Case: Hunsur Plywood Works Limited Vs. Commissioner of Income Tax

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 provisions 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 allowedThe Company went up in appeal. The appellate authority allowed its appeal. The claim of the appellant for development rebate wasThe Appellate Tribunal on the Revenues 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 bonusThereafter, on the application by the Commissioner of Income Tax, the following questions of law were referred to the HighWhether 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 rebateThe High Court after examining the provisions 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 in appeal to this Court

Court's reasoning:
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 Companys 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 itsIn 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 capitalWhen 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 bonusIt 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 orIn this case, neither in form nor in substance, has there been any distribution 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 bonus shares was, in the language of Rowlatt, J. (sic) "a bare machinery" for capitalising profits and there was no distribution of profits to the shareholders