Issuing bonus redeemable preference shares to equity shareholders is not deemed dividend

Case Name:

Briggs of Burton (India) (P.) Ltd., In re

A.A.R. NO. 654 OF 2004

Key Takeaways:

- Issuing bonus redeemable preference shares to equity shareholders does not result in the release of company assets to shareholders, as required for it to be considered a deemed dividend under Section 2(22)(a).

- The legislative intent is that the issuance of bonus preference shares to equity shareholders should not be treated as a deemed dividend at the time of issuance, but only when there is an actual release of company assets to shareholders.

- The ruling clarifies the tax treatment of such corporate actions and provides guidance to companies on their tax obligations.

Issue:

Whether the issuance of bonus redeemable preference shares by a company to its existing equity shareholders would tantamount to a dividend within the meaning of Section 2(22) of the Income Tax Act, 1961, and whether the company is required to deduct tax at source on such issuance.

Facts:

Briggs of Burton (India) (P.) Ltd. (the applicant company), a wholly-owned subsidiary of Briggs of Burton PLC (UK), intended to capitalize its free reserves by allotting fully paid redeemable bonus preference shares to its existing equity shareholders in proportion to their shareholding.

The applicant company sought an advance ruling from the AAR on whether this action would be considered a deemed dividend under Section 2(22), requiring the deduction of tax at source.

Arguments:

- The applicant company argued that the issuance of bonus redeemable preference shares would not result in the release of company assets to shareholders, as required under Section 2(22)(a) for it to be considered a deemed dividend. The redemption of preference shares is a contingent event, subject to certain conditions under the Companies Act, 1956.

- The jurisdictional Commissioner argued that the issuance of bonus preference shares results in the distribution of accumulated profits and could potentially entail the release of company assets to shareholders, which would bring it within the purview of Section 2(22).

Key Legal Precedents:

- CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC):

The Supreme Court held that the conversion of reserves into capital and the issuance of bonus shares do not involve the release of profits to shareholders; the money remains employed in the business as the company's proper capital.

- Sashibala Navnitlal v. CIT [1964] 54 ITR 478 (Guj.):

The Gujarat High Court, relying on the Dalmia Investment case, held that the issuance of bonus shares credited as fully paid up out of capitalized accumulated profits constitutes a distribution of capitalized accumulated profits, but does not entail the release of company assets.

Judgment:

The AAR ruled that when the applicant company allots bonus redeemable preference shares to its existing equity shareholders, no income would accrue to the non-resident equity shareholders (allottees), and therefore, the company is not required to deduct tax at source at this stage.

The AAR relied on the decisions in CIT v. Dalmia Investment Co. Ltd. and Sashibala Navnitlal v. CIT to conclude that the distribution of accumulated profits through the issuance of bonus redeemable preference shares to existing equity shareholders would not bring it within the mischief of Section 2(22)(a).

The AAR noted that while there is a distribution of accumulated profits, such distribution does not entail the release of company assets to shareholders, as required under Section 2(22)(a).

The AAR further clarified that the legislative intent behind Section 2(22)(b) is that the distribution of accumulated profits by way of issuing bonus shares to preference shareholders would be treated as a deemed dividend at the time of issuance itself.

However, the issuance of bonus preference shares to equity shareholders should not be treated as a deemed dividend at the time of issuance, but only when there is an actual release of company assets to shareholders within the meaning of Section 2(22)(a).

FAQs

Q1: What is the significance of this ruling?

A1: This ruling provides clarity on the tax treatment of corporate actions involving the issuance of bonus redeemable preference shares to equity shareholders. It clarifies that such issuance does not constitute a deemed dividend under Section 2(22) of the Income Tax Act, 1961, and therefore, the company is not required to deduct tax at source at the time of issuance.

Q2: What is the reasoning behind the court's decision?

A2: The AAR relied on the legal principles established in the Supreme Court's decision in CIT v. Dalmia Investment Co. Ltd. and the Gujarat High Court's decision in Sashibala Navnitlal v. CIT. These precedents held that the issuance of bonus shares does not involve the release of company assets to shareholders, which is a requirement for it to be considered a deemed dividend under Section 2(22)(a).

Q3: What are the implications of this ruling for companies?

A3: This ruling provides guidance to companies on their tax obligations when issuing bonus redeemable preference shares to equity shareholders. Companies can proceed with such corporate actions without the need to deduct tax at source at the time of issuance, as long as there is no actual release of company assets to shareholders.

Q4: Does this ruling apply to all types of bonus shares?

A4: No, this ruling specifically addresses the issuance of bonus redeemable preference shares to equity shareholders. The tax treatment may differ for other types of bonus shares or corporate actions, depending on the specific circumstances and the provisions of the Income Tax Act, 1961.

Q5: Can the tax authorities challenge this ruling in the future?

A5: While the AAR's ruling is binding on the applicant and the tax authorities in the present case, it is possible for the tax authorities to challenge the interpretation or application of the law in future cases or seek clarification from higher courts if they disagree with the ruling.