S.P.

DESAI
CHARTERED ACCOUNTANT

1.X ltd. is engaged in the business of manufacture of garments.

Sale proceeds of goods (domestic sale) 22,23,900

Sale proceeds of goods (export sale) 5,76,100
Amount withdrawn from general reserve (reserve was created
in 1996-97 by debiting P& L A/c) 2,00,000
Amount withdrawn from revaluation reserve 1,50,000
Total 31,50,000
Less: Expenses
Depreciation (normal) 6,16,000
Depreciation (extra depreciation because of revaluation) 2,70,000
Salary And Wages 2,10,000
Fringe Benefit Tax 10,000
Income –Tax 3,50,000
Outstanding Custom Duty (not paid as yet) 17,500
Proposed Dividend 60,000
Consultation fees paid to a tax expert 21,000
Other expenses 1,39,000
Net Profit 14,56,500

For tax purposes the company wants to claim the following:

 Depreciation U/S 80-IB (30 percent of Rs. 14,56,500)
 Depreciation U/S 32 (Rs. 5,36,000)

The company wants to set off the following losses/ allowances:

For Tax Purpose For Accounting Purpose
Rs. Rs.
Brought forward loss of 2000-01 14,80,000 4,00,000
Unabsorbed Depreciation __ 70,000

Compute the net income and tax liability of X Ltd. for the assessment year 2010-11
assuming that X Ltd. gets a deemed long-term gain of Rs. 60,000 U/S54D which is not
certified in profit and loss account.

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S.P.DESAI
CHARTERED ACCOUNTANT

2.The projected profit and loss accounts of X Ltd. and Y Ltd.(which are under the same
management) for the previous year 2009-10 are given below;

X Ltd.
Rs. Rs.
Cost of goods sold 45,00,000 Sale 65,00,000
Depreciation @ 15.3% on Rs. 1,53,000
10,00,000
Other Expenses 2,00,300
Net Profit 16,46,700
65,00,000 65,00,000

The company has set up an industrial undertaking in a notified industrial park and
qualified for 100 percent deduction U/S 80 IA. Written down value of plant and
machinery for income-tax purpose is Rs. 12,50,000.

Y Ltd.
Rs. Rs.
Cost of goods sold 61,00,00 Sale 86,00,000
0
Depreciation @ 13.91% of Rs. 1,98,91 Profit on sale of a plot of land
14,30,000 3 (long-term capital gain 1,20,000
determined U/S 48)
Net Profit 24,21,08
7
87,20,00 87,20,000
0

Y Ltd. is not entitled to any deduction U/S 80-IA. Written down value of assets for
income-tax purpose is Rs. 18,76,670.

3.A, B and C are three partners of a firm. Profit and Loss Account of the firm for the year
ending March 31, 2009 is as follows:

Rs. Rs.
Cost of goods sold 24,75,000 Sale 31,10,000
Other Expenses 2,44,000 Other receipts 5,000
Remuneration to partners:
A 90,000
B 1,02,000
C 1,50,000
Interest on capital to partners:
A 36,000
B 50,000

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S.P.DESAI
CHARTERED ACCOUNTANT
C 48,000
Net Profit 20,000
32,15,000 32,15,000

Personal incomes/ investment of partners are as follows:

A B C
Rs. Rs. Rs.
Rent (taxable) 60,000 90,000 70,000
Interest on bank deposit 30,000 50,000 40,000
PPF contribution 30,000 40,000 20,000

4..X Ltd. is a widely-held company. It is currently considering a major expansion of its

production facilities and the following alternatives are available:

Alternative Alternative Alternative

One Two Three
Rs. Rs. Rs.
Share capital 5,00,00,000 2,00,00,00 1,00,00,000
Debentures (14%) 0
Loan from financial institution/bank (@18%) ------ 2,00,00,00 1,50,00,000
0
------ 1,00,00,00 2,50,00,000
Expected rate of return (before tax) is 25%. 0
The rate of dividend of the company since
1980 is not less than 20% and the date of dividend declaration is June 30 every year.

The directors of a company propose to expand and modernize its business for which an
additional investment of Rs. 50 crore would be needed. They feel confident about raising
the entries sum of Rs. 50 crore either by making a further issue of equity shares or by
borrowings from financial institution at 18% p.a. They decide in favour of raising the
additional capital by issue of equity shares. The company present paid-up equity share
capital is Rs. 50 crore and it has been declaring dividend at 20% (ignoring dividend tax)
on Sept, 30 every year for the last five years though, considering the proposed expansion,
there is desire to raise it to 25%.

As a tax consultants do you approve of the proposal to raise the entire additional capital
through issue of equity shares or would you advise differently? Answer in detail, giving
reasons.

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S.P.DESAI
CHARTERED ACCOUNTANT

Meaning of Dividend [Sec. 2(22)]

Section 2(22) gives the definition of “deemed dividend” However, the definition laid
down by section 2(22) is inclusive and not exhaustive. If, thereore, a particular
distribution is not regarded as dividend within the extended meaning of expression in
section 2(22), it may still be dividend for the purpose of the Income-Tax Act.

U/S 2(22), the following payments or distributions by a company to its shareholders are
deemed as dividend to the extent of accumulated profits of the company:
a. any distribution entailing the release of company’s assets
b. any distribution of debenture, debenture-stock, deposit certificates and bonus to
preference shareholders
c. distribution on liquidation of company
d. distribution on reduction of capital
e. any payment by way of loan or advance by a closely-held company to a
shareholder holding substantial interest provided the loan should not have been
made in the ordinary course of business and money-lending should not be a
substantial part of the company’s business.

■ If dividend comes under (a) to (d), then the payer-company will pay dividend tax U/S
115-o and in the hands of recipient shareholders, it is not chargeable to tax.
Conversely, if dividend comes under (e), then it is taxable in the hands of shareholder. In
such case, the payer-company will not pay dividend tax.

■ The following shall not be treated as “dividend”-

a. any payment made by a company on purchase of its own shares in accordance
with the provisions contained in section 77A of the Companies Act; or
b. any distribution of shares made in accordance with the scheme of demerger by
the resulting company to the shareholders of the demerged company whether or not there
is a reduction of capital in the demerged company.

Accumulated Profits- Any payment or distribution under the aforesaid clauses is treated
as dividend. However, the payment or distribution under the aforesaid clauses can be
treated as dividend only to the extent of accumulated profits of the company. Therefore, it
is essential to discuss the meaning and scope of the expression “accumulated profits”.

■ Explanation 1 and 2 to section 2(22) throw light on the meaning of accumulated profits.

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S.P.DESAI
CHARTERED ACCOUNTANT

1.it is expressly provided that it does not include capital gains arising before April 1,
1946 and after March 31, 1948 but before April 1,1956.
2.in the case of a company, which is not in liquidation, it includes all profits of a
company up to the date of distribution or payment.
3.in the case of a company in liquidation, it includes all profits of the company up to the
date of liquidation. Where, however, the liquidation is consequent on the compulsory
acquisition of a company undertaking by the government or a government company.
Accumulated profits do not include any profits of the company prior to the three
successive years immediately preceding the previous year in which such acquisition took
place. For instance, if accounting year of the company is financial year and compulsory
acquisition takes place on, March 13,2007,its accumulated profits will exclude profits
accumulated up to March 31,2003.
WHETHER ACCUMULATED PROFITS INCLUDE CURRENT PROFITS-
Accumulated profits include all profits (accumulated or current )up to the date of
distribution or payment (or up to the of liquidation in the case of liquidation).
COMPUTATION OF ACCUMULATED PROFITS-Whether on the basis of
commercial profits or assessed profits-in a number of cases it has been held that
accumulated profits are computed on the basis of commercial profits.
CONTROVERSIAL ASPECTS OF THE TERM “ACCUMULATED PROFITS”-
Judicial classification on the basis of different judicial decisions, the following
conclusion can be drawn in respect of accumulated profits:
 Accumulated profits are computed on the basis of commercial profits and not
on the basis of assessed incomes.
 Depreciation- while calculating “accumulated profits”. An allowances for
depreciation at the rates provided by the income-tax act itself has to be made
by way of deduction.
 General reserve- accumulated profits include general reserve.
 Development Rebate, reserve, etc- accumulated profits also include
development rebate reserve, development allowance reserve and investment
allowances reserve, as these reserves are not in the nature of any expenditure
or outgoing. Building reserve fund is includible in accumulated profits,
because it is a fund set apart for constructing new building and is not in the
nature of depreciation fund.
 Provision for taxation and dividend- provision for taxation and dividend do
not form part of accumulated reserve.
 Addition by assessing officer- addition made by the assessing officer on
account of concealed income forms part of accumulated profits. Accumulated
profits do not include addition made by the assessing officer on account of
disallowance of inadmissible expenditure.
 Tax free income- accumulated profits include tax free income/revenue
receipts, e.g. agricultural income. However, capital profits (i.e. capital
gains)are taxable only when such gains are taxable under section 45.
 Whether profits of amalgamating company is part of accumulated profits-
strictly construed, “accumulated profits”. whether capitalized or not, held by
the amalgamating companies, which are separate independent entities, can not

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S.P.DESAI
CHARTERED ACCOUNTANT
by any stretch of imagination be treated as accumulated profits or capitalized
profits of amalgamated company.
 Subsidy- current profit would be part of accumulated profits but subsidy on
capital account can not treated as accumulated profits.
Distribution of accumulated profits entailing release of company assets
[section 2(22)(a)]- under sub-clause (a) of section 2(22), any distribution by a
company of its accumulated profits (whether capitalized or not ) is divided if it
entails the release of company assets. In other words, there are two conditions
prescribed by this clause- first, distribution should be from accumulated profits
(not from capital ) and secondly, such distribution must result in the release of the
assets by the company.
As on specific mode of distribution is prescribed by the clause, distribution may
be in the form of payment in cash or kind.
 Bonus share- one of the conditions laid down in sub-clause (a) o0f
section 2(22) is that distribution must entail the release of assets by the
company to its shareholders. When therefore, a company distributes
ordinary or equity bonus by capitalising its profits, then there is no
released of assts and, consequent, bonus share are not taxable as
dividend. It, however, bonus share are issued to preference shareholders,
it amount to distribution of dividend by virtue of sub-clause (b) of
section 2(22).
a. Distribution of accumulated profits in the form of debentures,
debenture stock [section 2(22)(b)]-under this clause the following two
distribution are treated as dividend to the extent of accumulated profits
(whether equity shareholders or preference shareholders )of debenture,
debenture –stock or deposit certificates in any form, whether with or without
interest: and
b. Distribution by a company to its preference shareholders of bonus share.
It is worthwhile to note that that under the aforesaid circumstances
distribution amounts to dividend in the hands of recipient even if there no
release of assets at the time of distribution.
Distribution of accumulated profits at the time of liquidation [section
2(22) (c)]- under sub-clause (c ),any distribution made by a company to its
shareholders on its liquidation is treated as dividend to the extent to which
such distribution is attributable to the accumulated profit (whether
capitalized or not ) of the company immediately before its liquidation.
Under sub-clause (c), the following are, however, not treated as dividend:
a. any distribution in respect of preference shares issued for full cash
consideration: and
b. any distribution insofar as such distribution is attributable to the
capitalized profits of the company representing bonus share allotted to
its equity shareholders after March 31,1964, but before April 1, 1965.

Distribution of accumulated profits on the reduction of its capital

[section.

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S.P.DESAI
CHARTERED ACCOUNTANT
2(22) (d)]- any distribution by a company to its shareholders on the reduction of capital is
treated as dividend to the extent the company processes accumulated profits (whether
capitalized or not ). However, the following are not treated as dividend under this clause:
a. any distribution out of accumulated profits which arose up to the previous year
1932-33 or up to the previous year ending during 1932-33.
b. Any distribution in respect of preference shares issued for full cash consideration:
and
c. Any distribution insofar as such distribution is attributable to the capitalized
profits of the company representing bonus share allotted to its equity shareholders
after March 31, 1964,but before April 1,1965.
If there is only reorganization of capital and it, in fact, results in splitting up of capital
of the company into two companies, and there is no reduction of capital in the
aggregate, section 2(22) (d) would not apply.

Distribution of accumulated profits by way of advance or loan [section.2(22) (e)-

under sub- clause (e), any loan or advances to shareholders or concern is treated as
dividend in certain cases.
Case 1 Case 2
1.loan or advances is given by a closely – 1. loan or advance is given by a closely-
held company. held company (say x ltd).
2. such loan is given to registered 2. such loan is given to a “concern”(say y)
shareholder.
3. the shareholders (getting the 3. one of the shareholders, beneficially
loan)beneficially holds 10 percent or more holding 10 percent equity share capital in x
of equity shares in the company (giving the ltd , has a substantial interest
loan).
4. such loan or advances is treated as 4. such loan or advances is treated as
dividend in the hands of shareholder. dividend in the hands of y.
Notes:
1.such loan or advance is treated as dividend to the extent of accumulated profits
(excluding capitalized profit)
2.loan or advance for the above purpose may be given to a shareholders (in case
1)directly or it may be given for the benefit of shareholders or on behalf of
shareholders.
3. “concern” for this purpose may be a HUF, sole proprietor, firm, AOP,BOI or a
company.
4. a person shall be deemed to have a substantial interest in a concern, if he is (at any
time during the previous year), beneficially entitled to at least 20 percent of income of
concern (if such concern is a company, then he should beneficially hold at least 20
percent equity share capital of the company)
5. where money-lending is a substantial part of the business of the company (giving
loan), the above provisions are not applicable.
6. if after giving loan or advance to a shareholder, the company declares normal
dividend and such dividend is set off against outstanding loan/advance, the amount so
set off will not be taken as “dividend”.

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S.P.DESAI
CHARTERED ACCOUNTANT
POINTS TO BE BORNE IN MIND WHILE APPLYING SECTION 2(22) (e)-in
order to understand the application and scope of sub-clause (e) of section 2(22), one
should keep in mind the following propositions derived from decided cases;
 Only registered shareholders- under sub-clause (e) the word
“shareholder” refers to the registered shareholders and not beneficial
owner of a share and hence a loan granted to a beneficial owner of share,
who is not a registered shareholders, cannot be regarded as loan or
advance to a “shareholders”.
 No restriction on account of deemed dividend-there is nothing in sub-
clause (e) of section 2(22)to restrict the deemed dividend to that portion
of accumulated profits which corresponds to the assesses shareholding in
the capital of the company. If a loan is given by a company to a
shareholders who owner 25 percent of share capital, the amount of loan
to the extent of entire accumulated profits (and not to the extent of 25
percent of accumulated profits) will be treated as dividend.
 Accumulated profits minus dividend under section 2(22) (e)-for the
purpose of section 2(22) accumulated profits get reduced by the amount
deemed as dividend under section 2(22) even if no adjustment is made in
the book of account. For instance, the total accumulated profits of A ltd.
Is Rs. 120 lakh. It gives a loan to x of rs. 50 lakh which is deemed as
dividend under section 2(22) (e). later on the company advance rs.76
lakh to y and such advance falls under section 2(22) (e) now rs.70 lakh
(i.e.rs.120lakh minus rs.50 lakh ) only shall be treated as dividend.
Suppose, a ltd further gives a loan to z (HUF) amounting to rs.10lakh
which satisfies conditions of section 2(22) (e) , then nothing shall be
taxable as dividend since there is no accumulated profits left
[rs.120lakh-rs.50lakh-rs.70lakh]
 Relationship of debtor and credit- in order to attract the provision of
section 2(22) (e) the important consideration is that there should be
loan /advance by a company to its shareholder. Every payment by a
company to its shareholders may not be loan /advance. To be treated as
loan every amount paid must make the company a creditors of the
shareholders for the amount. However, at the time when payment is
made, the company is already a debtor of the shareholders, the payment
would be merely a repayment by the company toward its already
existing debt.
 Repayment of loan- section 2(22) (e) is applicable even if loan is repaid
before the end of the previous year. In other word, the liability is
attracted at the moment the loan is given.
 Bona fide loans-a bona fide loan for a short duration is treated as
dividend if all the conditions of section 2(22) (e) are satisfied. If ,
however, any amount is deposited by the shareholders with the
company, its repayment does not attract the provision of section 2(22)
(e) because it does not result in advancing or giving loan to the
shareholders.

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S.P.DESAI
CHARTERED ACCOUNTANT
 Overdraft- an overdraft taken by a shareholders from the company is
treated as loan and taxable as dividend if condition of section 2(22)
(e)are satisfied.
 Loan in kind- section 2(22) (e)is applicable even if loan is given in kind.
 Loan on behalf of Assesses- where whenever the assesses, a managing
directors of a company, needed money he used to ask an employee to
take a loan from the company and pass it on to him even without
executing any pronote , it was held that the loans made by the company
to the employee fell in the category of “benefit” to the assesses and
were, therefore, assessable as deemed dividend in his hands-L
.Alagusundaram chettiar v. CIT [2002] 121 Taxman 587 (sc).
 Payment on behalf of shareholders- section 2(22) (e) covers not only
advances and loan to shareholders but any other payment by the
company on half of or for the individual shareholders, such as payment
of shareholders personal expenses, insurance premia ,etc .to the extent of
the accumulated profits of the company-CIT V.K. srinivasan [1963] 50
ITR 788 (Mad).
 Call money- the amounts due by assesses to the company towards the
first and second call moneys on the shares held by it in the company and
which were treated as having been paid up by making book entries in
running account can not be treated as a payment by way of loan by the
company to the assesses for purpose of section 2(22) (e)-G.R.
Govindarajulu naidu v. CIT [1973] 90 ITR 13 (MAD).
 Share application money- share application money received by a closely
held company can not be related as dividend under section 2(22) (e)
pending allotment of share- Ardee finvest (p) ltd .v. CIT [2001]79 ITD
547 (Delhi)
 Advance rent- X holds more than 10 percent equity share capital in a
(pvt) ltd. He lets out a property to a (pvt).ltd . under an agreement. On
may 20,2004, he receives rs.1,00,000 as advances rent under the
agreement. Advance rent will be deemed as dividend even if the amount
is received under the lease agreement. (not as a shareholders but as
landlord) or even if it a has to be adjusted against future rent- CIT V.
P.S. Abubucker [2004] 135 taxman 77 (mad).
Tax treatment in the hands of shareholders-tax treatment of dividend is as
follows-
DIVIDEND RECEIVED FROM A DOMESTIC COMPANY-if dividend
is covered by section 2(22) [not by clause (e) of section 2(22) and declared,
distribution or paid during April 1,1997 And March 31,2002 or after March
31, 2003, then it is not taxable in the hands of shareholders by virtue of
section 10(33) or 10(34). On such dividend the company declaring dividend
will pay dividend tax under section 115-0.
If a loan or advance is given after May 31,1997 which is deemed as
dividend under section 2(22) (e), then such loan or advancer is taxable under
section 56 as “dividend” in the hands of recipient without claiming any
deduction under section 80L OR 80M.

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CHARTERED ACCOUNTANT
DIVIDEND RECELVED FROM A NON-DOMESTIC COMPANY-
The exemption under section 10(33) or 10(34) is not available if divided is
received from a company other than a domestic company and consequently,
such dividend is chargeable to tax in the hands of recipient (in such case
there is no dividend tax by the payer).

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