses cannot be treated as loan or advances to the shareholder or for the individual benefit of the shareholder.

SECTION 22(2)(e ) Provides that -

Any payment by a company in which the public are not substantially interested of any sum by way of advance or loan to any shareholder who is the beneficial owner of 10% or more of the equity capital of the company will be deemed to be a dividend to the extent of the accumulated profits.

Loans refer to a debt provided by a financial institution for a particular period while Advances are the funds provided by the banks to the business to fulfil working capital requirement which are to be payable within one year.

The loan amount is required to be repaid along with the interest, either in lump sum or in suitable instalments. It can be a term loan (payable after 3 years) or demand loan (payable within 3 years). In the same way, advances also requirement repayment along with the interest within one year. 

6. Pradip Kumar Malhotra Vs. CIT(2011)338 ITR 538 (Cal.)

QUESTION: can the loan or advance given to a shareholder by the company , in return for an advantage conferred on the company by the shareholder, be deemed as dividend u/s. 2(22)(e)?

ANSWER: Let's understand the above question through an example, suppose Mr. A is holding 20% shares of M/s. ABC Co. Ltd., beneficially. The company has applied a working capital loan and Mr. A has given his premises as collateral to the bank for securing Working Capital Loan. After some time Mr. A requested the company for lifting of collateral from his premises. The Company wants to utilise Working Loan for some more time. The company has advanced Rs. 10.00 Lakhs to Mr. A against keeping his premises as collateral security with the bank.

In this case the payment of Rs. 10.00 Lakhs to Mr. A by the company does not consider as deemed dividend under section 2(22)(e ) because the payment is towards an advantage conferred on the company by the shareholder.

SECTION 22(2)(e ) Provides that -

Any payment by a company in which the public are not substantially interested of any sum by way of advance or loan to any shareholder who is the beneficial owner of 10% or more of the equity capital of the company will be deemed to be a dividend to the extent of the accumulated profits.

The phrase " by way of advance or loan" appearing in Section 2(22)(e ) must be construed to mean those advances or loans which a shareholder enjoys simply on account of being a person who is the beneficial owner of shares (not being Preference Shares) holding not less than 10% of the voting power. In case such advance or loan is given to such shareholder as a consequence of any further consideration which is beneficial to the company received from such shareholder , such advance or loan cannot be deemed as dividend within the meaning of the Act, 1961.

PLEASE NOTE THAT:  only gratuitous loan or advance given by a company to a shareholder,which is the beneficial owner of shares holding not less than 10% of the voting power , would come within the purview of Section 2(22)( e).

7. CIT Vs. Manjoo and Co.(2011)335 ITR 527 (Kerala)

QUESTION can winnings of prize money on unsold lottery tickets held by the distributor of lottery tickets be assessed as " Business Income" and be subject to normal rate of tax instead of the rates prescribed u/s. 115BB?

ANSWER: the receipt of prize money on winning in a lottery , is not in his capacity as a lottery distributor but as a holder of lottery ticket. It means the distributor has received the lottery prize not as a distributor but as a person holding lottery ticket. It will not be treated as Business Income and hence special rates as mentioned in the provisions of Section 115BB are applicable.

SECTION 115BB of the Income Tax Act, 1961

In Chapter XII of the Income-tax Act, after Section 115B, the following section shall be inserted with effect from the 1st day of April, 1987, namely: —

115BB. Tax on winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any form or nature whosoever.

Where the total income of an assessee includes any income by way of winnings from any lottery or crossword puzzle or race including horse race (not being income from the activity of owning and maintaining race horses) or card game and other game of any sort or from gambling or betting of any form or nature whatsoever, the income-tax payable shall be the aggregate of—

(i) the amount of income-tax calculated on income by way of winnings from such lottery or crossword puzzle or race including horse race or card game and other game of any sort or from gambling or betting of any form or nature whatsoever, at the rate of forty per cent.; and

(ii) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (i).

Explanation. For the purposes of this section, ''horse race" shall have the same meaning as in section 74A.

DISCLAIMER:  the case laws presented here is only for sharing information and knowledge with the readers. The views expressed are personal and should not be considered as professional advice. In case of necessity do consult with tax professional for more clarity and understanding on subject matter.