According to Sec 2(22) of the I.

T act 1961, dividends includes the following disbursements by the company to the shareholders, to the extent of accumulated profits. (a) Any distribution by a company to the extent of accumulated profits involving the release of the assets of the company [sec 2(22)(a)]

The company should posses accumulated profits.

A.P are distributed in cash or kind. Where the distribution is in kind, the market value of the asset shall be the deemed income in the hands of the shareholders.

types of dividends:

(a) Dividend declared by a domestic company. (b) Dividends or any other income distributed by UTI. (c) Dividends declared by a foreign company.

 W.E.F

2004-2005, dividend by a domestic company refer to section 115-O or after 1.4.2003 not to be included in computing the previous year total income of any person.

Deemed

dividend in sec10(34) is exempt but deemed dividend under sec2(22)(e) i.e loan & advance by closely held company to a specified shareholder.

 Liability

of tax has been shifted to the domestic company who shall pay an additional tax i.e DDT @ 15% + 5% surcharge + 2% plus secondary and higher E.C @ 1%. For 2011-2012 surcharge was 7.5%.

Dividend

received from a foreign company is liable to tax under the head of income from other sources under sec2(22)(e).

 Clause(23D),

income from specified undertakings or any specified company or a M.Fund is exempt. not apply to the transfer of the units of the above specified.

Shall

Ques) ABC has AP of Rs 3 L excluding capitalized profit of 1L. The company distributed assets of Rs 2.5 L. Compute the tax to be paid if the market value of the asset on the date of distribution is:

(a) Rs 2 L (b) Rs 3.5 L (c) Rs 4.5 L

Tax to be paid from the side of the company as it is exempt from shareholders side. It is to be paid as 16.223% on the amount paid as dividend.

So in the previous question amount that can be distributed as dividend shall be: (a) 2 L (b) 3.5 L (c) 4 L

As it cannot go beyond maximum A.P including capitalized profits as well.

 Any

distribution to its shareholders by a company of deb., deb. Stock, or deposit certificate in any form, whether with or without interest to the extent of AP, whether capitalized or not, and

Any

distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses A.P, whether capitalized or not.

(d)

Distribution of reduction of share capital [Sec. 2(22)(d)]: Any distribution to its share holders 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; For this purpose, profits of the company, up to the date of resolution permitting the reduction of share capital, shall form part of the accumulated profits. The supreme court held that amount distributed by the company on the reduction of its share capital has two components, namely: (a) Distribution of accumulated profits, and (b) Distribution of capital.

The amount received as reduction of capital, to the extent it can be attributed to accumulated profits , shall be deemed dividend under section 2(22)(d) and the balance amount received shall be on account of reduction of capital which will be subject to capital gain, if any.

Example 1: A company has accumulated profits of Rs. 3,00,000. (a) X, a shareholder who holds 25% shares, receive Rs. 50,000 from company on reduction of its capital. (b) X, a shareholder who holds 25% shares, receive Rs. 75,000 from company on reduction of its capital. (c) X, a shareholder who holds 25% shares, receive Rs. 2,40,000 from company on reduction of its capital.
Solution Case(a) : 50,000 x 100/25 =Rs. 2,00,000 which is less than accumulated profits of Rs. 3,00,000 shall be deemed dividend on which company shall have to pay DDT @ 16.223. Rs. 50,000 received by X shall be exempt in his hand as per Sec.10(34).

Case(b) : 75,000 x 100/25 =Rs. 3,00,000 which is equal to accumulated profits of Rs. 3,00,000 shall be deemed dividend on which company shall have pay DDT @ 16.223. Rs. 75,000 received by X shall be exempt in his hand as per Sec.10(34). Case (c) Liability in the hands of company On accumulated profit of Rs. 3,00,000, the company shall pay DDT @16.223% Rs. 3,00,000 x 25% =Rs. 75,000 will be exempt in the hands of share holders under section 10(34). Further, while computing the consideration price for computing the capital gain in the hands of X, the deemed dividend of Rs. 75,000 shall be deducted for the total amount of Rs. 2,40,000 received by X. Hence, the consideration price shall be Rs. 1,65,000 (Rs. 2,40,000 Rs.75,000). .

(e) Loans/advances to certain shareholders/concerns [section 2(22)(e)]: Any payment by a company, of any sum by way of advance or loan, to the extent of accumulated profits to:(i) A equity shareholder, who is beneficial owner of shares holding not less than 10% of the voting power; or (ii) Any concern in which shareholder is a member or a partner and in which he has substantial interest; or (iii) Any person, on behalf, or for the individual benefit, of any such shareholder. Such shareholder here means a shareholder who is beneficial owner of share holding not less than 10% voting power. Example: R(P) Ltd., gives a loan of Rs. 3,00,000 to G, who is not a shareholder. G gives this amount as loan to S who is shareholder in R Pvt. Ltd., holding 12% shares. In this case Rs. 3,00,000 shall be deemed dividend in the hands of S because the loan has given by the company to G for the benefit of S.

This provision is applicable only to companies in which the public is not substantially interested i.e. closely held companies. Further, such loan and advance given to such person shall be deemed to be dividend only to the extent to which it is shown that the company possesses accumulated profits on the date of loan, etc. Dividends not to include the following:
(i)

(ii) (iii)

(iv)

(v)

Loan advanced in the ordinary course of business by the money lending company. Dividend paid if set off against loan already treated as deemed dividend. Distribution in respect of non- participating shares issued for full cash consideration. Buy back of shares as per section 77A of Companies Act. Distribution of shares to the shareholders of demerged company.

Following expenses can be claimed as deductions from gross dividend income: 1. Collection charges- any reasonable sum paid by way of commission or remuneration to a banker or any other for the purpose of realising the dividend. 2. Interest on loaninterest on money borrowed for purchasing the shares can be claimed as deduction. The interest can be claimed even if no income is earned by way of dividend on such shares. It has been held by the Supreme Court that if the expenditure has been laid out for the purpose of earning the dividend income then whether income is actually earned or not is immaterial and deduction on account of interest can be claimed.

3. Any other expenditure- any other expenditure, not being a expenditure of a capital nature, expended wholly & exclusively for the purpose of making or earning such income, can be claimed as deduction. Gross dividend minus the above deductions is the income from dividend taxable under the head Income From Other Sources.

(A)

Benefits to the shareholders: under sec 2(22)(a) mere capitalization by issue of bonus shares to equity shareholders does not entail the release of assets of the company and hence shall not be deemed to be dividend. Therefore, when an equity shareholder receives bonus shares it is not treated as a dividend and neither the shareholder nor the company incurs any tax liability on the issue of such shares. Treatment on sale of bonus share- as per sec 55(2)(aa)(iiia), the cost of acquisition in relation to the financial assets(i.e. share or any other security) allotted to the assessee on or after 1-4-1981 without any payment and on the basis of holding of any financial asset, shall not be taken to be nil. Therefore, the cost of bonus shares shall be taken to be nil and the entire sale consideration received on the transfer of the bonus share shall be treated as capital gains.

However, in case bonus shares have been allotted to the assessee before 1-4-1981, although the cost of such bonus shares is nil but the assessee may opt for market value as on 1-4-1981 as the cost of acquisition of such bonus shares. Therefore, in case of bonus shares issued on or after 1-4-1981, the entire sale consideration shall be the capital gain. However, if the bonus shares are sold after a period of one year i.e. when they become long-term capital assets then there will be no capital gains tax because the long term capital gain on shares in exempt from tax if these are sold through a recognized stock exchange and the securities transaction tax has been paid.

(B) Benefits to the company- If the company does not declare the dividends out of its income then the profits are available to the company for being ploughed back into the business. This internal source of capital is a cost effective method of raising capital for expansion purposes or for setting up of new projects. In case the company distributes its income by way of dividends then the company shall have to look for alternative sources of raising capital for the growth of its business. The normal cost of raising capital in the market is about 12 to 14%. Where the company uses in the internal accruals, its saves on this cost.