1964 (3) TMI 17 - SC - Income Tax

Whether on the facts and circumstances of the case the profit computed at 3, 11, 646 on the sale of shares in Rohtas Industries Ltd. was in accordance with law ? Held that - The cost of 31, 909 shares namely 5, 83, 210 must be spread over those shares and the 31, 909 bonus shares taken together. The cost price of the bonus shares therefore was 2, 92, 141 because the bonus shares were to rank equal to the original shares. The answer to the question given by the High Court was therefore erroneous and the right answer would be that the profit computed at 3, 11, 646 was not in accordance with law. The appeal is therefore allowed

Issues Involved:
1. Determination of the cost of acquisition of bonus shares for ascertaining profits on their sale.
2. Methods of valuation of bonus shares.
3. Whether the bonus shares should be valued at their face value, nil, or by averaging the cost of original and bonus shares.

Issue-wise Detailed Analysis:

1. Determination of the Cost of Acquisition of Bonus Shares:
The primary issue in the judgment is how to determine the cost of acquisition of bonus shares to ascertain the profits made on their sale. The case involves the assessee who held shares in Rohtas Industries Ltd. and received bonus shares in 1945. The assessee sold these shares in 1948 and claimed a loss on the sale. The Income-tax Officer, Appellate Assistant Commissioner, and the Appellate Tribunal had differing views on how to value these bonus shares, leading to the appeal.

2. Methods of Valuation of Bonus Shares:
Several methods were proposed for valuing the bonus shares:
- Face Value Method: The High Court initially held that the cost of the bonus shares should be their face value, based on Lord Sumner's observations in Swan Brewery Co. Ltd. v. King and Commissioners of Inland Revenue v. Blott. However, this view was not accepted by the majority in Blott's case.
- Nil Value Method: The Appellate Assistant Commissioner and the Tribunal held that the bonus shares should be valued at nil, as the assessee paid nothing for them. This method was rejected by the Supreme Court as it would lead to the entire sale proceeds being treated as taxable profits, which would be unreasonable.
- Averaging Method: The Bombay High Court in Commissioner of Income-tax v. Maneklal Chunilal and Sons Ltd. and Emerald and Co. Ltd. v. Commissioner of Income-tax adopted the method of averaging the cost of original and bonus shares. This method was considered but ultimately not accepted by the Supreme Court.

3. Supreme Court's Analysis and Conclusion:
- Sarkar J.'s Judgment: Sarkar J. rejected the face value method and the nil value method. He emphasized that the cost of acquisition should be determined based on commercial principles and market value at the time of acquisition. He concluded that the bonus shares should be deemed to have been acquired at their market value on the date of their issue, following the principle laid down in Commissioner of Income-tax v. Bai Shirinbai K. Kooka.
- Hidayatullah J.'s Judgment: Hidayatullah J. also rejected the face value and nil value methods. He elaborated on the nature of bonus shares and the impact on the value of original shares. He concluded that the cost of bonus shares should be determined by spreading the cost of the original shares over the original and bonus shares taken together. This method was deemed appropriate as it reflects the true cost and impact on the shareholder's holdings.

Final Judgment:
The Supreme Court concluded that the profit computed at Rs. 3,11,646 was not in accordance with law. The correct method to determine the cost of acquisition of bonus shares is to spread the cost of the original shares over the original and bonus shares taken together. The appeal was allowed, and the High Court's answer was held to be erroneous. The correct profit to be added to the income returned was computed as Rs. 1,79,865.

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