Wednesday, March 6, 2013

This Tax Planning will reduce the Dividend Distribution Tax (DDT) bill of Corporates

                                                         By Subash Agarwal, Advocate

1.         Introduction

This year big corporate have borne the brunt of additional revenue mobilization exercise of the Finance Minister. Chidu has slapped a surcharge of 10% on corporates having taxable income above Rs. 10 crores. Simultaneously, 10% surcharge has also been imposed on an already high Dividend Distribution Tax (DDT) of 15%. This was one of the prime factor responsible for 290-point in the stock market on the budget eve.
The corporates shall be caught in a catch 22 situation- either to prune dividend and get investor unfriendly image or pay higher income tax and reduce the amount transferable to the shareholders' fund, which itself is utilised for the issue of bonus shares.

2.         A simple mechanism advised by the Supreme Court

There is a simple way out of this tight situation - the mechanism of buy back of shares, a remedy which the Hon'ble Supreme Court has unwittingly provided to the corporates shuddering with the thought of dividend tax outgo by making the following observations way back in 1965 in Punjab Distilling Industries Ltd. v. CIT 57 ITR 1-
" A company may, on the pretext of reducing its capital, utilise its accumulated profits to pay back to the shareholders the whole or part of the paid up amounts on the shares. A shareholder, though in form gets back the whole or a part of the capital contributed by him, in effect he gets a share of the accumulated profits, which if a straight forward course was followed, he should have received as dividend. This is a division of profits under the guise of division of capital, a distribution of profits under the colour of reduction of capital."

3.         Amendments made by Finance Act, 1999

Following amendments were made in the statute by the Finance Act, 1999 that unsettled the settled position as pronounced by the Supreme Court-

     (i)            Amendment in Section 2 (22) (iv): Dividend does not include any payment made by a company on purchase of its own shares from a share holder as per section 77A of the Companies Act. (w.e.f.. 01.04.2000)

   (ii)            Amendment in Section 46A: Where consideration is received from a company for purchase of its own shares, there is deemed capital gains, being the difference between the cost of acquisition and the value of consideration (w.e.f. 01.04.2000).

 (iii)            Amendment in Section 115-O: DDT is to be paid by a company. (amendment made earlier)

It appears that the aforesaid amendment was made way back in 1999 by the Finance Act, 1999 by the government oblivious of the above-mentioned Supreme Court judgement, which was lying buried in the Income –Tax Reports. In the absence of the above amendments, the consideration amount received on the buy-back could very well have been treated as dividend as per the interpretation of Supreme Court in the judgement mentioned above, thus, exigible to DDT u/s 115-O.

4.         Corporates can laugh all the way to the Bank and avoid DDT.

The amendment made by the government by inserting section 46 A and section 2(22)(iv) in the Income-tax Act, 1961 that the consideration received on the buy-back of shares by the shareholders shall attract capital gains tax in the hands of shareholders and the word dividend does not include any payment made by a company on purchase of its own shares from the shareholders in accordance with the provisions of section 77A of the Companies Act, 1956 by the Finance Act, 1999 enables companies to merrily distribute the accumulated profits in the form of buy back of shares on a proportionate basis to the shareholders which as per the Supreme Court judgement could have been construed as " deemed dividend" and escape paying dividend tax. The reduction in capital can subsequently be replenished by issue of bonus shares and the whole process may be repeated with regularity. Under section 77A(8) of the Companies Act, 1956, though further issue of shares is not allowed within a period of 24 months, issue of bonus shares is exempt from its purview. The shareholders on the other hand will also reap a bonanza if the shares bought back were held for more than one year, the difference between the amount received on buy back and the cost of shares shall be treated as long term capital gains in the hands of shareholders attracting little or zero tax in their hands.

5.         Finance Bill, 2013 leaves the window open.

Proposed Law:

     (i)            A new chapter XII-DA is proposed to be inserted.

   (ii)            A company will be liable to pay additional tax @ 20% of the distributed income.

(iii) The distributed income will be computed as under-
                        Consideration paid                                                      
Less:  Sum received at the time of issue of shares                                  

 (iv)            New Section 10(34A): Income arising to a shareholder on account of buy back of unlisted shares exempt from tax.

   (v)            Section 46A : Remains on the Statute Book. Income arising on buy-back of  listed shares  to be chargeable to capital gains tax, sale consideration received on buy-back being treated as deemed sale consideration.

 (vi)            Chapter XII-D : Inserted from effect from 01.06.2013 providing for and containing provisions additional tax on distribution of income of domestic company for buy- back of unlisted shares.

6.         Conclusion

The proposed amendment affects the buy-back of unlisted shares only and not the quoted shares. The window remains open for the listed companies to resort to tax planning for avoiding DDT by the mechanism of buy-back of shares. They can prune / forego dividend payments but distribute the largesse by first declaring bonus shares and then buying back the shares and in the process distributing cash to the shareholders in a roundabout fashion.

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