1960 (11) TMI 132 - HC - Income Tax

Summary

Issues Involved:

1. Valuation of bonus shares.
2. Computation of profit on the sale of shares.
3. Applicability of Section 12B of the Income-tax Act.
4. Legal interpretation of "capitalisation" of profits and issuance of bonus shares.

Detailed Analysis:

1. Valuation of Bonus Shares:
The primary issue was whether the bonus shares should be valued at their face value or considered as issued free of cost. The assessee argued that the cost price of the bonus shares should be fixed at the face value of Rs. 10 per share, while the Income-tax authorities contended that the cost price was nil since the shares were issued free.

The court delved into the statutory provisions under the English Companies Act, 1948, and the Indian Companies Act, 1956, which allow for the "capitalisation" of profits by issuing fully paid shares to shareholders. It was noted that the consideration for the bonus shares is the dividend or bonus declared by the company out of its undistributed profits, implying that the bonus shares are not issued free but are paid for by the shareholders through a set-off against the dividend.

The court cited several precedents, including *Swan Brewery Co. Ltd. v. King* and *Osborne v. Steel Barrel Co. Ltd.*, to support the view that the real cost of the bonus shares to the assessee is the face value of the shares as shown in the books of account.

2. Computation of Profit on the Sale of Shares:
The assessee sold 1,10,747 shares of Rohtas Industries Limited for Rs. 15,50,458 and claimed a loss of Rs. 7,444, which was rejected by the Income-tax Officer. The officer computed the net profit to be Rs. 2,39,317, asserting that the cost of the bonus shares should be computed on an "average basis" as per the Bombay High Court's decision in *Emerald and Co. Ltd.*

The court, however, disagreed with the "average basis" method and held that the bonus shares should be valued at their face value. Consequently, there was no legally taxable profit made by the assessee on the sale of the shares, and the computation of profit by the income-tax authorities was deemed incorrect.

3. Applicability of Section 12B of the Income-tax Act:
The Appellate Assistant Commissioner initially held that Section 12B of the Income-tax Act was not applicable but still considered the cost of the bonus shares to be nil. The court, however, did not focus on the applicability of Section 12B in detail but rather on the correct valuation of the bonus shares and the resultant profit computation.

4. Legal Interpretation of "Capitalisation" of Profits and Issuance of Bonus Shares:
The court explained the legal mechanism of capitalisation of profits, where a company issues fully paid shares to shareholders by capitalising its undistributed profits. This process involves declaring a dividend or bonus and issuing a corresponding number of new shares, applying the dividend or bonus in payment of the shares issued.

The court concluded that the bonus shares are not issued free but are paid for by the shareholders through the dividend or bonus declared by the company. This interpretation was supported by various judicial precedents and statutory provisions.

Conclusion:
The court held that the bonus shares should be valued at their face value, and no legally taxable profit was made by the assessee on the sale of shares of Rohtas Industries Limited. The income-tax authorities were wrong in holding that the profit should be computed at Rs. 3,11,646 or any other amount. The question of law referred by the Income-tax Appellate Tribunal was answered in favor of the assessee, and the assessee was entitled to the costs of the reference.