http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 7  

PETITIONER: M/S. HUNSUR PLYWOOD WORKS LTD.

       Vs.

RESPONDENT: THE COMMISSIONER OF INCOME-TAX

DATE OF JUDGMENT:       19/11/1997

BENCH: SUHAS C. SEN, V.N. KHARE

ACT:

HEADNOTE:

JUDGMENT:                THE 19TH DAY OF NOVEMBER, 1997 Present:                Hon’ble Mr. Justice Suhas C.Sen                Hon’ble Mr. Justice V.N. Khare Gopal Jain, Adv. for Mukul Mudgal, Adv. for the appellant J. Ramamurthy, Sr.Adv., T.C.Sharma, N.K.Agarwal, B.K.Prasad, Advs. with him for the Respondent                       J U D G M E N T      The following Judgment of the Court was delivered: SEN,J.      The  appellant   is  a   public  limited  company.  The assessment years  involved are 1972-73, 1973-74 and 1974-75. In regarded to the above assessment years, in the returns of Income  filed   by  the   appellant  before   the  assessing authority, a  claim towards  allowance of development rebate under section  33 of  the Income-tax  Act, 1961 (hereinafter referred  to  as  ’the  Act’)  was  made.,    The  assessing authority  allowed   the  claim  as  made  by  the  company. Subsequently,  the  assessing  authority  noticed  from  the balance sheet  of the appellant company that the company had made a transfer for sums from the development rebate reserve to share  capitalisation account  by issue  of bonus shares. The assessing authority concluded that the issuance of bonus shares amounted to distribution of profits by capitalisation and thus  the assessing  authority was  of the view that the provisions of  section 155(5)(ii)(a)  of the  Act applied to the instant case, as the development rebate reserve has been utilised for  distribution by  way of  dividend or  profits. Accordingly, the  assessing authority  passed an order under section 154  of the  Act withdrawing  the development rebate claim allowed earlier.      The Company went up on appeal.  The appellate authority allowed  its  appeal.    The  claim  of  the  appellant  for development rebate was sustained.      The  appellate   Tribunal  on   the  Revenue’s   appeal concurred  with  the  view  taken  by  the  first  appellate authority and  concluded that  there was  no distribution by way of dividend or profits in the issue of bonus shares.      Thereafter, on  the application  by the Commissioner of Income-tax, the  following questions of law were referred to

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 7  

the High Court :      "(a) Whether  on the  facts and  in      the circumstances  of the  case the      ITAT is  right in  law  in  holding      that issue of bonus shares from out      of the  development rebate  reserve      did not  account to distribution of      profits  within   the  meaning   of      section  34(3)(a)(i)   and  section      155(5)(ii)(a)?      (b) Whether or the facts and in the      circumstances of  the case the ITAT      is right in law in holding that the      ITO is not justified in withdrawing      the development rebate?"      The  High  Court  after  examining  the  provisions  of Section 34(3)(a)(i)  and Section 155(5)(ii)(a) of the Income Tax Act  held that  the issue  of bonus  shares resulted  in distribution  of   profits  and   therefore,  the  statutory requirement of  Section 34(3)(a)(i)  of  the  Act  had  been violated.  The High Court answered both the questions in the negative and in favour of the Revenue. The assessee has come up on appeal to this Court.      Section  33   of  the   Act  deals  with  allowance  of development rebate in respect of a new ship or new machinery or plant  owned by  the assessee,  if it was wholly used for the purpose  of business carried on by him. The allowance is given subject  to a  number of conditions.  We are concerned in this  case with  the condition  laid down  in Section 34, which is as under:      "34(3)(a).   The deduction referred      to  in  Section  33  shall  not  be      allowed unless  an amount  equal to      seventy  five   per  cent   of  the      development rebate  to be  actually      allowed is  debited to  the  profit      and loss  account of  the  relevant      previous year  and credited to  are      reserve account  to be  utilised by      the assessee  during  a  period  of      eight years  next following for the      purposes of  the  business  of  the      undertaking, other than-      (i)  for  distribution  by  way  of      dividends or profits."      Section 155(5)(ii)(a) which is also relevant in this case is as under :      "(5). Where  an allowance by way of      development rebate  has  been  made      wholly or  partly to an assessee in      respect of  a  ship,  machinery  or      plant installed  after the 31st day      of December, 1957 in any assessment      year under Section 33 of the Indian      Income-tax Act,  1992 (XI of 1922),      and subsequently-      (i) xx         xx     xx      xx      (ii) at  any time before the expiry      of the  eight years  referred to in      sub-section (3)  of Section 34, the      assessee   utilised    the   amount      credited  to  the  reserve  account      under  clause   (a)  of  that  sub-      section-      (a)  for  distribution  by  way  of

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 7  

    dividends or profits."      The assessee created a development rebate fund to avail of the  deduction under  Section 33.   Section 34(3)(a) does not prohibit  the assessee from using any amount credited to the fund  for the  purpose of  the business  but  he  cannot utilise the  amount for eight years for "distribution by way dividends or profits".  If the Income-tax Officer finds that the assessee had utilised any amount out of the reserve fund for distribution  by way  of dividends  or profits,  he  can withdraw  the   allowance  given   under   Section   33   by shareholders entitling  them to participate in the amount of the reserve but only as part of the capital.      The mechanism  and effect of issue of bonus shares have been explained by the English Courts in a number of cases. Lord Haldane in the case of Inland Revenue Commissioners vs. Blott (1921) AC 171 held:      "My Lords,  for the  reasons I have      given I  think it  is as  matter of      principle, within  the power  of an      ordinary joint  stock company  with      articles such  as those in the case      before us to determine conclusively      against the  whole world whether it      will  withhold   profits   it   has      accumulated  from  distribution  to      its shareholders  as income, and as      an alternative  not distribute them      at all, but apply them in paying up      the capital sums which shareholders      electing to take up unissued shares      would otherwise have to contribute.      If  this  is  done,  the  money  so      applied  is   capital   and   never      becomes profits in the hands of the      shareholder  at   all.    What  the      latter gets  is no doubt a valuable      thing.   But it  is a  thing in the      nature   of    an    extra    share      certificate in the company."      In that  case, Viscounts Haldane, Finally and Cave held that an  amount equal  to the face value of the shares could not be  regarded as received by the shareholders. A contrary view was taken by Lord Dunedin and Lord Summer who held that the word  "capitalisation" was  somewhat hazy and the amount that was  capitalised had to be treated as to have been paid to the shareholders.      In the  case of  Commissioners  of  Inland  Revenue  v. fisher’s Executors,  (1926) A.C.  395, Viscount  Cave  dealt proceeding under Section 155.      In this  case there  is no allegation that the assessee has distributed  any dividend out of the amounts standing to the credit  of the  fund.   But the  assessee  issued  bonus shares and  for that purpose transferred the amount standing to the credit of the fund to the share capital account.  The question is  whether under  these circumstances  issuance of bonus shares will amount to distribution of profits.      The answer  to the  question is  not easy.  One view is that issue  of bonus  shares to  the shareholders involves a dual operation  by  which  an  amount  is  released  to  the shareholders from  a reserve  fund but  was retained  by the Company and  applied in  payment of  the bonus  shares which were issued  as fully paid up.  The shareholders are treated as having  paid  for  the  bonus  shares  and  the  supposed payments by  the shareholders  are taken  to  share  capital account from  reserve fund  of the  Company.  In effect, the

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 7  

shareholders have  paid the  face value of the bonus shares. It  was   to  all   intents  and   purposes  equivalent   to distribution of accumulated profits in cash by the Company.      The second view is that when bonus shares are issued an amount equal  to the  face value  of the  shares  cannot  be regarded as  having been  received by the shareholders.  The issuance of bonus shares was nothing but mere capitalisation of  the   profits  of   the  company  in  respect  of  which certificates are  issued to the with a case of company which had large undistributed profits.  It decided to capitalise a part of  these profits  and distribute it pro rata among the ordinary shareholders  as a  bonus in  the form  of five per cent debenture stock.  The stock was duly issued, conditions providing that  the Company  might redeem  the stock after a certain time  and in certain events.  The question that came up for  decision was  whether the  bonus paid in the form of debenture stock  was income in the hands of the shareholders and was, therefore, liable to super tax. Viscount cave held:      "The whole  transaction  was  "bare      machinery" for capitalizing profits      and involved  no release  of assets      either as income or as capital."      In coming to this conclusion, Viscount Cave relied upon the following observation of Lord Finlay in Blott’s case:      "The general  scope and  effect  of      these   transactions    is   beyond      dispute.   There was an increase in      the capital  of the  company by the      retention of  the amounts available      for dividends.....The  use  of  the      sums which  had been  available for      dividend to  increase capital would      enable the  company to  carry on  a      larger    and    more    profitable      business, which  might be  expected      to yield  larger  dividends.    The      dividends, however,  were to  be in      the future.   So far as the present      was concerned there was no dividend      out  of  the  accumulated  profits;      these were  devoted  to  increasing      the capital  of the  company.   The      company had  power to  do  what  it      pleased with  any profits  which it      might make.   It  might  spend  the      accumulated    profits    in    the      improvement of  the company’s works      and buildings and machinery.  These      improvements might  lead to a great      accession of  business and increase      of   profits    by   which    every      shareholder would  benefit, but  of      course it could not for a moment be      contended that such a benefit would      render him  liable to  super tax in      respect of  it.   The benefit would      not be in the nature of income, and      super tax  can be  levied  only  on      income."      In our view, the principle stated by Lord Finlay really resolves the  controversy raised  in this case.  The profits made by  the Company  may be  distributed  as  dividends  or retained by the Company as its reserve which may be used for improvement of the company’s works, buildings and machinery. That will  enable the company to make larger profits.  There

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 7  

cannot be  any dispute  that the  shareholders will  benefit from the  improvements brought  about in  the profit  making apparatus of  the Company.   Likewise,  if  the  accumulated profits are  capitalised and  capital base of the Company is enlarged, this  may enable  the Company  to do  its business more profitably.   The shareholders will also benefit if the share capital is increased.  They may benefit immediately by issue  of  bonus  shares.    But  neither  in  the  case  of improvement in  the profit  making apparatus nor in the case of expansion of the share capital of the Company,  can it be said that  the shareholders have received any money from the Company.   They may  have benefited  in both the cases.  But this benefit cannot be treated as distribution of the amount standing to the credit of any reserve fund of the Company to its shareholders.      In fact,  the transfer  of the  amounts standing to the credit of  Development Rebate  Reserve to  the share capital account, does  not involve  any disbursement of money by the Company.   Nothing comes  out of  the till of the Company to the shareholder.   The  entire  amount  of  money  shown  as development rebate  reserve is  retained by  the Company  in another account.   It  cannot be  said that  by the issue of bonus shares,  the company  had distributed its reserve fund to the  shareholders even  though it had retained the entire amount with it in the share capital account.      It must  also be  noted that  while  dealing  with  the question of  valuation  of  bonus  shares  in  the  case  of Commissioner of  Income-Tax,  Bihar  vs.  Dalmia  Investment Co.Ltd. 52  ITR 567,  Hidayatullah, J. (as His Lordship then was) after  referring to Blott’s case (supra), preferred the view expressed  by Viscounts Haldane, Finlay and Cave to the dissenting view  taken by  Lord  Dunedin  and  Lord  Summer. Dealing with  effect of issue of bonus shares, Hidayatullah, J. held that "the floating capital used in the company which formerly consisted  of subscribed  capital and  the reserves now becomes  the subscribed  capital of  the  Company".  The certificates in  the hands of the shareholders were property from which income will be derived in future.      Hidayatullah, J.  in Dalmia’s  Case, also  quoted  with approval a  passage from  a decision of the Supreme Court of United States, Eisner v. Macomber (1920) 252 U.S. 189:      "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      interests 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

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 7  

    old certificates have been split up      in effect  and have  diminished  in      value to the extent of the value of      the new."      When a  shareholder gets a bonus share the value of the original share  held by  him goes  down.    In  effect,  the shareholder gets two shares instead of the one share held by him and  the market  value as well as the intrinsic value of the two  shares put  together will be the same or nearly the same as  the value  of the  original share  before the bonus issue.      It   appears   from   the   various   decisions   cited hereinabove, that  issuance of  bonus shares does not amount to distribution  of accumulated  profit of  a company.   The shareholder  derives   some  benefit   by  the   process  of capitalising of  the accumulated  profits but  at  the  same time, the  value of  his original  shareholding  goes  down. Viewed from any angle,  it cannot be said that in this case, the  assessee-Company   had  distributed  any  part  of  its Development Rebate  Reserve Fund  when it  issued the  bonus shares.   The accumulated  profit lying to the credit of the Development Rebate Reserve has been retained by the Company. The  amount  has  been  transferred  to  the  share  capital account,   If that  was not  done the intrinsio value of the shares held by the shareholders would have been more.  After the issue  of the  bonus shares,  the intrinsio value of the original shares  have gone  down rateably.   The accumulated profits of the Company have remained with the Company in one account or another.      On behalf  of the  Revenue, our  attention was drawn to the judgment  in the  case of  Leader Engineering  Works vs. Commissioner of Income Tax, Amritsar-II 124 ITR 44. That was a case  of partnership  firm.   The amount  standing to  the credit of development rebate reserve account was debited and the capital  accounts of  the partners  in  the  partnership account were correspondingly credited.  It was held that the identity of  the  development  rebate  reserve  account  had completely disappeared.   The  amount standing to the credit of that  reserve was  placed at the disposal of the partners who were  free to  withdraw the same for their own purposes. In that  case it  was held  that the  transfer of the amount standing to  the credit of the development rebate reserve in the  individual’s   account  of  the  partners  amounted  to distribution of  profits.   We fail to see how this decision helps  the   Revenue  in  the  facts  of  this  case.    The shareholders are  not entitled  to draw  any money  from the share capital account of the company.  The money standing to the credit  of the Development Rebate Reserve is retained by the Company  in another account.  A shareholder cannot claim that any part of the share capital of the company belongs to him or make use of its.      The question as to the substance of the transaction was also raised.   The  case, however,  has to be decided on the basis of  the language  of the  statute.   There has been no distribution from  the development  rebate fund.  The result might have  been different  had the statute been differently worded but  we shall  have to  take the stature as it is and not in  any other  sense.   Moreover, as  was pointed out by Lord Summer in Fisher’s case that desires and intentions are things of  which a  company is  incapable.   These  are  the mental operations  of its  shareholders and  officers.   The only intention  that the company has is such as is expressed in or  necessarily follows  from its  proceedings.    It  is hardly a  paradox to  say  that  the  form  of  a  company’s resolutions and instruments is their substance.

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 7  

    In this  case, neither  in form  not in  substance, has there been  any distribution  of profits  by the  company in making the  bonus issue.   If the substance and not the form of the transaction is looked to, the issue of a bonus shares was, in  the language  of Rowlatt, J. "a bare machinery" for capitalising  profits  and  there  was  no  distribution  of profits to the shareholders.      We are  unable to uphold the view expressed by the High Court that  the issue  of bonus  shares in the facts of this case amounted  to distribution of accumulated profits of the Company shown  as Development  Rebate  Reserve  Fund.    The appeals are  allowed.   The judgment  under  appeal  is  set aside.  There will be no order as to costs.