“A Cauliflower inspite of being a flower, is a vegetable”, "Kamal Hassan was a woman in the movie chachi 420 & so was Robin Williams in Mrs Doubtfire". One thing which stands out in the above mentioned lines is, things can take a form of something which they are not!! An immediate question would be, What is it got to do with this article? Interestingly the Income Tax Act contains similar situations in the form of “Deeming Provisions”

The Income Tax Act contains a wide array of deeming provisions like Deemed Income, Deemed Profits, Deemed to Accrue or Arise in India, so on & so forth. The word ‘Deemed’ in common parlance means ‘to regard as’ or ‘to consider as’ or to be more clear it is used to call or consider a thing, something which it is not. However attention is drawn to the fact that the word Deemed is used in different senses by the Act. The intention of using this word can take any of the following forms:-
It can be used to give a comprehensive description that includes what is obvious. Eg: making a statement that the Word Fruit includes an apple which is quite obvious!
It can be used to put beyond doubt a particular construction that might be otherwise uncertain. Eg: removal of uncertainty relating to classification of income as capital gains or other income under clauses (c) & (d) of Section 2 (22
Lastly it may be used to create a ‘Legal Fiction’ by giving an artificial or extended meaning to a word.
Here the Act gives a word or a transaction a status of what it otherwise would not have been.
Eg: Treating Tusshar kapoor as Shahrukh Khan & casting him in a movie.

The Act may frame a deeming provision explicitly by using the word Deemed in the heading of a Section like in the case of Deemed Profits, or may frame it implicitly in the form of an inclusive definition, like the



definition of Dividend U/s 2 (22) which is the point of discussion of this article.
Section 2 (22) defines the term Dividend for the purposes of income tax & contains five clauses starting
with clause (a) & terminating with (e) with each covering five different cases.
As dividend requires the existence of profits, dividend under this section also requires such existence & the term Accumulated Profits comes into picture. Dividend under this section is restricted to the amount of accumulated profits of the company & hence it becomes imperative to analyze the constituents of this word.

Accumulated Profits for the purpose of Section 2(22):

In case of a company (which is not in liquidation), it includes all profits of a company up to the date of distribution or payment.
However, in the case of a company in liquidation it includes all profits of the company up to the date of liquidation.
Where, the liquidation is consequent on the compulsory acquisition of a company’s undertaking by the Government Company, accumulated profits do not include any profits of the company prior to the three successive years immediately preceding the previous year in which such acquisition took place.
This term includes a surprise packet in the form of ‘Capitalized profits’ (Bonus Shares) covering sub-clauses (a) to (d).
Now, once the stage is set, the curtain can be raised & the clauses relating to Dividend can be unleashed.



Distribution Entailing Release of Assets Section 2(22) (a)

The deeming provision kicks off by bringing into the ambit of dividend any distribution by the company involving release of assets to the extent of accumulated profits whether capitalized or not. The following two conditions have to be fulfilled for dividend to arise under this section:
Distribution has to be from the accumulated profits only and not from capital.
Such distribution must necessarily result in the release of the company’s assets.

The assets distributed maybe fixed assets or current assets or even investments! Where a company distributes amongst its shareholders the shares held by it in another company, the same amounts to dividend. The quantum of dividend will be the market value of assets on the date on which the shareholders are entitled to receive dividend [ CIT v. Central India Industries Ltd (SC) ].

Distribution of Debentures or Bonus Shares in Certain Cases Section 2(22) (b)

Under this clause the following two distributions by the company to the extent of accumulated profits whether capitalized or not are treated as dividend:
Distribution by a company to its shareholders (whether equity or preference) of debentures, debenture-stock or deposit certificates given by the company for non-issuance of dividend in any form, whether with or without interest; and
Distribution as bonus shares to its ‘preference shareholders’.

Its worthwhile to note that under this clause distribution amounts to dividend even if there is no release of assets at the time of distributions.

Distribution by a Company in Liquidation Section 2(22) (c)

ABC Ltd goes into liquidation and its liquidator distributes the surplus to all shareholders. If you being a shareholder of the Company think that the amount received on liquidation would merely constitute capital gains, then you are in the wrong notion.

Under this clause, any distribution made to the shareholders on liquidation of the Company is considered as ‘Dividend’ to the extent of the company’s accumulated profit whether capitalized or not and consequently taxable as income in the hands of shareholders. However any distribution out of the profits earned after liquidation is not covered under this clause..

Quantum of distribution to be treated as Deemed Dividend

Each distribution made by the liquidator is treated as dividend to the extent it is attributable to accumulated profits. Therefore, the distribution would be split in the ratio of the company’s share capital & accumulated profits. The portion attributable to the share capital would constitute capital repayment & that attributable to the accumulated profits would be assessable as dividend. [ CIT v. Girdhardas & Co (SC)].

For instance: If the share capital & general reserve of a liquidating company is Rs.5,00,000 and Rs.7,00,000 and the company distributes Rs.60,000 to a particular shareholder, then Rs.35,000 is treated as dividend & the balance Rs.25,000 is attributable towards share capital.


Amount Distributed by a Company on Account of Capital Reduction Section 2(22) (d)

This clause covers the situation of capital reduction. Under section 2(22)(d) any distribution to the shareholders on account of reduction of capital is treated as ‘Dividend’ to the extent the Company possesses accumulated profits whether capitalized or not. The wording 'to the extent of accumulated profit' indicates that the distribution received will be first treated as dividend & then will be classified as capital repayment. In this regard a reference can be drawn to the case of Colgate-Palmolive India Ltd. On May 9th of this year the company announced reduction of its capital by reducing the face value of its shares from Rs.10 to Re.1 thereby announcing a 'Deemed Dividend' of Rs. 9 to its shareholders
However, the following are not treated as dividend:

Any distribution in respect of preference shares issued for full cash consideration.
A case where there is a re-organization or splitting up of the capital of the Company .


Loan or advance given by a Closely Held Company in certain situations Section 2(22) (e)
This is the clause which has the real effect of creating a ‘Deeming Fiction’. This clause takes the shareholder for a roller-coaster ride by bringing into the tax net certain payments which, by any stretch of imagination cant be termed as income in the first place. here the Act expands the scope of the term Dividend altogether The following two payments by closely held companies are deemed to be dividends, to the extent of accumulated profits:
Any loan or advance given to a shareholder having 'Beneficial interest'.
Any loan or advance given to a 'Concern' in which the above mentioned shareholder has 'Substantial interest'.
It is very important to understand the meaning of the terms used in the provision in order to have a clear picture of it.
- Closely held company: is the one which does not have any public interest, Private Companies in general.
- Beneficial Interest: Minimum of 10% of the shareholding of the company
- Concern: Can be in the form of a HUF, AOP/BOI, Partnership Firm or a Company.
- Substantial Interest: In case of a company means at-least 20% of the shareholding & for any other concern relates to entitlement of at-least 20% of the share in profits.
Quantum of Dividend
An important issue under this clause is the quantum of the dividend amount:- it must be noted that the amount that is deemed to be dividend does not have any relevance to the percentage of shares held by the holder as in other clauses, E.g. If a person holds 15% of shares in a company & the whole amount of accumulated profit is given to him as loan; then the whole amount that is given to him will be considered as deemed dividend. This clause was enacted to curb the malpractices by certain shareholders amounting to misutilization of company's funds.

Who Carries the Burden of Tax?
The discussion now leaves us with the question of onus of tax. Is it the company? Or the shareholder? who is made to bite the dust??. The following table throws light on the question.

Incidence of tax on deemed dividend:

U/s 2 (22)	Domestic Companies	Foreign Companies
(a)	Company	Share Holder
(b)	Company	Share Holder
(c)	Company	Share Holder
(d)	Company	Share Holder
(e)	Share Holder	Share Holder

Note: The Domestic Companies { clauses (a) to (d)} are liable for tax on distribution of dividends as envisaged in Section 115-0 at 12.5%+surcharge+education cess bringing the total tally to 14.025% & hence it becomes tax-free in the hands of the shareholders by virtue of Section 10 (34). In case of dividend under sub clause (e), the shareholder has to offer the same to tax as Income from other sources.

As mentioned in the outset, the word deemed can be used by the Act for more than one purpose. In this backdrop we can seek to analyze the five clauses of Section 2 (22).
The clauses (a) & (b) seem to be providing a description of what is obvious, as the distributions contained there-in are dividends in normal sense.
The next two clauses i.e, (c) & (d) remove the uncertainty as to whether the income should be treated as capital gains totally or some portion constitutes dividend
The last clause (e) clearly enlarges the meaning of of the term dividend by bringing into its ambit certain matters which otherwise may not fall within the provision.
Amongst the various clauses of Section 2 (22), clause (e) is a hard hitting one since the shareholder suffers a ‘Double-Whammy’. He is cast with the burden of paying tax on the amount availed by him though he may repay the amount in future. This clause is indeed harsh in nature but, it demonstrates the power of the weapon available with the revenue in the form of ‘Deeming Provisions’.