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Income Tax Laws – I

Notes dividend referred to above apply only to payments or distributions made by a company as
defined in Section 2(17) of the Income-tax Act.
Since the meaning and scope of the term ‘dividend’ used in the income-tax Act is much wider
than what is commonly understood, it covers not only payments as dividends made by a company
in accordance with the provisions of company law but also various other payments which may
not amount to dividend under company law.
In order to be chargeable to tax as dividend, it is not essential that the dividend must be paid
only in cash although the provisions of Company Law require that a dividend must always be
paid in cash or by cheque. In all cases where a dividend is paid in any form other than cash, say
in the form of goods, securities or shares, even of another company, the amount of dividend
which is liable to income-tax must be taken to be the market value of the thing received as
dividend.

Example: If ‘A’ company distributes dividends to its shareholders in the form of shares
of its wholly owned subsidiary company ‘B’ at the face value of ` 100 each while the market
value is ` 150 per share, the liability to tax on the part of the company would be on the basis of
the market value of the share. For this purpose, it is immaterial if the shares are such that a part
of the shares cannot be divided for being utilized towards tax deductible at source. The company’s
liability to pay distribution tax is not in any way affected or reduced by the fact that the dividend
in question is paid in kind or is calculated on a basis different from what the income-tax law
provides.
It is likely that the company may not comply with some of the provisions of Company Law in
the matter of declaration and payment of dividends. Even in such cases, non-observance of the
various formalities or the provisions of Company Law by the company concerned would not in
any way affect the taxability of the amount as dividend in the hands of the Company.
Consequently, if a company, in violation of law, distributes dividends out of its share premium
account, the Company would still be taxable regardless of the fact that the payment in question
does not come out of the revenue profits of the declaring company.

In the process of capitalisation of the accumulated profits and reserves, a company may normally
resort to the issue of bonus shares. This is mostly done in cases when a company is prosperous
and has a large surplus and after some time it is decided to convert the surplus into capital and
divide the capital amongst the members in proportion to their rights. This is done by issuing
fully paid shares representing the increased share capital.
Bonus shares are issued out of credit balance to the Profit and Loss Account and out of reserves
and the shareholders to whom the shares are issued, have to pay nothing. The purpose is to
capitalise profits which may be otherwise available for distribution. If the Articles of Association
of a company permit, a company can capitalise profits and reserves and issue fully paid shares
on a nominal value equal to the amount capitalised to its shareholders. This is permissible
subject, however, to the provisions of Sections 78 and 205 of the Companies Act and guidelines
issued in this regard by the SEBI.
When bonus shares are issued by a company to its equity shareholders the company is not
chargeable to distribution tax on the value of the bonus shares. This is because of the fact that
according to Section 2(22)(a), the distribution of accumulated profits of a company would result
in dividend only if there is release of the company’s assets as a result of such distribution. This
is because of the fact that the effect of the bonus issue is that the profits remain in the hands of the
company as capital and the shareholders receive only paper certificates as evidence of their
interest in the additional capital so set aside or capitalised. The transaction takes nothing out of
the company’s coffers and puts nothing into the shareholders’ pockets and the only result is that
the company which, before the resolution, could have distributed the profits by way of dividend

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