Introduction:
The Income Tax Act, 1961 is a comprehensive law that governs the taxation of income in India. Section 2(22) of the Act is an important provision that deals with the definition of ‘dividend’ and its various sub-categories. In this blog, we will discuss the different aspects of Section 2(22) in detail, including its meaning, scope, and applicability.
Meaning of Dividend:
The term ‘dividend’ is a common term in corporate finance and refers to the distribution of profits by a company to its shareholders. Section 2(22) of the Income Tax Act defines the term ‘dividend’ as any payment made by a company, not being a company in which the public are substantially interested, to its shareholders, as a distribution of its accumulated profits, whether capitalized or not, but does not include:
- Any payment made by a company on buyback of its shares, as per Section 46A of the Act.
- Any distribution of accumulated profits made by a company to its shareholders, if the company is a venture capital company or a venture capital fund.
- Any distribution of accumulated profits made by a company to its shareholders, if the company is a specified company.
- Any distribution of accumulated profits made by a company to its shareholders, if the company is a subsidiary of a specified company.
Scope of Section 2(22):
Section 2(22) applies to any payment made by a company, not being a company in which the public are substantially interested, to its shareholders, as a distribution of its accumulated profits. The section is applicable to both domestic as well as foreign companies operating in India. However, the section does not apply to a company in which the public are substantially interested, as such companies are subject to different rules and regulations.
Applicability of Section 2(22):
Section 2(22) of the Income Tax Act applies to the following types of payments:
- Dividend paid by a closely held company to its shareholders.
- Any payment made by a company to its shareholders in the form of a loan or advance, if such payment is made out of its accumulated profits.
- Any payment made by a company to its shareholders in the form of a distribution of assets on its liquidation, if such distribution is made out of its accumulated profits.
Tax Implications:
Section 2(22) has significant tax implications for both the company making the payment and the shareholder receiving the payment. If a company makes a payment covered under Section 2(22), it is required to pay a dividend distribution tax (DDT) on the amount of such payment at the rate of 15%. The shareholder receiving the payment is also subject to taxation under the Act, and such payment is treated as income in the hands of the shareholder and taxed accordingly.
Exemptions under Section 2(22):
Section 2(22) of the Income Tax Act also provides for certain exemptions from the definition of dividend. These include:
- Any amount paid by a company to its shareholders in lieu of the share of profits or any other payment made by the company on its winding up, provided such payment is not a distribution of its accumulated profits.
- Any payment made by a company to its shareholders as a loan or advance, if such payment is made in the ordinary course of its business and is not a distribution of its accumulated profits.
- Any payment made by a company to its shareholders as consideration for the purchase of its own shares, provided such payment is made in accordance with the provisions of the Act.
Significance of Section 2(22):
Section 2(22) of the Income Tax Act is significant in the following ways:
- It defines the term ‘dividend’ and its various sub-categories, providing clarity on the taxation of dividends.
- It provides for exemptions from the definition of dividend, ensuring that payments made by a company in certain circumstances are not subject to tax.
- It imposes a dividend distribution tax on companies making payments covered under Section 2(22), which contributes to the revenue of the government.
- It ensures that shareholders receiving payments covered under Section 2(22) are subject to taxation, thereby preventing tax evasion.
Penalties for Non-Compliance:
Non-compliance with the provisions of Section 2(22) of the Income Tax Act can result in penalties and legal consequences. If a company fails to pay the dividend distribution tax (DDT) on payments covered under Section 2(22), it can be subject to penalties and interest. The penalty can be up to 100% of the tax due, depending on the circumstances.
Similarly, if a shareholder fails to report the receipt of a payment covered under Section 2(22) in their tax return, they can be subject to penalties and interest. The penalty can be up to 200% of the tax due, depending on the amount of the payment.
Recent Changes:
In recent years, there have been several changes to the provisions of Section 2(22) of the Income Tax Act. In the Union Budget 2020, the government announced that the dividend distribution tax (DDT) would be abolished, and the tax on dividends would be shifted to the shareholders. This means that companies making payments covered under Section 2(22) would no longer be required to pay DDT, and the tax would be paid by the shareholders at their applicable tax rate.
Another change introduced in the Union Budget 2021 was the extension of the scope of Section 2(22) to cover payments made by a company to its shareholders in the form of a buyback of shares. This means that such payments would be subject to tax in the hands of the shareholders, similar to other payments covered under Section 2(22).
Conclusion:
In conclusion, Section 2(22) of the Income Tax Act, 1961 is an important provision that deals with the definition of ‘dividend’ and its various sub-categories. The section has significant tax implications for both companies and shareholders and is applicable to any payment made by a closely held company to its shareholders as a distribution of its accumulated profits. It is important for taxpayers to understand the scope and applicability of Section 2(22) to comply with the provisions of the Act and avoid any penalties or legal consequences.
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Frequently Asked Questions (FAQ’s)
- What is Section 2(22) of the Income Tax Act?
Section 2(22) of the Income Tax Act is a provision that defines the term ‘dividend’ and its various sub-categories. It also provides for exemptions from the definition of dividend and imposes a dividend distribution tax on companies making certain payments.
2. What types of payments are covered under Section 2(22)?
Payments made by closely held companies to their shareholders as a distribution of accumulated profits, including dividends, deemed dividends, and certain other payments, are covered under Section 2(22).
3. Are there any exemptions from the definition of dividend?
Yes, Section 2(22) provides for certain exemptions from the definition of dividend, including payments made by a company to its shareholders in lieu of a share of profits, loans or advances made in the ordinary course of business, and payments made for the purchase of the company’s own shares.
4. What is the dividend distribution tax (DDT)?
The dividend distribution tax (DDT) is a tax imposed on companies making certain payments covered under Section 2(22). It is calculated as a percentage of the amount of the payment and is paid by the company.
5. Who is responsible for paying the dividend distribution tax (DDT)?
The company making the payment covered under Section 2(22) is responsible for paying the dividend distribution tax (DDT).
6. Are shareholders subject to tax on payments covered under Section 2(22)?
Yes, shareholders receiving payments covered under Section 2(22) are subject to tax, either as dividend income or as deemed dividend income.
7. What are the penalties for non-compliance with Section 2(22)?
Non-compliance with the provisions of Section 2(22) can result in penalties and legal consequences, including fines and interest charges.
8. What changes have been made to Section 2(22) in recent years?
In recent years, there have been several changes to the provisions of Section 2(22), including the abolition of the dividend distribution tax (DDT) and the extension of the section to cover payments made by a company to its shareholders in the form of a buyback of shares.
9. What is the impact of the abolition of the dividend distribution tax (DDT)?
The abolition of the dividend distribution tax (DDT) means that companies making payments covered under Section 2(22) would no longer be required to pay DDT, and the tax would be paid by the shareholders at their applicable tax rate.
10. How can I ensure compliance with Section 2(22)?
To ensure compliance with Section 2(22), companies should accurately determine and report any payments covered under the section, and shareholders should report any such payments in their tax returns. Seeking professional advice and guidance can also help ensure compliance.
