TMI Blog1972 (7) TMI 63X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee 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 of smaller denomination by converting each share of the face value of Rs. 500 into two shares of the face value of Rs. 250 each. The result was that in lieu of 79 shares of the face value of Rs. 500 each, the assessee received 158 shares, each of the face value of Rs. 250. Thereafter, on 23rd August, 1961, the company at an annual general meeting resolved to capitalise its accumulated profits and apply them in issuing one fully paid up bonus share of the face value of Rs. 250 for every four shares of the face value of Rs. 250 each held by a shareholder. The assessee accordingly received on 5th September, 1961, 39 fully paid up bonus shares by virtue of its existing holding of 158 shares. Within a few days thereafter, on 12th September, 1961, the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore 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 which the transfer took place. What is a "capital asset" is defined in section 2(14) and, apart from certain exclusions, it means property of any kind held by an assessee. It was common ground between the parties in the present case that the bonus shares constituted "capital asset" transferred by the assessee. Section 48 provides the mode of computation of capital gains; it says that capital gains shall be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset, expenditure incurred wholly and exclusively in connection with such transfer as also the cost of acquisition of the capital asset and the cost of any improvement to it "Cost of acquisition", in relation to a capital a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the shareholder previously by virtue of original share certificates is after the issue of bonus shares held on the basis of more certificates. There is nothing new acquired by the shareholder. There is no addition to his interest in the company; his proportional interest remains the same. The bonus shares and the original shares together now represent the same proportional interest which the original shares represented before the issue of bonus shares. The real effect of issue of bonus shares is as if the original shares are split up. The bonus shares are, therefore, really, in effect and substance, part of the original shareholding and must be held to have been acquired when the original shares were purchased and the conclusion must inevitably follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 the 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 part, though indirectly, in the management of the company's affairs. If the majority of shareholders sides with him, he can have a resolution passed which would be binding on the company and, lastly, he can institute proceedings for winding up of the company which may result in a distribution of the net assets among the shareholders". This is only a broad statement of the rights in action which a share confers on a shareholder. These rights are numerous: they are rights in the company as well as against it. They are contractual as well as conferred by the Companies Act, 1956. But, whatever be the nature and extent of these rights conferred by a share, one thing is clear, as pointed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 out of the accumulated profits but bonus shares credited as fully paid up. The transaction, to use the words of Viscount Cave in Commissioners of Inland Revenue v. John Blott [1921] 8 T.C.101 (H.L. ) , takes "nothing out of the company's coffers "and puts "nothing into the shareholders' pockets", but what happens is that the accumulated profits which are capitalised are applied in paying up the amounts due on bonus shares to be issued to the shareholders as fully paid up bonus shares. The shareholders receiving bonus shares credited as fully paid up are given credit for the capital sums whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly 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 [1963] 33 Comp.Cas.862;[1964] 3 S.C.R.698;A.I.R.1964 S.C.250 where Sarkar J. said, though in a slightly different context: "in company law ' allotment' means the appropriation out of the previously unappropriated capital of a company, of a certain number of shares to a person. Till such allotment the shares do not exist as such. It is on allotment in this sense that the shares come into existence". But even apart from authority, from a purely semantic point of view, it is difficult to see how bonus shares which are an object of dominion transferable in the peculiar manner provided by company law can be said to be acquired or held by a share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red 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 immediately preceding the date of its transfer. There was some argument advanced before us on the construction of the word "held "in this definition and it was urged on behalf of the revenue that this word indicated that the assessee must be a registered holder of the bonus shares. The bonus shares, it was contended, could not be said to be held by the assessee unless they stood in the name of the assessee in the share register of the company and since they ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 as the bonus shares are beneficially owned by the assessee, whether in his own name or in the name of another, they would be held by the assessee within the meaning of section 2(42A). The extreme contention of the revenue seeking to read the word "held" as meaning "held as a registered owner" cannot, therefore, be accepted. But the revenue is right in its contention that the requirement that the capital assets must be held by the assessee for not more than twelve mo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 be proportionally distributed because, as pointed out by Pennington in his book on Company Law (second edition), at page 132, it is often found after the issue of bonus shares that "the aggregate price for the original shares and the bonus shares issued in right of it is greater than the price of the original shares before the issue". These circumstances clearly indicate that the bonus shares can be said to be held by the assessee only from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... res 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 dividend and return of that dividend by the shareholder as his contribution in respect of the bonus shares issued to him. The learned judge was, therefore, called upon to consider whether there is any payment of dividend to the shareholder when bonus shares are issued by a company. It was in the context of this question that the learned judge made t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 represented "an additional share in the increased capital" and "confer title to a larger proportion of the surplus assets at a general distribution". The bonus shares are clearly a new capital asset acquired by a shareholder, though after the acquisition, the monetary value of the interest of the shareholder represented by the original shares and bon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 not from the date when the original shares in respect of which they are issued were acquired by the shareholder. The bonus shares in the present case were, therefore, acquired by the assessee on 5th September, 1961, and they were held by him from that date and ..... X X X X Extracts X X X X X X X X Extracts X X X X
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