Under section 37 of the Income-tax Act 1961(the Act) any expenditure not of a capital or personal nature laid out or expended wholly and exclusively for the purposes of the business is allowed as a deduction while computing business income of a company. Similar position I understand exists around the world eg United Kingdom[1]

United States of America it seems generally excludes the distribution  of property(including by way of dividends)from the profit and gains of the corporation under section 312 of the Internal Revenue Code by decreasing such profits.

A company is not obliged to distribute dividend to equity shareholders but may have to distribute dividends to preference shareholders at a fixed percentage of the share face value.

We take up the case of deduction as expenditure of dividends declared i.r.o. equity shareholders:

Dividend to Equity Shareholders:

There is no compulsion on a company to declare dividend to equity shareholders. However once it is declared under the Companies Act 2013 penal consequences arise for non-payment thereof without adequate reasons.

Companies declare dividends for a variety of reasons some of which are listed below:

• Showing financial stability

• Attracting investors

• Maintaining and improving Market Value

• Improving or maintaining reputation of the company for the purposes of doing business

repaying shareholders as a return on capital invested in the company

A company except a section 25 company under the 1956 Act or a section 8 company  under the 2013 Act is formed with the sole purpose of doing business.

In the prospectus issued by Companies inviting subscription to equity shares the purpose for utilizing such subscription towards the Company’s business is  set out.

The Supreme Court of India in the case of Sree Meenakshi Mills Vs Commissioner of Income-tax Madras[2] has held that expenditure incurred not for direct and immediate benefit but for the benefit of the business of the Company would be an allowable expenditure.

The  Supreme Court of India in the case of Bacha F.Guzdar Vs Commissioner of Income-tax has held that  [3] a company is a separate legal entity having separate legal existence from its shareholders.

The term expenditure is not defined under the Income-tax Act 1961. However the Supreme Court of India in the case of Indian Molasses Co. (P) Ltd vs CIT [4]has held that expenditure is what is paid out or away and is something which is gone irretrievably. The Supreme Court of India in the case of CIT vs Nainital Bank Ltd[5] has also held that In its normal meaning the expression "expenditure" denotes "spending" ,or "paying out or away" i.e. something that goes out of the coffers of the assessee.

Article 112 of the Constitution of India relating to  Annual Financial statements for Union of India also refers to the term Expenditure.

The Companies Act 2013 under schedule III does not treat dividend distributed as an expenditure to be shown in the profit and loss account.The same is understandable since the reporting requirement is to the shareholders. However if a company is taken as a separate legal person the amount  of dividend paid would qualify as an expenditure in as much as it is paid to a separate person or legal entity.

The Oxford Dictionary defines the term “Expenditure” as “the Amount of money that is spent”

The Cambridge Dictonary defines the term Expenditure to mean “the act of using or spending energy time or money”

The Act under section 37 does not disallow any dividend payments specifically but only disallows personal expenses.

There are many reported decisions to the effect that a company being an Artificial Juridical Person cannot have any personal expenditure for example Sayaji Iron and Engineering Company vs CIT[6]

Therefore dividend paid by a company cannot be regarded as a personal expenditure of the company.

Dividend payments are treated as cost of equity in  the Dividend Capitalization Model which is used by companies to compare and make decisions on whether to borrow or to issue additional capital.

While determining taxable income for the private party in profit sharing contracts with the Central Government in respect of Oil and Gas Contracts/ Mining revenue sharing contracts, the Central Government share of revenue is  allowed as a deduction from the total revenue  or is completely excluded from the total revenue of the private party. Similarly dividend declared although determined by the Board and approved by the Annual General Meeting of the Company is a payment to another under the contractual business related obligation in respect of share in profits of the company under the Companies Act which accrues on declaration and should therefore be treated similarly.

Section 40(b) and 40(ba) in respect of Firms and Association of Persons specifically disallow certain payments to the partners or members./allow certain payments within limits The shares of the partners and members  in profits are specifically exempted from income-tax  under section 10(2A) /no income tax is payable under section 86 by the member of Association of Persons. However dividends are specifically included in  income as defined under section 2(24 ) of the Act and there is no provision similar to section 40(b) or (ba) for disallowing dividend.

Section 1305 of the Corporation Tax Act 2009 UK (referred to for comparison) clearly disallows dividend while calculating profits of a Corporation. This would mean that unless there is a specific disallowance provided for dividend the same may be considered as a business expenditure. However there is no provision in the Act specifically disallowing dividend payments.

All of above support the view that payment of dividend by a company is wholly and exclusively for the purpose of the business of the company and can therefore be regarded as a deductible expenditure for tax purposes unless specifically prohibited by law.

Dividends to Preference Shareholders

In case of preference shareholders all the above arguments would apply. In addition to the above the accrual of the preference share dividend expenditure may not depend upon the approval  in the AGM since accrual thereof would depend upon earning of income for the year and would generally be on the 31st of March each year (in India) and the end of the tax year in the relevant country.

Hence in all locations worldwide subject to the specific provisions in this regard under law it may be possible to put up a case for reduction of dividend distributed from taxable income of the company either by way of deduction as expenditure or reduction from taxable income.