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MANU/SC/0103/1964
Equivalent Citation: AIR1964SC1464, [1964]52ITR567(SC), [1964]7SCR210
IN THE SUPREME COURT OF INDIA
Assessment Year: 1949-1950
Decided On: 13.03.1964
Appellants:Commissioner of Income Tax, Bihar
Vs.
Respondent:Dalmia Investment Co. Ltd.
Hon'ble Judges/Coram:
A.K. Sarkar, J.C. Shah and M. Hidayatullah, JJ.
Subject: Direct Taxation
Relevant Section:
Indian Income Tax Act, 1922 - Section 2; Indian Income Tax Act, 1922 - Section 66(1)
Acts/Rules/Orders:
Indian Income Tax Act - Section 2, Indian Income Tax Act - Section 66(1); Unemployment Relief Tax (Assessment) Act, 1933; Finance Act, 1962
Cases Referred:
Emerald and Co. Ltd. vs. Commissioner of Income Tax, Bombay City, Bombay MANU/MH/0013/1955; Commissioner of Income Tax, Bombay City I, Bombay vs. Bai Shirinbai K. Kooka MANU/SC/0237/1962
Disposition:
In Favour of Department
Citing Reference:
Emerald and Co. Ltd. v. CIT Relied On
Commissioner of Income-tax v. Maneklal Chunilal and Sons Ltd. Mentioned
Commissioner of Income-tax, Bombay City, Bombay MANU/MH/0013/1955 Discussed
Swan Brewery Company Limited v. The King Discussed
Commissioner of Inland Revenue v. Blott Mentioned
Osborne (H.M. Inspector of Taxes) v. Steel Barrel Co. Ltd. Distinguished
Commissioners of Inland Revenue v. Fisher's Executors Mentioned
Commissioner of Income-tax, Bengal v. Mercantile Bank of India Limited Mentioned
Commissioner of Income-tax v. Bai Shirinbai K. Kooka MANU/SC/0237/1962 Discussed
Swan Brewery Company Ltd. v. Rex Discussed
Commissioner of Inland Revenue v. John Blott Mentioned
Bouch v. Sproule Mentioned
Nicholas v. Commissioner of Taxes of the State of Victoria Distinguished
Eisner v. Macomber Discussed
Case Note:
Direct Taxation – bonus shares - Sections 2 and 66 (1) of Indian Income-tax Act, Unemployment Relief Tax (Assessment) Act, 1933 and Finance Act, 1962 - question is how to determine cost of acquisition of bonus shares for ascertaining profits made on sale of them – Apex Court held, bonus shares can be valued by spreading cost of old shares over old shares and new issue taken together if shares rank pari passu - when they do not price may have to be adjusted either in proportion of face value they bear or on equitable considerations based on market price before and after issue.
Industry: Finance
JUDGMENT
A.K. Sarkar, J.
1. This matter has come before us on a case stated by the Income-tax Appellate Tribunal. The question is how to determine the cost of acquisition of bonus shares for ascertaining the profits made on a sale of them. The assessment year concerned is 1949-50 for which the accounting year is the calendar year 1948.
2. The assessee held shares by way of investment and also as stock in trade of his business as a share dealer. We are concerned in this case only with its holdings of ordinary shares in Rohtas Industries Ltd. In 1944 the assessee acquired 31,909 of these shares at a cost of Rs. 5,84,283/- and was holding them in January 1945. In that month the Rohtas Industries Ltd. distributed bonus shares at the rate of one ordinary bonus share for each original share and so the assessee got 31,909 bonus shares. Between that time and December 31, 1947, the assessee sold 14,650 of the original shares with the result that on January 1, 1948 it held the following shares :- (a) 17,259 original shares acquired in 1944, (b) 31,909 bonus shares issued in January 1945, (c) 59,079 newly issued shares acquired in the year 1945 after the issue of the bonus shares and (d) 2,500 further shares acquired in 1947. The total holding of the assessee on January 1, 1948 thus came to 1,10,747 shares which in its books had been valued at Rs. 15,57,902/-. In arriving at this figure the assessee had valued the bonus shares at the face value of Rs. 10/- each and the other shares at actual cost. On January 29, 1948, the assessee sold all these shares for the total sum of Rs. 15,50,458/-, that is, at Rs. 14/- per share and in its return for the year 1949-50 claimed a loss of Rs. 7,444/- on the sale. It is this return which has led to this appeal.
3. The Income-tax Officer held that the assessee was not entitled to charge as the cost of acquisition of the bonus shares a sum equivalent to their face value for nothing had in fact been paid and he computed their cost at Rs. 6-8-0 per share. He arrived at this price by the following method, which has been called as the method averaging :
584283 x Face value of bonus shares :
319090 x 1/31909.
4. In adopting this procedure the Income-tax Officer purported to follow the decision of the Bombay High Court in Commissioner of Income-tax v. Maneklal Chunilal and Sons Ltd. [I.T. Ref. No. 16 of 1948, unreported]. The Bombay High Court later following this case in Emerald and Co. Ltd. v. Commissioner of Income-tax, Bombay City, Bombay MANU/MH/0013/1955 : [1956]29ITR814(Bom) . On that basis he held that the assessee had made a profit of Rs. 2,39,317 by way of capital gains and levied tax on it accordingly. On appeal the Appellate Assistant Commissioner held that theses shares were not investment shares but formed the assessee's stock in trade on which it was liable to pay income-tax and not capital gains tax. He also held that the assessee having adopted the method of valuing the stocks at cost and no price having actually been paid for the bonus shares, it must be held that there was an inflation in the opening stock by Rs. 3,19,090. This figure, it mat be observed, represented the cost of the bonus shares at their face value. In his opinion the bonus shares had to be valued at nil. The appellate Commissioner's conclusion was that the assessee was liable to be taxed on a trading profit of Rs. 3,11,646/- in respect of the sale of shares. Those view was confirmed on a further appeal to the Appellate Tribunal. It is however not clear whether the Tribunal held that there had been a trading profit or capital gains. This matter does not seem to have been raised at any stage after the Appellate Commissioner's order and is not material to the real question that has to be decided.
5. After the Tribunal's judgment the assessee got an order from the High Court directing the Tribunal to refer the following question to it :
"Whether on the facts and circumstances of the case the profit computed at Rs. 3,11,646/- on the sale of shares in Rohtas Industries Ltd. was in accordance with law ?"
6. The answer to this question admittedly depends on the cost of acquisition, if any, to be properly attributed to the bonus shares. If the Appellate Commissioner's method of valuing them at nil was wrong, the question had to be answered in the negative. The High Court, following the judgment of Lord Sumner in Swan Brewery Company Limited v. The King (1914) A.C. 231, held that the real cost of the bonus shares to the assessee was the face value of the shares and answered the question in the negative. The observations of Lord Summer which he later expressed more fully in Commissioner of Inland Revenue v. Blott (1921) 2 A.C. 171, no doubt, lend support to the High Court's view. I shall consider the view expressed by Lord Sumner later. Now, I wish to notice another case on which the High Court also relied and that was Osborne (H.M. Inspector of Taxes) v. Steel Barrel Co. Ltd. 24 T.C. 293. I do not think that the observations of Lord Greene M.R. in this case to which the High Court referred, are of any assistance. All that was there said was that when fully paid shares were properly issued for a consideration other than cash, the consideration must be at the least equal in value to the par value of the shares and must be based on an honest estimate by the directors of the value of the assets acquired. In that case fully paid shares had been issued in lieu of stocks and the question was as to how the stocks were to be valued. That case had nothing to do with the issue of bonus shares or the ascertainment of the cost of their acquisition.
7. As I have said earlier, Lord Sumner's observation it Blott's case (1921) 2 A.C. 171 certainly supports the view taken by the High Court but in that case Lord Sumner was in a minority. The other learned Judges, excepting Lord Dunedin, who took a somewhat different view to which reference is not necessary because it has not been relied upon, held that when the articles of a company authorise the issue of bonus shares and transfer of a sufficient amount out of the accumulated profits in its hands representing their face value to the share capital account, what happens when the articles are acted upon is a capitalisation of the profits and the bonus shares issued are not in the hands of the share-holder income liable to tax. In Blott's case (1921) 2 A.C. 171 the articles gave the power which had been acted upon. Lord Sumner on the other hand held that since a company could not issue shares for nothing nor pay for them out of its profits, it must be held that what happened in such a case was as if the company had issued cash dividend to the shareholder and had set if off against the liability of the shareholder to pay for the bonus share issued to him.
8. I think the preferable view is that taken by the majority of the Judges. When the articles permit the issue of bonus shares and the transfer of undivided profits direct to the share capital account, it cannot be said that a cash dividend must be deemed to have been declared which could be set off against the liability to pay for the shares. This is not what was done in fact. What in fact was done, and legally done, was to transfer the profits to the share capital account by a resolution passed by the majority of the shareholders so that the shareholders never acquired any right to any part of it. The view taken by the majority has since been followed unanimously, and even if it was open to doubt, for myself, at this distance of time, I would not be prepared to depart from it : Commissioners of Inland Revenue v. Fisher's Executors (1926) A.C. 395 and Commissioner of Income-tax, Bengal v. Mercantile Bank of India Limited (1936) A.C. 478. It is of some significance to observe that the latter is a case from India.
9. In the present case the record does not contain any reference to the resolutions resulting in the issue of the bonus shares nor to the provisions of the articles but the case has proceeded before us on the basis that the bonus shares had been legally issued under powers contained in the articles and the profits had been equally legally transferred to the share capital account without the shareholders having acquired any right in them. Following the majority opinion in Blott's case (1921) 2 A.C. 171, I think I must hold that the High Court was in error in the view it took in the present case. There is no foundation for proceeding on the basis as if the bonus shares had been acquired by the assessee at their face value. Its profits cannot be computed on that basis.
10. Two other methods of ascertaining the cost of acquisition of the bonus shares for computing the profits made on their sale have been suggested. One of them is the method of averaging which is the method adopted by the Bombay High Court in the cases earlier mentioned. The other is the method of finding out the fall in the price of the original shares on the issue of the bonus shares and attributing to the latter shares that fall and to value them thereby. The object of these methods seems to me to find out what the bonus shares actually cost the assessee. But this would be an impossible task for they actually cost the assessee nothing; it never paid anything for them. There would be more reason for saying that it paid the face value of the bonus shares because the profits of the Company of a similar amount which might otherwise have come to it had been directly appropriated to the share capital account on the issue of the bonus shares. But this method I have rejected already and, for the reason that no amount was actually paid for the bonus shares by the assessee. For the same reasons the two suggested methods for ascertaining the actual cost of these shares have also to be rejected. If however it were to be said that these methods were for finding out the market value of the bonus shares - the importance of which value for the present purpose will soon be seen - I would say that the only way to find out the market value is from the market itself.
11. How then is the cost of the bonus shares to be determined ? We start with this that nothing in fact was paid for them. But if the cost of acquisition is nil, the whole of the sale proceeds of the shares would be taxable profits. In Commissioner of Income-tax v. Bai Shirinbai K. Kooka MANU/SC/0237/1962 : [1962]46ITR86(SC) , this Court has approved of the Bombay High Court's view that "obviously, the whole of the sale proceeds or receipts could not be treated as profits and made liable to tax, for that would make no sense" (p. 397). So the profits cannot be ascertained on the basis that the bonus shares had been acquired for nothing. The view taken by the Appellate Commissioner and the Tribunal cannot be supported.
12. It seems to me that the cost price of the bonus shares has to be decided according to the principle laid down in Bai Shirinbai Kooka's case MANU/SC/0237/1962 : [1962]46ITR86(SC) . The assessee in that case had purchased shares many years ago by way of investment at a comparatively lower price. She started trading with them from April 1, 1945. The question was how the profits on the sale of these shares were to be ascertained. The sale price was known but what was the cost price ? The High Court said that in order to arrive at real profits one must consider the accounts of the business on commercial principle and construe profits in their normal and natural sense, a sense which no commercial man would misunderstand. The High Court's conclusion was this : When the assessee purchased the shares at a lesser price, that is what they cost her and not the business; but so far as the business was concerned, the shares cost the business nothing more or less than their market value on April 1, 1945. This date, it will be remembered, was the date when the business was started. These observations were fully approved by this Court.
13. Bai Shirinbai Kooka's case MANU/SC/0237/1962 : [1962]46ITR86(SC) , therefore is authority for the proposition that where it cannot be shown what was paid for the acquisition of a trading asset by a trader, it has for tax purposes to be deemed to have been acquired at the market value of the date when it was acquired. I think on the authority of this case, the bonus shares must in the present case be deemed to have been acquired at the market value of the date of their issue.
14. I would, therefore, answer the question framed in the negative.
M. Hidayatullah, J.
15. This appeal by the Commissioner of Income-tax, Bombay raises the important question how bonus shares must be valued by an assessee who carries on business in shares. The assessee here is Dalmia Investment Co. Ltd. (now Shri Rishab Investment Co. Ltd.) which is a public limited company and the bonus shares were issued in the calendar year 1945 by Rohtas Industries Ltd. in the proportion of one bonus share for one ordinary share already held by the shareholders. In this way, the assessee company received 31,909 bonus shares of the face value of Rs. 10/- per share which shows that its previous holding was 31,909 ordinary shares. The existing ordinary shares were purchased by the assessee company for Rs. 5,85,283/-. We now come to the assessment year 1949-50 which corresponded to the accounting period of the assessee company - the calendar year 1948. The assessee company was holding shares as investment and was also dealing in shares. The shares in the trading account, being the stock-in-trade, were valued at the beginning of the year and also at the end of the year and the book value was based on cost. Between December 31, 1945 and January 1, 1948, the assessee company sold some shares of Rohtas Industries Ltd. and bought others. Its holding on the first day of January 1948 was 1,10,747 shares which were valued in its books at Rs. 15,57,902/-. The assessee company sold these shares on January 29, 1948 to Dalmia Cement and Paper Marketing Company Limited for Rs. 15,50,458/-. This date, it may be pointed out, fell within the period in which capital gains were taxable. The assessee company returned a loss of Rs. 7,444/- on this sale. In its books it had valued these shares as follows :
16. The amount of Rs. 3,19,090/- which represented the cost of the bonus shares in the above account was debited to the investment account and an identical amount was credited to a capital reserve account. The loss which was returned was the difference between Rs. 15,57,902/- claimed to be the cost price of 1,10,747 shares and their sale price of Rs. 15,50,458/-.
17. The return was not accepted by the Income-tax Officer, Special Investigation Circle, Patna. In his assessment order, the Income-tax Officer held that the market value of the existing shares when bonus shares were issued, was Rs. 18/- per share and the value of the shares was Rs. 5,74,362/- (31,909 x Rs. 18). He held that the sale of the shares took place at Rs. 14/- per share. To this data he purported to apply a decision of the High Court of Bombay in Commissioner of Income-tax v. Maneklal Chunnilal and Sons [Income-tax Reference No. 16 of 1948 dt. 23-3-1949], and held that there was profit of Rs. 7/8/0 per bonus share and the total profit was Rs. 2,39,317/- which he held was capital gain. He brought Rs. 2,39,317/- to tax as capital gains.
18. Before the Appellate Assistant Commissioner, Patna, reliance was placed upon the decision of the Bombay High Court in Emerald and Co. Ltd. v. Commissioner of Income-tax, Bombay City MANU/MH/0013/1955 : [1956]29ITR814(Bom) , and it was argued that by applying the principle laid down in that case, the average cost was Rs. 9/10/0 per share and total profit Rs. 1,49,355/-. The Appellate Assistant Commissioner did not accept the above calculation. According to the Appellate Assistant Commissioner, the bonus shares had cost nothing to the assessee company. He omitted Rs. 3,19,090/- from the book valuation and held that the actual cost of 1,10,747 shares was Rs. 12,38,812/- and that the assessee company instead of suffering a loss of Rs. 7,444/- on the sale of the shares had actually made profit of Rs. 3,11,646/-. He issued a notice to the assessee company and enhanced the assessment.
19. On further appeal to the Tribunal, the assessee company submitted again on the strength of the ruling of the Bombay High Court in Emerald and Co. Ltd. v. Commissioner of Income-tax, Bombay City MANU/MH/0013/1955 : [1956]29ITR814(Bom) , that the actual profit was Rs. 1,57,326/-. This was done by spreading the cost of the 31,909 ordinary shares over those shares and bonus shares taken together and adding to half the cost attributable to the old ordinary shares the cost of new purchases in the same year and finding out the average cost of shares other than bonus shares.
20. The Tribunal did not accept this calculation. According to the Tribunal it was not possible to put a valuation upon shares for which nothing was paid. The Tribunal held that the old shares and bonus shares could not be "clubbed together" and the decision of the Appellate Assistant Commissioner was right. The Tribunal, however, stated a case under s. 66(1) of the Income-tax Act at the instance of the assessee company suggesting the question for the opinion of the High Court :
"Whether on the facts and circumstances of the case, the profit computed at Rs. 3,11,646/- on the sale of shares in Rohtas Industries Ltd. was in accordance with law ?"
21. The reference was heard by V. Ramaswamy, C.J. and Kanhaiya Singh, J. They held that the Income-tax authorities were wrong in holding that profit should be computed at Rs. 3,11,646/- or at any other amount. According to them, there was no profit on the sale of 31,909 shares and they answered the question in favour of the assessee. Before the High Court it was contended by the assessee company that the bonus shares must be valued at their face value of Rs. 10/- per share and the Department contended that they should be valued at nil. It appears that the other methods of calculation of the cost price of bonus shares were abandoned at that stage. Ramaswami, C.J. and Kanhaiya Singh, J. held that the issue of bonus shares was nothing but a capitalisation of the company's reserve account or the profits and the bonus shares could not be considered to be issued free. According to them, the payment for the shares must be found in the bonus which was declared from the undistributed profits and the face value of the bonus shares represented the detriment to the assessee company in respect of the undistributed reserves. The present appeal was brought against the decision of the High Court by special leave granted by this Court.
22. It will be seen from the above that there are four possible methods for determining the cost of bonus shares. The first method is to take the cost as the equivalent of the face value of the bonus shares. This method was followed by the assessee company in making entries in its books. The second method adopted by the Department is that as the shareholder pays nothing in cash for the shares, cost should be taken at nil. The third method is to take the cost of the original shares and to spread it over the original shares and bonus shares taken collectively. The fourth method is to find out the fall in the price of the original shares on the stock exchange and to attribute this to the bonus shares. Before us the assessee company presented for our acceptance the first method and the Department the third method. We shall now consider which is the proper way to value the bonus shares.
23. It is convenient to begin with the contention that the cost of bonus shares must be taken to be their face value. The argument requires close attention, because support for it is sought in certain pronouncements of Lord Sumner to which reference will be made presently. Mr. Kapur contends that a company cannot ordinarily issue shares at a discount, and argues that a fortiori it cannot issue shares for nothing. He submits therefore that the issue of bonus shares involves a twofold operation - the creation of new shares and the declaration of a dividend or bonus which dividend or bonus must be deemed to be paid to the shareholder and to be returned by him to acquire the new shares. Since the amount credited in the books of the company as contribution of capital by the shareholder is the face value of the bonus shares, he contends that the cost to the shareholder is equal to the face value of the bonus shares. He relies upon the decision of the Privy Council in Swan Brewery Company Ltd. v. Rex (1914) A.C. 231. In that case, Lord Sumner observed :
"True, that in a sense it was all one transaction, but that is an ambiguous expression. In business, as in contemplation of law, there were two transactions, the creation and issue of new shares on the company's part, and on the allottees' part the satisfaction of the liability to pay for them by acquiescing in such a transfer from reserve to share capital as put an end to any participation in the sum of Pounds 101,450 in right of the old shares, and created instead a right of general participation in the company's profits and assets in right on the new shares, without any further liability to make a cash contribution in respect of them."
24. Lord Sumner adhered to his view later in the House of Lords in Commissioner of Inland Revenue v. John Blott 8 Tax Cases 101, but Lord Dunedin and he were in a minority, and this view was not accepted by the majority. In view of this conflict, it is necessary to state what really happens when a company issues bonus shares.
25. A limited liability company must state in its memorandum of association the amount of capital with which the company desires to do business and the number of shares into which that capital is to be divided. The company need not issue all its capital at the same time. It may issue only a part of its capital initially and issue more of the unissued capital on a later date. After the company does business and profits result, it may distribute the profits or keep them in reserve. When it does the latter, it does not keep the money in its coffers; the money is used in the business and really represents an increase in the capital employed. When the reserves increase to a considerable extent, the issued capital of the company ceases to bear a true relation to the capital employed. The company may then decide to increase its issued capital and declare a bonus and issue to the shareholders in lieu of bonus, certificates entitling them to an additional share in the increased capital. As a matter of accounting the original shares in a winding up before the increase of issued capital would have yielded to the shareholder the same return as the old shares and the new shares taken together. What was previously owned by the shareholder by virtue of the original certificates is after the issue of bonus shares, held by them on the basis of more certificates. In point of fact, however, what the shareholders gets is not cash but property from which income in the shape of money may be derived in future. In this sense, there is no payment to him but an increase of issued capital and the right of the shareholder to it is evidenced not by the original number of certificates held by him but by more certificates. There is thus no payment of dividend. A dividend in the strict sense means a share in the profits and a share in the profits can only be said to be paid to the shareholder when a part of the profits is released to him in cash and the company pays that amount and the shareholder takes it away. The conversion of the reserves into capital does not involve the release of the profits to the shareholder; the money remains where it was, that is to say, employed in the business. Thereafter the company employs that money not as reserves of profits, but as its proper capital issued to and contributed by the shareholders. If the shareholder were to sell his bonus shares, as shareholders often do, the shareholder parts with the right to participation in the capital of the company, and the cash he receives is not dividend but the price of that right. The bonus share when sold may fetch more or may fetch less than the face value and this shows that the certificate is not a voucher to receive the amount mentioned on its face. To regard the certificate as cash or as representing cash paid by the shareholder is to overlook the internal process by which that certificate comes into being.
26. We may now see what was decided in the Swan Brewery's 1914) A.C. 231] case. In that case the company had not distributed all its profits in the past. As a result, it had a vast reserve fund. The company increased its capital and from the reserve fund, issued shares pro rata. These shares, it was held by Lord Summer, were dividend. It was claimed in that case that there was no dividend and no distribution of dividend, because nothing had been distributed and noting given. Where formerly there was one share, after the declaration of bonus there were two but the right of participation was the same. This argument was not accepted and the face value of the shares was taken to be dividend. Section 2 of the Act of Western Australia, however, defined dividend to include "every profit, advantage or gain intended to be paid or credited to or distributed among the members of any company." It is obvious that it was impossible to hod that the bonus shares were outside the extended definition.
27. Swan Brewery's (1914) A.C. 231 case has been accepted as rightly decided on the special terms of the section, as indeed it was. In Blott's 8 Tax Cases 101 case, Rowlatt, J. observed that the bonus shares were included in the expression "advantage" occurring in the highly artificial definition of the word "dividend". In the Court of Appeal, Lord Sterndale, M.R. and Warrington and Scrutton, L. JJ. distinguished the case on the same ground. It was, however, pointed out by the Master of Rolls that in Bouch v. Sproule (1887) 12 A.C. 385. Lord Herschell had observed that in such a case, the company does not pay or intend to pay any sum as dividend but intends to and does appropriate the undivided profits and deals with them as an increase of the capital stock in the concern.
28. Blott's 8 Tax Cases 101 case then reached the House of Lords. It may be pointed out at this stage that it involved a question whether super-tax was payable on the amount represented by the face value of the bonus share. For purposes of assessment of super-tax which was (as it is in our country) a tax charged in respect of income of an individual the total of all income from all sources had to be taken into account and the tax was exigible if the total increased a certain sum. Such additional duty is really nothing but additional income-tax and is conveniently described as super-tax. Viscounts Haldane, Finlay and Cave held that an amount equal to the face value of the shares could not be regarded as received by the tax payer and that there was no more than the capitalisation of the profits of the company in respect of which certificates were issued to the shareholders entitling them to participate in the amount of the reserve but only as part of the capital. Lords Dunedin and Summer, however, held that the word "capitalisation" was somewhat "hazy" and the issue of the shares involved a dual operation by which an amount was released to the shareholder but was retained by the company and applied in payment of those shares. In our opinion, and we say it respectfully, the better view is that of the majority and our conclusions set out earlier accord substantially with it.
29. It follows that though profits are profits in the hands of the company but when they are disposed of by converting them into capital instead of paying them over to the shareholders, no income can be said to accrue to the shareholder because the new shares confer a title to a larger proportion of the surplus assets at a general distribution. The floating capital used in the company which formerly consisted of subscribed capital and the reserves now becomes the subscribed capital. The amount said to be payable to the shareholders as income goes merely to increase the capital of the company and in the hands of the shareholders the certificates are property from which income will be derived. Lord Dunedin did not rely upon Swan Brewery's (1914) A.C. 231 case. He held that as the company could not pay for another, the shareholder must be taken to have paid for the bonus shares himself and the payment was the amount which came from the accumulated profits as profits. Lord Summer, however, stated that in Swan Brewery's (1914) A.C. 231 case, he did not rely upon the extended definition of dividend in the Australian Statute, but upon the principle involved. He observed that as a matter of machinery, what was done was to keep back the money released to the shareholder for application towards payment for the increased capital.
30. Lord Sumner had already adhered to his view in an earlier cases of the Privy Council, but Swan Brewery's (1914) A.C. 231 case and Blott's 8 Tax Cases 101 case were considered by the Privy Council in Commissioner of Income-tax, Bengal v. Mercantile Bank of India Ltd. and others (1936) A.C. 478. Lord Thankerton distinguished Swan Brewery's (1914) A.C. 231 case and followed Blott's 8 T C 101 case, though in Nicholas v. Commissioner of Taxes of the State of Victoria (1940) A.C. 744, Blott's 8 Tax Cases 101 case was distinguished on the ground that the definition in the Unemployment Relief Tax (Assessment) Act, 1933 also included within a person's assessable income "any dividend, interest, profit or bonus credited, paid or distributed to him by the company from any profit derived in or from Victoria or elsewhere by it", and that bonus shares must be regarded as dividend under that definition.
31. The Indian Income-tax Act defines "dividend" and also extends it in some directions but not so as to make the issue of bonus shares a release of reserves as profits so that they could be included in the term. The face value of the shares cannot therefore be taken to be dividend by reason of anything in the definition. The share certificate which is issued as bonus entitles the holder to a share in the assets of the company and to participate in future profits. As pointed out above, if sold, it may fetch either more or less. The market price is affected by many imponderables, one such being the yield or the expected yield. The detriment to the shareholder, if any, must therefore be calculated on some principle, but the method of computing the cost of bonus shares at their face value does not accord either with fact or business accountancy.
32. Can we then say that the bonus shares are a gift and are acquired for nothing ? At first sight, it looks as if they are so but the impact of the issue of bonus shares has to be seen to realise that there is an immediate detriment to the shareholder in respect of his original holding. The Income-tax Officer, in this case, has shown that in 1945 when the price of shares became stable it was Rs. 9/- per share, while the value of the shares before the issue of bonus shares was Rs. 18/- per share. In other words, by the issue of bonus shares pro rata, which ranked pari passu with the existing shares, the market price was exactly halved, and divided between the old and the bonus shares. This will ordinarily be the case but not when the shares do not rank pari passu and we shall deal with that case separately. When the shares rank pari passu the result may be stated by saying that what the shareholder held as a whole rupee coin is held by him, after the issue of bonus shares, in two 50 nP. coins. The total value remains the same, but the evidence of that value is not in one certificate but in two. This was expressed forcefully by the Supreme Court of United States of America, quoting from an earlier case, in Eisner v. Macomber 252 U.S. 189 - 64 L.Ed. 521, thus :
"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. It property is not diminished, and their interests are not increased........ The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones................. In short, the corporation is no poorer and the stock-holder is no richer than they were before......... If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $ 417,450 the sum upon which he was taxed......... What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new.
................. if a shareholder sells dividend stock, he necessarily disposes of a part of his capital interests, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished."
33. Swan Brewery's (1914) A.C. 231 case, it may be pointed out, was distinguished here also on the basis of the extended definition. It follows that the bonus shares cannot be said to have cost nothing to the shareholder because on the issue of the bonus shares, there is an instant loss to him in the value of his original holding. The earning capacity of the capital employed remains the same, even after the reserve is converted into bonus shares. By the issue of the bonus shares there is a corresponding fall in the dividends actual or expected and the market price moves, accordingly. The method of calculation which places the value of bonus shares at nil cannot be correct.
34. This leaves for consideration the other two methods. Here we may point out that the new shares may rank pari passu with old shares or may be different. The method of cost accounting may have to be different in each case but in essence and principle there is no difference. One possible method is to ascertain the exact fall in the market price of the shares already held and attribute that fall to the price of the bonus shares. This market price must be the middle price and not as represented by any unusual fluctuation. The other method is to take the amount spent by the shareholder in acquiring his original shares and to spread it over the old and new shares treating the new as accretions to the old and to treat the cost price of the original shares as the cost price of the old shares and bonus shares taken together. This method is suggested by the Department in this case. Since the bonus shares in this case rank pari passu with the old shares there is no difficulty in spreading the original cost over the old and the new shares and the contention of the Department is this case is right. But this is not the end of the present discussion. This simple method may present difficulties when the shares do not rank pari passu or are of a different kind. In such cases, it may be necessary to compare the resultant price of the two kinds of shares in the market to arrive at a proper cost valuation. In other words, if the shares do not rank pari passu, assistance may have to be taken of other evidence to fix the cost price of the bonus shares. It may then be necessary to examine the result as reflected in the market to determine the equitable cost. In England paragraph 10 of Schedule Tax to the Finance Act, 1962 provides for such matters and for valuing Rights issue but we are not concerned with these matters and need not express an opinion.
35. It remains to refer to three cases to which we have already referred in passing and on which some reliance was placed. In The Commissioner of Income-tax (Central), Bombay v. M/s. Maneklal Chunilal and Sons Ltd., Bombay [I.T. Ref. No. 16 of 1948 d. 23rd March 1949], the assessee held certain ordinary shares of the face value of Rs. 100/- in Ambica Mills Ltd. and Arvind Mills Ltd. These two companies then declared a bonus and issued preference shares in the proportion of two to one of the face value of Rs. 100/- each. These preference shares were sold by the assessee and if the face value was taken as the cost, there was a small profit. The Department contended that the entire sale proceeds were liable to be taxed, because the assessee had paid nothing for the bonus shares and everything received by it was profit. The assessee's view was that the cost was equal to the face value of the shares. The High Court rejected both these contentions and held that the cost of the shares previously held must be divided between those shares and the bonus shares in the same proportion as their face value, and the profit or loss should then be found out by comparing the cost price calculated on this basis with the sale price. In our opinion, there is difficulty in the High Court's decision. The preference shares and the ordinary shares could hardly be valued in the proportion of their face value. The ordinary shares and the preference shares do not rank pari passu.
36. The next case is Emerald Co. Ltd. v. C.I.T., Bombay City MANU/MH/0013/1955 : [1956]29ITR814(Bom) . In that case, the assessee had, at the beginning of the year, 350 shares of which 50 shares were bonus shares and all were of the face value of Rs. 250/- each. The assessee sold 300 shares and claimed a loss of Rs. 35,801/- by valuing the bonus shares at face value. The Department arrived at a loss of Rs. 27,766/- by the method of averaging the cost, following the earlier case of the Bombay High Court just referred to. The Tribunal suggested a third method. It ignored the 50 shares and the loss was calculated by considering the cost of 300 shares and their sale price. The loss worked out at Rs. 27,748/-, but the Tribunal did to disturb the order of the Appellate Assistant Commissioner in view of the small difference. The High Court held that the method adopted by the Department was proper but this Court, on appeal, held that in that case the method adopted by the Tribunal was correct. This Court did not decide which of the four methods was the proper one to apply, leaving that question open. The reason was that the assessee originally held 50 shares in 1950; in 1951, it received 50 bonus shares. It sold its original holding three days later and then purchased another 100 shares after two months. In the financial year 1950-51 (assessment year 1951-52), the Income-tax Officer averaged the price of 150 shares and found a profit of Rs. 1,060/- on the sale of 50 shares instead of a loss of 1,365/- which was claimed. The assessee did not appeal. In the financial year 1951-52 (assessment year 1952-53), the assessee started with 150 shares (100 purchased and 50 bonus). It then purchased 200 shares in two lots and sold 300 shares, leaving 50 shares. The assessee company claimed a loss of Rs. 35,801/-. The Income-tax Officer computed the loss at Rs. 27,766/- and the Tribunal computed the loss at Rs. 27,748/-. The Tribunal, however, did not disturb the loss as computed by the Income-tax Officer in view of the slender difference of Rs. 18/-. The High Court's decision was reversed by this Court, because the High Court ignored all intermediate transactions and averaged the 300 shares with the 50 bonus shares. The shares in respect of which the bonus shares were issued were already averaged with the bonus shares. This was not a case of bonus shares issued in the year of account. It involved purchase and sale of some of the shares. The average cost price of the original and bonus shares was already fixed in an earlier year by the Department and this fact should have been taken into account. No doubt, Chagla, C.J. observed that it was not known which of the several shares were sold in the year of account, but in the Statement of the Case it was clearly stated that bonus shares were untouched.
37. The decision of this Court in Emerald Company's MANU/MH/0013/1955 : [1956]29ITR814(Bom) case, however, lends support to the view which we have expressed here. The bonus shares can be valued by spreading the cost of the old shares over the old shares and the new issue taken together, if the shares rank pari passu. When they do not, the price may have to be adjusted either in the proportion of the face value they bear (if there is no other circumstance differentiating them) or on equitable considerations based on the market price before and after the issue.
38. Applying the principles to the present case, the cost of 31,909 shares, namely, Rs. 5,84,283/- must be spread over those shares and the 31,909 bonus shares taken together. The cost price of the bonus shares therefore was Rs. 2,92,141/- because the bonus shares were to rank equal to the original shares. The account would thus stand as follows :-
39. The answer to the question given by the High Court was therefore erroneous and the right answer would be that the profit computed at Rs. 3,11,646/- was not in accordance with law. The appeal is therefore allowed with costs here and in the High Court.
40. Appeal allowed.
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MANU/SC/0838/1998
Equivalent Citation: AIR1998SC340, [1998]229ITR112(SC), JT1997(9)SC296, 1997(7)SCALE242, (1998)1SCC355, (1997)143CTR(SC)313,(1997)Supp5SCR285,(1997)95TAXMAN460(SC)
IN THE SUPREME COURT OF INDIA
Civil Appeal Nos. 140-42 of 1988
Assessment Year: 1972-1973;1973-1974;1974-1975
Decided On: 19.11.1997
Appellants: Hunsur Plywood Works Ltd.
Vs.
Respondent: Commissioner of Income Tax
Hon'ble Judges/Coram:
S.C. Sen and V.N. Khare, JJ.
Counsels:
For Appellant/Petitioner/Plaintiff: Gopal Jain and Mukul Mudgal, Advs
For Respondents/Defendant: J. Ramamurti, Senior Adv., T.C. Sharma, N.K. agarwal and B.K. Prasad, Advs.
Subject: Direct Taxation
Relevant Section:
Income Tax Act, 1961 - Section 155(5)(ii)(a), Income Tax Act, 1961 - Section 34(3)(a)(i)
Acts/Rules/Orders:
Income Tax Act, 1961 - Section 33, Income Tax Act, 1961 - Section 34(3), Income Tax Act, 1961 - Section 154, Income Tax Act, 1961 - Section 155(5)
Cases Referred:
United States, Eisner v. Macomber, 252 US 189, (1920) 64 L Ed 521 ; IRC v. Blott (1921) 2 AC 171 : 1921 All ER 810; IRC v. Fisher's Executors 1926 AC 395 : 95 LJ KB 487; CIT v. Dalmia Investment Co. Ltd. MANU/SC/0103/1964; Leader Engineering Works v. CIT MANU/PH/0308/1980
Prior History:
From the Judgment and Order dated 18-9-1987 of the Karnataka High Court in S.C.L.A.Ps. Nos. 131-133 of 1986
Disposition:
In Favour of Assessee
Citing Reference:
v. Dalmia Investment Co. Ltd. MANU/SC/0103/1964 Discussed
Commissioners of Inland Revenue v. Fisher's Executors Discussed
Inland Revenue Commissioners v. Blott Discussed
Commissioner of Income Tax, Amritsar-ll MANU/PH/0308/1980 Discussed
Supreme Court of United States, Elsner v. Macomber Discussed
Case Note:
Direct Taxation - development reserve fund - Sections 34 (3) and 155 (5) of Income Tax Act, 1961 - whether Tribunal right in holding that development rebate reserve did not amount to distribution of profits under Section 34 (3) (a) (i) and Section 155 (5) (ii) (a) - transfer of amounts standing to credit of development rebate reserve to share capital account does not involve any disbursement of money by Company - entire amount of money shown as development rebate is retained by Company in another account - when shareholder gets bonus share value of original share held by him goes down - accumulated profit lying to credit of development rebate reserve been retained by Company - amount been transferred to share capital account otherwise intrinsic value of shares had been more - after issue of bonus shares intrinsic value of original shares been gone down rateably - neither in form nor in substance in any distribution of profits by company in making bonus issue - held, issue of bonus shares not amounted to development rebate reserve fund.
HELD See paras 4, 17, 20, 21, 23, 24 and 25.
Industry: Miscellaneous
JUDGMENT
S.C. Sen, J.
1. The appellant is a public limited company. The assessment years involved are 1972-73, 1973-74 and 1974-75. In regard to the above assessment years, in the returns of income filed by the appellant before the assessing authority, a claim towards allowance of development rebate under Section 33 of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') was made. The assessing authority allowed the claim as made by the company. Subsequently. The assessing authority noticed from the balance sheet of the appellant company that the company had made a transfer of sums from the development rebate reserve to share capitalisation account by issue of bonus shares. The assessing authority concluded that the issuance of bonus shares amounted to distribution of profits by capitalisation and thus the assessing authority was of the view that the provision of Section 155(5)(ii)(a) of the Act applied to the instant case, as the development rebate reserve has been utilised for distribution by way of dividend or profits. Accordingly, the assessing authority passed an order under Section 154 of the Act withdrawing the development rebate claim allowed earlier.
2. The Company went up on appeal. The appellate authority allowed its appeal. The claim of the appellant for development rebate was sustained.
3. The Appellate Tribunal on the Revenue's appeal concurred with the view taken by the first appellate authority and concluded that there was no distribution by way of dividend or profits in the issue of bonus shares.
4. Thereafter, on the application by the Commissioner of Income-tax, the following questions of law were referred to the High Court :
"(a) Whether on the facts and in the circumstances of the case the ITAT is right in law in holding that issue of bonus shares from out of the development rebate reserve did not amount to distribution of profits within the meaning of Section 34(3)(a)(i) and Section 155(5)(ii)(a)?
(b) Whether on the facts and in the circumstances of the case the ITAT is right in law in holding that the ITO is not justified in withdrawing the development rebate?"
5. The High Court after examining the provision of Section 34(3)(a)(i) and Section 155(5)(ii)(a) of the Income Tax Act held that the issue of bonus shares resulted in distribution of profits and therefore, the statutory requirement of Section 34(3)(a)(i) of the Act had been violated. The High Court answered both the questions in the negative and in favour of the Revenue. The assessee has come up on appeal to this Court.
6. Section 33 of the Act deals with allowance of development rebate in respect of new ship or new machinery to loan owned by the assessee, if it was wholly used for the purpose of business carried on by him. The allowance is given subject to a number of conditions. We are concerned in this case with the condition laid dawn in Section 34, which is as under :
"34(3)(a). The deduction referred to in Section 33 shall not be allowed unless an amount equal to seventy five percent of the development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of eight years next following for the purposes of the business of the undertaking, other than-
(i) for distribution by way of dividends or profits."
Section 155(5)(ii)(a) which is also relevant in this case is as under :
"(5). Where an allowance by way of development rebate has been made wholly or partly to an assessee in respect of a ship, machinery to plant installed after the 31st day of December, 1957 in any assessment year under Section 33 of the Indian Income Tax Act, 1922 (XI of 1922), and subsequently-
(i) * * *
(ii) at any time before the expiry of the eight years referred to in Sub-section (3) of Section 34, the assessee utilised the amount credited to the reserve account under Clause (a) of that sub-section-
(a)for distribution by way of dividends or profits."
7. The assessee created a development rebate fund to avail of the deduction under Section 33, Section 34(3)(a) does not prohibit the assessee from using any amount credited to the fund for the purpose of its business but he cannot utilise the amount for eight years for "distribution by way of dividends or profits". If the Income-tax Officer finds that the assessee had utilised any amount out of the reserve fund for distribution by way of dividends or profits, he can withdraw the allowance given under Section 33 by proceeding under Section 155.
8. In this case there is no allegation that the assessee has distributed any dividend out of the amounts standing to the credit of the fund. But the assessee issued bonus shares and for that purpose transferred the amount standing to the credit of the fund to the share capital account, the question is whether under these circumstances issuance of bonus shares will amount to distribution of profits.
9. The answer to the question is not easy. One view is that issue of bonus shares to the shareholders involves a dual operation by which an amount is released to the shareholders from a reserve fund but was retained by the Company and applied in payment of the bonus shares which were issued as fully paid up. The shareholders are treated as having paid for the bonus shares and the supposed payments by the shareholders are taken to shares and capital account from reserve fund of the Company. In effect, the shareholders have paid the face value of the bonus shares. It was to all intents and purposes equivalent to distribution of accumulated profits in cash by the Company.
10. The second view is that when bonus shares are issued an amount equal to the face value of the shares cannot be regarded as having been received by the shareholders. The issuance of bonus shares was nothing but mere capitalisation of the profits of the company in respect of which certificates are issued to the shareholders entitling them to participate in the amount of the reserve but only as part of the capital.
11. The mechanism and effect of issue of bonus shares have been explained by the English Courts in a number of cases.
12. Lord Haldane in the case of Inland Revenue Commissioners v. Blott, (1921) AC 171, held.
"My Lords, for the reasons I have given I think it is, as matter of principle, within the power of an ordinary joint stock company with articles such as those in the case before us to determine conclusively against the whole world whether it will withhold profits it has accumulated from distribution to its shareholders as income and as an alternative not distribute them at all, but apply them in paying up the capital sums which shareholders electing to take up unissued shares would otherwise have to contribute. If this is done, the money so applied is capital and never becomes profits in the hands of the shareholder at all. What the latter gets is no doubt a valuable thing. But it is a thing in the nature of an extra share certificate in the company."
13. In that case, Viscounts Haldane. Finlay and Cave held that an amount equal to the face value of the shares could not be regarded as received by the shareholders. A contrary view was taken by Lord Dunedin and Lord Sumner who held that the word "capitalisation" was somewhat hazy and the amount that was "capitalised had to be treated as to have been paid to the shareholders.
14. In the case of Commissioner of Inland Revenue v. Fisher's Executors, (1926) A.C. 395, Viscount Cave dealt with a case of a company which had large undistributed profits. It decided to capitalise a part of these profits and distribute it pro rata among the ordinary shareholders as a bonus in the form of five per cent debenture stock. The stock was duly issued, conditions providing that the Company might redeem the stock after a certain time and in certain events. The question that came up for decision was whether the bonus paid in the form of debenture stock was income in the hands of the shareholders and was, therefore, liable to super tax. Viscount Cave held :
"The whole transaction was "bare machinery" for capitalizing profits and involved no release of assets either as income or as capital."
15. In coming to this conclusion, Viscount Cave relied upon the following observation of Lord Finally in Blott's case :
"The general scope and effect of these transactions is beyond dispute. There was an increase in the capital of the company by the retention of the amounts available for dividends....The use of the sums which had been available for dividend to increase capital would enable the company to carry on a larger and more profitable business, which might be expected to yield larger dividends. The dividends, however, were to be in the future. So far as the present was concerned there was no dividend out of the accumulated profits: these were devoted to increasing the capital of the company. The company had power to do what it pleased with any profits which it might make. It might spend the accumulated profits in the improvement of the company's works and buildings and machinery. These improvements might lead to a great accession of business and increase of profits by which every shareholder would benefit, but of course it could not for a moment be contended that such a benefit would render him liable to super tax in respect of it. The benefit would not be in the nature of income, and super tax can be levied only on income."
16. In our view the principle stated by Lord Finlay really resolves the controversy raised in this case. The profits made by the Company may be distributed as dividends or retained by the Company as its reserve which may be used for improvement of the company's works, buildings and machinery. That will enable the company to make larger profits. There cannot be any dispute that the shareholders will benefit from the improvements brought about in the profit making apparatus of the Company. Likewise, if the accumulated profits are capitalised and capital base of the Company is enlarged, this may enable the Company to do its business more profitably. The shareholders will also benefit if the share capital is increased. They may benefit immediately by issue of bonus shares. But neither in the case of improvement in the profit making apparatus nor in the case of expansion of the share capital of the Company, can it be said that the shareholders have received any money from the Company. They may have benefited in both the cases. But this benefit cannot be treated as distribution of the amount standing to the credit of any reserve fund of the company to its shareholders.
17. In fact the transfer of the amounts standing to the credit of Development Rebate Reserve to the share capital account, does not involve any disbursement of money by the Company. Nothing comes out of the till of the Company to the shareholder. The entire amount of money shown as development rebate reserve is retained by the Company in another account. It cannot be said that by the issue of bonus shares, the Company had distributed its reserve fund to the shareholders even though it had retained the entire amount with it in the share capital account.
18. It must also be noted that while dealing with the question of valuation of bonus shares in the case of Commissioner of Income-Tax, Bihar v. Dalmia Investment Co. Ltd. MANU/SC/0103/1964 : [1964]52ITR567(SC) , Hidayatullah, J. (as His Lordship then was) after referring to Blott's case (supra), preferred the view expressed by Viscounts Haldane, Finlay and Cave to the dissenting view taken by Lord Dunedin and Lord Sumner. Dealing with effect of issue of bonus shares, Hidayatullah, J. held that "the floating capital used in the company which formerly consisted of subscribed capital and the reserves now becomes the subscribed capital of the Company". The certificates in the hands of the shareholders were property from which income will be derived in future.
19. Hidayatullah, J. Dalmia's Case, also quoted with approval a passage from a decision of the Supreme Court of United states, Eisner v. Macomber (1920) 252 U.S. 189:
"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished, and their interests are not increased....The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest the new shares and the original shares together representing the same proportional interests that the original shares represented before the issue of the new ones....In short, the corporation is no poorer and the stock-holder is no richer than they were before....If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $ 417,450 the sum upon which he was taxed....What has happened is that the plaintiffs old certificates have been split up in effect and have diminished in value to the extent of the value of the new."
20. When a shareholder gets a bonus share the value of the original share held by him goes down. In effect, the shareholder gets two shares instead of the one share held by him and the market value as well as the intrinsic value of the two shares put together will be the same or nearly the same as the value of the original share before the bonus issue.
21. It appears from the various decisions cited hereinabove, that issuance of bonus shares does not amount to distribution of accumulated profit of a company. The shareholder derives some benefit by the process of capitalising of the accumulated profits but at the same time, the value of his original shareholding goes down. Viewed from any angle, it cannot be said that in this case, the assessee-Company had distributed any part of its Development Rebate Reserve Fund when it issued the bonus shares. The accumulated profit lying to the credit of the Development Rebate Reserve has been retained by the Company. The amount has been transferred to the share capital account. If that was not done the intrinsic value of the shares held by the shareholders would have been more. After the issue of the bonus shares, the intrinsic value of the original shares have gone down rateably. The accumulated profits of the Company have remained with the Company in one account or another.
22. On behalf of the Revenue, our attention was drawn to the judgment in the case of Leader Engineering Works v. Commissioner of Income Tax, Amritsar-II MANU/PH/0308/1980. That was a case of partnership firm. The amount standing to the credit of development rebate reserve account was debited and the capital accounts of the partners in the partnership account were correspondingly credited. It was held that the identity of the development rebate reserve account had completely disappeared. The amount standing to the credit of that reserve was placed at the disposal of the partners who were free to withdraw the same for their own purposes. In that case it was held that the transfer of the amount standing to the credit of the development rebate reserve in the individual's account of the partners amounted to distribution of profits. We fail to see how this decision helps the Revenue in the facts of this case. The shareholders are not entitled to draw any money from the share capital account of the company. The money standing to the credit of the Development Rebate Reserve is retained by the Company in another account. A shareholder cannot claim that any part of the share capital of the company belongs to him or make use of it.
23. The question as to the substance of the transaction was also raised. The case, however, has to be decided on the basis of the language of the statute. There has been no distribution from the development rebate fund. The result might have been different had the statute been differently worded but we shall have to take the statute as it is and not in any other sense. Moreover, as was pointed out by Lord Sumner in Fisher's case that desires and intentions are things of which a company is incapable. These are the mental operations of its shareholders and officers. The only intention that the company has is such as is expressed in or necessarily follows from its proceedings. It is hardly a paradox to say that the form of a company's resolutions and instruments is their substance.
24. In this case, neither in form nor in substance, has there been any destitution of profits by the company in making the bonus issue. If the substance and not the form of the transaction is looked to, the issue of a bonus shares was, in the language of Rowlatt, J. "a bare machinery" for capitalising profits and there was no distribution of profits to the shareholders.
25. We are unable to uphold the view expressed by the High Court that the issue of bonus shares in the facts of this case amounted to distribution of accumulated profits of the Company shown as Development Rebate Reserve Fund. The appeals are allowed. Judgment under appeal is set aside. There will be no order as to costs.
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Madhya Pradesh High Court
Commissioner Of Income-Tax vs Pushpraj Singh on 26 August, 1997
Equivalent citations: 1998 232 ITR 754 MP
Author: A Mathur
Bench: A Mathur, D Misra
JUDGMENT A.K. Mathur, C.J.
1. This is an application under Section 256(2) of the Income-tax Act, 1961, at the instance of the
Revenue. The Revenue has raised the following two questions of law for answer by this court by
calling for the statement of the case :
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal had jurisdiction to
allow the assessee to raise different grounds of appeal, particularly in view of the fact that the issues
were not raised before the Commissioner of Income-tax (Appeals) and the Commissioner of
Income-tax (Appeals) had not considered the issue of his order ?
(2) Whether the Tribunal was right in law in holding that the rights did not vest with the assessee in
the shares and securities and, therefore, surplus arising out of
Asked 8 years ago
Respected Sir,
In continuation to above, A case named DEPUTY COMMISSIONER OF INCOME TAX vs. GIRNAR INVESTMENT LTD. ITAT, DELHI ‘F’ BENCH Sikander Khan, A.M. & Y.K. Kapur, J.M. ITA No. 4330/Del/1998 17th July, 2003 (2005) 92 TTJ (Del) 711 :(2004) 88 ITD 419 (Del) that belongs to Section 45, 48, 55(2)(iiia), Asst. Year 1995-96, in which it was stated in last para:
“This brings us to the last submission of the assessee that the amendment carried
out in s. 55 by incorporation of sub-s. (iiia) clarifies the grey area as by virtue of the amendments the cost of bonus shares has been mandated to be taken as nil. The submission of the assessee was that on account amendment which has been carried out to clear doubt, the benefit of same should be given to the assessee. When we examined this contention of the assessee, we found that the amendment is operative from 1st April, 1996. It has no retrospective effect.”
Whether from this can it be not deduced that if the A.y. would have been 1996-97 or later years, the benefit can be given.
Thanks with Regards,
DEPUTY COMMISSIONER OF INCOME TAX vs. GIRNAR INVESTMENT LTD.
ITAT, DELHI ‘F’ BENCH
Sikander Khan, A.M. & Y.K. Kapur, J.M. ITA No. 4330/Del/1998 17th July, 2003 (2005) 92 TTJ (Del) 711 :
(2004) 88 ITD 419 (Del)
Section 45, 48, 55(2)(iiia),
Asst. Year 1995-96
Decision in favour of Revenue
Counsel appeared :
R.R. Prasad, for the Appellant : G.C. Sharma, for the Respondent
Order
y.k. kapur, j.m. :
The Revenue is in appeal before us challenging the order of CIT(A) dt. 20th May, 1998 on the ground reproduced
below : "On the facts and in the circumstances of the case, the CIT(A) has erred both on facts and in law in
deleting the addition of Rs. 62,16,000 holding that there could be no capital gains on the sale of bonus shares since
their cost of acquisition cannot be determined by relying on the Supreme Court’s decision in the case of CIT vs.
B.C. Srinivasa Shetty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294 (SC): (a) despite the fact that this case is
distinguishable on the fact as it pertains to capital gains on ‘goodwill’ and not to capital gains on ‘bonus shares’.
(b) Despite the fact that the Supreme Court has held that capital gains is attracted on the sale of bonus shares and
has even laid down exhaustive principles for determining the cost of bonus shares in the case of CIT vs. Dalmia
Investment Co. Ltd. (1964) 52 ITR 567 (SC) and in the case of Shekhavati General Traders Ltd. vs. ITO 1972
CTR (SC) 120 : (1971) 82 ITR 788 (SC)."
2. The genesis of the present litigation as emanating from the order of the AO and that of the CIT (A) is that the
assessee which is an investment company filed a return of income declaring as total income of Rs. 64,18,600
comprising of income from capital gains, dividend income and interest income. Notice under s. 143(2) was issued
and during the course of assessment proceedings, the AO noticed that the assessee had not offered the capital
gains on the sale of bonus shares for taxation. The capital gain has arisen on account of the sale of 12985 equity
shares of M/s Vardhaman Spinning & General Mills Co. Ltd. which shares were sold for a consideration of Rs.
62.16 lakhs. This is also on record that these shares were acquired by the assessee-company in the year 1982 as
bonus shares, i.e., no costs were incurred by the company for acquiring these shares. As the assessee did not offer
the amount received by it on account of the sale of bonus shares for taxation, the AO issued a notice to Showcause
as to why the amount of Rs. 62.16 lakhs which according to him represented a long-term capital gain be not
subjected to taxation.
3. Show-cause notice issued by the AO was duly replied to by the assessee wherein it was contended that the
assessee had acquired the bonus shares without incurring any costs and therefore, the amount realised by the sale
of such an asset, is not exigible to tax. The assessee also contended that if acquisition of an asset has no cost to the
assessee, then the provisions relating to the levy of tax as capital gain under s. 45(1) r/w 48(1) would not apply.
Before the AO, the assessee while advancing his arguments further submitted that where the transactions to which
provision of s. 48(1) which deals with mode of computation of capital gains cannot be applied, must be regarded
as never intended by s. 45(1). Apart of the submission referred to above, the assessee relied upon certain legal
precedents including the judgment of the apex Court in the case of CIT vs. B.C. Srinivasa Shetty (1981) 21 CTR
(SC) 138 : (1981) 128 ITR 294 (SC).
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The AO after considering the arguments raised by the assessee as well as the case law relied upon came to the
conclusion that the assessee during the relevant assessment year has earned capital gain through the sale of bonus
shares and brought the amount/sale proceeds received by the assessee within the tax net.
The assessee being not satisfied with the order of the AO filed an appeal before the CIT(A). The arguments raised
by the assessee before the AO were reiterated before the CIT(A). The CIT(A) after hearing the assessee and taking
notice of the judgment of the apex Court in B.C. Srinivasa Shetty’s case (supra) proceeded to hold that as the
bonus shares had no cost of acquisition, the amount received on its sale cannot be brought within the tax net as
capital gain.
The Revenue has a grievance to the said order of the CIT(A) and is in appeal before us on the grounds reproduced
above.
We may at this stage say that though this was appeal of the Department, the assessee who was represented by Shri
G.C. Sharma, senior advocate, had filed written submissions.
At the time of hearing Mr. G.C. Sharma, senior advocate, submitted that he be permitted to open up for which
permission was granted.
At the threshold the submissions of the learned senior counsel was that no capital gain can be imposed on an asset
which has no cost of acquisition. The learned senior counsel would contend that in the case of bonus shares, there
being no costs of acquisition or improvement thereon, the question of acquiring of any capital gain or their
taxability would not arise. The learned senior counsel would contend that the capital asset is acquired once at a
price and the price cannot be subjected to variation by the subsequent happening. The learned senior counsel
submitted that the cost of acquisition of capital asset being constant and there being no improvement to the capital
asset in the case of shares, in the event of the application of averaging formula, the cost of acquisition of capital
asset would change which would hit the intention of legislature which intended the cost of acquisition of capital
asset to be constant. The learned counsel submitted that what he says draws support from s. 48 of the IT Act
which deals with mode of computation of capital gains, whereunder it has been mandated that the income
chargeable to capital gain shall be computed by deducting from full value of consideration received as a result of
transfer of capital asset expenditure incurred wholly or exclusively in connection with such transfer, the cost of
acquisition of the asset and cost of improvements, when confronted with the judgment of the apex Court in the
case of CIT vs. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (SC) wherein the apex Court has laid down that
the cost of bonus shares has to be determined by applying the formula of cost of original shares upon number of
original shares plus number of bonus shares, the learned senior counsel submitted that argument which he is
raising today was not raised before the apex Court and therefore, the judgment is distinguishable. Similar
observations were made by learned senior counsel with respect to another judgment of the apex Court in the case
of Excorts Farm (Ramgarh) Ltd. vs. CIT (1996) 136 CTR (SC) 434 : (1996) 222 ITR 509 (SC). After having said
so the learned senior counsel submitted that as the cost of acquisition of the original shares cannot vary, the cost of
bonus shares has to be taken as nil and thus the amount received may be as capital receipt but it cannot be exigible
to tax. The learned senior counsel placed very heavy reliance on the judgment of the apex Court in B.C. Srinivasa
Shetty’s case (supra) and submitted that the said case applied with full force. After having said so the learned
senior counsel drew our attention to the amendment carried out in s. 55(2) by incorporation of cl. (iiia) wherein it
has been mandated that if an assessee on the basis of his holding is allotted any financial asset, the cost of
acquisition of such asset shall be taken to be nil.
The learned senior counsel submitted that the incorporation of s. 55(2)(iii a) in the Act substantiates his
submission that the receipt on account of sale of bonus shares is not exigible to tax and the judgment of B.C.
Srinivasa Shetty’s case (supra) has full applicability. Apart from this, the learned senior counsel relied upon CIT
vs. Octavious Steel & Co. Ltd. (1997) 137 CTR (Cal) 257 : (1996) 221 ITR 810 (Cal) and CIT vs. Pushpraj Singh
(1998) 150 CTR (MP) 680 : (1998) 232 ITR 754 (MP) and (1995) 212 ITR 357 (St). After the learned senior
counsel had concluded, we confronted him with a judgment of the Bombay High Court in Seth Rajesh Family
Trust No. 1 vs. CIT (1995) 127 CTR (Bom) 390 : (1995) 215 ITR 530 (Bom), as well, with regard to which we
shall deal within later part of the order.
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11. To the arguments raised by the learned senior counsel, the learned Departmental Representative submitted that
the issue is covered by Dalmia’s Investment (P) Ltd. case (supra) and Shekhavati General Traders Ltd. vs. ITO
1972 CTR (SC) 120 : (1971) 82 ITR 788 (SC). The submission of the learned Departmental Representative was
that the cost of bonus shares is not only determinable but determined on the principles of averaging as held by
various Courts as well as the apex Court. According to learned Departmental Representative there is a clear
distinction between the determination of the cost of goodwill and that of bonus shares. The submission of the
learned Departmental Representative was that in view of the distinction between cost of acquisition of goodwill
and cost of determination of bonus shares, B.C. Srinivasa Shetty’s case (supra) has no application and the very
foundation of the reasoning of commissions while relying on Shetty’s case (supra) is questionable. The other
submission of the learned Departmental Representative was that the cost of bonus shares with respect to the period
prior to 1st April, 1996, has to be determined, can be determined on the principle of averaging. According to the
learned Departmental Representative the assessment year being 1995-96 which expires on 31st March, 1996 and
the amendment having come into force on 1st April, 1996 being not retrospective in nature has no application to
the present proceedings which pertain to year ending 31st March, 1996.
12. We have heard the parties and taken ourselves through the record and given our deep thought to the
submissions of the learned senior counsel who had tried to distinguish the judgment of the apex Court in Dalmia
Investment Co. case (supra) on the ground that the question that cost of capital asset cannot vary was neither
raised nor considered in Dalmia’s case (supra) the law laid down in Dalmia’s (supra) and in subsequent case
following Dalmia’s case (supra) is not binding. Since the issue was seriously raised and canvassed and claimed to
have been raised for the first time and the claim was made by learned senior counsel with authority it compelled
us to do our private study/research when we found that this is not so.
12A. This issue and the identical arguments were raised before the Calcutta High Court in the case of Sutlej
Cotton Mills Co. Ltd. vs. CIT (1979) 119 ITR 666 (Cal), wherein the issue before the Calcutta High Court was to
examine the action of the Tribunal which had for the purposes of computation of capital gain had averaged the
cost of original and the bonus shares. The Calcutta High Court disagreed with the Tribunal and held that
subsequent issue of bonus shares does not affect the cost of acquisition of original shares meaning thereby that if
the cost of original shares cannot change, the cost of bonus shares has to be taken as nil.
13. To the similar effect is another judgment of the Calcutta High Court reported in the case of CIT vs. Steel
Groups Ltd. (1981) 22 CTR (Cal) 354 : (1981) 131 ITR 234 (Cal) wherein the Calcutta High Court once again
held that while computing capital gains the assessee was concerned with cost of acquisition i.e. the price which
was paid by the assessee for acquiring the capital asset on the date it was acquired subject to such adjustment as
laid down under s. 55 and the assessee has no concern with what would be the value of the asset on some
subsequent event; in other words, subsequent event need not be taken into account.
14. The issue of the price of bonus shares came up before the Delhi High Court in the case of Escorts Farms
(Ramgarh) Ltd. vs. CIT (1983) 35 CTR (Del) 170 : (1983) 143 ITR 749 (Del) and the contentions raised before
the Calcutta High Court in the case of Sutlej Cotton Mills’s case (supra) were repeated. It was contended before
the Delhi High Court that the cost of acquisition i.e. price paid by the assessee for acquiring such shares subject to
adjustment referred to in s. 55 is material and subsequent issue of bonus shares does not affect or alter or dilute the
costs of acquisition of original shares. The Delhi High Court did not agree with the view of the Calcutta High
Court in Sutlej Cotton Mills case (supra) and held that the actual costs to the assessee of the original shares has to
be spread over on both the original and bonus shares and, for the purposes of computing capital gain resulting
from the transfer of original shares, the cost of original shares has to be determined on such averaging. The
difference of opinion between Calcutta High Court in Sutlej Cotton Mills case and Steel Groups Ltd. case (supra)
on one side and of Delhi High Court in Escorts Farms (Ramgarh) (supra) on the other side stands resolved by the
apex Court in Escorts Farms (Ramgarh) Ltd. case (supra) wherein the apex Court has confirmed the view of Delhi
High Court in (1983) 143 ITR 749 (Del) (supra) and held that where bonus shares are issued and some of original
shares are sold subsequently the average costs has to be reckoned only on the basis of average value and while
holding this, the apex Court confirmed its earlier view in (1964) 52 ITR 567 (SC) (supra), in the case of Dalmia
Investment Co. Ltd. and observed that other cost of original shares has to be spread over the original and bonus
shares on their average.
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The net effect of the observation of the apex Court in (1996) 222 ITR 509 (SC) (supra), is that the view of the
Delhi High Court in 143 ITR 119 (supra) which had dissented from Calcutta High Court in Sutlej Cotton Mills
case (supra) is where identical arguments of this kind raised before us were raised stands confirmed and that the
view of the Calcutta High Court does not lay down a good law. The arguments raised by the assessee before us
that the cost of original shares cannot be altered or varied in the light of the judgments of the apex Court in (1996)
222 ITR 509 (SC) (supra) and (1964) 52 ITR 567 (SC) (supra), needs outright rejection. Another argument of the
assessee was that as the cost of acquisition of bonus shares is nil, in view of judgment of B.C. Srinivasa Shetty’s
case (supra), no capital gain tax is exigible. While making this submission, the learned senior counsel lost track of
fact that B.C. Srinivasa Shetty’s case (supra) pertained to the issue of valuation of goodwill while the case in hand
pertained to the issue and valuation of bonus shares and according to us B.C. Srinivasa Shetty’s case (supra) had
no application while arriving at the value of bonus shares. The view we take that B.C. Srinivasa Shetty’s case
(supra) had no application while taking out the costs of bonus shares, find support from the judgment of the
Bombay High Court in the case of Seth Rajesh Family Trust No. 1 vs. CIT (supra). We may with respect refer to
the relevant observations of the Bombay High Court. The Bombay High Court rejected the identical contention as
raised before us of the assessee that the transfer of bonus shares did not give rise to capital gain for the purpose of
IT Act as no price had been paid for the acquisition of bonus shares and it could not be said as to on what
particular date the bonus shares came into existence. This contention was raised in the context of the judgment of
the apex Court in B.C. Srinivasa Shetty’s case (supra). The relevant portion of the Bombay High Court in (1995)
127 CTR (Bom) 390 : (1995) 215 ITR 530 (Bom) (supra) reads as under : "The Tribunal rejected the contention of
the assessee and held that the principle laid down in the decision of the Supreme Court in B.C. Srinivasa Shetty’s
case (supra) was not applicable to the gains arising out of the sale of bonus shares. In arriving at the above
conclusion, the Tribunal relied upon the decisions of the Supreme Court in Dalmia Investment Co. Ltd. (1964) 52
ITR 567 (SC) and CIT vs. Gold Mohore Investment Co. Ltd. (1969) 74 ITR 62 (SC) and of the Bombay High
Court CIT vs. V. Alcock Ashdown & Co. Ltd. (1979) 8 CTR (Bom) 223 : (1979) 119 ITR 164 (Bom). Hence, this
reference at the instance of the assessee.
We have carefully considered the contention of the assessee and the order of the Tribunal. We have also perused
the decision of the Supreme Court in CIT vs. B.C. Srinivasa Shetty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294
(SC) on which reliance is placed by the assessee. We are, however, of the clear opinion that the ratio of the said
decision has no application to gains arising from sale of bonus shares because of the well-settled legal position
that the case of the bonus shares cannot be taken to be nil. Such shares have to be valued by spreading the cost of
the old shares over the old shares and the bonus shares taken together treating the bonus shares as accretions of the
old, if they rank pari passu. If they do not, the price may have to be adjusted either in proportion to the face value
they bear or on equitable considerations based on the market price before and after issue. (See CIT vs. Dalmia
Investment Co. Ltd. (supra) and CIT vs. Gold Mohore Investment Co. Ltd. (supra). It is settled by the decision of
this Court in D.M. Dehanukar vs. CIT (1973) 88 ITR 454 (Bom) that the above method of valuation of bonus
shares would apply irrespective of the fact whether the assessee is a dealer in shares or an investor.
The above legal position was reiterated by this Court in W.H. Brady & Co. Ltd. vs. CIT (1979) 10 CTR (Bom)
221 : (1979) 119 ITR 359 (Bom). In the above case, the assessee had treated the cost of acquisition of bonus
shares as nil. The ITO spread the cost of original shares over the whole of 2,680 shares which included 670
original shares and 2010 bonus shares. In appeal, the appellate AAC agreed with the assessee, but on further
appeal. The Tribunal restored the order of the ITO. On a reference, the High Court held that the ITO rightly
followed the method of valuation laid down by the Supreme Court in CIT vs. Dalmia Investment Co. Ltd. (supra),
it was further held that in view of the decision of this Court in D.M. Dahhankur vs. CIT (supra) it was not
permissible to content that the case of an investor in shares was different from that of a dealer in shares.
In view of the above legal position, we are of the clear opinion that the Tribunal was right in law in holding that
the gains arising out of the sale of bonus equity shares held by the assessee were liable to be included in the
income of the assessee as capital gains for the purpose of income-tax." When the learned senior counsel for the
assessee was confronted with the aforesaid observations of the Bombay High Court which we felt were directed
on the point and clinched the issue the learned senior counsel sought to distinguish the Bombay High Court
decision by referring to the judgment of the Calcutta High Court in CIT vs. Octavious Steel & Co. Ltd. (supra),
and of the Madhya Pradesh High Court in (1998) 232 ITR 754 (MP) (supra) and reliance was also placed on the
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statute portion of (1995) 212 ITR 357 (St). But we must say that in view of the clear and to the point judgment of
the Bombay High Court in Seth Rajesh Family Trust No. 1 case (supra), the reliance placed by the assessee on the
said rulings do not advance the case of the assessee and have thus no hesitation in holding the B.C. Srinivasa
Shetty’s case (supra) has no application where it comes to the question of taxability of receipts on account of sale
of bonus shares, as capital gains. This brings us to the last submission of the assessee that the amendment carried
out in s. 55 by incorporation of sub-s. (iiia) clarifies the grey area as by virtue of the amendments the cost of
bonus shares has been mandated to be taken as nil. The submission of the assessee was that on account
amendment which has been carried out to clear doubt, the benefit of same should be given to the assessee. When
we examined this contention of the assessee, we found that the amendment is operative from 1st April, 1996. It
has no retrospective effect. We must say that whenever the legislature wants an amendment to be retrospective, it
makes it so. Various instances of an amendment carried out under the IT Act with retrospective effect can be
found out in the Act itself and where the legislature has not made an amendment retrospective, we are afraid we
cannot say so. Law permits the Courts to interpret law but prohibits the Court from legislating. If we say that the
benefit of the amendment carried out in s. 55 by incorporation of cl. (iii a) to sub-s. (2) can be extended for the
earlier years when the amendment was not there we will be committing an illegality which we feel that we should
not do. The position in the matter for the period prior to 1st April, 1996 would remain the same as propounded by
the apex Court in Dalmia Investment Ltd., Bombay High Court in Seth Rajesh Family Trust No. 1 case, apex
Court in Escorts Farms (Ramgarh) Ltd. (supra). We, therefore, in view of the discussion above no hesitation in
saying that (i) costs on bonus shares prior to 1st April, 1996 can be arrived at on the principle of averaging (ii) the
judgment of the apex Court in the case of B.C. Srinivasa Shetty’s (supra) has no application while calculating
capital gains on bonus shares (iii) the amendment to s. 55(2) by incorporation of cl. (iii a) w.e.f. 1st April, 1996 is
substantive and has no retrospective effect.
22. As a result of the discussion above, the appeal of Revenue succeeds and is hereby allowed.
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Asked 8 years ago
