Section 94 of ITA, 1961 : Section 94: Avoidance Of Tax By Certain Transactions In Securities

Explanation using Example

Example Application of Section 94 of The Income-tax Act, 1961

Imagine Mr. A owns 1,000 shares of XYZ Ltd. The company announces that it will pay dividends on a certain date, known as the record date. Just before the record date, Mr. A sells his shares to Mr. B, with an agreement that he will buy them back shortly after the dividend is paid. Mr. B receives the dividend since he is the owner of the shares on the record date, but Mr. A buys back the shares at a slightly higher price, which reflects the dividend payout.

Under Section 94(1), the Income Tax Act deems the dividend income received by Mr. B as income of Mr. A for tax purposes, despite Mr. B being the one who actually received it. This is because the transaction was structured in such a way that Mr. A, the original owner, avoided receiving the dividend income directly, which would have been taxable for him.

The law sees through the arrangement and taxes Mr. A on the dividend income, preventing him from using this method to avoid paying income tax on his dividend earnings.