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TMI Blog1953 (6) TMI 12X X X X Extracts X X X X X X X X Extracts X X X X ..... nce shares and 22,500 ordinary shares, in each case of ₹ 100 each. Under clause 5 of the Memorandum of Association of the company, the preference shares confer on their holders the right to a fixed cumulative preferential dividend at the rate of 6 per cent per annum on the capital for the time being paid up thereon. The shares have been fully paid up. For the year 1948, the company decided to pay on its preference shares a dividend at the rate of 6 per cent. per annum, less Income Tax, and, in fact, paid to them a sum of ₹ 1,54,687. At the same time it declared a dividend of 12 1/2 per cent. free of Income Tax on its ordinary shares and paid on that account a sum of ₹ 9,17,063. No question arises in this reference with regard to that payment. With out deduction of Income Tax, a dividend of 6 per cent on the preference shares would have amounted to ₹ 2,25,000. The company keeps its accounts by the English calendar year and therefore the assessment year, relative to the accounting year 1948 was the year 1949-50. The rates of Income Tax for that year were fixed by the Indian Finance Act of 1949. Section 9 of that Act provided that for the year beginning on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cent. In respect of the preference shares, it was bound under its Memorandum of Association to pay a dividend of 6 per cent, but it purported to discharge that liability by paying not a sum of ₹ 2,25,000 which would represent the full 6 per cent, but only a sum of ₹ 1,54,687 which represented 6 per cent less Income Tax. In the course of its assessment for 1949-50 the company raised a contention that in computing the excess for the purpose of the first proviso to clause B of Part I of Schedule III of the Finance Act of 1949 only the sum of ₹ 1,54,687 should be taken as the amount of the dividend declared on the preference shares and not the sum of ₹ 2,25,000. The only question in the present reference is whether that contention of the company was right. It was held by the Income Tax Officer to be wrong, but by the Appellate Assistant Commissioner to be right and again held to be wrong by the Appellate Tribunal. The company has thereafter brought up the question to this Court and it has been referred in the following form :- Whether the expression dividend declared in the proviso (i) to clause B of Part I of the Third Schedule to the Indian Finance Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt. less Income Tax. Was that a declaration of ₹ 1,54,687 or of ₹ 2,25,000 ? Before dealing with the contentions of the parties, it will be useful to refer broadly to the incidents of a declaration of a dividend from the point of view of company law and of a declaration free of or less tax, as concerning the company on the one hand and the shareholders on the other. A dividend is the share of a company's profits whether at a fixed rate or otherwise, which is allocated to the shareholders at a division. The profits are determined by deducting the expenditure from the receipts, but not also by deducting the Income Tax, because tax is not one of the items of expenditure incurred in order to the earning of profits, but is a levy on the profits after they have been earned. A dividend can be paid only out of the profits though it need not be out of the profits of the current year. But in every case it is for the company to decide whether it will pay any dividend at all and if it decides to pay, what sum it will set aside to be declared and distributed by way of dividends. In determining the quantum of the sum, which is called divisible fund, the company has to take int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... declared less tax, a portion of the fund will remain in the hands of the company. In the first case the company will have to pay tax on its total profits including in them the divisible fund from other funds in its hands, but in the second case it will be able to apply to such payment a portion of the divisible fund itself. This, however, can happen only when a divisible fund is first created merely on the basis of a certain percentage of the share capital and a dividend of that percentage is declared tax-free in one case and less tax in the other. In actual practice the divisible fund will be a particular sum which the company thinks it can pay by way of dividends and the percentage of the dividend and the form in which it will be declared will be a matter of calculation. The company will take into account the financial implications of tax-free dividend and a dividend less tax and decide a dividend of what percentage and what form it can pay with the fund which it has set aside for distribution as dividends. The whole of the divisible fund will be paid out. What is important to notice, however, is that as between a declaration of a certain percentage of dividend tax-free and a de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of which the dividend has been paid. But Section 49B of the Income Tax Act provides that when a dividend has been paid by a company to a shareholder the latter shall, if the dividend is included in his total income in his own assessment, be deemed to have himself paid tax in respect of the dividend at the rate applicable to the income of the company. In other words, the payment by the company is treated as payment by the shareholder who thus gets the benefit of it. Because he gets such benefit, the amount of payment is deemed to be his additional income on the dividends and accordingly Section 16(2) of the Act provides that in including the dividend in his total income the amount actually received shall be increased to such an amount as would leave a sum equal to it, if the Income Tax at the rate applicable to the company were deducted therefrom. In other words, the true dividend income is taken to be a hypothetical sum which, after deduction of tax at the company rate, would be reduced to the amount actually received. Next comes Section 18(5) which, so far as dividend income is concerned, is practically of the same effect as Section 49B and it provides that any sum by which a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (2) is that in the first case, the net or basic amount taken for grossing up will be the full percentage of the dividend which the shareholder has received in full, while in the second case it will be the sum reduced from the full percentage by deduction of tax, which is the sum the shareholder has actually received. In each case, the sum actually received by the shareholder will be taken only as a net sum to which the gross sum of the dividend has been reduced by deduction of tax. It will, therefore, be grossed up. Only when a dividend has been declared out of profits wholly exempt from tax, no grossing up will be necessary or permissible, because the amount of dividend received by the shareholder is a gross and not a net amount and obviously one cannot gross up what is already gross. It will be clear from what I have said so far that when a dividend is declared tax free, the shareholder really gets the benefit of a larger dividend. The tax-free dividend , observed Lord Macmillan in Cull v. Commissioners of Inland Revenue, is not really a dividend of the amount received, but a dividend of a larger sum less the tax thereon. It is therefore treated notionally as Income Tax at t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the income of the shareholders, being only treated as, or deemed to be such, income under certain special provisions of the Income Tax Act. Reference was also made to the decision of the Bombay High Court in Bai Lalita v. Tata Iron and Steel Company Ltd. and the decision in Purshottamdas Harkisondas v. Central India Spinning, Weaving and Manufacturing Company Limited. On the authority of those cases as also the case of the Ashton Gas Company, it was contended that the holders of preference shares though entitled to a fixed dividend of 6 per cent, were not entitled to be paid that dividend free of tax because if they were so paid, they would in fact be paid more than 6 per cent and the whole burden of the tax would fall on the ordinary shareholders. A fixed preferential dividend of a stated percentage according to Mr. Mitra was fully paid by payment of a sum computed at that percentage less Income Tax and a declaration of a dividend of that percentage would mean the declaration of the reduced sum actually paid. In the present case that sum was ₹ 1,54,687. The contention of Mr. Meyer who appeared on behalf of the Commissioner of Income Tax was as follows. It was immateri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red . Assuming that one has merely to read the proviso according to its language and see what dividend was declared in a given case, the answer must be in favour of the assessee, because what was declared was not a dividend of 6 per cent., but a dividend of 6 per cent. less tax. It appears from the authorities that the declaration was in conformity with the rights of preference shareholders for the dividend assured to them must be taken as inclusive of tax. But even if the declaration was not in accordance with the rights of the preference shareholders and gave them less than what they were entitled to the matter is of no importance for the present purpose, because what we are concerned with is not what ought to have been declared but what was actually declared. The textual argument of Mr. Meyer is therefore not sufficient for the Revenue to succeed. I may also add that, in fact, there was no error in the declaration, because in the absence of any special provision in the Memorandum or Articles of Association of a company, shareholders entitled to a dividend of a stated percentage are as matter of law entitled to receive it subject to tax, and even if the declaration in the pres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 313, which was the tax amount in the present case, should be taken as a part of the dividend of 6 per cent. and as included in the amount covered by a declaration of that percentage. I do not think that the effect of Ashton Gas Company's case was as contended by Mr. Meyer. It was not a tax case at all and it did not decide that in a dividend of 10 per cent, inclusive of tax, the tax part was a part of the dividend. All that it decided was that in paying a dividend of 10 per cent free of tax, the company had divided more of its profits than it was permitted by the special Act to do and that it was to take 10 per cent of its profits as inclusive of tax and see at what rate a dividend within the statutory limit could be declared. The true import of the decision in Ashton Gas Company's case was explained at length by Lord Wright in Culls case at pages 76 and 77, and after pointing out that the case had not been even mentioned by any of the Lords in Neumann's case, although it had been cited, and that it had not been referred to by the Court of Appeal in Culls case itself, he observed that with regard to questions relating to Income Tax, Ashton Gas Company's case should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the company were depleted to the extent of ₹ 70,313. The depletion of the company's funds which can really be said to have been caused by the declaration of the dividend was limited to ₹ 1,54,687, which was the only amount that the company would not have to part with, if it did not declare a dividend, and, therefore, it seems clear to me that the financial effect of the declaration was co-extensive with that sum and did not extend to the further sum of ₹ 70,313. As I have already said, that amount of ₹ 70,313 the company would have to pay and part with in any event irrespective of any declaration of dividend, because it was a part of the tax payable by it on its own profits. This in my view is the right approach to the question. The provision in the Finance Act is looking at a dividend declaration from the point of view of the company and not from the point of view of the shareholder and it is directed at ascertaining what was left in the hands of the company after the declaration of the dividend and to what extent the funds of the company were affected by reason of the declaration. The receipts of the company, after the deduction of expenditure, are ..... X X X X Extracts X X X X X X X X Extracts X X X X
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