Deepak Insulated Cable Corporation Ltd. vs Commissioner of Income Tax

S. Rajendra Babu, J.—These two references arise under the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as "Act"). The question referred for our opinion are as follows :

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the capital should not be increased to the extent of bonus shares issued out of general reserves ?

(2) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal is right in law holding that the income exempt under Chapter VI-A of the Income Tax Act, 1961, should be reduced in computing the capital base for the purposes of surtax assessment ?"

The first question has been referred for our opinion at the instance of the assessee while the second question has been referred at the instance of the Revenue.

The facts leading to the reference of the first question are as follows :

For the assessment year 1972-73, the assessee filed the return showing chargeable profits of Rs. 1,23,917. A revised statement was subsequently filed on March 22, 1974 and, according to the statement, the chargeable profit is only Rs. 1,10,109. The company claimed a sum of Rs. 7,50,819 as effective increase in the utility of share capital by issue of bonus shares during the year ending on March 31, 1972. The assessee, relying upon the rule 3 of the Second Schedule of the Act, raised a contention that the bonus shares were issued by capitalising the general reserve which is separately added in the computation and the said sum is to be taken as part of capital and the capital should be increased. The Surtax Officer rejected this contention holding that there is no rise in the capital as computed in accordance with rules 1 and 2 of the Second Schedule and, therefore, the claim is inadmissible. This view was affirmed, on appeal, by the Commissioner (Appeals) by holding that, by issue of bonus shares from reserves, there is definitely an increase in the paid-up capital of the company, but there is no increase in capital on the opening day as such, following the decision of the Bombay High Court in Commissioner of Income Tax, Bombay City III Vs. Century Spg. and Mfg. Co. Ltd., Aggrieved by this order, the assessee carried the matter further in second appeal to the Tribunal. The Tribunal also took an identical view as that of the lower authorities and dismissed the appeal of the assesse. Thus, at the instance of the assessee, the present references are made to this court on the question set forth above.

Learned counsel for the assessee contended that even though paid-up capital is increased during the course of the previous year, proportionate increase should be made in the capital invested in the business by reference to rule 3 of the Second Schedule to the Act, because, as a consequence of issue of the bonus shares, though out of reserves, the share capital was increased to that extent. It is the submission of learned counsel that what is contemplated under rule 3 is the increase of the capital on account of increase of paid-up share capital without reference to the increase or decrease in the reserves and, therefore, what is to be looked at in interpreting or construing rule 3 is only increase or decrease in the paid-up capital and, for that purpose, any other element referred to in the in rule 1 which goes to make up the capital is irrelevant. Learned counsel for the Revenue, however, countered these arguments by relying upon various decisions of several High Courts to which reference will be made later and submitted that there is a fallacy in the argument addressed for the assessee that inasmuch as the amount of reserve and proportionate increase in the capital will certainly enter into the computation as others wise it will lead to a double benefit the assessee and submitted that no other arguments is possible in the circumstances of the case. The controversy centres round rule 3 of the Second Schedule to the Act. The said rule reads as follows :

"Where after the first day of the previous year relevant to the assessment year the capital of a company, as computed in accordance with the foregoing rules of this Schedule, is increased by any amount during that previous year an account of increase of paid-up share capital or is reduced by any amount on account of reduction of paid-up share capital ... such capital shall be increased or reduced, as the case may be, by a sum which bears to that amount the same proportion as the number of days of the previous year during which the increase or the reduction remained effective bears to the total number of days in that previous year."

This section has been very clearly analysed by the Bombay High Court in Commissioner of Income Tax, Bombay City III Vs. Century Spg. and Mfg. Co. Ltd., It is to the following effect. "We have to bear these principles in mind for interpreting the provisions of rule 3. The provisions of rule 3 will be attracted so far as increase in the computation of capital employed in a business is concerned only if the following conditions are fulfilled :

There must be an increase in the capital of the company of as computed in accordance with rules 1 and 2 of the Second Schedule after the 1st day of the previous year relevant to the assessment year.

There should be an increase by any amount during the previous year in the capital computed in accordance with rules 1 and 2 of the Second Schedule.

Such increase by any amount may be brought about by -

(a) on account of increase of paid-up share capital, or

(b) issue of debentures, or

(c) borrowing of any moneys referred to in clause (v) of rule 1."

Unless these conditions are fulfilled as set forth above, the assessee cannot claim a benefit under rule 3 extracted above. The Bombay High Court, while analyzing the provisions, took the view that, with reference to the definition of chargeable profits in section 2(5) of the Act and section 2(8) of the Act which refers to statutory deductions and stated that when a part of the amount standing to the credit of a general reserve is, during the course of the previous year, capitalised by issue of fully paid-up free bonus shares, there is no increase by any amount in the capital computed in accordance with the provisions of rules 1 and 2 of the Second Schedule to the Act. Similar view has been taken by the Calcutta High Court in Alkali and Chemical Corporation of India Ltd. Vs. Commissioner of Income Tax, and followed by the same High Court in Indian Explosives Ltd. Vs. Commissioner of Income Tax, There, their Lordships, after noticing the controversy, stated that the problem involved in the interpretation of rule 3 is only arithmetical, inasmuch as what is ultimately to be computed under the Second Schedule to the Surtax Act is the amount of tax and the reserves also is a necessary element that goes to make up the capital. While taking note of the increase of share capital by issue of bonus shares out of reserves, the corresponding decrease in the amount of reserves cannot be overlooked. Though, as contended by learned counsel for the assessee, it is possible to take two views in the matter as appeared to the Calcutta High Court, in our view, the alternative view can only be taken by misreading the rules. To similar effect, the Madras High Court also stated the law on the point in Commissioner of Income Tax, Tamil Nadu-II Vs. Sundaram Clayton Ltd. , as follows :

"Whatever might bqe the interpretation of that rule, so far as the language of rule 3 of the Second Schedule to the Surtax Act is concerned, both as a, matter of first impression and on the authorities we have earlier referred to, we have no doubt whatever that a mere capitalisation of the reserves and the issue of fully paid up bonus shares, subsequent to the first day of the previous year, cannot come within the ambit of the said rule. So as to enable the assessee to obtain an increase over the capital computed as on the first day of that previous year."

Again, the Delhi High Court, in Additional Commissioner of Surtax, Delhi-II Vs. Food Specialities Ltd., referred to with particular emphasis on identical contention advanced before their Lordships as it has been done before us, while agreeing with the contentions of learned counsel that. Unless there is an increase in the capitan as already computed under rule 1, rule 3 will not come into operation, disagreed with the other argument that the closing words of the rules make it clear that, in my case, where there is an increase in the capital as contemplated by the opening words, the increase available to the assessee will be a proportionate part of "that amount", the words "that amount" clearly refer to the words "any amount" referred to in the opening part of the rule. In other words, it is only to the extent of the surplus or excess over the capital as computed at the beginning of the previous year that the assessee gets the relief as envisaged in rule 3. Thus, their Lordships gave additional reasoning to what had been stated by the Delhi (sic) and Calcutta High Courts. Thus, all the arguments advanced by learned counsel for the assessee have been met by the various decisions referred to above and it is necessary to refer to the two decisions relied upon by learned counsel for the assessee. In Commissioner of Income Tax Vs. Mohan Meakin Breweries Ltd., the Himachal Pradesh High Court was concerned with the interpretation of rule 2 of the Second Schedule of the Super Profits Tax Act, 1963. That rule reads as follows (at p. 592) :

"Rule 2 : Where. After the first day of the previous year relevant to the assessment year, the paid-up share capital of a company is increased or reduced by any amount during that previous year, the capital computed in accordance with rule 1 shall be increased or decreased, as the case may be, by a portion of that amount which is proportional to the portion of the previous year during which the increase or the reduction of the paid-up share capital remained effective."

Learned counsel for the assessee contended that there is hardly any difference between rule 2 of the Second Schedule of the Super Profits Tax Act and the rule with which we are concerned and, therefore, what has been stated by the High Court should be accepted by us, in that decision, their Lordships took a view that, on the language employed by the said rule, they cannot reduce the reserve to the extent of its capitalisation and, if they compute the reserve as it was on the first day of the previous year, the proportionate increase has to be made in the share capital leading to a benefit which, according to the Revenue, leads to a double benefit but on their interpretation of the letter of the law, held that this double benefit cannot be denied to the assessee. But a careful reading of the rule with which we are concerned and the rule with which their Lordships of the Himachal Pradesh High Court were concerned, discloses that there is substantial difference. What is contemplated under the rule with which we are concerned is only computation of the capital which results in increase or decrease on account of increase in the paid-up share capital or on certain other circumstances mentioned in the rule, while the rule cited in the decision referred to above merely refers to increase in "paid-up share capital", the rule with which we are concerned refers to increase in "capital of a company" as allowable with the foregoing rules of the Schedule is increased by any amount (sic). Thus, there is substantial difference between the language employed in the rule cited in the decision and the rule before us. In Commissioner of Income Tax, Bombay City-II Vs. Geoffrey Manners and Co. Ltd., the Bombay High Court merely followed the decision in Commissioner of Income Tax Vs. Mohan Meakin Breweries Ltd., Therefore, neither of the decisions relied on by the assessee can have any bearing or relevance for the purposed of interpretation of the rule on hand, in the circumstances, we have got to answer question No. 1 referred for our opinion in the affirmative and against the assessee.

The second question can be answered without much difficulty in as much as it has been covered by a direct authority concluded in the case of Second Income Tax Officer, Company Circle, Bangalore and Another Vs. Stumpp, Schuele and Somappa Private Ltd. First Income Tax Officer, Company Circle, Bangalore and Another, following the said decision, for the reasons stated above, we answer the second question referred for our opinion in the affirmative and against the Revenue.