Court denies deduction claim for dividends on preference shares, ruling against company under Income-tax Act

The High Court of Karnataka ruled against the company/assessee in a case concerning the deduction of liability on account of dividend on preference shares under section 256(1) of the Income-tax Act, 1961. The court held that dividends to preference shareholders cannot be equated with interest on borrowed capital, as preference share capital is considered a contribution to the company's capital, not a borrowing subject to interest payment. Consequently, the court denied the company's deduction claim for dividends paid to preference shareholders for the assessment years 1980-81 and 1981-82.

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Issues involved: Interpretation of deduction of liability on account of dividend on preference shares u/s 256(1) of the Income-tax Act, 1961.

Summary:
The High Court of Karnataka considered the question of law regarding the deduction of liability on account of dividend on preference shares u/s 256(1) of the Income-tax Act, 1961. The company, registered under the Companies Act, claimed deduction for dividends paid to preference shareholders for the assessment years 1980-81 and 1981-82. The company relied on section 36(1)(iii) of the Act for the deduction. However, the Tribunal disallowed the deduction, leading to the question of law at hand.

The company argued that the dividend paid to preference shareholders should be treated as interest paid in respect of capital borrowed by the company, thus eligible for deduction. The court examined the statutory provisions and ruled that the construction proposed by the company was not supported by a plain reading of the law or any permissible rule of interpretation.

The court referred to section 85 of the Companies Act, which defines preference share capital and highlights that dividends, including those on preference shares, can only be paid out of the profits of the company. Preference share capital is considered a contribution to the company's capital by shareholders, not a borrowing subject to interest payment. Therefore, the court concluded that dividends to preference shareholders cannot be equated with interest on borrowed capital.

In light of the above analysis, the court answered the question against the company/assessee and in favor of the Revenue, denying the deduction claim. No costs were awarded in this judgment.

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