Commissioner of Income-Tax, Bihar Vs.
Dalmia Investment Co. Ltd.  INSC 74 (13 March 1964)
13/03/1964 SARKAR, A.K.
CITATION: 1964 AIR 1464 1964 SCR (7) 210
F 1967 SC 614 (5) F 1969 SC1183 (7,8) D 1971
company-Dealing in shares-Bonus shares-Valuation.
The assessee company dealt in shares and also
held investments of shares on January 1, 1948. The assessee held 1,10,747, shares
of Rohtas Industries at a book value of Rs. 15,57,902/-. Of these shares 31,909
were bonus shares issued by Rohtas Industries in 1945 at the face value of Rs. lo/,
each and the assessee had debited the investment account in respect of the
bonus shares by Rs. 3,19,090 with a corresponding entry in the capital reserve
account on its credit side for the same amount. The assessee acquired these
bonus shares at a cost of Rs. 5,84,283 in 1944. On January 29, 1948, the
assessee sold the entire lot of 1,10,747 shares for Rs. 15,50,458. The assessee
deducted the sale price from the book value of Rs. 15,57,902 and claimed a loss
of Rs. 7,444 on the sale of shares. The appellate Tribunal valued the bonus
shares at nil and held that the assessee had made a profit of Rs. 3,11,646/-.
On a reference the High Court held that the Tribunal was wrong in holding that
the assessee had made a profit of Rs. 3,11,646/-.
Held (per Hidayatullah and Shah, JJ.): (i)
The 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 shares certificate which is issued as bonus entitles the
holder to a share in the assets of the company and to participate in future
profits. 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. The market price is affected by many
imponderables, one such being the yield or the expected yield. The detriment to
the share holder, 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.
Swan Brewery Co. Ltd. v. Rex (1914) A.C. 231,
Commissioner of Inland Revenue v. John Blott,
8 Tax Cases 101, approved.
Bouch V. Sproule, (1887) 12 A.C. 385,
Commissioner of Income-tax, Bengal v.
Mercantile Bank of India Ltd., 1936 A.C. 478 and Nicholas v. Commissioner of
Taxes of the State of Victoria, 1940 A.C. 744, referred to.
(ii) The bonus shares cannot be said to have
cost nothing to the share holder because on the issue of its 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 211 actual or expected and the market price
The method of calculation which places the
value of bonus shares, at nil cannot be correct.
(iii) 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 taking the
middle price not that represented by any unusual fluctuations. On the facts of
this case it was held that 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.
Commissioner of Income-tax v. Maneklal
Chunilal and Sons, Income-tax Reference No. 16/1948, dt. 23-3-1949,
Emerald and Co. Ltd. v. Commissioner of
Income-tax, Bombay City, (1956) 29 I.T.R. 814, distinguished.
Eisner v. Macomber, 252 U.S. 189-64 L.Ed.
521, referred to.
Per Sarkar, J. (dissenting): (i) The view
taken by the majority of Judges in Blott's case is a correct one. In that case
the learned Judges held that when the articles of a company authorise the issue
of bonus shares and the 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. Following the majority opinion in Blott's case it
was held 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.
Commissioner of Inland Revenue v. Blott
(1921)2 A.C. 171, relied on.
Swan Brewery Co. Ltd. v. King (1914) A.C.
Osborne (H.M. Inspector of Taxes) v. Steel
Barrel Co. Ltd., 24 T.C. 293, inapplicable.
Commissioner of Inland Revenue v. Fisher's
Executors, (1926) A.C. 395 and Commissioner of Income-tax, Bengal v. Mercantile
Bank of India Ltd., (1936) A.C. 478, referred to.
Commissioner of Income-tax v. Maneklal
Chunilal and Sons Ltd., I.T. Ref. No. 16 of 1948 and Emerald and Co. Ltd. v.
Commissioner of 1ncome-tax, Bombay City, 29
I.T.R. 814, referred to.
(ii) Bai Shirinbai Kooka's case is the
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. On the basis of this authority the Bonus shares must in the present
case be deemed to have been acquired at the market value of the date of their
(iii) On the basis of the same authority, it
would not be correct to say that the bonus shares had been acquired for
212 The view taken by the Appellate
Commissioner and the Tribunal cannot be supported.
Commissioner of Income-tax v. Bai Shirinbai
K. Kooka,  Supp. 3 S.C.R. 391, relied on.
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 780 of 1962.
Appeal by special leave from the judgment and
decree dated November 28, 1960, of the Patna High Court, in Miscellaneous
Judicial Case No. 724 of 1958.
K. N. Rajagopal Sastri and R. N. Sachthey,
for the appellant.
S. K. Kapur and B. N. Kirpal, for the
March 13, 1964. The judgment of HIDAYATULLAH
and SHAH, JJ.
was delivered by HIDAYATULLAH J. SARKAR J. delivered
a dissenting opinion.
SARKAR, J.-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.
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.
213 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.
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.(1). The Bombay High Court
later followed this case in Emerald and Co. Ltd. v. Commissioner of Income-tax,
Bombay City, Bombay (2). 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 these
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 may be observed,
represented the cost of the bonus shares at their face value. It% his opinion
the bonus shares had to be valued at nit. 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. These 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
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
was in accordance with law?" 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 (1) (I.T. Ref. No. 16 of 1948, unreported).
(2) 29 I.T.R. 814.
214 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(1), 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 Sumner which he
later expressed more fully in Commissioner of Inland Revenue v. Blott(2) , 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(3). 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.
As I have said earlier, Lord Sumner's
observation in Blott's case (2) 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 the 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
(2) 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
it off against the liability of the shareholder to pay for the bonus share
issued to him.
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 (1) (1914) A.C. 231. (1921) 2 A.C.
(3) 24 T.C. 293.
215 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(1) and Commissioner of Income-tax, Bengal v.
Mercantile Bank of India Limited(2). It is of
some significance to observe that the latter is a case from India.
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(3) 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 preceding on the basis as if the bonus shares had been
acquired by the assessee at their face value. Its profits cannot be computed on
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 (1) (1926) A.C. 395. 2) (1936) A.C. 478.
(3 ) (1921) 2 A.C. 171.
216 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.
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(1) 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.
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(1). 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 principles 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
Bai Shirinbai Kooka's case(1) 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.
I would, therefore, answer the question
framed in the negative.
(1)  Supp. 3 S.C.R. 391.
217 HIDAYATULLAH, J.-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 cut, 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
shares Book value
--------------------------------------------------------------(1) 17,259 (out
of 31,909 original 13,10,951 Proportionate shares). cost from Rs. 5,84,283.
(2) 31,909 Bonus shares 3,19,090. 00 at face
value of Rs. 10 per share (3) 59,079 Now Issue shares 8,88,561-00at cost.
(4) 2,500 New purchase shares 39,300 00at
-----------------Total 1,10,747 shares
15,57,902. 00 -----------------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/.
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 218 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 Incometax v. Maneklal Chunnilal and Sons(1)
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
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(2) 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.
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(2) 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.
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?" (1)
Income-tax Reference No. 16 of 1948 dt. 23-3-1949.
(2) (1956) 29 I.T.R. 814.
219 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
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 cast 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
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 220 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(1).
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 pound 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." Lord
Sumner adhered to his view later in the House of Lords in Commissioner of
Inland Revenue v. John Blott(2) 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.
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
(1) (1914) A.C. 231.
(2) 8 Tax Cases 101.
221 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 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.
We may now see what was decided in the Swan
Brewery's(1) 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 Sumner, were dividend. It was claimed in that case that there was no
dividend and no distribution of dividend, because nothing had been distributed
and nothing 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 hold that the bonus
shares were outside the extended definition.
Swan Brewery's(1) case has been accepted as
rightly decided on the special terms of the section, as indeed it was. In
Blott's(2) case, Rowlatt, J. observed that the bonus shares were included in
the expression "advantage" occurring in the (1) (1914) A.C. 231.
(2) 8 Tax Cases 101.
222 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(1) 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.
Blott'S(2) 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 Sumner, 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.
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(3)
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
(1887) 12 A.C. 385. (2 ) 8 Tax Cases 101.
(3) (1914) A.C. 231.
223 the amount which came from the
accumulated profits as profits. Lord Sumner, however, stated that in Swan
Brewery's(1) 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.
Lord Sumner had already adhered to his view
in an earlier case of the Privy Council, but Swan Brewery's(1) case and
Blott's(2) case were considered by the Privy Council in Commissioner of
Income-tax, Bengal v. Mercantile Bank of India Ltd. and others(3). Lord
Thankerton distinguished Swan Brewery's(1) case and followed Blott's(2) case,
though in Nicholas v. Commissioner of Taxes of the State of Victoria(4),
Blott's (2) ,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.
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.
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 Tanked 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 (1)(1914) A.C. 231.
(3)(1936) A.C. 478.
(2) 8 Tax Cases 101.
(4) (1940) A.C. 744.
224 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(1) thus:
"A stock dividend really takes nothing
from the property of the corporation, and adds nothing to the interests of the
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 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.
necessarily disposes of a part of his capital
interest, 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." Swan Brewery's (2) 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.
(1) 252 U.S. 189-64 L.Ed. 521. (2)(1914) A.C.
225 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 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.
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 Chunnilal and Sons Ltd., Bombay(1), 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 (1)I.T. Ref. No. 16 of 1948 d. 23rd March 1949.
226 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.
The next case is Emerald Co. Ltd. v. C.I.T.,
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. 1,060/on the sale of 50 shares instead of a loss of Rs. 1,365/which
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 (1)(1956) 29 I.T.R. 814.
227 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.
The decision of this Court in Emerald
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.
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:
Share in Rohtas Industries Ltd.
1 . Old issue of 17,259 shares brought
forward from 1945, at (proportionate) cost 1,58, 035
2. Bonus shares 31,909 received in 1945, at
(proportionate, spread out) cost 2,92,141
3. New issue 59,079 shares brought forward
from 1945 8,88,561
4. New purchases 2,500 shares brought forward
from 1947 39,300 Total 1,10,747 shares 13,78,037 Sales of all the above shares
in 1948 15,50,458 Profit 7,444 Profit to be added to the income returned
1,79,865 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.
(1956) 29 I.T.R. 814.