A write up on

Taxation and dividend decisions. Taxation and dividend policies. Tax considerations in dividend policy and bonus issue.

In
MANAGEMENT OF BUSINESS TAX

Submitted to: Dr. Madan Lal FMS, BHU

Submitted by: Sumit Choudhari (R.N. 15) & Sushil Mohan (R.N. 16) MBA ( Finance)

TAXATION AND DIVIDEND DECISIONS Dividend [ Sec. 56 (2) (i)] Dividend from an Indian company is not taxable in the hands of shareholders (company declaring dividend will have to pay dividend tax under section 115-O). However, deemed dividend under section 2(22) (e) from an Indian company or any dividend from a foreign company is taxable in the hands of shareholders under the head Income from other sources, regardless of the fact whether shares are held by the assessee as investment or as stock-in-trade.

Dividend under the Income- Tax Act Section 2(22) gives the definition of dividend. The definition laid down by sec. 2(22) is inclusive and not exhaustive. If, therefore, a particular distribution is not regarded as dividend within the extended meaning of the expression in sec. 2(22), it may still be dividend provided it is dividend under the ordinary meaning of the expression. Under section 2(22), the following payments and distributions by a company to its shareholders are deemed as dividend to the extent of accumulated profits of the company. Any distribution entailing the release of companys assets Any distribution of debenture, debenture-stock, deposit certificate and bonus to preference shareholders, Distribution on liquidation of a company, Distribution on reduction of capital, 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 companys business.

a. b. c. d. e.

If dividend comes under (a) to (d), then the payer company will pay dividend tax under section 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 shareholders. In such case, the payer -company will not pay dividend tax.

TAX ON DIVIDENDS, ROYALTY AND TECHNICAL SERVICE FEES IN THE CASE OF FOREIGN COMPANIES. 115A. (1) Where the total income of (a) a non-resident (not being a company) or of a foreign company, includes any income by way of (i) dividends [other than dividends referred to in section 115-O] ; or (ii) interest received from Government or an Indian concern on monies borrowed or debt incurred by Government or the Indian concern in foreign currency ; or (iii) income received in respect of units, purchased in foreign currency, of a Mutual Fund specified under clause (23D) of section 10 or of the Unit Trust of India, the income-tax payable shall be aggregate of (A) the amount of income-tax calculated on the amount of income by way of dividends [other than dividends referred to in section 115-O], if any, included in the total income, at the rate of twenty per cent ; (B) the amount of income-tax calculated on the amount of income by way of interest referred to in sub-clause (ii), if any, included in the total income, at the rate of twenty per cent ; (C) the amount of income-tax calculated on the income in respect of units referred to in sub-clause (iii), if any, included in the total income, at the rate of twenty per cent ; and (D) the amount of income-tax with which he or it would have been chargeable had his or its total income been reduced by the amount of income referred to in subclause (i), sub-clause (ii) and sub-clause (iii) ; (b) [a non-resident (not being a company) or a foreign company, includes any income by way of royalty or fees for technical services other than income referred to in sub-section (1) of section 44DA] received from Government or an Indian concern in pursuance of an agreement made by the foreign company with Government or the Indian concern after the 31st day of March, 1976, and where such agreement is with an Indian concern, the agreement is approved by the Central Government or where it relates to a matter included in the industrial policy, for the time being in force, of the Government of India, the agreement is in accordance with that policy, then, subject to the provisions of sub-sections (1A) and (2), the income-tax payable shall be the aggregate of, (A) the amount of income-tax calculated on the income by way of royalty, if any, included in the total income, at the rate of thirty per cent if such royalty is received in pursuance of an agreement made on or before the 31st day of May, 1997 and twenty per cent where such royalty is received in pursuance of an agreement made after the 31st day of May, 1997 [but before the 1st day of June, 2005; (AA) the amount of income-tax calculated on the income by way of royalty, if any, included in the total income, at the rate of ten per cent if such royalty is received in pursuance of an agreement made on or after the 1st day of June, 2005;

(B) the amount of income-tax calculated on the income by way of fees for technical services, if any, included in the total income, at the rate of thirty per cent if such fees for technical services are received in pursuance of an agreement made on or before the 31st day of May, 1997 and twenty per cent where such fees for technical services are received in pursuance of an agreement made after the 31st day of May, 1997[but before the 1st day of June, 2005] ; and (BB) the amount of income-tax calculated on the income by way of fees for technical services, if any, included in the total income, at the rate of ten per cent if such fees for technical services are received in pursuance of an agreement made on or after the 1st day of June, 2005; and] (C) the amount of income-tax with which it would have been chargeable had its total income been reduced by the amount of income by way of royalty and fees for technical services. Explanation.For the purposes of this section, (a) fees for technical services shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9 ; (b) foreign currency shall have the same meaning as in the Explanation below item (g) of sub-clause (iv) of clause (15) of section 10 ; (c) royalty shall have the same meaning as in Explanation 2 to clause (vi) of subsection (1) of section 9 ; (d) Unit Trust of India means the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963).] (1A) Where the royalty referred to in clause (b) of sub-section (1) is in consideration for the transfer of all or any rights (including the granting of a licence) in respect of copyright in any book to an Indian concern [or in respect of any computer software to a person resident in India], the provisions of sub-section (1) shall apply in relation to such royalty as if the words [the agreement is approved by the Central Government or where it relates to a matter] included in the industrial policy, for the time being in force, of the Government of India, the agreement is in accordance with that policy] occurring in the said clause had been omitted : Provided that such book is on a subject, the books on which are permitted, according to the Import Trade Control Policy of the Government of India for the period commencing from the 1st day of April, 1977, and ending with the 31st day of March, 1978, to be imported into India under an Open General Licence : [Provided further that such computer software is permitted according to the Import Trade Control Policy of the Government of India for the time being in force to be imported into India under an Open General Licence.] [Explanation 1].In this sub-section, Open General Licence means an Open General Licence issued by the Central Government in pursuance of the Imports (Control) Order, 1955.] [Explanation 2.In this sub-section, the expression computer software shall have the meaning assigned to it in clause (b) of the Explanation to section 80HHE.] (2) Nothing contained in sub-section (1) shall apply in relation to any income by way of royalty received by a foreign company from an Indian concern in pursuance of an agreement made by it with the Indian concern after the 31st day of March, 1976, if such agreement is

deemed, for the [purposes of the first proviso] to clause (vi) of sub-section (1) of section 9, to have been made before the 1st day of April, 1976; and the provisions of the annual Finance Act for calculating, charging, deducting or computing income-tax shall apply in relation to such income as if such income had been received in pursuance of an agreement made before the 1st day of April, 1976.] [(3) No deduction in respect of any expenditure or allowance shall be allowed to the assessee under sections 28 to 44C and section 57 in computing his or its income referred to in subsection (1). (4) Where in the case of an assessee referred to in sub-section (1), (a) the gross total income consists only of the income referred to in clause (a) of that sub-section, no deduction shall be allowed to him or it under Chapter VI-A; (b) the gross total income includes any income referred to in clause (a) of that subsection, the gross total income shall be reduced by the amount of such income and the deduction under Chapter VI-A shall be allowed as if the gross total income as so reduced were the gross total income of the assessee. (5) It shall not be necessary for an assessee referred to in sub-section (1) to furnish under subsection (1) of section 139 a return of his or its income if (a) his or its total income in respect of which he or it is assessable under this Act during the previous year consisted only of income referred to in clause (a) of subsection (1); and (b) the tax deductible at source under the provisions of Chapter XVII-B has been deducted from such income.]

SPECIAL PROVISIONS RELATING TO TAX ON DISTRIBUTED PROFITS OF DOMESTIC COMPANIES TAX ON DISTRIBUTED PROFITS OF DOMESTIC COMPANIES. 115-O. (1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of [fifteen] per cent.] (1A) The amount referred to in sub-section (1) shall be reduced by, (i) the amount of dividend, if any, received by the domestic company during the financial year, if (a) such dividend is received from its subsidiary; (b) the subsidiary has paid tax under this section on such dividend; and (c) the domestic company is not a subsidiary of any other company :

Provided that the same amount of dividend shall not be taken into account for reduction more than once; (ii) the amount of dividend, if any, paid to any person for, or on behalf of, the New Pension System Trust referred to in clause (44) of section 10. Explanation.For the purposes of this sub-section, a company shall be a subsidiary of another company, if such other company, holds more than half in nominal value of the equity share capital of the company.] (2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on distributed profits under sub-section (1) shall be payable by such company. (3) The principal officer of the domestic company and the company shall be liable to pay the tax on distributed profits to the credit of the Central Government within fourteen days from the date of (a) declaration of any dividend; or (b) distribution of any dividend; or (c) payment of any dividend, whichever is earliest. (4) The tax on distributed profits so paid by the company shall be treated as the final payment of tax in respect of the amount declared, distributed or paid as dividends and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid. (5) No deduction under any other provision of this Act shall be allowed to the company or a shareholder in respect of the amount which has been charged to tax under sub-section (1) or the tax thereon. [(6) Notwithstanding anything contained in this section, no tax on distributed profits shall be chargeable in respect of the total income of an undertaking or enterprise engaged in developing or developing and operating or developing, operating and maintaining a Special Economic Zone for any assessment year on any amount declared, distributed or paid by such Developer or enterprise, by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2005 out of its current income either in the hands of the Developer or enterprise or the person receiving such dividend

DEDUCTION ON DIVIDEND ( SECTION 194) The principal officer of an Indian company or a company which has made the prescribed arrangements for the declaration and payment of dividends (including dividends on preference shares) within India, shall, before making any payment in cash or before issuing any cheque or warrant in respect of any dividend or before making any distribution or payment to a shareholder, [who is resident in India,] of any dividend within the meaning of sub-clause (a) or sub-clause (b) or sub-clause (c) or sub-clause (d) or sub-clause (e) of clause (22) of section 2, deduct from the amount of such dividend, income-tax at the rates in force : [Provided that no such deduction shall be made in the case of a shareholder, being an individual, if (a) the dividend is paid by the company by an account payee cheque; and (b) the amount of such dividend or, as the case may be, the aggregate of the amounts of such dividend distributed or paid or likely to be distributed or paid during the financial year by the company to the shareholder, does not exceed [two thousand five hundred] rupees: Provided further that the provisions of this section shall not apply to such income credited or paid to (a) the Life Insurance Corporation of India established under the Life Insurance Corporation Act, 1956 (31 of 1956), in respect of any shares owned by it or in which it has full beneficial interest; (b) the General Insurance Corporation of India (hereafter in this proviso referred to as the Corporation) or to any of the four companies (hereafter in this proviso referred to as such company), formed by virtue of the schemes framed under sub-section (1) of section 16 of the General Insurance Business (Nationalisation) Act, 1972 (57 of 1972), in respect of any shares owned by the Corporation or such company or in which the Corporation or such company has full beneficial interest; (c) any other insurer in respect of any shares owned by it or in which it has full beneficial interest :] [Provided also that no such deduction shall be made in respect of any dividends referred to in section 115-O.]

TAX CONSIDERATIONS IN BONUS ISSUE

For some years now, the issue of bonus equity shares has been a common phenomenon on the Indian bourses. However, one reads about other types of bonuses being issued by companies to shareholders. While some issue bonus dividends, while others proposes to issue bonus preference shares. The big question: what will be the tax treatment of the different types of bonuses, and which is more beneficial? To get a grip on the tax treatment, one needs to understand two provisions in the tax laws: the definition of dividend, and the manner of computing capital gains in respect of bonus issue of securities. DEFINITION OF DIVIDENDS: Under the tax laws, if a company distributes its accumulated profits through the release of any of its assets to shareholders, the distribution will be regarded as a dividend. The definition also includes the distribution of debentures or deposits by a company, irrespective of whether the debentures or deposits are interest-bearing or not. Further, any issue of bonus shares to preference shareholders (equity shares are not included) is also deemed to be a dividend. Computation of capital gains: In the case of bonus shares and securities, if a person, by virtue of his holding a share or any other security, is allotted additional shares and securities without having to make any payment, then for the purpose of computing capital gains, the cost of the new shares and securities is to be taken as nil. The cost of the original share or security remains unchanged. For example, if a company issues bonus equity shares, there is no tax implication in the hands of the shareholders in the year of issue of the bonus shares. But when the bonus shares are finally sold, the entire sale proceeds are taxable as capital gains. This is because the cost of the acquisition of such shares is regarded as nil. BONUS DIVIDENDS: This is a one-time dividend given on a particular occasion through the issue of dividend warrants (cheques). The company pays this out of its post-tax profits, and, therefore, does not get any deduction from its taxable income. BONUS DEBENTURES: Since bonus debentures are covered by the definition of dividends due to their specific inclusion, shareholders will have to pay tax on the capital value of the debentures they get. Further, since bonus debentures are issued out of the post-tax profit accumulated by the company, the company does not get any deduction for the value of the debentures that have been issued. In subsequent years, when the debentures are either sold or redeemed, the sale price or the redemption amount received by the debenture holder will not be taxable to the extent of the capital value of the debentures already taxed as dividend in the year of the issue of the bonus debentures. A view is however possible that, the issue of bonus debentures is also covered by the provisions relating to taxation of capital gains on the sale of bonus issues, since it involves the allotment of a security (debenture) without any payment. Since it is covered under two different provisions of law, the provision that is more specific to the case will be applicable. Again, since the definition of dividends has a specific reference to the distribution of debentures to shareholders, the more acceptable view is that the issue of bonus debentures should be regarded as dividends, rather than be covered by the provisions relating to capital gains from bonus issues.In subsequent years, when the company pays interest on the debentures, the company is allowed a deduction for this while computing its taxable income; the interest is taxable as the income of the debenture holders who receive it. Therefore, where

bonus issues of debentures are concerned, they are not tax-efficient at the time of issue, but are subsequently tax-efficient over the life of the debentures. Bonus issues of preference shares: The issue of such a bonus to equity shareholders does not involve any distribution of assets by the company to shareholders, nor is it otherwise specifically included in the definition of dividends. Such bonus issues will, therefore, be governed by the provisions relating to capital gains from bonus issues, and will not be taxed as dividends. Therefore, at the time of the issue of bonus preference shares, neither is the shareholder taxed, nor does the company get a deduction from its taxable income for the value of the bonus preference shares. When the bonus preference shares are finally sold by the shareholder or redeemed, the cost of the preference shares is to be taken as nil, and the entire sale/redemption proceeds taxable as capital gains in the shareholders hands. In subsequent years, however, preference dividends declared by the company are taxable as dividend income in the shareholders hands; on the companys part, the dividend has to be distributed out of its post-tax profits, for which it does not get any deduction from its taxable income. Therefore, this is tantamount to double taxation of the companys profits in subsequent years, since the company pays tax on its profits, while the shareholder pays tax on the distributed profits received as preference dividends. Bonus issues of preference shares are, therefore, tax-efficient in the year of allotment, but not so over the subsequent life of the preference shares. Therefore, in the current scenario, bonus preference shares are more beneficial from a shareholders tax perspective when compared with bonus debentures. However, when we compare the situation over the subsequent life of the preference shares or debentures, debentures prove to be more tax-friendly.

REFERENCES 1. Direct taxes Law & Practices, By Dr. Girish Ahuja , AY 2009-10. 2. Incometaxindia.gov.in