Case Note & Summary
The case involved an appeal by a private limited company assessee against the decision of the High Court of Delhi concerning the computation of capital gains on the sale of original shares. The assessee derived income from investment, agriculture, and brick kiln business, and was an investor in shares. For the assessment years 1967-68 and 1968-69, the assessee sold shares of Escorts Limited and declared capital gains. The Income Tax Officer did not accept the cost of acquisition as returned and recomputed capital gains by spreading the original cost over the original shares and subsequent bonus shares and averaging the same. This computation was confirmed by the Appellate Assistant Commissioner and the Income Tax Appellate Tribunal, which relied on Commissioner of Income-tax, Bihar v. Dalmia Investment Co. Ltd. (1964) 52 ITR 567. At the assessee's instance, the Tribunal referred two questions of law to the High Court under Section 256(1) of the Income-tax Act, 1961, asking whether the Tribunal was justified in determining cost of acquisition by spreading and averaging, and if not, whether the assessee was justified in taking original cost under Section 45. The High Court answered the first question in the affirmative in favour of the revenue and declined to answer the second question. Before the Supreme Court, the assessee argued that the subsequent issue of bonus shares was of no consequence and would not alter the original cost of acquisition of the shares. The shares sold were original shares and by an investor, unlike cases relied by the revenue where shares sold were bonus shares and assessees were dealers in shares. The revenue contended that the subsequent issue of bonus shares had the effect of altering the original cost of acquisition irrespective of whether the assessee was an investor or dealer and whether shares sold were original or bonus shares. The Supreme Court examined the relevant statutory provisions, namely Sections 2(14), 45(1), 48, and 55(2) of the Income-tax Act, 1961, and the nature of bonus shares as explained in company law authorities. The Court noted that bonus shares are not a gift but represent capitalization of profits or reserves, and that issuing bonus shares reduces the market value of each share correspondingly while the total holding may remain the same. The Court distinguished earlier decisions dealing with dealers in shares and sale of bonus shares, where business profits rather than capital gains were in issue. It held that for an investor selling original shares, the cost of acquisition must be taken at the actual amount paid, and the subsequent issue of bonus shares does not dilute or average that cost. Consequently, the Supreme Court allowed the assessee's appeals and set aside the High Court's decision, ruling in favour of the assessee on the computation of capital gains.
Headnote
A) Income Tax - Capital Gains - Cost of Acquisition of Original Shares - Income-tax Act, 1961, Sections 45, 48, 55(2) - The core dispute was whether the cost of acquisition of original shares should be the actual amount paid or an averaged cost after issue of bonus shares. The Court analyzed that bonus shares are not a gift but represent capitalization of profits and that the original shares retain their original cost. The Supreme Court held that for original shares sold, actual cost must be taken, and the subsequent bonus issue does not alter that cost (Paras 1-6). B) Income Tax - Capital Gains vs Business Profits - Investor and Dealer Distinction - Income-tax Act, 1961, Section 45 - The assessee was an investor in shares, while earlier decisions involved dealers in shares and sale of bonus shares, where business profits were computed differently. The Court distinguished those cases, observing that the question in those cases was computation of profits and gains in business, not capital gains on sale of original shares by an investor. Held that the distinction is relevant and the averaging principle cannot be applied to an investor selling original shares (Paras 3-4). C) Income Tax - Bonus Shares - Nature and Effect on Cost Base - Income-tax Act, 1961, Section 2(14) and Section 48 - Bonus shares are issued by capitalization of profits or reserves, not as gifts; the market value per share reduces, but total holding value may remain the same. The Court relied on company law authorities to explain that issuing bonus shares does not create additional cost to the shareholder. Held that cost of acquisition of original shares remains the actual cost paid, and no part of that cost is transferred to bonus shares (Paras 5-6).
Issue of Consideration
How should the cost of acquisition of original shares be determined for capital gains tax when bonus shares are subsequently issued; whether the Tribunal was justified in spreading the original cost over original and bonus shares and averaging the same; whether the assessee was justified in taking the original cost under Section 45 of the Income-tax Act, 1961
Final Decision
Supreme Court allowed the assessee's appeals and held that the cost of acquisition of original shares should be taken at actual cost, and the subsequent issue of bonus shares does not have the effect of altering the original cost of acquisition for the purposes of capital gains under Sections 45 and 48 of the Income-tax Act, 1961.
Law Points
- Cost of acquisition for capital gains under Section 48 is actual cost
- Subsequent issue of bonus shares does not alter original cost of original shares
- Bonus shares represent capitalization of profits and are not a gift
- Distinction between investor and dealer in shares for capital gains vs business profits
- Averaging cost over original and bonus shares applies only when bonus shares are sold
- not original shares
