ITO 8(1)(2), MUMBAI vs. SHAILESH D. SHAH, MUMBAI

We notice that the Authority for Advance Rulings has considered an identical issue in the case of Briggs of Burton (India) (P) Ltd (274 ITR 595) and the AAR has held that, when a company issues bonus redeemable preference shares to existing equity shareholders, no income would accrue to non-resident equity shareholders being allottees and, therefore, company is not required to deduct tax at source and further distribution of accumulated profits through issue of bonus redeemable preference shares to existing equity shareholders would not bring it within mischief of section 2(22). The relevant discussions made by AAR are extracted below:-

5. From a careful consideration of the (definition of dividend given in the IT Act), it is clear that distribution of accumulated profits by the company through issue of bonus redeemable preference shares to the existing equity shareholders would not bring it within the mischief of Section 2(22) of the IT Act, 1961. The relevant provisions are as under :

2(22) dividend includes--

3 Shri Shailesh D. Shah (a) any distribution by a company of accumulated profits, whether capitalized or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company; (b) any distribution to its shareholders by a company of debentures, debenture- stock or deposit certificates in any form, whether with or without interest, and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalized or not"

From a reading of the Sub-clause (a), it will be clear that not only there has to be a distribution by the company of accumulated profits, but such distribution must entail the release of assets by the company to the shareholders. This issue has been dealt with in a number of judicial pronouncements, and the following passages from the decision of Hon'ble Gujarat High Court in the case of Sashibala Navnitlal v. CIT (1964) 54 ITR 478 (Guj), lucidly explains the legal position :

"As observed by Hidayatullah J. in CIT v. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (SC) after the accumulated profits are converted into capital and bonus shares are issued credited as fully paid up "the company employs that money not as reserves of profit, but as its proper capital issued to and contributed by the shareholder". If this be the correct legal analysis of what happens when bonus shares are issued by a company, it is clear that at that stage there is a distribution of capitalized accumulated profits, though that distribution does not take the form of payment of accumulated profits in cash to the shareholders and does not, therefore, entail release of any assets of the company so as to fall within Section 2(6A)(a) [of the 1922 Act). This view which we are taking is amply supported by authorities but, more than the authorities, there is a statutory enactment which clearly shows that when bonus shares are issued credited as fully paid up out of capitalized accumulated profits, there is distribution of capitalized accumulated profits though such distribution does not entail release of assets of the company."

The above view of the Hon'ble Gujarat High Court is based on the decision of Hon'ble Supreme Court in the case of CIT v. Dalmia Investment Co. Ltd (supra). It has been held by the Hon'ble apex Court as under :

"A dividend in the strict sense means a share in the profits and a share in the profits can only be said to be paid to the shareholder when a part of the profits is released to him in cash and the company pays that amount and the shareholder takes it away. The conversion of the reserves into capital does not involve the release of the profits to the shareholder; the money remains where it was, that is to say, employed in the business. Thereafter the company employs that money not as reserves of profits, but as its proper capital issued to and contributed by the shareholder."

4 Shri Shailesh D. Shah "The Indian IT Act defines "dividend and also extends it in some directions but not so as to make the issue of bonus shares a release of reserves as profits so that they could be included in the term.

The above interpretation is further clarified by reading of 2(22)(b) [for which there is no corresponding provision in the 1922 Act], in which the words "if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company" are omitted. In other words, distribution of accumulated profit by way of issue of bonus shares to preference shareholders of the company will have to be treated as deemed dividend at the time of issue itself. It necessarily follows that the legislative intent is that issue of bonus preference shares, to equity shareholders should not be treated as deemed dividend at the time of issue, but only when it can be said that there is a release of assets of the company to the shareholder within the meaning of Sub-clause (a).

For the above mentioned reasons, we rule as follows :

When the applicant allots bonus redeemable preference shares to the existing equity shareholders, no income would accrue to the non-resident equity shareholders being the allottees and, therefore, the company is not required to deduct tax at source at this stage.