Redemption of capitalised preference shares can be taxed as dividend when repayment releases assets and distributes accumulated profits.

Redemption of redeemable preference shares issued out of capitalised accumulated profits was treated as a fresh distribution of accumulated profits because the repayment in cash released company assets; the redemption amount was therefore taxable as dividend under section 2(6A)(a) of the Income-tax Act, 1922. The earlier capitalisation of profits did not prevent the later charge on redemption. The price paid to acquire the shares was held not deductible in computing dividend income, as it was incurred before the relevant year and was capital expenditure, not revenue expenditure.

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Issues: (i) Whether the amount received on redemption of redeemable preference shares issued out of capitalised accumulated profits was taxable as dividend under section 2(6A)(a) of the Income-tax Act, 1922. (ii) Whether the purchase price paid for acquiring the redeemed shares was allowable as a deduction in computing dividend income.

Issue (i): Whether the amount received on redemption of redeemable preference shares issued out of capitalised accumulated profits was taxable as dividend under section 2(6A)(a) of the Income-tax Act, 1922.

Analysis: The provision extended the meaning of dividend to a distribution of accumulated profits, whether capitalised or not, only where the distribution entailed release of the company's assets. The issue of bonus preference shares out of capitalised profits was treated as a distribution of accumulated profits, but not one involving release of assets, because the profits were converted into share capital and remained in the company's coffers. On redemption, the company returned the preference share capital in cash to the holders, and that payment represented the very capitalised accumulated profits earlier converted into preference share capital. The redemption therefore produced a fresh physical distribution of those accumulated profits and did entail release of assets. The fact that the same accumulated profits had earlier been capitalised did not prevent their later distribution on redemption.

Conclusion: The amount of Rs. 38,000 received on redemption was dividend within section 2(6A)(a) and was rightly assessed in the hands of the assessee.

Issue (ii): Whether the purchase price paid for acquiring the redeemed shares was allowable as a deduction in computing dividend income.

Analysis: The shares were purchased before the accounting year in question, so the price could not be treated as expenditure incurred in that year for computing the year's income. In any event, the amount paid to acquire the shares was capital expenditure and was not deductible against dividend income under the charging provision relied upon.

Conclusion: The purchase price was not allowable as a deduction.

Final Conclusion: The reference was answered against the assessee on both questions, and the tax treatment of the redemption amount was upheld.

Ratio Decidendi: Where accumulated profits are capitalised into redeemable preference share capital, their later repayment on redemption constitutes a distribution of accumulated profits entailing release of assets and is taxable as dividend; the acquisition price of the shares is capital expenditure and not deductible against such income.

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