Plywood Works Ltd. Vs. The Commissioner of Income-Tax  INSC 835 (19 November 1997)
C. SEN, V.N. KHARE
19TH DAY OF NOVEMBER, 1997 Present:
Mr. Justice Suhas C.Sen Hon'ble Mr. Justice V.N. Khare Gopal Jain, Adv. for Mukul
Mudgal, Adv. for the appellant J. Ramamurthy, Sr.Adv., T.C.Sharma, N.K.Agarwal,
B.K.Prasad, Advs. with him for the Respondent
following Judgment of the Court was delivered:
appellant is a public limited company. The assessment years involved are
1972-73, 1973-74 and 1974-75.
regarded 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.
the assessing authority noticed from the balance sheet of the appellant company
that the company had made a transfer for sums from the development rebate
reserve to share capitalisation account by issue of bonus shares.
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.
the assessing authority passed an order under section 154 of the Act
withdrawing the development rebate claim allowed earlier.
Company went up on appeal. The appellate authority allowed its appeal. The
claim of the appellant for development rebate was sustained.
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.
on the application by the Commissioner of Income-tax, the following questions
of law were referred to the High Court :
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 account to distribution of profits within the meaning of
section 34(3)(a)(i) and section 155(5)(ii)(a)? (b) Whether or 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?" The 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 on appeal to this Court.
33 of the Act deals with allowance of development rebate in respect of a new
ship or new machinery or plant 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
down in Section 34, which is as under:
The deduction referred to in Section 33 shall not be allowed unless an amount
equal to seventy five per cent of the development rebate to be actually allowed
is debited to the profit and loss account of the relevant previous year and
credited to are 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
Where an allowance by way of development rebate has been made wholly or partly
to an assessee in respect of a ship, machinery or plant installed after the
31st day of December, 1957 in any assessment year under Section 33 of the
Indian Income-tax Act, 1992 (XI of 1922), and subsequently- (i) xx xx xx xx
(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." 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 the business but he cannot utilise the amount for eight years for
"distribution by way 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 shareholders entitling them to participate in the
amount of the reserve but only as part of the capital.
mechanism and effect of issue of bonus shares have been explained by the
English Courts in a number of cases.
in the case of Inland Revenue Commissioners vs. Blott (1921) AC 171 held:
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.
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." In that case, Viscounts Haldane, Finally 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 Summer
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.
case of Commissioners of Inland Revenue v. fisher's Executors, (1926) A.C. 395,
Viscount Cave dealt proceeding under Section 155.
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.
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 share capital account from reserve
fund of the Company. In effect, the shareholders have paid the face value of
the bonus shares.
to all intents and purposes equivalent to distribution of accumulated profits
in cash by the Company.
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
with a case of 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:
whole transaction was "bare machinery" for capitalizing profits and
involved no release of assets either as income or as capital." In coming
to this conclusion, Viscount Cave relied upon the following observation of Lord Finlay in Blott's
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;
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." 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.
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.
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
must also be noted that while dealing with the question of valuation of bonus
shares in the case of Commissioner of Income-Tax, Bihar vs. Dalmia Investment Co.Ltd. 52 ITR 567, 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 Summer.
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.
J. in 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:
stock dividend really takes nothing from the property of the corporation, and
adds nothing to the interests of the shareholders.
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 plaintiff's old certificates have been
split up in effect and have diminished in value to the extent of the value of
the new." 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.
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.
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.
amount has been transferred to the share capital account, If that was not done
the intrinsio value of the shares held by the shareholders would have been
more. After the issue of the bonus shares, the intrinsio 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.
behalf of the Revenue, our attention was drawn to the judgment in the case of
Leader Engineering Works vs. Commissioner of Income Tax, Amritsar-II 124 ITR
44. 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.
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 its.
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 stature as it is and not in any other sense. Moreover, as was
pointed out by Lord Summer 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
this case, neither in form not 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 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.
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. The judgment under appeal is set aside. There will be no order as