Chapter 4: Taxation of Dividend & Deemed Dividend
CHAPTER
Taxation of Dividend
4 & Deemed Dividend
Question 1 [Dividend & 80M – Past RTP Q.]
ABC Ltd. ,an Indian company, receives the following dividend income during the P.Y. 2023-24 -
(i) from shares held in BCD Inc., a Danish company, in which it holds 25% of nominal value of
equity share capital– `65,000;
(ii) from shares held in EFG Inc., an English company, in which it holds 31% of nominal value
of equity share capital– `1,50,000.
(iii) From shares held in HIJ Inc., a Dutch company, in which it holds 62% of the nominal value
of equity share capital- `1,07,000.
(iv) From shares held in Indian subsidiaries, – `47,000.
ABC Ltd. has paid remuneration of `16,000 for realising dividend, the breakup of which is as follows
–
(1) `4,000 (BCD Inc.);
(2) `7,000 (EFG Inc.)
(3) `5,000(Indian subsidiaries)
The business income of ABC Ltd. computed under the provisions of the Act is `48 lakh. Compute
the total income and tax liability of ABC Ltd., ignoring MAT. Assuming that ABC Ltd. has distributed
dividend of `4,20,000 in February, 2024. Ignore the provisions of double taxation avoidance
agreement, if any, applicable in this regard. T/O of company for PY 21-22 is 450 Crores. Ignore the
provisions of section 115BAA.
Answer
Computation of Total Income of ABC Ltd. for A.Y.2024-25
Particulars `
Profits and gains of business or profession 48,00,000
Income from other sources (See Note below) 3,69,000
Gross Total income 51,69,000
Less: Deduction u/s 80M
(i) Dividend from Dom. & Foreign Company. 3,69,000
(ii) Dividend distributed by ABC Ltd. 4,20,000 (3,69,000)
Whichever is Lower
Total Income/Net Taxable Income 48,00,000
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Chapter 4: Taxation of Dividend & Deemed Dividend
Particulars `
From BCD Inc., a Danish company 65,000
From EFG Inc., an English company 1,50,000
From HIJ Inc., a Dutch company 1,07,000
From shares in Indian subsidiaries 47,000
Dividend is taxable at normal rates [No deduction is allowed in respect of any expenses 3,69,000
except interest as per sec 57]
Computation of tax liability of ABC Ltd. for the A.Y.2024-25
Particulars `
Tax @ 30% on balance income of `48,00,000 14,40,000
Add: Health & Education cess @ 4% 57,600
Tax liability 14,97,600
Question 2 [Sec 2(22)(e) – SM Q.]
Pico Ltd. is a company in which the public are not substantially interested. Tico is a Shareholder of
the company holding 15% of the equity shares. The accumulated profits of the company as on
31.03.2023 amounted to `10,00,000/-. The company lent `1,00,000/- to Tico by an account payee
bank draft on 01.10.2023. The loan was not connected with the business of the company. Tico
repaid the loan to the company by an account payee draft on 30.03.2024. Examine the effect of the
borrowing and repayment of the loan by Tico on the computation of his total income for A.Y. 2024-
25.
Answer
As per section 2(22)(e), any payment by a company in which the public are not substantially interested, being
a person who is the beneficial owner of shares holding not less than 10% of the voting power, shall be treated
as dividend to the extent to which the company possesses accumulated profits.
In the instant case, Pico Ltd. is a company in which the public are not substantially interested. The company
has accumulated profits of `10,00,000/- on 31.03.2023. The loan given by the company to Tico was not in the
course of its business. Tico holds more than 10% of the equity shares in the company. Therefore, assuming
that Tico has voting power equivalent to his shareholding, Section 2(22)(e) comes into play and the sum of
`1,00,000/- representing the amount lent by the company to Tico is treated as Deemed Dividend u/s 2(22)(e),
the liability arises the moment the loan is borrowed by the shareholder and it is immaterial whether the loan is
repaid before the end of accounting year or not. Therefore, the repayment of loan by Tico of the company on
30.03.2024 will not affect the tax ability of the sum of `1,00,000/- as dividend in hands of Shareholder.
Question 3 [Sec 2(22)(e) – SM Q.]
Meera, Managing Director of Spiritual Engineering Pvt. Ltd. holds 70% of its paid up capital of `20
Lakhs. The balance as at 31.03.2023 in General Reserve was `6 Lakhs. The company on
01.07.2023 gave an interest free loan of `5 Lakhs to its supervisor having salary of `4000/- p.m.
who in turn on 15.08.2023 advanced the said amount of loan so taken from the company to Smt.
Meera. The A.O. had taxed the amount of advance in the hands of Meera. Is the action of the A.O.
correct?
Answer
The company had advanced a loan to an employee who in turn had advanced the same to the Managing
Director of the company holding 70% of its capital. By virtue of the provisions of Section 2(22)(e), the same
shall be treated as the payment by a company on behalf of, or for individual benefit of any such shareholder
(who holds not less than 10% of the voting power), to the extent to which the company possesses
accumulated profits.
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Chapter 4: Taxation of Dividend & Deemed Dividend
In this case, the company has reserves of `6 Lakhs on 31st March of the preceding year and the amount of
loan advanced on 1st July is `5 Lakhs. Therefore, the payment is to be treated as deemed dividend. The
amount of interest free loan of `5 Lakhs given by the company to the supervisor who in turn had given the
same to Smt. Meera, shall be construed as the amount given for the benefit of Ms. Meera and is treated as
deemed dividend been held by the Supreme Court in the case of L. Chettiar (2001). In this case, dividend
income is taxable in hands of Meera.
Question 4 [Sec 2(22)(e) – NOV-16]
MNO Ltd., a listed company, wanted some credit facilities from the bank for its business purpose.
The bank insisted on personal guarantee of the directors as a precondition for providing financial
assistance to the company. The directors were employees of the company who were drawing
salary from the company. A resolution was passed for paying commission to the directors and a
sum of `24.50 lakhs each was paid as commission calculated at the rate of 1.5% of the principal
sum, in respect of which personal guarantee was furnished by the directors to the bank.
The assesse claimed the expenses as business expenditure. But applying section 36(1)(ii), the
Assessing Officer held that if the amount was not paid to them as commission, the same would
have been payable as dividend. Is the action of the Assessing Officer valid?
Answer
The issue under consideration in this case is whether guarantee commission paid by a company to its
employee directors is deductible as its business expenditure, where such guarantee was given by the
employee directors to the bank for enabling credit facility to the company, and whether it can be contended
that the same would have been payable as dividend had it not been paid as commission.
In the absence of any specific disallowance, an expenditure incurred wholly and exclusively for the purpose
of business has to be allowed under section 37.
The directors of the company are employee of the company and are entitled to remuneration for the services
rendered as employees. In this case, they also provided personal guarantee to banks, since it was a pre-
condition laid down by the bank to provide financial assistance to the company. This act of providing
personal guarantee was clearly beyond the scope of their services as employees of the company.
The assessee-company, in its commercial wisdom, had passed a resolution resolving that the directors be paid
commission for providing their personal guarantees for the financial assistance availed by the assesse-
company from the bank. In such a case, the Assessing Officer only has to determine whether the transactions
are real and genuine.
Further, as regards section 36(1)(ii), the recipient directors were not entitle to receive the amount as
commission in lieu of dividend. Dividend is paid to all the shareholders and the recipient directors were not
the only shareholders of the company. The payment of commission, hence, cannot be taken as payment of
dividend, since payment of dividend would result in payment to all the shareholders and not to select
shareholders.
Therefore, the action of the Assessing Officer, holding that if the amount was not paid to them as
commission, the same would have been payable as dividend, is not valid.
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Chapter 5: Taxation in Case of Liquidation & Buy Back
CHAPTER
Taxation in Case of
5 Liquidation & Buy Back
Question 1 [Liquidation – NOV-16 ]
Mr. Raghu purchased `10,000 equity shares of AB Avenues Private Limited on 25.5.2005
`1,20,000. The company went into liquidation on 31.7.2023. The following is the summarized
financial position of the company as on 31.7.2023.
Liabilities ` Assets `
60,000 equity shares of `10 6,00,000 Agricultural lands in urban area 22,00,000
each
General reserve 40,00,000 Cash at bank 32,22,212
Liability for income tax 8,22,212
54,22,212 54,22,212
The assets remaining after discharging liability for income tax were distributed to the shareholders
in the proportion of their shareholding. The market value of agricultural land as on 31.7.2023 is
`60,00,000. The agricultural land received as above was sold by Mr. Raghu on 28.2.2024 for
`15,00,000.
Discuss the tax implication in the hand of the company and Mr. Raghu. The cost inflation indices
are F.Y. 2005-06: 117 and 2023-24: 348
Answer
Tax implications in the hands of the company
Distribution of capital assets amongst the shareholders on liquidation of the company is not regarded as
“transfer” in the hands of the company. Consequently, there will be no capital gains in the hands of the
company as per section 46(1).
Any distribution made to the shareholders of a company on its liquidation, to the extent to which distribution
is attributable to the accumulated profits of the company immediately before its liquidation would be deemed
as dividend under section 2(22)(c). Therefore, distribution made to shareholders to the extent of `40,00,000,
being the amount of general reserves on the date liquidation would be deemed as dividend. It will be taxable
in hands of shareholders as dividend. Mr. Raghu is 1/6 shareholder so (40,00,000x1/6) Taxable in his hands
in PY 23-24 in IFOS.
Tax implications in the hands of Mr. Raghu (shareholder)
(i) On liquidation (31.7.2023)
As per section 46(2), where a shareholder on the liquidation of a company receives any money or
other assets from the company, he shall be chargeable to income-tax under the head “capital gains”
in respect of the money so received or the market value of the other assets on the date of the
distribution, as reduced by the amount assessed as dividend under section 2(22)(c) and the sum so
arrived at shall be deemed to be the full value of consideration for the purpose of section 48.
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Chapter 5: Taxation in Case of Liquidation & Buy Back
Particulars `
Net distributed profits to the extent of accumulated profits 40,00,000
Mr. Raghu holds 1/6th of the shareholding of the company, Market value of 10,00,000
agricultural land received (`60 lakhs x 1/6th)
Cash at bank [1/6th of (32,22,212 - 8,22,212)
The tax liability ascertained at `8,22,212 has to be reduced from bank balance 4,00,000
while computing full value of consideration under section 46(2).
14,00,000
Less: Deemed dividend under section 2(22)(c) – 1/6th of `40,00,000 6,66,667
Consideration for computing Capital Gain (FVOC) 7,33,333
Less: Indexed cost of acquisition of Shares [(`1,20,000 x 348) /117] 3,56,923
Long term capital gains 3,76,410
Dividend under section 2(22)(c) amounting to `6,66,667 will be taxable in hands of Raghu under
IFOS.
(ii) On sale of agriculture land
Where the capital asset became the property of the assesse on the distribution of the capital assets of a
company on its liquidation and the assessee has been assessed to capital gains in respect of that asset
under section 46, the cost of acquisition means the fair market value of the asset on the date of
distribution as per section 55(2)(b)(iii). Hence, the short- term capital gains in the hands of Mr.
Raghu (shareholder) at the time of sale of urban agricultural land should be computed as follows:
Particulars `
Sale consideration 15,00,000
Less: Fair market value of the agricultural land on the date of distribution 10,00,000
Short term capital gain 5,00,000
Question 2 [Buy Back – Past RTP ]
Dal Ltd., a domestic company, purchases its own unlisted shares on 17th August, 2023.
The consideration for buy back amounted to `18 lakh, which was paid on the same day. Dal Ltd.
had received `11 lakh on issue of these shares one year back.
Compute the additional income-tax payable by Dal Ltd. Further, determine the interest, if any,
payable if such tax is paid to the credit of the Central Government on 7th November, 2023. Would
there be any tax implication in the hands of the shareholders ? Discuss.
Answer
As per section 115QA, the distributed income would be subject to additional income-tax @ 20% (plus
surcharge @12% and Health & education cess @ 4%) in the hands of the domestic company. Distributed
income is the consideration paid by the company for buy back of its own unlisted shares which is in excess of
the sum received by the company at the time of issue of such shares.
Accordingly, Dal Ltd is liable to pay `1,63,072 as additional income-tax, which is the amount calculated @
23.296% (20% plus surcharge @ 12% plus cess @4%) on `7 lakh, being its distributed income (i.e., `18 lakh
— `11 lakh).
The additional income-tax was payable on or before 31st August, 2023. However, the same was paid only on
7th November, 2023.
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Chapter 5: Taxation in Case of Liquidation & Buy Back
Interest u/s 115QB is attracted @1% for every month or part of the month on the amount of tax not paid or
short paid for the period beginning from the date immediately after the last date on which such tax was
payable and ending with the date on which the tax is actually paid.
In this case, the period for which interest @ 1% per month or part of a month is leviable is calculated as
under—
Period No. of months/part of month
• 1st September - 30th September (whole of first month) 1
• 1st October – 31st October, (whole of second month) 1
• 1st November –7th November, (part of third month) 1
Total number of months 3
Interest u/s 115QB is payable @1% per month for 3 months on the amount of additional tax payable i.e.,
`1,63,072. Therefore, interest payable u/s 115QB is `4,892.
The income arising to the shareholders in respect of such buyback of unlisted shares by Dal Ltd. would be
exempt u/s 10(34A) in their hands.
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Chapter 6: Taxation in Case of Amalgamation and Demerger
CHAPTER
Taxation in Case of
6 Amalgamation and Demerger
Question 1 [Demerger – NOV-15 ]
DSK (P) Ltd., a domestic company having two undertakings engaged in manufacturing of cement
and steel, decided to hive off cement division to RSA (P) Ltd, a domestic Indian company, by way
of demerger. The net book value of assets of DSK (P) Ltd. Was `40 Crores before demerger. The
net book value of assets transferred to RSA (P) Ltd was `10 crores. The demerger was made in
January 2024. In the scheme of demerger, it was fixed that for each equity shares of `10 each (fully
paid up) of DSK (P) Ltd. Two equity shares of `10 each (Fully paid) were to be issued.
One shareholder Mr. K.T. held 25000 equity shares in DSK (P) Ltd. which were acquired in the
Financial Year 2002-03 for `6,00,000/-. Mr. K.T. received 50000 equity shares from RSA (P) Ltd.
Consequent to demerger in January 2024. He sold all the shares of RSA (P) Ltd for `8,00,000/- in
March 2024. In this background you are request to answer the following:—
(a) Does the transaction of demerger attract any Income Tax Liability in the hands of DSK (P)
Ltd and RSA (P) Ltd.
(b) State the conditions in brief, which are to be satisfied under the Act for a demerger.
(c) Compute the capital Gain that could arise in the hands of KT on receipt of shares of RSA
(P) Ltd.
(d) Compute the Capital gains that could arise in the hands of Mr. K. T. on sale of shares of
RSA (P) Ltd.
(e) Will the sale of shares by Mr. K. T. affect the tax benefit availed by DSK (P) Ltd. and/or RSA
(P) Ltd.?
(f) Is Mr. K. T. eligible to avail any tax exemption under any of the provisions of the Income Tax
Act, 1961 on the sale of shares of RSA (P) Ltd.? if so, state in brief.
Notes:
Financial Year CII
2002-03 105
2023-24 348
Answer
(a) No, the transaction of demerger would not attract any income tax liability in the hands of DSK (P)
Ltd. or RSA (P) Ltd.
As per section 47(vib), any transfer in a demerger is a capital asset, by the demerged company to the
resulting company would not be regarded as “Transfer” for levy of capital gains tax liability if the
resulting company is an Indian Company.
Hence, Capital Gains tax liability would not be attracted in the hands of DSK (P) Ltd., the demerged
company in this case, since RSA (P) Ltd. is an Indian Company.
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Chapter 6: Taxation in Case of Amalgamation and Demerger
(b) Refer “COMPACT” Theory Book
(c) There would be no capital gains liability in the hands of Mr. K. T. on receipt of shares of RSA (P)
Ltd.
Since as per Section 47(vid), any issue of shares by the resulting company in a scheme of demerger to
the shareholders of the demerger company will not be regards as transfer for levy of capital gains tax,
if the issue is made in consideration of demerger of the undertaking.
(d) Yes, the Capital Gains would arise in the hands of Mr. K.T. on sale of shares of RSA (P) Ltd.
Particulars `
Sale Consideration 8,00,000
Less: Indexed Cost of Acquisition of shares of RSA (P) Ltd.
Cost of Acquisition of shares of RSA (P) Ltd. as per section 49(2C)
COA of shares of DSK (P) Ltd. × Net Book value of assets transferred in a demerger
Net worth of the demerged Company immediately Before demerger
6, 00, 000 × ` 10 Crores
= ` 1, 50, 000 / -
` 40 Crores
Indexed Cost of Acquisition of shares of RSA (P) Ltd. 1,50,000 × 348 4,97,143
105
LTCG (Since POH of shares in demerged company is also to be considered) 3,02,857
(e) No, sale of shares by Mr. K. T. would not affect the tax benefits availed by DSK (P) Ltd. or RSA (P)
Ltd. One of the conditions to be satisfied is that the shareholders holding not less than three fourths in
the value of the shares in the demerged company become shareholders of the resulting company by
virtue of the demerger. It is presumed that the condition is satisfied in this case.
There is no stipulation that they continue to remain shareholders for any period of time thereafter.
(f) Since the resultant capital gain on sale of shares of RSA (P) Ltd. is a long-term capital gain (on
account of the period of holding (POH) of shares in demerged company being considered by virtue of
section 2(42), Mr. K. T. can avail exemption u/s 54F by investing the entire net consideration in
purchase (within one year before and two years after the date of transfer) or construction (within three
years after the date of transfer) of one residential house in India. If part of the net consideration would
be available.
Question 2 [Demerger – NOV-02 ]
X Ltd., a pharmaceutical company having accumulated losses and unabsorbed depreciation to be
set off in future for `130 lacs and `250 lacs as on 31.3.2023 was demerged on 16.5.2023 and 30%
of its total assets were transferred to the resulting company, XY Ltd. How shall the accumulated
losses and unabsorbed depreciation of the demerged company be dealt with in the return for
Assessment Year 2024-25 of the resulting company:
(i) When the same are not directly relatable to the undertakings transferred and
(ii) When the same are directly relatable to the undertakings transferred.
Answer
Section 72A(4) provides that notwithstanding anything contained in any other provisions of this Act, in the
case of a demerger, the accumulated loss and the allowance for unabsorbed depreciation of the demerged
company shall –
(a) Where such loss or unabsorbed depreciation is directly relatable to the undertakings transferred to the
resulting company, be allowed to be carried forward and set off in the hands of the resulting
company;
(b) Where such loss or unabsorbed depreciation is not directly relatable to the undertakings transferred to
the resulting company, be apportioned between the demerged company and the resulting company in
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Chapter 6: Taxation in Case of Amalgamation and Demerger
the same proportion in which the assets of the undertakings have been retained by the demerged
company and transferred to the resulting company and be allowed to be carried forward and set off in
the hands of the demerged company or the resulting company, as the case may be.
Therefore, if the loss and unabsorbed depreciation relates directly to the undertakings transferred, then such
loss and depreciation shall be carried forward by the resulting company and not the demerged company.
However, if such loss and unabsorbed depreciation is not directly relatable to the undertakings
transferred to the resulting company, then the loss and depreciation shall be apportioned between the
demerged company and resulting company in the following proportion:
Assets retained by the demerged company : Assets transferred to the resulting company
The law is silent about the period of carry forward of such losses and depreciation. Logically, such losses and
depreciation should be allowed to be carried forward for the balance number of years for which the demerged
company would have carried forward.
Loss to be carried forward by
X Ltd. (` In lakh) XY Ltd. (` In lakh)
When the losses are directly relatable to undertaking
transferred
- Loss - 130
- Depreciation - 250
When the losses are not directly relatable to undertaking
transferred
- Loss 91 39
- Depreciation 175 75
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