PETITIONER: COMMISSIONER OF INCOME-TAX, BIHAR Vs. RESPONDENT: DALMIA INVESTMENT CO. LTD. DATE OF JUDGMENT: 13/03/1964 BENCH: SARKAR, A.K. BENCH: SARKAR, A.K. HIDAYATULLAH, M. SHAH, J.C. CITATION: 1964 AIR 1464 1964 SCR (7) 210 CITATOR INFO : F 1967 SC 614 (5) F 1969 SC1183 (7,8) D 1971 SC2389 (3,5,6) ACT: Income-tax Act-Business--Investment company-Dealing in shares-Bonus shares-Valuation. HEADNOTE: The assessee company dealt in shares and also held invest- ments 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, disapproved. Commissioner of Inland Revenue v. John Blott, 8 Tax Cases 101, approved. Bouch V. Sproule, (1887) 12 A.C. 385, referred to. 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 moves accordingly. 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, disapproved. 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 majo- rity 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. 231, disapproved. 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. Mer- cantile 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 issue. (iii) On the basis of the same authority, it would not be correct to say that the bonus shares had been acquired for nothing. 212 The view taken by the Appellate Commissioner and the Tribunal cannot be supported. Commissioner of Income-tax v. Bai Shirinbai K. Kooka, [1962] Supp. 3 S.C.R. 391, relied on. JUDGMENT:
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 appel-
lant.
S. K. Kapur and B. N. Kirpal, for the respondent.
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 en-
titled 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. Thise 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 decided.
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 Industries Ltd.
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. 171.
(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 refer-
ence 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 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.
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 Commis-
sioner of Income-tax v. Bai Shirinbai K. Kooka(1) this Court
has approved of the Bombay High Court’s view that “obvious-
ly, 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 this Court.
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) [1962] 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 propor-
tion 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 follows:
————————————————————–
Existing shares Book value
—————————————————————
(1) 17,259 (out of 31,909 original 13,10,951 Proportionate shares). cost from Rs. 5,84,283. RS.
(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 cost.
——————
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 deci-
sion of the High Court of Bombay in Commissioner of Income-
tax 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 gains.
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 Incometax, 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 this Court.
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
shares.
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 im-
possible 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 supertax 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 share-
holders, 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 pro-
fits. 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 Com-
missioner of Income-tax, Bengal v. Mercantile Bank of India
Ltd. and others(3). Lord Thankerton distinguished Swan Bre-
wery’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 shareholders.
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. 231.
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 com-
panies 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., Bombay City(1).
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 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 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 Company’s(1) 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
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.
Rs.
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 theabove 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.
Appeal allowed.
(1956) 29 I.T.R. 814.
UP (D)SCI-8(a)
228