TMI Blog1972 (7) TMI 27X X X X Extracts X X X X X X X X Extracts X X X X ..... to what is the date from which bonus shares issued by a company can be said to be held by an assessee : is it the date when they are issued or is it the date the original shares in respect of which they are issued were acquired by the assessee ? The question assumes importance because when bonus shares are sold by I he assessee and there is capital gain, the incidence of tax on such capital gain varies according as the bonus shares are short-term capital assets or long-term capital assets. If they are short-term capital assets, the incidence is higher : if they are long-term capital assets, the incidence is lower : and the question whether they are short-term capital assets or long-term capital assets depends on how long they have been held by the assessce immediately preceding the date of transfer. The short facts giving rise to the reference may be briefly stated as follows : Some time prior to 1st January, 1954, the assessee purchased 79 shares of the face value of Rs. 500 each in the share capital of Sarangpur Cotton Manufacturing Company Ltd. (hereinafter referred to as " the company ") In 1961, the company sub-divided its shares of the face value of Rs, 500 each into shares ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssued and they were, therefore, held by the assessee from the date of issue and not from the date when the original shares were acquired and, on this view, treated the bonus shares as short-term capital assets. The assessee thereupon appealed to the Tribunal and in the appeal, the assessee was successful in persuading the Tribunal to accept his point of view. The Tribunal held that the bonus shares were held by the assessee from the date when the original shares were acquired and they were, therefore, long-term capital assets. This view taken by the Tribunal is assailed in the present reference at the instance of the revenue. We shall presently set out the rival arguments of the parties in regard to the interesting question before us but before we do so, it would be convenient at this stage to refer to some of the relevant provisions of the Income-tax Act, 1961. Section 45 imposes charge of capital gains tax on " any profits or gains arising from the transfer of a capital asset effected in the previous year " and provides that such profits and gains shall be chargeable to income-tax under the head " Capital gains " and shall be deemed to be the income of the previous year in whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ths immediately preceding the date of their transfer, they would be short-term capital assets; otherwise, they would be long-term capital assets. The argument of the revenue was that the bonus shares came into existence for the first time when they were issued and, therefore, they could not be held by the assessee before the date of their issue. They were held by the assessee only since the date of their issue, namely, 5th September, 1961, and since they were sold within a few days on 12th September, 1961, they were short term capital assets. The assessee sought to repel this submission by advancing a very interesting argument. The assessee contended that. in order to ascertain the true nature of the transaction which takes place when bonus shares are issued, the court must look at the substance of the transaction and not its form. If regard is had to the substance of the transaction, it is clear that when bonus shares are issued, there is no creation of a new capital asset by the company or acquisition of a new capital asset by the shareholder. The bonus shares add nothing to the interest of the shareholders and take nothing out of the pocket of the company. What was owned by th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pect of dividends, return of capital on a winding-up, voting, and the like. " Though for the purposes of the Sale of Goods Act a share is included in the definition of " goods " and it is regarded as movable property, so far as the law in India is concerned, it is in its true nature, what the English law calls, a chose-in-action which entitles its owner to certain rights in action as distinguished from rights in possession. What is the broad spectrum of those rights inaction is clear from the following passage from the judgment of Mukherjee J. in Chiranjitlal Chaudhuri v. Union of India , where the learned judge says : " His interest (that is, interest of a shareholder) is represented by the share he holds and the share is a movable property according to the Indian Companies Act ... Ordinarily, he is entitled to enjoy the income arising from thre shares in the shape of dividends; the share like any other marketable commodity can be sold or transferred by way of mortgage or pledge. The holding of the share in his name gives him the right to vote at the election of directors and thereby take a parti though indirectly, in the management of the company's affairs. If the majority of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e words of Gower, " more into line with the true excess of assets over liabilities " and may for that purpose capitalise its accumulated profits and issue fully paid up bonus shares of a nominal value equal to the amount capitalised to its shareholders. These bonus shares may be either ordinary or preference shares and, even amongst preference shares, they may be cumulative preference shares or non-cumulative preference shares, redeemable preference shares or irredeemable preference shares, and preference shares with priority in repayment of capital on winding up or preference shares without such priority. Where this happens the accumulated profits which are capitalised remain in the coffers of the company and no part of them actually goes into the pockets of the shareholders : the only change that takes place is that the accumulated profits which prior to capitalisation were employed in the business as accumulated profits are thenceforth employed as part of the issued capital of the company. The accumulated profits which might have been divided amongst the shareholders as dividend are impounded to increase the capital of the company and what the shareholders get is not any payment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amongst such members in the proportions aforesaid . . . ." Whenever such a resolution is passed in general meeting, regulation 97 provides that the board shall make all appropriations and applications of the undivided profits resolved to be capitalised and all allotments and issues of fully paid up shares. It will be seen from these regulations that when a resolution is passed by the company at a general meeting for capitalising its accumulated profits and issue of bonus shares credited as fully paid up, the board of directors would allot fully paid up bonus shares to the shareholders in the proportion of their respective holdings by appropriating and applying, the accumulated profits capitalised for that purpose. The bonus shares would then come into existence and the capitalised accumulated profits would constitute additional share capital issued to and contributed by the shareholders. Till then it cannot be said that the bonus shares are in existence. That is very clear from the observations of the Supreme Court in Gopal Jalan and Co. v. Calcutta Stock Exchange Association where Sarkar J. said, though in a slightly different context: " in company law ' allotment ' means the ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... areholder. Since bonus shares are issued to the shareholders in proportion to their respective holdings and no new share capital is subscribed by the shareholders but the capital sums due on the bonus shares are paid up out of capitalised accumulated profits, the proportional interest of each shareholder in the company would undoubtedly remain the same. But that is not determinative of the question as to when bonus shares can be said to have been acquired by the shareholder. The bonus shares plainly and indubitably confer right on the shareholder to an additional share in the increased capital of the company and also entitle him to an additional right to vote as also to obtain income in the shape of money out of the profits of the company and they must, therefore, be held to be acquired when they are issued by the company. There is also inherent evidence in the provisions of the Income-tax Act, 1961, which goes to show that bonus shares cannot be regarded as having been acquired by a shareholder before they are issued. The definition of short-term capital asset in section 2(42A) contemplates that the capital asset must be held by an assessee for not more than twelve months immedi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... " or "of the ownership of the assessee. The Division Bench also took into account the fact that the certificates referred to in section 5(1)(xvi) were issued by the Central Government under a scheme which provided that an individual can purchase such certificates only to the extent of Rs. 25,000 and no more. This decision cannot, therefore, be regarded as having any binding authority so far as the construction of the word " held " in section 2(42A) of the Income-tax Act is concerned. The word " held ", according to its plain natural sense, means " belonging to " or " of the ownership of ". Where a capital asset is of the ownership of an assessee but is held by him in the name of his nominees, it can appropriately, without any straining of language, be said that the capital asset is held by the assessee. The capital asset may be held by the assessee in his own name or in the name of any other person. Moreover, it must be remembered, that the word " held " is used in section 2(42A) with reference to any capital asset. It is not limited to shares. The concept of a registered holder cannot, therefore, be introduced in the construction of the section. So long is the bonus shares are be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e same class as the original shares, but what we have said above demonstrates clearly and pointedly the utter untenability of the argument put forward on behalf of the assessee. Then, again, section 55(2)(i) which defines " cost of acquisition " in relation to a capital asset speaks of a case " where the capital asset became the property of the assessee before the first day of January, 1954 ". We would, therefore, have to ask the question: When do bonus shares become the property of the assessee ? Can they become the property of the assessee before they are issued ? The answer is plainly no. If the bonus shares were regarded as property of the assessee from the date when the original shares were acquired, how would section 55(2)(i) be applied in a case where the original shares were acquired prior to 1st January, 1954? How would the assessee in such a case be able to exercise the option given by section 55(2)(i) ? How would it be possible to ascertain the fair market value of the bonus shares on 1st January, 1954, when they were not in existence. The market value of the original shares on 1st January, 1954, could not be taken as the market value of the bonus shares nor could it b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as the method adopted by the department, that as the shareholder pays nothing in cash for the shares, cost should be taken at nil. The third method is to take the cost of the original shares and to spread over the original shares and the 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. Having set out these four methods, the learned judge proceeded to examine the merits of each method. He first took up for consideration the first method. The argument in support of the first method was that the issue of bonus shares involves a two-fold 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 the books of the company as contribution of capital by the shareholder is the face value of the bonus shares, it was contended that the cost to the shareholder is equal to the face value of the bonus shares. The foundation of this argument was that the issue of bonus shares involves payment of divid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her. There is, therefore, no receipt of monetary value by the shareholder which can be regarded as dividend when bonus shares are issued. These observations made in tie context of a totally different question and fog a wholly different purpose cannot be taken out of their context and utilised for the purpose of supporting a contention that the bonus shares must be held to be acquired by the shareholder when the original shares are purchased. Hidayatullah J. has not said anywhere in the judgment that the bonus shares must be held to be carved out of the original shareholding. He, undoubtedly, accepted the third method of determining the cost of bonus shares but that was not on the ground that the bonus shares are part of the original shareholding. On the contrary, he took care to make it clear at page 580 of the report that the bonus shares are accretions to the original shares and that was the reason why he took the view that the cost of the original shares should be spread over the original shares and bonus shares taken collectively. It is indeed difficult to see how bonus shares could be treated as carved out of the original shares when in the words of Hidayatullah J. they repres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Commissioner of Income-tax v. Dalmia Investment Co. Ltd., but we fail to see how they throw any light on the question before us. They were, like the observations of Hidayatullah J. in Commissioner of Income-tax v. Dalmia Investment Co. Ltd., made in a totally different context where the question was whether any income is received by the shareholder when a stock dividend is issued to him. It was for this reason that Mr. Justice Pitney said that " a stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders ". The corporation is no poorer and the stockholder is no richer than they were before. These observations cannot be torn out of their context and projected into the determination of a wholly different question, namely, when can the stock-dividend be said to be acquired by a shareholder. No reliance can therefore, be placed on these observations in support of the contention urged on behalf of the assessee. We are, therefore, of the view that bonus shares issued by a company are acquired by a shareholder when they are issued and they must be taken to be held by the shareholder from the date, of their issue and ..... X X X X Extracts X X X X X X X X Extracts X X X X
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