1998 (12) TMI 5 - SC - Income Tax

Deemed dividend u/s2(22)(e) and share capital reduction payouts: accumulated profits reduced; capital gains recalculated on remand

A deemed dividend under s. 2(22)(e) must be treated as a dividend payment out of accumulated profits, because s. 194 mandates tax deduction on such ... Scope and ambit of deemed dividends - reduce the accumulated profits of the company for the purposes of calculating the distribution of accumulated profits under section 2(22)(d) - pro-rata distribution of some properties of the company and payment of money to the shareholders - Whether, the Appellate Tribunal was right in holding that no capital gain was assessable in the hands of the assessee as there was no extinguishment of any right of the assessee and consequently there was no transfer within the meaning of section 2(47), by the assessee of any capital assets for the assessment year 1963-64? - HELD THAT:- Under section 194 of the Income-tax Act, an obligation is cast upon the principal officer of the company to deduct from the payment so made under section 2(22)(e), Income-tax Act, at the rates in force. Section 194 clearly treats such payment as dividend. Therefore, when a loan by a company to a shareholder in the manner set out in section 2(22)(e) is treated as a deemed dividend, it is to be treated as payment out of the accumulated profits of the company. Any legal fiction will, therefore, have to be carried to its logical conclusion. If the payment under section 2(22)(e) is treated as a deemed dividend and is required to be so treated to the extent that the company possesses accumulated profits, the logical conclusion is that this payment must be considered as adjusted against the company's accumulated profits to the extent that it is treated as deemed dividend while calculating accumulated profits of the company. Whenever accumulated profits of the company are required to be determined, such an adjustment will have to be made. The High Court was, therefore, right in coming to the conclusion that when section 2(22)(e) is read with the language of section 194 which provides for deduction of tax on such 'dividend', as also the statutory restriction under the Companies Act on payment of dividend out of any capital assets, it would be reasonable to come to the conclusion that the sum must be taken to have come out of the accumulated profits. It must, therefore, be treated as dividend for all purposes, and would go to reduce the accumulated profits of the company whether capitalised or not whenever such accumulated profits are required to be determined. Question is, therefore, answered in the affirmative and in favour of the assessee. Assessable to any capital gains tax in respect of the amounts/property received by him from the company as a result of the reduction of his share capital - The assessee in the present case has been paid not merely cash but has also been given a property for the reduction in the value of his shares from Rs. 1,000 to Rs. 210. Out of the total amounts so received including the value of the property so received, the portion attributable to accumulated profits will have to be deleted. Only the balance amount can be treated as a capital receipt. Thereafter looking to the cost of acquisition of that portion of the share which has been diminished, capital gains will have to be determined. The Tribunal, while computing capital gains, will have to decide how this property should be valued for the purpose of deciding what the assessee has received on reduction in the value of his shares, and whether any capital gains have accrued to the assessee or not. This question was not required to be considered by the Tribunal because the Tribunal came to the conclusion that there being no transfer of any capital asset, the question of capital gains did not arise. But the question will now have to be considered and decided by the Tribunal when the matter goes back before it for the determination of capital gains, if any. Question is, therefore, answered in the negative and in favour of the Revenue. The appeal is disposed of accordingly. Issues Involved:1. Interpretation of section 2(22) of the Income-tax Act in relation to deemed dividends.2. Assessment of capital gains tax on amounts received due to reduction of share capital.Detailed Analysis:Issue 1: Interpretation of section 2(22) of the Income-tax Act in relation to deemed dividends:The case involved a shareholder who received amounts from a company due to the reduction of share capital. The question was whether such amounts should be considered as deemed dividends and how they impact the accumulated profits of the company. Section 2(22)(e) of the Income-tax Act deems any payment by a company to a shareholder as a deemed dividend to the extent of the company's accumulated profits. The court clarified that when a company's payment is treated as a deemed dividend, it should be considered as coming out of the accumulated profits of the company, whether capitalised or not. The court emphasized that any legal fiction must be logically concluded, and such payments should reduce the accumulated profits of the company. Therefore, the sum received by the shareholder was deemed as a dividend, reducing the accumulated profits of the company. The court answered Question No. 1 in favor of the assessee.Issue 2: Assessment of capital gains tax on amounts received due to reduction of share capital:The second issue revolved around whether the shareholder was liable for capital gains tax on the amounts received from the company as a result of the reduction in share capital. The court referred to section 45(1) of the Income-tax Act, which imposes tax on profits or gains arising from the transfer of a capital asset. The court interpreted 'transfer' under section 2(47) to include the extinguishment of any rights in a capital asset, leading to a charge under section 45. The court held that the reduction in share capital extinguished the shareholder's rights proportionately, constituting a transfer and subjecting the amount received to capital gains tax. The court also discussed the impact of section 2(22)(d) on such capital gains, emphasizing that distributions correlated with accumulated profits are deemed as dividends. The court concluded that the shareholder's receipt was partly attributable to accumulated profits and partly to capital, with the former being taxable as dividend and the latter as capital gains. The court answered Question No. 2 in favor of the Revenue.In conclusion, the judgment clarified the treatment of amounts received by a shareholder due to the reduction of share capital, addressing both the deemed dividends under section 2(22) and the assessment of capital gains tax under section 45.