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 "dividend" and the legal fiction must be carried to its logical end; consequently, the amount treated as deemed dividend is adjusted against and reduces the company's accumulated profits whenever those profits are computed. The HC's view was upheld and the issue was decided in favour of the assessee. On reduction of share capital where a shareholder received cash and property, the portion attributable to accumulated profits is excluded as dividend, but the balance is a capital receipt and capital gains must be computed by valuing the property and applying cost of acquisition; the Tribunal's "no transfer/no capital gains" view was rejected and the matter remitted, in favour of the Revenue.

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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.

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