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Income Tax Laws – I

Notes accumulated profits, whether capitalised 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 [section 2(22)(b)].

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Caution Bonus shares given to equity shareholders are not treated as dividend.

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
capitalised or not, is deemed to be dividend income [section 2(22)(c)]. Any distribution
made out of the profits of the company after the date of the liquidation cannot
amount to dividend. It is a repayment towards capital
Accumulated profits include all profits of the company up to the date of liquidation
whether capitalised 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 three successive previous years immediately preceding
the previous year in which such acquisition took place subject to certain exceptions.

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Caution The dividend does not include a distribution made in accordance with sub-clause (c)
in respect of any share issued for full cash consideration, where the holder of the share is
not entitled in the event of liquidation to participate in the surplus assets.

Distribution on 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 capitalised or not, shall be deemed to be dividend
[section 2(22)(d)].
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 dividend to the extent of the accumulated
profits. If the loan is not covered by the accumulated profits, it is not deemed to be
dividend [section 2(22)(e)].

Notes There are two exceptions to this rule:
1. 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 is
not deemed to be dividend.
2. Where a loan had been treated as dividend and subsequently the company declares
and distributes 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 again be treated as a dividend.

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