Case Note & Summary
This case involved the method of computing profit or loss on the sale of bonus shares in the hands of a dealer in shares. The respondent, Gold Mohore Investment Co. Ltd., was a dealer in shares. During the assessment years 1949-50 and 1950-51, the company held shares in two different companies. In each case, it was allotted bonus shares ranking pari passu with the original shares. Upon allotment, the assessee credited the face value of the bonus shares to a capital reserve account, treating them as received free of cost. Subsequently, the assessee sold both the original and bonus shares. In its income tax returns, it computed the profit or loss on each transaction by taking the actual price paid for the original shares together with the face value of the bonus shares as the total cost of acquisition. This resulted in a loss on the sale of one company's shares and a small profit on the other. The Income Tax Officer did not accept this method. Instead, he calculated the profit and loss by spreading the cost of acquiring the original shares over the total number of shares, including the bonus shares acquired free of cost. This averaging method reduced the cost per share and consequently increased the taxable profit or reduced the loss. The Appellate Assistant Commissioner and the Income Tax Appellate Tribunal upheld the Officer's view. On a reference, the High Court reversed the decision, holding in favour of the assessee. The Revenue then appealed to the Supreme Court. The Supreme Court held that the correct method of determining the profit or loss on the sale of bonus shares, where the bonus shares rank pari passu with the original shares, is to take the cost of the original shares and spread it over all the shares (both original and bonus) to find the average price of all shares. This principle was based on the reasoning that bonus shares are merely a capitalization of profits and do not represent any additional cost to the shareholder beyond the original investment. The Court distinguished the decision in Emerald & Co. Ltd. v. Commissioner of Income-tax Bombay, and followed the view expressed in Dalmia Investment Company Ltd. v. Commissioner of Income-tax, Bihar and other cases. The appeals were allowed, the High Court's order was set aside, and the method adopted by the Income Tax Officer was restored. The judgment established that for a dealer in shares, the cost basis for computing profit or loss on bonus shares must be determined by averaging the original cost over the entire holding.
Headnote
A) Income Tax - Computation of Business Profits - Method of Calculating Cost of Bonus Shares Where They Rank Pari Passu - Income Tax Act, 1922 - Assessee company, a dealer in shares, received bonus shares free of cost ranking pari passu with existing shares and treated the face value of bonus shares as additional cost, resulting in low profit/loss. Income Tax Officer applied average method spreading original cost over all shares. Held, the correct method is to average the cost of original shares over the total number of shares (original plus bonus) to determine profit or loss on sale of any of them.
Issue of Consideration
Whether the profit or loss on sale of bonus shares should be computed by treating the face value of bonus shares as part of cost, or by spreading the cost of original shares over both original and bonus shares
Final Decision
Appeals allowed; High Court's decision set aside; the correct method of computing profit or loss is to average the cost of original shares over the total number of original and bonus shares.
Law Points
- When original shares and bonus shares rank pari passu
- the cost of acquisition of the original shares must be spread over the total number of shares (original plus bonus) to compute the average cost per share for determining profit or loss on sale of any of them
- Bonus shares issued free of cost do not add to the cost of acquisition
- The face value of bonus shares cannot be treated as cost when computing business profits
