Accumulated Profits and Deemed Dividend

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. However, Section 2(22) of the Income Tax Act, 1961 has devised a special inclusive definition of dividend.

Inclusions in Dividend

The following disbursements by the company to its shareholders are included as ‘Dividends’ as per Section 2(22) –

Section 2(22)(a)

Any distribution by a company of accumulated profits, whether capitalized 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.

However, mere capitalization of accumulated profits 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.

Two conditions are essential for treating a distribution to be deemed dividend

(i) the company should possess accumulated profits;

(ii) such accumulated profits are distributed in cash or in kind. Where the distribution is in kind, the market value of the asset (and not the book value) shall be deemed dividend in the hands of the shareholders.

Section 2(22)(b)

(i) Any distribution to its shareholders (equity or preference) by a company of debentures, debenture-stock, or deposit certificates in any form, whether with or without interest, and

(ii) any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalized or not;

Notes –

It may be noted that debentures issued to the shareholders shall be deemed dividend and taxable in the hands of the company to the extent of accumulated profits including capitalized profits (i.e. bonus shares).
Bonus shares allotted to equity shareholders does not amount to deemed dividend but bonus shares allotted to preference shareholders shall amount to deemed dividend under section 2(22)(b) and the company shall pay dividend tax on such bonus shares allotted to preference shareholders.

Section 2(22)(c)

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;

When a company goes into liquidation and its assets are distributed in cash or in kind to the shareholders, there is no capital gain to the company as per section 46(1) but there is capital gain to the shareholders.

Section 2(22)(d)

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 capitalized or not;

For this purpose, profits of the company, upto the date of resolution permitting the reduction of share capital, shall form part of the accumulated profits.

Note – 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 shall not be treated as deemed dividend.

The Supreme Court in the case of CIT v Narasimhan (1999) 236 ITR 327 (SC) held that amounts distributed by a company on reduction of its share capital has two components, namely –

(a) Distribution of accumulated profits, and

(b) Distribution of capital.

Hence, 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.

Section 2(22)(e)

Any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to the extent of accumulated profits (excluding capitalized profits) to –

(i) a equity shareholder, being a person who is the beneficial owner of shares holding not less than ten per cent of the voting power, or

(ii) any concern in which such shareholder (holding not less than 10% voting power) is a member or a partner and in which he has a 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 shareholding not less than 10% voting power.

Inclusions in accumulated profits

The expression “accumulated profits” in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation, but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place.

Definitions for the purposes of this clause

(a) “Concern” means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company;

(b) A person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern;