Commissioner
of Income Tax, Mumbai Vs. M/S General Insurance Corporation [2006] Insc 616 (25 September 2006)
Ashok
Bhan & Markandey Katju Bhan, J.
The
question which arises for consideration in this appeal is, as to whether the
expenditure incurred in connection with the issuance of bonus shares is a
capital expenditure or revenue expenditure. The question of law framed in the
High Court was:
-
Whether on the
facts and in the circumstances of the case and in law the Tribunal was right in
holding that the expenditure incurred on account of share issue is allowable
expenditure? The Assessee is an Insurance Company which has four subsidiaries.
For the assessment year 1991-92 the assessee filed a return of income of Rs. 58,52,80,850/-
along with the audit report. The assessing Officer disallowed a few expenses
incurred as revenue expenditure, one of them being in the sum of Rs. 1,04,28,500/-
incurred towards the stamp duty and registration fees paid in connection with
the increase in authorized share capital. The respondent-assessee had during
the accounting year, incurred expenditure separately for:
-
The
increase of its authorized share capital and
-
The issue of
bonus shares.
The
Assessing Officer disallowed both the items of expenditure as revenue
expenditure. According to him, the expenses incurred were towards a capital
asset of a durable nature for the acquisition of a capital asset and,
therefore, the expenses could only be attributable towards the capital
expenditure.
The assessee
being aggrieved filed an appeal under Section 143 (3) before the CIT (Appeals).
Disallowance of Rs. 1,04,28,500/- in respect of stamp duty and registration
fees incurred in connection with the increase in the authorized share capital
were bifurcated by the CIT (Appeals) into two categories, one relating to the
increase in authorized share capital from Rs. 75 crores to Rs. 250 crores and
second relating to issue of bonus shares. In respect of the first category of
expenditure it was held that the same was not allowable in terms of the
judgments of the Bombay High Court in the case of Bombay Burmah Trading
Corporation, vs. CIT, (1984) 145 ITR 793 and Richardson Hindustan Limited
second category was allowed as revenue expenditure being directly covered by
the decision in Bombay Burmah Trading Corporation's case (supra).
The
revenue being aggrieved challenged the order passed by the CIT (Appeals) before
the Income Tax Appellate Tribunal (for short "the Tribunal"). The
Tribunal upheld the decision of the CIT (Appeals) treating the expenses
incurred towards the issue of bonus shares as revenue expenditure by observing
inter alia as under:
"We
have carefully considered the rival submissions. The basis for the judgment by Hon'ble
Supreme Court in the case of Brooke Bond India Limited vs. CIT, (1997) 225 ITR
798 (SC), has been that the expenditure was connected with the expansion of the
capital base of the Company and therefore such expenditure was capital
expenditure.
However,
in the case of issue of bonus shares there does not take place an expansion of
the capital base of the company but only re- allocation of the existing funds.
We, therefore, hold that the Learned CIT (Appeals) rightly decided this issue
in favour of the assessee.
This
ground of appeal is therefore rejected." The revenue thereafter filed an
appeal under Section 260- A of the Income tax Act (for short "the
Act") before the High Court of Bombay, raising two questions of law. The
High Court in its judgment has affirmed the Tribunal's judgment by following
its earlier decision in the case of Bombay Burmah Trading Corporation (supra).
This Court granted leave qua the question of law as reproduced in para 1 of
this judgment.
On the
question, as to whether the expenses incurred in connection with the issue of
bonus shares is a revenue expenditure or a capital expenditure, there is a
conflict of opinion between the High Courts of Bombay and Calcutta on the one
hand and Gujarat and Andhra Pradesh on the other.
Bombay
and Calcutta High Courts have taken the view that the expenses incurred in
connection with the issue of bonus shares is a revenue expenditure whereas
Gujarat and Andhra Pradesh High Courts have taken the view that the expenses
incurred in connection with the bonus shares is in the nature of capital
expenditure.
Learned
counsel for the appellant relying upon the commentary to the Companies Act by A
Ramaiya, Sixteenth Edition 2004, which occurs in the commentary to Section 81
of the Indian Companies Act, - "When a company prospers and accumulates a
large surplus it converts this surplus into capital and divides the capital
among its members in proportion to their rights. This is done by issuing fully
paid shares representing the increased capital. The shareholders to whom the
shares are allotted have to pay nothing. The purpose is to capitalize the gains
which may be available for division or utilize quasi-capital gains. Bonus
shares go by the modern name "capitalization of shares". AND the
judgments of the Gujarat High Court in Ahmedabad Manufacturing and and the two
judgments of the Andhra Pradesh High Court in 689 wherein it has been held that
the issuance of bonus shares increases the issued and paid up capital of the
company and the bonus shares of the company are directly connected with the
acquisition of capital and an advantage of enduring nature. CONTENDS that the expenses
incurred towards issue of bonus shares confers an enduring benefit to the
company which has a resultant impact on the capital structure of the company
and therefore, it should be regarded as the capital expenditure. Reliance has
also been placed upon the judgments of this Court in Punjab State Industrial
(SC). He also relied upon in CIT vs. Motor Industries Co. Ltd., (1998) 229 ITR
137 of Karnataka High Court, in CIT vs. Ajit Mills Limited, (1994) 210 ITR 658,
Gujrat Steel Tubes Ltd., vs. CIT, (1994) 210 ITR 358 of Gujarat High Court
& Union Carbide India Ltd., vs. CIT, (1993) 203 ITR 584 of Calcutta High Court.
As
against this, learned senior counsel appearing for the respondent contends that
undoubtedly increase in share capital by the issue of fresh shares leads to an
inflow of fresh funds into the company expands or adds to, its capital employed
resulting in expending its profit making apparatus, but THE ISSUE OF BONUS
SHARES by capitalization of reserves is merely a reallocation of a company's
funds. There is no inflow of fresh funds or increase in the capital employed,
which remains the same. The issue of bonus shares leaves the capital employed
unchanged and therefore, does not result in conferring an enduring benefit to
the company and the same has to be regarded as revenue expenditure. He has
relied upon the judgment of this Court in CIT vs. Dalmia Investment Co. Ltd.,
(1964) 52 ITR 567 (SC), Bombay 516 (Bombay) and the subsequent judgments of the same Court taking the
same view and the judgment of the Calcutta Commissioner of Income-Tax, (1993)
204 ITR 545.
We may
at the outset indicate that this Court has laid down the test for determining
whether a particular expenditure is revenue or capital expenditure in the case
of after considering the law on the subject in detail observed at page 8 as
under:
"The
decided cases have, from time to time, evolved various tests for distinguishing
between capital and revenue expenditure but no test is paramount or conclusive.
There is no all embracing formula which can provide a ready solution to the
problem; no touchstone has been devised. Every case has to be decided on its
own facts keeping in mind the broad picture of the whole operation in respect of
which the expenditure has been incurred. But a few tests formulated by the
courts may be referred to as they might help to arrive at a correct decision of
the controversy between the parties. One celebrated test is that laid down by
Lord Cave, L.C. in Atherton vs. British Insulated and Helsby Cables Ltd., 10 TC
155, where the learned Law Lord stated :
When
an expenditure is made, not only once and for all, but with a view to bringing
into existence an asset or an advantage for the enduring benefit of a trade,
there is very good reason (in the absence of special circumstances leading to
an opposite conclusion) for treating such an expenditure as properly
attributable not to revenue but to capital.'' [Emphasis supplied] In short,
what has been held in this case is that if the expenditure is made once and for
all with a view to bringing into existence an asset or an advantage for the
enduring benefit of a trade then there is a good reason for treating such an
expenditure as properly attributable not to revenue but to capital. This is so,
in the absence of special circumstances leading to an opposite conclusion.
Decisions
of this Court in Punjab State Industrial Development Corporation Ltd. (supra)
and Brooke Bond Mills Limited, (1994) 210 ITR 658, Gujrat Steel Tubes Ltd., vs.
CIT, (1994) 210 ITR 358 & Union Carbide India Ltd., vs. CIT, (1993) 203 ITR
584 of Calcutta High Court are of not much assistance to us. All these cases
relate to the issue of fresh shares which lead to an inflow of fresh funds into
the company which expands, or adds to its capital employed in the company
resulting in the expansion of its profit making apparatus. Expenditure incurred
for the purpose of increasing company's share capital by the issue of fresh
shares would certainly be a capital expenditure as has been held by this Court
in the cases cited above.
Effect
of issuance of bonus share has been explained by this Court in Dalmia
Investment Co. Ltd., (supra) where the question of valuation of bonus share was
considered. After (1920) 252 U.S. 189, of the Supreme Court of United States of
America, Mr. Justice Hidayatullah explained the consequences of issue of bonus
shares by observing thus:
".
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." It
is further observed at pages 577-578:
"It
follows that though profits are profits in the hands of the company, 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 shareholders 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." [Emphasis supplied] The Gujarat High Court in Ahmedabad
Manufacturing (1986) 162 ITR 800 has held, that the expenses incurred towards
the issuance of bonus shares is a capital expenditure.
Bonus
shares issued by the assessee company also constitute its capital bonus shares,
as right shares are an integral part of the permanent structure of the company
and are not in any way connected with the working capital of the company which
is utilized to carry on day to day operations of the business.
Negativing
the contention of the assessee that no benefit whatsoever is derived by the assessee
company when its profits and/or reserves are converted into paid-up shares, it
was held that as a result of the increase in the paid up share capital the
creditworthiness of the assessee-company would increase which would be a
benefit or advantage of enduring nature. That the bonus shares are an integral
part of the permanent structure of the assessee-company. The bonus shares are
not different from rights shares as, according to it, in the case of bonus
shares a bonus is first paid to the shareholders who pay it back to the company
to get their bonus shares. This reasoning of the Gujarat High Court was evident
from the following extracts from its judgment:
At
page 808:
"It
is clear that when bonus shares are issued, two things take place:
-
bonus is paid to
the shareholders; and
-
wholly or partly
paid-up shares are issued against the bonus payable to the shareholders. The
shareholders invest the bonus paid to them in the shares and that is how the
bonus shares are issued to them.
In our
opinion, therefore, it would not make any difference whether paid-up share
capital is augmented by issuance of right shares or bonus shares to the
shareholders.
.
.
As
already pointed out above, bonus shares are not different from rights shares."
The above observation is completely contrary to the observation of this Court
in Dalmia Investment Co. Ltd., (supra), which judgment had not been referred to
by the Gujarat High Court. In the case of Dalmia Investment Co. Ltd., (supra)
this Court has held that floating capital used in the company which formerly
consisted of subscribed capital and the reserves now becomes the subscribed
capital. The conversion of the reserves into capital did not involve the
release of the profits to the shareholder; the money remains where it was, that
is to say, employed in the business. In the face of these observations the
reasoning given by the Gujarat High Court cannot be upheld.
We do
not agree with the view taken by the Gujarat High Court that increase in the
paid up share capital by issuing bonus shares may increase the creditworthiness
of the company but that does not mean that increase in the credit worthiness
would be a benefit or advantage of enduring nature resulting in creating a
capital asset.
The
Andhra Pradesh High Court has in Vazir Sultan view that the expenditure
incurred on the issue of bonus shares was capital in nature because the issue
of bonus shares led to an increase in the company's capital base.
The
observations and conclusions are erroneous as they run contrary to the
observation made by this Court in Dalmia Investment Co. Ltd., (supra). The
capital base of the company prior to or after the issuance of bonus shares
remains unchanged.
Issuance
of bonus shares does not result in any inflow of fresh funds or increase in the
capital employed, the capital employed remains the same. Issuance of bonus
shares by capitalization of reserves is merely a reallocation of company's
fund. This is illustrated by the following hypothetical tabulation which
establishes that bonus shares leaves the capital employed untouched, because in
the hypothetical example, the capital employed remains the same (i.e. Rs. 600)
both pre and post issuance of bonus shares.
Sl.No.
Particulars
Pre-Bonus Issue Rs.
On
Bonus Issue Rs.
Post
Bonus shares Rs.
-
Pre-paid share
capital 100 100+100=200 200
-
Reserve 500
500-100=400 400
-
Total 600 600 600
As
observed earlier, the issue of bonus shares by capitalization of reserves is
merely a reallocation of company's funds. There is no inflow of fresh funds or
increase in the capital employed, which remains the same. If that be so, then
it cannot be held that the Company has acquired a benefit or advantage of
enduring nature. The total funds available with the company will remain the
same and the issue of bonus shares will not result in any change in the capital
structure of the company. Issue of bonus shares does not result in the expansion
of capital base of the company.
The
case Wood Craft Products Limited (supra) of the Calcutta High Court is similar
to the case of the respondent.
In
that case as well there was increase of authorized share capital by the issue
of fresh shares and a separate issue of bonus shares. The Calcutta High Court
drew a distinction between the raising of fresh capital and the issue of bonus
shares and held that expenditure on the former was capital in nature as it
changed the capital base. On the other hand, in the case of bonus shares, was
held to be revenue expenditure following the decision of the Supreme Court in Dalmia
Investment Co. Ltd., (supra) on the ground that there was no change in the
capital structure at all.
In our
considered opinion, the view taken by the Bombay and Calcutta High Courts is correct to the effect that the expenditure
on issuance of bonus shares is revenue expenditure. The contrary judgments of Gujarat and Andhra Pradesh High Courts are
erroneous and do not lay down the correct law.
For
the reasons stated above, the question referred to us, is answered in the
affirmative, i.e., in favour of the assessee and against the revenue.
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