Case Note & Summary
The Supreme Court of India addressed an income tax appeal concerning the correct method of determining the cost of acquisition of bonus shares for computing profit on their sale. The assessee, Dalmia Investment Co. Ltd., dealt in shares and held investments. In 1944, it acquired 31,909 ordinary shares of Rohtas Industries Ltd. at a cost of Rs. 5,84,283. In January 1945, Rohtas Industries issued bonus shares at a ratio of one bonus share for each original share, so the assessee received 31,909 bonus shares. After selling some original shares, on January 1, 1948, the assessee held 1,10,747 shares, comprising 17,259 original shares acquired in 1944, 31,909 bonus shares, 59,079 newly issued shares acquired in 1945 after the bonus issue, and 2,500 further shares acquired in 1947. The book value of the total holding was Rs. 15,57,902, with the bonus shares valued at their face value of Rs. 10 each, amounting to Rs. 3,19,090, and the other shares at actual cost. On January 29, 1948, the assessee sold all 1,10,747 shares for Rs. 15,50,458, i.e., Rs. 14 per share, and claimed a loss of Rs. 7,444 in its return for assessment year 1949-50. The Income-tax Officer computed the cost of the bonus shares at Rs. 6-8-0 per share by an averaging method and held that the assessee had made a capital gain of Rs. 2,39,317. The Appellate Assistant Commissioner held the shares were stock-in-trade, not investments, valued the bonus shares at nil, and computed a trading profit of Rs. 3,11,646. The Income-tax Appellate Tribunal confirmed this view. On a reference, the Patna High Court held that the Tribunal's computation of Rs. 3,11,646 was not in accordance with law, relying on Swan Brewery Co. Ltd. v. The King, and treated the face value as the real cost of the bonus shares. The Commissioner of Income-tax appealed to the Supreme Court. The main legal issue was how to determine the cost of acquisition of bonus shares for computing profit on sale. The Revenue argued that bonus shares had nil cost as no amount was paid, so the Tribunal's computation of profit was correct. The assessee contended that bonus shares could not have nil cost and should be valued at least at face value, so no taxable profit arose. The Supreme Court, by majority of Hidayatullah and Shah JJ., with Sarkar J. dissenting, held that bonus shares cannot be valued at face value or nil. The majority reasoned that the Income-tax Act defines dividend but issue of bonus shares is not a release of reserves as profits; a bonus share certificate is not a voucher to receive its face amount. Bonus shares cannot be said to cost nothing because their issue causes an instant loss in the value of original holding, as earning capacity remains the same after reserve is converted into shares. The correct method, where bonus shares rank pari passu with old shares, is to spread the original cost of the old shares over both old and bonus shares. Where shares do not rank pari passu, cost may be adjusted in proportion of face value or on equitable considerations based on market price before and after the issue. On the facts, the bonus shares ranked pari passu, so spreading original cost over old and new shares was appropriate. Sarkar J. dissented on reasoning, holding that bonus shares should be deemed acquired at market value on the date of issue, following Bai Shirinbai Kooka. The court dismissed the appeal and held that the profit of Rs. 3,11,646 computed by the Tribunal was not in accordance with law.
Headnote
A) Income Tax - Bonus Shares - Cost of Acquisition - Spreading Original Cost over Old and Bonus Shares - Income-tax Act, 1922, Not mentioned - Dispute pertained to valuation of 31,909 bonus shares in Rohtas Industries for computing profit on sale of entire holding of 1,10,747 shares on January 29, 1948. The majority held that where bonus shares rank pari passu with old shares, the original cost of old shares must be spread over both old and bonus shares to determine cost of acquisition; valuing bonus shares at face value or nil was rejected. Held that the method of valuation must accord with business accountancy and the actual economic detriment to the shareholder (Paras Not mentioned). B) Income Tax - Dividend - Issue of Bonus Shares - Not Dividend Income - Income-tax Act, 1922, Not mentioned - The Income-tax Act definition of dividend does not make issue of bonus shares a release of reserves as profits; the face value of bonus shares cannot be treated as dividend because the share certificate is not a voucher to receive the face amount. Held that bonus shares confer a share in assets and future profits, and market value may fluctuate, so face value is not cost (Paras Not mentioned). C) Income Tax - Valuation of Bonus Shares - Nil Valuation Rejected - Income-tax Act, 1922, Not mentioned - Bonus shares cannot be cost nothing because issue of bonus shares causes an instant loss in value of original holding; earning capacity remains same after reserve converted into shares, with corresponding fall in dividends and market price. Held that nil valuation method is incorrect (Paras Not mentioned). D) Income Tax - Valuation of Bonus Shares - Non-Pari Passu Shares - Adjustment Methods - Income-tax Act, 1922, Not mentioned - If bonus shares do not rank pari passu, cost may be adjusted in proportion of face value or on equitable considerations based on market price before and after issue, taking middle price, not unusual fluctuations. Held that on facts, bonus shares ranked pari passu, so spreading original cost over old and new shares was appropriate (Paras Not mentioned). E) Income Tax - Dissenting Opinion - Bonus Shares Deemed Acquired at Market Value on Issue Date - Income-tax Act, 1922, Not mentioned - Per Sarkar J., following Commissioner of Income-tax v. Bai Shirinbai K. Kooka, [1962] Supp. 3 S.C.R. 391, where cost of acquisition of a trading asset cannot be shown, it must be deemed acquired at market value on date of acquisition; bonus shares deemed acquired at market value on issue date, not nil. Held that the majority in Commissioner of Inland Revenue v. Blott correctly held bonus shares are not taxable income; High Court's answer negative was correct, but reasons differed (Paras Not mentioned).
Issue of Consideration
How to determine the cost of acquisition of bonus shares for ascertaining the profit made on sale of those shares, where the assessee held both original and bonus shares as stock-in-trade.
Final Decision
The Supreme Court dismissed the appeal and held that the profit of Rs.3,11,646 computed by the Tribunal was not in accordance with law. By majority (Hidayatullah and Shah JJ., Sarkar J. dissenting), the Court held that the cost of acquisition of bonus shares which rank pari passu with original shares must be determined by spreading the original cost of the old shares over both old and bonus shares. Valuing bonus shares at face value or nil was rejected.
Law Points
- Bonus shares are not dividend income
- cost of acquisition of bonus shares ranking pari passu must be determined by spreading original cost of old shares over old and bonus shares
- face value of bonus shares cannot be treated as cost
- nil valuation of bonus shares is incorrect
- issue of bonus shares capitalises profits not releases reserves as income
