Case: Commissioner Of Income-Tax, Bihar Vs. Dalmia Investment Co. Ltd

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.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. 5,85,238/-. 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 share. 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:Existing shares Book value(1) 17,259 (out of 31,909 original shares) Rs.3,10,951.00 nP. Proportionate cost from Rs. 5,84,283(2) 31,909 Bonus shares Rs. 3,19,090.00 nP. at face value of Rs. 10/- per share.(3) 59,079 New issue shares Rs. 8,88,561.00 nP. at cost.(4) 2,500 New purchase shares Rs. 39,300.00 nP. at cost.Total 1,10,747 shares Rs. 15,57,902.00 nP.14. 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/-.15. 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 IT Ref. No. 16 of 1948 D/- 23-3-1949 (Bom) 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.16. Before the Appellate Assistant Commissioner, Patna, reliance was placed upon the decision of the Bombay High Court in 1956-29 ITR 814   : (AIR 1956 Bom 284  ) 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 a profit of Rs. 3,11, 646/-. He issued a notice to assessee company and enhanced the assessment.17. On further appeal to the Tribunal, the assessee company submitted again on the strength of the ruling of the Bombay High Court in 1956-29 ITR 814   : (AIR 1956 Bom 284  ) 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.18. 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 Highon 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 withreference 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 companys 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.

Court's reasoning:
21. 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 shareholder 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 shareholder. 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.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 inponderables, 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 businessfirst 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. TheOfficer, 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. Macamber, (1919) 252 US 189 : 64 Law EdIt 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.29. 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 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 in 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.30. It remains to refer to three cases to which we have already referred in passing and on which some reliance was placed. In IT Ref. No. 16 of 1948 D/- 23-3-1949 (Bom) 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 assessees 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 Courts 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.31. The next case is 1956-29 ITR 814   : (AIR 1956 Bom 284  ). 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 not 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. 1060/- on the sale of 50 shares instead of a loss of Rs. 1365/- 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 Courts 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 were36 ITR 257   (SC)32. The decision of this Court in Emerald Companys 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 circumstances differentiating them) or on equitable considerations based on the market price before and after the issue.*(1959) 36 ITR 257 (SC)33. Applying the principles to the present case, the cost of 31,909 shares, namely, Rs. 5,83,210/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 :Shares in Rohtas Industries Ltd.1. Old issue of 17,259 shares brought forward from 1945, at (proportionate cost ... ... ... Rs. 1,58,0352. Bonus shares 31,909 received in 1945, at (proportionate spread out) cost ... ... ... Rs. 2,92,1413. New issue 59,079 shares brought forward from 1945... ... ... Rs. 8,88,5614. New purchases 2,500 shares brought forward from 1947 ... Rs. 39,300Total 1,10,747 shares ... Rs. 13,78,037Sales of all the above shares in 1948 ... ... ... Rs. 15,50,458Profit ... ... Rs. 7,444Profit to be added to the income returned ... ... ... Rs. 1,79,865Sales of all the above shares in 1948 ... ... ... Rs. 15,50,458 Profit ... ... Rs. 7,444 Profit to be added to the income returned ... ... ... Rs. 1,79,865