Complications arise when a company engaged in agricultural operations declares dividends
Where the company's income is partly from agriculture and partly from manufacture, the profits on the sale will have to be apportioned and the element in the profits referable to the manufacturing process will be taxable as business profits.
Dividend taxation has undergone many changes in the past decade. To encourage equity investments, dividends were completely exempted from income-tax in the hands of the shareholders from 1997 onwards. Earlier, the exemption was limited to Rs 12,000.
To safeguard the loss of revenue by the abolition of tax on dividends, Section 115-O was introduced in the Income-Tax Act, 1961 with effect from April 1,1997. The tax was levied on distributed profits of the companies on the amount of dividends they distributed.
The idea was that the incidence of the levy should be on the company and not passed on to the shareholder. It is thus a tax on the company and not on the shareholder. The system has been working very well and shareholders have been reaping huge benefits by way of exemption from tax on the dividends.
However, complications arise when a company engaged in agricultural operations declares dividends. As we know, agricultural income is completely exempt from taxation. However, the exemption will not apply if the agricultural produce is subjected to a process which will render it fit to be taken to the market.
Raw sugarcane or raw green tea leaf may be exempt but not when it is subjected to a process to make it fit for human consumption. Where the company's income is partly from agriculture and partly from manufacture, the profits on the sale will have to be apportioned and the element in the profits referable to the manufacturing process will be taxable as business profits. This is provided for in the Income-Tax Rules.
Tea plantations offer 40 per cent of their income for Central income-tax and the balance 60 per cent is exempt as agricultural income. When such companies distribute profits as dividends, even the 60 per cent agricultural income is distributed. The question arises, how will Section 115O operate on such dividends distributed by tea plantations? Even the vires of the Section was questioned.
If the additional distribution tax on dividends is to be levied on the agricultural part of the profits, such levy will have to be struck down. The tax is levied on the company and not on the shareholder. It was argued before the Calcutta High Court that since the additional tax was only on part of the income, which relates to declaration of dividends, there could not be any mechanism providing for segregation of such income, as such distribution of profits would also include agricultural income.
The Calcutta High Court rejected the argument. If a tea company has a net income of Rs 100, Rs 40 would be liable to income-tax at the prescribed rate and the assessee would be assessed accordingly. By virtue of Section 115-O if the company declares Rs 50 for distribution among the shareholders, it would have a proportionate liability.
It is true that in case the company decides to distribute a part of the income, it would be impossible to find out whether that part included the whole of the agricultural income or a part of it. This exercise now is not relevant in view of Rule 8 of the Income-Tax Rules.
In such an event the company would be charged on Rs 40 for income-tax and on Rs 50 for additional income-tax proportionately. The High Court also pointed out that the Rs 50 as a whole cannot be taxed at the prescribed rate of additional tax. Such additional tax would be levied on Rs 20 being 40 per cent of Rs 50. Hence, at the end of the day, the company would have to pay income-tax at the prescribed rate on Rs 40 as well as additional income-tax at the prescribed rate on Rs 20.
The above judgment of the Calcutta High Court in Jayshree Tea and Industries Ltd. vs Union of India (285 ITR 506) is the first ruling on the interpretation of Section 115-O. This was an appeal by the company against a single judge order upholding the levy on the entire income of the company.
The Division Bench modified the order on the lines indicated above and appears a reasonable interpretation of Section 115-O read in conjunction with Section 10(33) and Rule 8 of the Income-Tax Rules.
It may be remembered that Rule 7 provides for apportionment of taxable income in the case of companies whose income is partially agricultural and partially non-agricultural. Rule 7A and Rule 7B were brought in by the I-T (Second Amendment) Rules 2001 with effect form April 1,2002 , that is, assessment year 2002-03 onwards.
In respect of rubber plantations, 35 per cent of the income is subjected to Central income-tax under Rule 7A. Income from coffee grown and cured by the seller in India will suffer a Central income-tax of 25 per cent of the income. However, where the income is derived from sale of coffee grown, cured, roasted and grounded by the seller in India, 40 per cent of such income shall be deemed to be income liable to Central income-tax.
In all these cases, Section 115-O will have to be applied on the dividends distributed out of the taxable income of the rubber or coffee companies on the lines indicated by the Calcutta High Court ruling.
This is indeed a matter of substantial relief from the rigours of Section 115-O in the case of agricultural plantation companies. The additional dividend distribution tax will be far less than imagined hitherto.
T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)