Commissioner of Income Tax vs Harsh Chemical Ltd.

On an application u/s 256(1) of the Income Tax Act, 1961, the Tribunal has referred the following questions set out at page 7 of the paper book.

"1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in applying the ratio of the judgment of the Supreme Court in Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, , in holding that the bonus shares were not capital assets u/s 2(14) and the sale thereof does not give rise to capital gains liable to tax under Sections 45 and 48 of the Act ?

Whether the Tribunal was right in its view that Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, has effected a change in the legal position hitherto obtaining since Commissioner of Income Tax, Bihar Vs. Dalmia Investment Co. Ltd., , with regard to capital gains on the sale of bonus shares and in that view exempting the surplus arising out of the sale of bonus shares from capital gains tax ?"

The assessee, Harsh Chemicals Ltd. is a company. The relevant assessment year is 1992-93. The assessee has 55,000 equity shares in Russell Industries Ltd. The shares were purchased in the account year relevant to the assessment year 1994-95 (sic). In respect of those shares, the assessee was allotted bonus shares on May 27, 1991, in the ratio 1 : 1. Thus, the assessee obtained 55,000 bonus shares. All these shares were sold in two lots on August 27, 1991, and September 3, 1991, for a total consideration of Rs. 3,91,82,000. A subsidiary part of the sale price was deposited in the units under the Capital Gains Scheme, 1983, in order to claim exemption of the entire capital gain u/s 54A. The Assessing Officer has seen that the bonus shares were held by the assessee for a very short period, that is less than a year and, therefore, they give rise to short-term capital gains and the second reason for assessing the capital gain tax on bonus shares was that they have the average cost. Therefore, the case of Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, has no application.

In appeal before the Commissioner of Income Tax (Appeals), the Commissioner of Income Tax (Appeals) has upheld the view taken by the Assessing Officer. In appeal before the Tribunal, the Tribunal has followed the decision of the apex court in the case of Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, and allowed the appeal of the assessee holding that in view of the decision of the apex court in the case of Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, , bonus shares were not capital assets within the meaning of Section 2(14) of the said Act.

Therefore, the sale thereof does not give rise to capital gains liable to tax u/s 45 of the Act.

None appeared for the assessee. Heard learned counsel for the Revenue.

Mr. Agarwal submits that now the issue has been concluded by a decision of the apex court in the case of Escorts Farms (Ramgarh) Ltd. Vs. Commissioner of Income Tax, New Delhi, . Their Lordships in the case of Escorts Farms (Ramgarh) Ltd. Vs. Commissioner of Income Tax, New Delhi, , have considered whether bonus shares have any cost of acquisition for the purpose of capital gains liable to tax u/s 45 of the Act. While considering the issue whether bonus shares have any cost for taxing capital gains on the sale of such bonus shares, their Lordships have analysed the issue at page 521 which reads as under :

"A close analysis of the facts of the above case, and the ultimate conclusion reached by this court, will go to show that the learned judges laid stress on the fact that the assessee had opted to take the cost of acquisition as provided by the relevant statute, i.e., statutory cost of acquisition and thus substituting the market value as on January 1, 1954, in the place of the actual cost of acquisition, and only in such a case, the subsequent issue of bonus shares cannot affect the issue. It is implicit from the above decision that the principle of averaging by spreading the cost over the old shares and the new bonus shares as enunciated by this court in Commissioner of Income Tax, Bihar Vs. Dalmia Investment Co. Ltd., , and other cases, will apply as a general rule in cases where the assessee claims to deduct the actual cost of acquisition, instead of the statutory cost of acquisition. It also stands to reason since the fair market value as per the ''statutory cost of acquisition'' will be a notional or fictional figure-- mostly inflated--having no connection with the original or actual cost. We should bear in mind that it is after discussing the effect or impact of the issue of the bonus shares, on the value of the original shares generally and also the various possible methods for determining the cost of the bonus shares, this court in Commissioner of Income Tax, Bihar Vs. Dalmia Investment Co. Ltd., , stated that the real cost to the assessee of the bonus shares cannot be taken to be nil or their face value and they have to be valued by spreading the cost of the old shares over the old shares and the new issue (bonus shares), taken together, etc. The principle so laid down is one of the general applications. We should also state that the character of the owner of the shares as an ''investor'' or as a ''dealer'' is of no consequence."

Following the view taken by the learned judge in the case of Escorts Farms (Ramgarh) Ltd. Vs. Commissioner of Income Tax, New Delhi, , it appears that the Tribunal has committed an error in following the decision of the Supreme Court in the case of Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, .

In the result, we answer the first question in the negative, that is, in favour of the Revenue and against the assessee. We also answer the second question in the negative, that is, in favour of the Revenue and against the assessee.

The reference application so made, accordingly, stands disposed of.

All parties are to act on a xerox signed copy of this dictated order on the usual undertaking.