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CASE NO.: Appeal (civil)  4422 of 2001

PETITIONER: Commissioner of Income Tax, Mumbai

RESPONDENT: M/s General Insurance Corporation

DATE OF JUDGMENT: 25/09/2006

BENCH: ASHOK BHAN & Markandey Katju

JUDGMENT: J U D G M E N T

Bhan, J.

       The question which arises for consideration in this  appeal is, as to whether the expenditure incurred in  connection with the issuance of bonus shares is a capital  expenditure or revenue expenditure.  The question of law  framed in the High Court was:

(i)     Whether on the facts and in the circumstances of the  case and in law the Tribunal was right in holding that  the expenditure incurred on account of share issue is  allowable expenditure?   

       The Assessee is an Insurance Company which has four  subsidiaries.  For the assessment year 1991-92 the assessee  filed a return of income of Rs. 58,52,80,850/- along with the  audit report.  The assessing Officer disallowed a few expenses  incurred as revenue expenditure, one of them being in the  sum of Rs. 1,04,28,500/- incurred towards the stamp duty  and registration fees paid in connection with the increase in  authorized share capital.  The respondent-assessee had during  the accounting year, incurred expenditure separately for: (i)     The increase of its authorized share capital and (ii)    The issue of bonus shares.

       The Assessing Officer disallowed both the items of  expenditure as revenue expenditure.  According to him, the  expenses incurred were towards a capital asset of a durable  nature for the acquisition of a capital asset and, therefore, the  expenses could only be attributable towards the capital  expenditure.    

       The assessee being aggrieved filed an appeal under  Section 143 (3) before the CIT (Appeals).   Disallowance of Rs.  1,04,28,500/- in respect of stamp duty and registration fees  incurred in connection with the increase in the authorized  share capital were bifurcated by the CIT (Appeals) into two   categories,   one relating to the increase in authorized share  capital from Rs. 75 crores to Rs. 250 crores and second  relating to issue of bonus shares.  In respect of the first  category of expenditure it was held that the same was not  allowable in terms of the judgments of the Bombay High Court  in the case of Bombay Burmah Trading Corporation, vs.   CIT, (1984) 145 ITR 793 and Richardson Hindustan Limited  

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Vs. CIT, (1988)169 ITR 516.  The expenditure falling under  second category was allowed as revenue expenditure being  directly covered by the decision in Bombay Burmah Trading  Corporation’s case (supra).   

       The revenue being aggrieved challenged the order passed  by the CIT (Appeals) before the Income Tax Appellate Tribunal  (for short "the Tribunal").  The Tribunal upheld the decision of  the CIT (Appeals) treating the expenses incurred towards the  issue of bonus shares as revenue expenditure by observing  inter alia as under:  

       "We have carefully considered the rival  submissions.  The basis for the judgment by  Hon’ble Supreme Court in the case of Brooke  Bond India Limited vs. CIT, (1997) 225 ITR  798 (SC), has been that the expenditure was  connected with the expansion of the capital  base of the Company and therefore such  expenditure was capital expenditure.   However, in the case of issue of bonus shares  there does not take place an expansion of the  capital base of the company but only re- allocation of the existing funds.  We, therefore,  hold that the Learned CIT (Appeals) rightly  decided this issue in favour of the assessee.   This ground of appeal is therefore rejected."   

The revenue thereafter filed an appeal under Section 260- A of the Income tax Act (for short "the Act") before the High  Court of Bombay, raising two questions of law.  The High  Court in its judgment has affirmed the Tribunal’s judgment by  following its earlier decision in the case of Bombay Burmah  Trading Corporation (supra).  This Court granted leave qua  the question of law as reproduced in para 1 of this judgment.   

On the question, as to whether the expenses incurred in  connection with the issue of bonus shares is a revenue  expenditure or a capital expenditure, there is a conflict of  opinion between the High Courts of Bombay and Calcutta on  the one hand and Gujarat and Andhra Pradesh on the other.   Bombay and Calcutta High Courts have taken the view that  the expenses incurred in connection with the issue of bonus  shares is a revenue expenditure whereas Gujarat and Andhra  Pradesh High Courts have taken the view that the expenses  incurred in connection with the bonus shares is in the nature  of capital expenditure.   

Learned counsel for the appellant relying upon the  commentary to the Companies Act by A Ramaiya, Sixteenth  Edition 2004, which occurs in the commentary to Section 81  of the Indian Companies Act, - "When a company prospers and  accumulates a large surplus it converts this surplus into  capital and divides the capital among its members in  proportion to their rights.  This is done by issuing fully paid  shares representing the increased capital.  The shareholders to  whom the shares are allotted have to pay nothing.  The  purpose is to capitalize the gains which may be available for  division or utilize quasi-capital gains.  Bonus shares go by the  modern name "capitalization of shares".  AND   the judgments  of the Gujarat High Court in Ahmedabad Manufacturing and  Calico Pvt. Ltd. Vs. Commissioner of Income-Tax, (1986)  162 ITR 800, CIT Vs. Mihir Textiles Limtied, (1994) 206 ITR  112 (Gujarat), Gujarat Steel Tubes Limited Vs. CIT, (1994)  210 ITR 358, CIT Vs. Ajit Mills Limited, (1994) 210 ITR 658

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and the two judgments of the Andhra Pradesh High Court in  Vazir Sultan Tobacco Co. Ltd. Vs. CIT, (1990) 184 ITR 70  and Vazir Sultan Tobacco Co. Ltd. Vs. CIT, (1988) 174 ITR  689 wherein it has been held that the issuance of bonus  shares increases the issued and paid up capital of the  company and the bonus shares of the company are directly  connected with the acquisition of capital and an advantage of  enduring nature.  CONTENDS that the expenses incurred  towards issue of bonus shares confers an enduring benefit to  the company which has a resultant impact on the capital  structure of the company and therefore, it should be regarded  as the capital expenditure.   Reliance has also been placed  upon the judgments of this Court in Punjab State Industrial  Development Corporation Ltd. Vs. CIT, (1997) 225 ITR 792  (SC) and Brooke Bond India Ltd. Vs. CIT, (1997) 225 ITR 798  (SC).  He also relied upon in CIT vs. Motor Industries Co.  Ltd., (1998) 229 ITR 137 of Karnataka High Court, in CIT vs.  Ajit Mills Limited, (1994) 210 ITR 658, Gujrat Steel Tubes  Ltd., vs. CIT, (1994) 210 ITR 358 of Gujarat High Court &  Union Carbide India Ltd., vs. CIT, (1993) 203 ITR 584 of  Calcutta High Court.   

As against this, learned senior counsel appearing for the  respondent contends that undoubtedly increase in share  capital by the issue of fresh shares leads to an inflow of fresh  funds into the company expands or adds to, its capital  employed resulting in expending its profit making apparatus,  but THE ISSUE OF BONUS SHARES by capitalization of  reserves is merely a reallocation of a company’s funds.  There  is no inflow of fresh funds or increase in the capital employed,  which remains the same.  The issue of bonus shares leaves  the capital employed unchanged and therefore, does not result  in conferring an enduring benefit to the company and the  same has to be regarded as revenue expenditure.   He has  relied upon the judgment of this Court in CIT vs. Dalmia  Investment Co. Ltd., (1964) 52 ITR 567 (SC), Bombay  Burmah Trading Corporation Ltd. Vs. CIT, (1984) 145 ITR  793, Richardson Hindustan Limited Vs. CIT, (1988) 169 ITR  516 (Bombay) and the subsequent judgments of the same  Court taking the same view and the judgment of the Calcutta  High Court in  Wood Craft Products Limited Vs.  Commissioner of Income-Tax, (1993) 204 ITR 545.    

We may at the outset indicate that this Court has laid  down the test for determining whether a particular  expenditure is revenue or capital expenditure in the case of  Empire Jute Co. Ltd. Vs. CIT, 1980 (4) SCC 25.  This Court  after considering the law on the subject in detail observed at  page 8 as under:  

"The decided cases have, from time to  time, evolved various tests for  distinguishing between capital and  revenue expenditure but no test is  paramount or conclusive. There is no all  embracing formula which can provide a  ready solution to the problem; no  touchstone has been devised. Every case  has to be decided on its own facts  keeping in mind the broad picture of the  whole operation in respect of which the  expenditure has been incurred. But a few  tests formulated by the courts may be  referred to as they might help to arrive at  a correct decision of the controversy

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between the parties. One celebrated test  is that laid down by Lord Cave, L.C. in  Atherton vs. British Insulated and  Helsby Cables Ltd., 10 TC 155, where  the learned Law Lord stated :  

When an expenditure is made,  not only once and for all, but with a  view to bringing into existence an  asset or an advantage for the  enduring benefit of a trade, there is  very good reason (in the absence of  special circumstances leading to an  opposite conclusion) for treating  such an expenditure as properly  attributable not to revenue but to  capital.’’                                                 [Emphasis supplied]

In short, what has been held in this case is that if the  expenditure is made once and for all with a view to bringing  into existence an asset or an advantage for the enduring  benefit of a trade then there is a good reason for treating such  an expenditure as properly attributable not to revenue but to  capital.  This is so, in the absence of special circumstances  leading to an opposite conclusion.  

Decisions of this Court in Punjab State Industrial  Development Corporation Ltd. (supra) and Brooke Bond  India Ltd. (supra) and  CIT Vs. Motor Industries Co. Ltd.,  (1998) 229 ITR 137 of Karnataka High Court, CIT Vs. Ajit  Mills Limited, (1994) 210 ITR 658, Gujrat Steel Tubes Ltd.,  vs. CIT, (1994) 210 ITR 358 & Union Carbide India Ltd., vs.  CIT, (1993) 203 ITR 584 of Calcutta High Court are of not  much assistance to us.  All these cases relate to the issue of  fresh shares which lead to an inflow of fresh funds into the  company which expands, or adds to its capital employed in the  company resulting in the expansion of its profit making  apparatus.  Expenditure incurred for the purpose of increasing  company’s share capital by the issue of fresh shares would  certainly be a capital expenditure as has been held by this  Court in the cases cited above.    

Effect of issuance of bonus share has been explained by  this Court in Dalmia Investment Co. Ltd., (supra) where the  question of valuation of bonus share was considered.    After  quoting the decision in the case of Eisner Vs. Macomber,  (1920) 252 U.S. 189, of the Supreme Court of United States of  America,  Mr. Justice Hidayatullah explained the  consequences of issue of bonus shares by observing thus:

"\005. In other words, by the issue of bonus  shares pro rata, which ranked 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 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."

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       It is further observed at pages 577-578:

       "It follows that though profits are profits  in the hands of the company, when they are  disposed of by converting them into capital  instead of paying them over to the  shareholders, no income can be said to accrue  to the shareholders 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."                                                          [Emphasis supplied]      

The Gujarat High Court in Ahmedabad Manufacturing  and Calico Pvt. Ltd. Vs. Commissioner of Income-Tax,  (1986) 162 ITR 800 has held, that the expenses incurred  towards the issuance of bonus shares is a capital expenditure.   Bonus shares issued by the assessee company also constitute  its capital bonus shares, as right shares are an integral part of  the permanent structure of the company and are not in any  way connected with the working capital of the company which  is utilized to carry on day to day operations of the business.   Negativing the contention of the assessee that no benefit  whatsoever is derived by the assessee company when its  profits and/or reserves are converted into paid-up shares, it  was held that as a result of the increase in the paid up share  capital the creditworthiness of the assessee-company would  increase which would be a benefit or advantage of enduring  nature.     That  the bonus shares are an integral part of the  permanent    structure of the       assessee-company.       The  bonus shares are not different from rights shares as,    according  to it,   in   the case of bonus shares a bonus is first  paid to the shareholders who pay it back to the company to  get their bonus shares.  This reasoning of the Gujarat High  Court was evident from the following extracts from its  judgment: At page 808: "It is clear that when bonus shares are  issued, two things take place: (i) bonus is paid  to the shareholders; and (ii) wholly or partly  paid-up shares are issued against the bonus  payable to the shareholders.  The shareholders  invest the bonus paid to them in the shares  and that is how the bonus shares are issued to  them. In our opinion, therefore, it would not  make any difference whether paid-up share  capital is augmented by issuance of right  shares or bonus shares to the shareholders.  \005\005\005\005\005\005\005 \005\005\005\005\005\005\005\005.  \005\005\005\005\005\005\005\005\005\005 \005\005\005. As already pointed out above, bonus  shares are not different from rights  shares\005\005\005.."

       The above observation is completely contrary to the  observation of this Court in Dalmia Investment Co. Ltd.,

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(supra), which judgment had not been referred to by the   Gujarat High Court.    In the case of Dalmia Investment Co.  Ltd., (supra) this Court has held that floating capital used in  the company which formerly consisted of subscribed capital  and the reserves now becomes the subscribed capital.  The  conversion of the reserves into capital did not involve the  release of the profits to the shareholder; the money remains  where it was, that is to say, employed in the business.  In the  face of these observations the reasoning given by the Gujarat  High Court cannot be upheld.

       We do not agree with the view taken by the Gujarat High  Court that increase in the paid up share capital by issuing  bonus shares may increase the creditworthiness of the  company but that does not mean that increase in the credit  worthiness would be a benefit or advantage of enduring nature  resulting in creating a capital asset.  

       The Andhra Pradesh High Court has in Vazir Sultan  Tobacco Co. Ltd. Vs. CIT, (1990) 184 ITR 70 (AP), taken the  view that the expenditure incurred on the issue of bonus  shares was capital in nature because the issue of bonus  shares led to an increase in the company’s capital base.   

       The observations and conclusions are erroneous as they  run contrary to the observation made by this Court in Dalmia  Investment Co. Ltd., (supra).  The capital base of the  company prior to or after the issuance of bonus shares  remains unchanged.  

       Issuance of bonus shares does not result in any inflow of  fresh funds or increase in the capital employed, the capital  employed remains the same.  Issuance of bonus shares by  capitalization of reserves is merely a reallocation of company’s  fund.  This is illustrated by the following hypothetical  tabulation which establishes that bonus shares leaves the  capital employed untouched, because in the hypothetical  example, the capital employed remains the same (i.e. Rs. 600)  both pre and post issuance of bonus shares.

Sl.No. Particulars Pre-Bonus  Issue

Rs. On Bonus Issue

Rs. Post Bonus  shares Rs. 1. Pre-paid share  capital 100 100+100=200 200 2. Reserve 500 500-100=400

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400 3. Total 600 600 600

       As observed earlier, the issue of bonus shares by  capitalization of reserves is merely a reallocation of company’s  funds.  There is no inflow of fresh funds or increase in the  capital employed, which remains the same.  If that be so, then  it cannot be held that the Company has acquired a benefit or  advantage of enduring nature.  The total funds available with  the company will remain the same and the issue of bonus  shares will not result in any change in the capital structure of  the company.  Issue of bonus shares does not result in the  expansion of capital base of the company.   

        The case Wood Craft Products Limited (supra) of the  Calcutta High Court is similar to the case of the respondent.   In that case as well there was increase of authorized share  capital by the issue of fresh shares and a separate issue of  bonus shares.  The Calcutta High Court drew a distinction  between the raising of fresh capital and the issue of bonus  shares and held that expenditure on the former was capital in  nature as it changed the capital base.  On the other hand, in  the case of bonus shares, was held to be revenue expenditure  following the decision of the Supreme Court in Dalmia  Investment Co. Ltd., (supra) on the ground that there was no  change in the capital structure at all.  

In our considered opinion, the view taken by the Bombay  and Calcutta High Courts is correct to the effect that the  expenditure on issuance of bonus shares is revenue  expenditure.  The contrary judgments of Gujarat and Andhra  Pradesh High Courts are erroneous and do not lay down the  correct law.

For the reasons stated above, the question referred to us,  is answered in the affirmative, i.e., in favour of the assessee  and against the revenue.