FINANCIAL MANAGEMENT DECISIONS

Q.1. The directors of a Domestic Company, whose existing capital is Rs. 1 crore all in Equity Shares, proposes to expand its business for which an additional investment of Rs. 50 lakh would be needed. The entire money can be raised either by issue of Equity Shares or by issue of 10% Debentures. They decide in favor of issue of Equity Shares. As a Tax Consultant do you approve the proposal? Assume that rate of return is 20% and rate of income tax is 30%.



Q.2. A Ltd. is a widely-held company. It proposes to increase its production for which it will require Rs. 1,00,00,000. The company proposes the following three alternatives for the structure of the additional capital :


Expected return on capital employed in business in 25% (before tax). Generally, companies engaged in similar business are paying 20% dividend on its share capital. Tax rate is 30%, Surcharge 5% and Education cess 3%.
You have to advise the company as to which alternative it should choose for the capital structure so as to pay maximum dividend to the shareholders.



Q.3. An Indian company with a paid-up (for cash) share capital of Rs. 10,00,000 divided into 10,000 equity shares off Rs.100 each went into liquidation on 30th June, 2009. On that date its reserves created out of profits amounted to Rs. 7,00,000 and the balance to the credit of its profit and loss account was Rs. 50,000. The liquidator realised the assets at prices considerably in excess of their book values and after meeting and providing for all liabilities including the liability for taxation had a distributable sum of Rs. 26,50,000 which he duly distributed to shareholders on 1st March, 2012. Company S, a holder of 500 shares acquired by it on 1st July, 1977 at a cost of Rs. 10,000 approaches you for advice as to the treatment for income tax purposes for the amount received by it from the liquidator. The fair market value of shares of Company S on 1.4.1981 was Rs. 20,000. The cost inflation index for 1981-82 was 100 and for 2011-12 was 785.



Q.4. Ram took a loan off 1,00,000 on 10.9.2011 from a company in which the public are not substantially interested. The company also paid insurance premium Rs. 5,000 on his behalf. He holds 25% equity shares of the company. On the date of loan and paying the premium the accumulated profits of the company were Rs. 80,000. Subsequently in the same year the company declared dividends to its shareholders. The dividends on the shareholding of Mr. Ram amounting Rs.15,000 was set-off against the amount of loan etc. Compute the amount that should be included in the income of Mr. Ram.


The amount of actual dividend Rs. 15,000 is set-off against loan etc., hence, such dividend (Rs. 15,000)is not to be treated as a dividend distributed by the company u/s 115-O.
Note : The deemed dividend u/s 2(22)(e) is not exempt u/s 10(34). Further, tax shall be deducted at source on such dividends.

Q.5. On 1.1.2005 X Ltd. had allowed to its equity shareholders fully paid preference shares of Rs.100 each by way of bonus shares. Y was one such shareholder who was allotted 10 preference shares by way of bonus shares. On 1.8.2011 he sold such bonus preference shares to Z who paid Rs.100 per share as purchase price.
On 31.12.2011 the company redeemed the preference shares at a premium of 10%.
Discuss Y’s liability at the time or receiving bonus shares and sale of bonus shares Z’s liability in respect of the amount received on redemption and the liability of X Ltd. for A.Y. 2012-13.


Assessment Year 2012 – 13
Whenever the bonus shares are redeemed the amount received on such shares (including any premium, if any) is deemed as dividend. However, such dividend is exempt in the bands of the recipient of the dividend u/s 10(34).
X Ltd.’s liability on redemption of bonus shares :

Assessment Year 2012 – 13
On redemption of bonus shares, it would be deemed that the company has distributed dividend @ Rs. 110 per share redeemed. On such amount the company would be liable to pay tax @ 15% + Surcharge @ 5% plus Education cess @ 3% u/s 115-O.

Q.6. X Co. ltd. (a closely-held company engaged in trading) having accumulated profits of Rs.5,00,000 advanced a loan of Rs.1,00,000 to a partnership firm on 15.4.2011. Mr. Ram possesses 15% equity shares in X Co. Ltd. and has 25% share in the profits of the firm. Is Mr. Ram or the firm liable to tax in the given case?

Solution :

Assessment Year 2012 – 13
If a closely- held company which possesses accumulated profits, grants a loan or advance to a shareholders, who possesses at least 10% voting power in the company, it is deemed to be divided to the extent of accumulated profits or loan/advance, whichever is less. Similarly if the loan/advance is given to a concern in which such a shareholder has substantial interest (entitled to at least 20% profits of the concern not being a company) it will be deemed to be dividend to the extent of loan/advance or accumulated profits, whichever is less.

In the given case Mr. Ram possesses 15% equity shares in X Co. Ltd. and 25% shares of profit in the firm, hence, a loan of Rs. 1,00,000 given to the firm shall be deemed dividend to the firm, hence, a loan of Rs. 1,00,000 given to the firm shall be deemed
dividend to the firm for tax purposes u/s 2(22)(e). 
On such deemed dividend the firm is liable to pay tax.

Q.7.  The shares of X (P) Ltd., a closely-held company, are held by three persons as under:
         A-8,500,
         B-900,
         C-600.

The company has accumulated profits Rs.8,00,000.
From the following information determine the amount of dividends chargeable in the hands of shareholders and X (P) Ltd. for A.Y. 2012-13:
(i) On 20th June, 2011, A took a loan from the company. Rs.2,00,000.
(ii) On 10th Dec., 2011, C took a loan from the company Rs.3,00,000.
(iii) On 15th Feb., 2012, the company declared dividend Rs.50 per share i.e. Rs. 5,00,000.
(iv) A requested the company to adjust Rs.1,00,000 of dividends against his loan. The company agreed to it.

Solution :
Assessment Year 2012 – 13
Computation of chargeable Dividends in the hands of Shareholders
(i) A : He is holding more than 10% of shares of the closely-held company. Hence, the loan of Rs. 2,00,000 (subject to maximum of accumulated profits) shall be deemed dividends. Such dividend is chargeable in his hands. The adjustment of loan Rs. 1,00,000 against dividends declared by the company will not affect his tax liability. He is liable to pay tax on Rs. 2,00,000.
(ii) C : He is holding less than 10% of shares of the closely-held company. Hence, the loan of Rs. 3,00,000 will be a genuine business transactions and it will not be deemed dividend. Therefore, neither C nor the company is liable to pay tax on this amount.
(iii) X (P) Ltd. The company has declared dividends Rs. 5,00,000 and adjusted Rs. 1,00,000 (loan to A). Thus, the company has distributed dividend Rs. 4,00,000. On this amount (Rs. 4,00,000) the company is liable to pay tax @ 16.2225% u/s 115-O.
(iv) The amount of dividend received by A (Rs. 3,25,000), B (Rs. 4,000) and C (Rs. 30,000) from X (P) Ltd. shall be exempt u/s 10(34).