TMI Blog1964 (3) TMI 17X X X X Extracts X X X X X X X X Extracts X X X X ..... l. 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 investments and also as stock-in-trade of its 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 Co. Ltd. v. King 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 Commissioners of Inland Revenue v. Blott, no doubt, lends 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.. I do not think that the observations of Lord Greene, M.R., in this case to which the High Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 and Commissioner of Income-tax v. Mercantile Bank of India Ltd. 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, 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. On ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price was known but what was the cost price? The High Court said that in order to arrive at the 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, 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -------------------- Total 1,10,747 Rs.15,57,902.00 nP. -------------------- ---------------------------------------------------------------------------- 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 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 Income-tax v. Maneklal Chunilal and Sons and held that there was a profit of Rs. 7-8-0 per bonus share and the total profit was Rs. 2,39,317 which be held was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... John Blott but Lord Dunedin and he were in 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere 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 case has been accepted as rightly decided on the special terms of the section as indeed it was. In Blott's case, Rowlatt J. observed that the bonus shares were included in the expression "advantage" occurring in the 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 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 c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Swan Brewery's 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 shareholders 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 case and Blott's case were considered by the Privy Council in Commissioner of Income-tax v. Mercantile Bank of India Ltd. Lord Thankerton distinguished Swan Brewery's case and followed Blott's case, though in Nicholas v. Commissioner of Taxes of the State of Victoria, Blott's 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 pound 4,17,450 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. . . . If a shareholder sells dividend stock, he 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shares. The average cost price of the original and bonus shares was 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 Co.'s 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. 5,83,210 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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