Investment in shares is a business and earning of dividend is not only purpose of investment, dividend being taxable S. 14A should not be applied.

[C.A. DEV KUMAR KOTHARI]

Investment in shares is also a business:

Investing into shares is a business activity. This is adventure in nature of commerce and is business within meaning under section 2(13) and section 28 of the Income-tax Act, 1961.

Capital asset:

When shares are held as investment, they are ‘capital assets’ of the business of investing into shares.

Computation of income and related aspects:

When a person carry investment activity he derives different type of incomes which can fall under one or more head of income as provided in the Act.

Dividend earned falls under the head ‘income from other sources’. It may be taxable or exempt will depend on policy of government and provision of the tax law. For example in our country we find that dividend is taxable at distribution stage and exempted in hands of shareholders. When there was no tax at distribution stage, dividend was taxable in hands of shareholders/ unit holders.

On sale of such shares income falls under the head ‘capital gains’. In case of short term gain it is taxable, in case of long-term capital gains it may be taxable or exempt in some situations. Therefore, earning of taxable income is more probable than earning of exempted income.

Any hedging gains in such activity will be ‘business income’.

 When such shares are also used as a tool to gain by way of intra-day trading, the gains will be ‘business profit’.

Expenses incurred for acquisition will be cost of acquisition and capital cost.

There cannot be any cost of improvement in case of shares, because a shareholder cannot make any addition or alteration in shares to effect improvement. Improvement in quality of shares shall depend on future prospects of company, the industry and economy, quality of management of company, profitability, profits retained, dividend paid , goodwill earned  etc. Therefore, in one sense it can be said that share in a company is not a ‘capital asset’ in context of section 45 read with section 48. Because these provisions contemplate an asset which can be acquired and also improved by incurring money. Shares can be acquired, but cannot be improved by incurring money on making changes in shares.

Expenses incurred to hold and carry investment should be regarded as recurring expenses for the purpose of business of investing.

Various purposes of acquiring shares:

Promoters of company or people in management of company acquire and hold shares to have control over the company by way of voting rights and management participation.

Traders acquire shares for trading purposes.

Investors acquire shares for capital appreciation and dividend earnings.

Dividend earning is generally very low in priority. Only in cases where shares are purchased just before record date for dividend and then also sold within short period from the record date, it can be said that shares in such circumstances were acquired for earning dividend. The law has made special provisions to deal with such situations vide provisions of section 94.

Misconception about dividend:

Unfortunately in minds of revenue authority there is wrong conception that shares are acquired to earn dividend. This wrong perception is also found when we read some of judgments of Courts and Tribunal. This need to be corrected by proper analysis.  If we go by logic, of return on investment, we can conclude that earning of dividend is not main purpose in acquisition of shares. We find that a large number of companies do not declare any dividend. There are few companies which pay dividend regularly. In such cases also dividend yield is very poor. In fact from a recent study and report dated 09.01.2012  by ICICI Direct.com we find that  out of BSE 500 companies, companies which have given yield by way of dividend in excess of 2% per annum for last seven years are considered as high dividend paying companies.  BSE 500 are good blue chip companies. Even in that lot we find number of companies in which dividend  yield is  2%  or more is just  THIRTY ONLY.

The preamble of the report reads as follows (with highlights added by author):

Dividend Yield Stocks

High dividend yield stocks offer a safe haven to investors where safety has greater priority compared to high returns. Hence, even if the market remains volatile, going ahead, an investor can still get a decent return on investment, thanks to good dividend yielding stocks. The dividends are paid no matter what direction the stocks move and can provide a higher yield on investment in a weak market. We have analysed the dividend yield pattern of BSE 500 companies and have filtered companies, which have been providing a dividend yield of at least 2% or more for the last seven years.

In this study dividend yield is calculated on financial year end closing price. Therefore, the yield worked out is not necessary correct but is indicative however, it can be considered as reliable since seven years closing price and dividend are considered.

The report and list of these companies

Exhibit 1: Consistently

Exhibit 1: Consistently high dividend yield stocks

Company Name	I direct Code	Div. Yield 2011 %	Div. Yield 2010 %	Div. Yield 2009 %	Div. Yield 2008%	Div. Yield 2007 %	Div. Yield 2006 %	Div. Yield 2005 %
Alfa Laval (I) #	ALFLAV	2.4	2.1	2.7	2.3	3.0	2.5	3.4
Allahabad Bank	ALLBAN	2.6	3.9	6.4	4.6	4.1	5.1	3.6
Andhra Bank	ANDBAN	3.6	4.6	10.0	5.4	5.0	4.3	2.8
Ashok Leyland	ASHLEY	3.5	2.7	5.5	4.3	3.9	3.3	4.8
Castrol India #	CASIND	3.3	4.1	4.5	3.9	4.0	3.3	3.8
Chambal Fertilizers	CHAFER	2.4	3.1	4.3	3.6	5.8	4.6	6.2
Clariant Chemicals #	COLCHE	4.1	5.3	12.3	3.0	5.3	7.6	2.4
Deepak Fertilizers	DEEFER	3.2	4.0	7.1	3.6	3.5	3.0	4.8
Electrosteel Castings	ELECAS	4.0	2.4	9.2	2.9	3.3	3.4	3.0
Finolex Industries	FININD	3.4	4.6	3.6	4.6	4.4	4.3	4.3
G N F C	GNFC	3.4	2.9	5.4	3.2	4.9	3.7	5.4
GE Shipping Co	GESHIP	3.0	2.7	4.3	4.0	5.7	3.4	5.9
Graphite India	CAREVE	3.8	4.0	13.7	5.8	5.8	2.0	2.3
GRUH Finance	GRUFIN	3.1	3.0	5.2	2.6	2.2	2.7	4.7
Hindustan Unilever	HINLEV	2.2	2.7	3.1	4.2	2.8	2.5	3.5
Indian Overseas Bank	INDOVE	3.5	3.8	9.9	2.6	2.9	2.7	3.2
Karnataka Bank	KARBAN	2.8	3.3	9.2	2.5	2.1	3.0	2.8
Nava Bharat Ventures	NAVBHA	2.7	2.1	5.4	2.6	4.0	2.5	2.3
O N G C	ONGC	3.0	3.0	4.1	3.3	3.5	3.4	4.5
Polyplex Corporation	POLCOR	4.9	4.1	6.2	3.8	3.9	2.4	4.3
State Bank of Travancore	STABTR	2.4	2.6	6.1	2.1	3.3	2.4	3.7
S C I	SCI	5.1	3.2	8.5	4.3	4.9	5.0	4.7
Supreme Industries	SUPIND	2.4	3.2	4.7	4.6	3.2	3.2	3.2
Syndicate Bank	SYNBN	3.0	3.5	6.3	3.7	4.4	2.8	3.7
T N Newsprint	TAMNEW	3.8	5.0	7.9	4.5	4.8	2.6	4.7
Tata Chemicals	TATCHE	3.0	2.8	6.4	3.2	3.9	2.7	4.3
Tata Elxsi	TATELX	2.8	2.2	8.5	4.4	2.4	3.3	3.0
Tata Investment Corporation	TATINV	3.1	2.6	6.5	3.1	4.4	2.8	4.0
VST Industries	VSTIND	7.0	5.8	13.3	6.5	6.1	2.6	5.4
Wyeth	WYELED	2.6	2.8	7.8	6.6	6.6	4.0	4.9

Source: Capitaline, ICICIdirect.com Research

# data for Alfa Laval, Clariant Chemicals and Castrol represents year 2010 to 2004 as these companies have a December year ending and the latest financial year end data available is till

December 2010

Note : Dividend yield is calculated on financial year end closing price

 In real life we find that more than 95% of listed companies do not pay any dividend even over a long period of five years. Dividend yield is about 0.5 to 1 % on overall basis on any stock exchange, if we consider total market capitalization and total dividend distributed by listed companies. Therefore, it is wrong to say that earning of dividend is main purpose of investing in shares or that shares are purchased to earn dividend when shares are held for a considerable period. Only in situations contemplated in section 94 it can be said that shares were purchased to earn dividend. In any other situation it cannot be said that shares were purchased to earn dividend.

Dividend is taxable:

Dividend is taxable. Dividend distributed by a company or mutual fund constitutes ‘total income’ or ‘chargeable income’ within the context of the Income-tax Act, 1961. Though it is levied as an additional tax, on companies or mutual funds, yet it is established that dividend is exempted in hands of shareholders or unit holders only when dividend has been subjected to levy of tax at distribution stage. This is a way of collecting tax in simple way.  The tax levied under section 115 O and 115 R is finally collected tax it is not refundable or allowable in any hands and in any situation.  Therefore, it cannot be said that dividend is an income which does not form part of total income or chargeable income in the context of the income-tax Act, 1961. Therefore, section 14A should not be applicable in the case of earnings by way of dividend.

Section 14A is attracted only in relation to income which does not form part of total income under the Income-tax Act. As dividend form part of total income in hands of company or mutual fund and it is taxed, therefore, section 14A is not at all applicable.