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TMI Blog1970 (2) TMI 39X X X X Extracts X X X X X X X X Extracts X X X X ..... in-trade. The assessee's practice from year to year is to show the shares held by him as his stock-in-trade at the actual cost. In other words, he does not value the holding of his stock-in-trade at the end of each year at the market price, but continues to carry forward his holding from year to year at its original cost. During the accounting year the Tata Iron and Steel Co. Ltd. made what is known as " rights issue " of ordinary shares. The company offered its existing shareholders for subscription one new share of the rights issue for every five existing old shares. The assessee had, under the terms of the offer, a right to himself subscribe for 350 new shares of the rights issue offered to him by paying Rs. 75 for the face value of each of the new shares or to renounce the right and sell his right to the new shares which were offered to him. The assessee exercised the option to sell his right to subscribe to the 350 new shares offered to him and did not himself subscribe to any of these 350 new shares. By this sale he realised a sum of Rs. 27,500. In the assessment of his income for the above assessment year 1960-61 the assessee claimed, firstly, that the amount of Rs. 27,5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e new shares offered under the rights issue were to rank pari passu with the existing old ordinary shares and that a shareholder who exercised his right to subscribe to the appropriate number of shares offered to him would have to pay Rs. 75 per share to the company, that being the face value of each share. To help us to decide the questions arising in this reference four judgments of the Supreme Court have been brought to our notice. The first judgment is that in Commissioner of Income-tax v. Dalmia Investment Co. Ltd. In that case bonus ordinary shares were issued in respect of ordinary shares held in the company by the assessee in that case. He was a dealer in shares. The bonus shares were to rank pari passu with the original or old shares. It was held that the real cost of the bonus shares to the assessee cannot be taken to be nil, nor its face value. Hidayatullah J., in delivering the judgment on behalf of the majority, has observed in his judgment : " 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 foll ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was entitled to set off that loss against the capital gain of Rs. 45,262.50. She contended that, in the alternative, her right to receive the new shares was a right which was embedded in her old shares and, consequently, when she realised the sum of Rs. 45,262.50 by selling her right, the capital gain should be computed after deducting from that amount the value of the embedded right which became liquidated. The Supreme Court held that the assessee was entitled to deduct from the sum of Rs. 45,262.50 the loss suffered by way of depreciation in her holding of the old shares. The judgment in this case observes at pages 654-55 of the report as follows : " At the time, therefore, when the appellant renounced her right to take these new shares, the capital asset which she actually possessed consisted of her old 710 shares plus this right to take 710 new shares. At the time of her transaction, her old shares were valued at Rs. 253 per share, so that the capital asset in her possession can be treated to be the cash value of 710 multiplied by Rs. 253 of the old shares plus this right to obtain new shares. After she had transferred this right to obtain new shares, the capital assets that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the right which she subsequently transferred. The capital gain made by her would, therefore, be represented only by the difference between the money realised on transfer of the right, and the amount which she lost in the form of depreciation of her original shares in order to acquire that right. Looked at in this manner also, it is clear that the net capital gain by her would be represented by the amount realised by her on transferring the right to receive new shares, after deducting therefrom the amount of depreciation in the value of her original shares, being the loss incurred by her in her capital asset in the transaction in which she acquired the right for which she realised the cash. This method of looking at the transaction also leads to the same conclusion which we have indicated in the preceding paragraph. The view that we have taken finds support from the principle laid down by this court for valuation of bonus shares issued by a company to holders of original shares in the case of Commissioner of Income-tax v. Dalmia Investment Co. Ltd. " The above observations of the Supreme Court appearing at page 654 hold that the correct method for evaluating the capital gain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rt in respect of the bonus shares. We are, however, not considering in this case such a situation, because the assessee in our case did not himself apply for any of the 350 rights shares offered to him, but sold out the right to obtain all the 350 shares in the open market. Mr. Joshi, however, contended that in cases where the right to apply for the new shares of the rights issue is sold the correct method would be first to ascertain a shareholder's actual cost in respect of the old shares, then add to it the amount payable by him to the company for the new rights shares, then spread the aggregate amount over the aggregate of the old and new shares and so ascertain the average price which would be his actual cost price. Now as he sells out his new rights shares the amount payable in respect of those shares was added in the first step, only notionally, and therefore the second step would be to deduct the amount payable to the company per new share from the above average cost price and if the resulting amount is smaller than the sale price per share the difference would be his profit or capital gain, as the case may be, but if the amount is larger the difference would be his loss. Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re, but only notionally, though not in fact. -------------------- Rs. 2.50 cost price, on averaging as above, of one new share. Rs. 25.00 sale proceeds of the right to one new share. Deduct Rs. 2.50 actual cost of one new share as above. ------------------ Rs. 22.50 profit or capital gain, as the case may be, liable to be brought to tax. Example No. 2 : Take Rs. 200, as being the actual cost price of one old share. Rs. 200.00 cost price of one old share. Add Rs. 100.00 payable to the company for one new rights share. -------------------- Rs. 300.00 Therefore Rs. 150.00 average cost price per share. Deduct Rs. 100.00 taken above as paid to the company for one new share, but only notionally, though not in fact. -------------------- Rs. 50.00 cost price, on averaging as above, of one new share. Rs. 25.00 being the sale proceeds of the right to one share of the rights issue is actually less than the above cost price of Rs. 50 and therefore there is a loss of Rs. 25. He pointed out that if the principle in Dhun Kapadia's case is held applicable in each of these two examples, what would be taxable would be Rs. 5, though in example No. 1 the profit is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laid down by the Supreme Court in Dhun Kapadia's case. Mr. Joshi made various attempts to distinguish our case from the case of Dhun Kapadia ; but, in our opinion, he could not point out any effective distinction. One of the distinctions he sought to make was that Dhun Kapadia's case was a case of capital gains, whereas the case before us is of business profits. Now, in our opinion, it is a distinction which does exist, but it makes no difference, because in the case of both capital gains and revenue profit the amount is ascertained by deducting the cost price from the sale proceeds. In the case of capital gains the excess is a gain in the capital, whereas in the case of business profits, the excess is a revenue profit, but none the less, basically. both are profits. Of course, the fact whether it is capital gain or business profit merely affects the incidence and the rate of tax and the actual amount of tax may vary because of that reason, but the method of calculating the actual amount does not vary and is the same. We do not see any distinction which makes a difference between the facts in the case before us and those before the Supreme Court in Dhun Kapadia's case. We are, th ..... 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