1996 (9) TMI 4 - SC - Income Tax

How the cost of the acquisition of the original shares should be determined for the purposes of capital gains tax - Tribunal was justified in determining the cost of acquisition of the original shares by spreading the original cost over the original and the bonus shares and then averaging the same and on that basis working out the capital gain - High Court held that the valuation made by the Revenue regarding the cost of the original shares is proper and valid

Summary

Issues Involved:
1. Determination of the cost of acquisition of original shares for capital gains tax when bonus shares are issued subsequently.
2. Whether the assessee was justified in taking the value of the shares at their original cost under Section 45 of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Determination of the Cost of Acquisition of Original Shares

The primary issue was how to determine the cost of acquisition of original shares for capital gains tax purposes when bonus shares are subsequently issued. The appellant, a private limited company and an investor in shares, sold shares of Escorts Limited in the assessment years 1967-68 and 1968-69 and declared the capital gains. The Income-tax Officer did not accept the cost of acquisition as returned by the assessee and computed the capital gains differently. The Appellate Tribunal confirmed the computation, relying on the decision in CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567.

The High Court held that the valuation made by the Revenue regarding the cost of the original shares was proper and valid. It answered question No. 1 in the affirmative and in favor of the Revenue. The appellant contended that the cost of acquisition should be taken at "actual cost" and that the subsequent issue of bonus shares should not alter this cost. However, the High Court, relying on decisions such as CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 and CIT v. Gold Co. Ltd. [1970] 78 ITR 16, held that the issuance of bonus shares impacts the original shares, altering their cost.

The Supreme Court affirmed the High Court's decision, noting that when bonus shares are issued, the cost of the original shares must be averaged over the original and bonus shares. This principle applies irrespective of whether the shares are held by an investor or a dealer. The court emphasized that the character of the owner of the shares as an "investor" or "dealer" is of no consequence, and the surplus receipt is taxed either as "capital gains" or "profit or loss," as applicable.

Issue 2: Justification of Taking the Value of Shares at Their Original Cost

The second issue was whether the assessee was justified in taking the value of the shares at their original cost under Section 45 of the Income-tax Act, 1961. The High Court declined to answer this question. The appellant argued that the High Court erred by not considering that the shares sold were original shares held by an "investor," and the computation of capital gains should not be affected by the issuance of bonus shares. The appellant relied on Shekhawati General Traders Ltd. v. ITO [1971] 82 ITR 788, where the court held that the subsequent issue of bonus shares was irrelevant for computing capital gains.

The Supreme Court distinguished the Shekhawati case, noting that it involved shares acquired before January 1, 1954, with the option to take the fair market value as on that date. In contrast, the shares in the present case were acquired after 1954, and the option of taking the fair market value as on January 1, 1954, was not available. The court held that the principles laid down in Shekhawati do not apply where the statutory cost of acquisition option is not exercised.

The Supreme Court concluded that the High Court was correct in holding that the subsequent issue of bonus shares affects the original cost of acquisition of the shares. The judgment of the High Court answering question No. 1 in favor of the Revenue was upheld, and the appeals were dismissed.

Conclusion:

The Supreme Court confirmed that the cost of acquisition of original shares must be averaged over the original and bonus shares when bonus shares are issued. This principle applies regardless of whether the shares are held by an investor or a dealer. The court also distinguished the Shekhawati case, emphasizing that its principles do not apply when the statutory cost of acquisition option is not available. The appeals were dismissed with no order as to costs.