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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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-

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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

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             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

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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

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(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

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