Star Company Limited vs Commissioner of Income Tax (Central)

Sankar Prasad Mitra, J.—This is a Reference u/s 66(1) of the Indian income tax Act, 1922. The assessment year is 1951-52. The corresponding accounting year is the year ending on March 31, 1951. The Assessee was a dealer in shares. In respect of the shares which were its stock-in-trade, it received certain bonus shares. The Assessee was not required to pay any cash for these bonus shares. In the accounting year the Assessee had sold 1,000 bonus shares of the Burrakar Coal Company Limited, 45 of the Pahargoomia Tea Company Limited and 25 of the Bengal Paper Mills Limited. In the books of accounts these shares when received were valued at their face values.

The income tax Officer was of the view that the cost to the Assessee of the bonus shares was ''nil'' and that after the issue of the bonus shares the amount that was originally paid for the purchase of the shares became the cost of the original shares and the bonus shares, and on that basis he re-constructed the Assessor�s share accounts.

The computation of profit or loss in the share account by the income tax Officer was upheld by the Appellate Assistant Commissioner. Before the Appellate Tribunal, two contentions were raised� (i) that the bonus shares were capital in nature and, therefore, any profit arising from these shares was a capital profit and (ii) the value of a bonus share at the time of the receipt was its face value. The Tribunal held that, the closing stock should not be valued on the average cost basis as was done by the income tax Officer and directed that in computing the profit or loss from the sale of shares, the value of the closing stock should be altogether ignored. It was also of opinion that the cost of bonus shares to the Assessee was nil as it paid nothing for these shares and disallowed the Assessor�s claim for taking the face value of the bonus shares as the cost. It also held that the receipts of the bonus shares were receipts in the revenue account since the Assessee was holding shares as its trading stock-in-trade.

From these facts and circumstances the following questions of law have been referred to us:

(1) Whether on the facts and in the circumstances of the case the receipts of bonus shares were capital receipts in the hands of the Assessee ?

(2) If not, whether the Assessee was entitled to bring these shares in its trading stock by valuing them at their face values ?

(3) If not, whether on the facts and in the circumstances of the case the cost of bonus shares to the Assessee was nil ?

At the hearing there appeared to be no dispute between the parties that the receipts of bonus shares, in the instant case, should be treated as receipts in the revenue account and that the answer to the first question ought to be in the negative.

Supporting the decision of the Tribunal, on the value of bonus shares, Mr. Balai Pal, learned Counsel for the Commissioner, has made a number of points. I propose to discuss his contentions one by one.

The first point of Mr. Pal is that, the profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to be the meaning of the word ''profits'' in relation to any trade or business. Unless and until you have ascertained that there is such a balance, nothing exists to which the name ''profits'' can properly be applied:Russell v. Aberdeen Town and County Bank 2 Tax Cas 321 (327).

In the case of bonus shares, the bonus is provided out of the credit balance of the profit and loss account, out of reserves, or out of one of the quasi-capital funds, so that the share-holder to whom the shares are allotted have to pay nothing. A bonus issue cannot be used for the purpose of raising new capital; its purpose is to capitalize profits which may be available for distribution, or to utilize quasi-capital funds: vide Palmer''s Company Law (20th ed., pp. 149-150). Mr. Pal contends that though the bonus shares have undoubtedly a value they do not cost anything to the Assessee. Naturally, when they are sold and they fetch an income, if assessable in law, the income on which the Assessee is to be assessed is whatever value it fetches without anything being deducted in respect of cost.

Mr. Pal then contended that the issue of the bonus shares to the share-holders is entirely at the discretion of the company following the procedure warranted by its Memorandum or Articles arid is in no way different from a gift made by the company to its share-holders.

Reliance was placed by learned Counsel for the Respondent oh the observations of Lord Haldane in Commissioners of Inland Revenue v. Blott (1921) 2 A.C. 171 (184), which were as follows:

My Lords, for the reasons I have given I think that it is, as a matter of principle within the power of an ordinary joint stock company with articles such as those in the case before us to determine conclusively against the whole world whether it will withhold profits it has accumulated from distribution to its shareholders as income, and as an alternative not to distribute them at all, but apply them in paying up the capital sums which shareholders electing to take Up un-issued shares would otherwise have to contribute. If this is done the money so applied is capital and never becomes profits in the hands of the share-holder at all. What the latter gets is no doubt a valuable thing. But it is a thing in the nature of an extra certificate in the company. His new shares do not give him an immediate right to a larger amount of the existing assets. These remain where they were. The new shares simply confer a title to larger proportion of the surplus assets, if and when a general distribution takes place as in a winding up. In these assets the undistributed profits now allocated to capital will be included, profits which will be used by the company for its business, but. henceforth as part of its issued share-capital. Such a transaction appears to me to be one purely of internal management, with which...no Court can interfere.

Mr. Balai Pal has urged that in the passage quoted above it'' has been correctly stressed that the issue of bonus shares is a matter of internal management of the company and supports his contention that such issues are at the company''s discretion.

Mr. Pal then referred to the decision of the United States Supreme Court in Eisner v. Macomber 64 Law Ed. 521. It has been held in this case that the Congress was given no power by the income tax amendment to the Federal Constitution to tax, without apportionment as income of a stock-holder in a Corporation, a stock dividend made lawfully and in good faith against accumulated profits earned by the Corporation since the adoption of such amendment. Such dividends; according to the U.S. Supreme Court, are not income. In this case, in January 1916, the Board of Directors of the Standard Oil Company of California, in order to re-adjust capitalization, decided to issue additional shares sufficient to constitute a stock dividend of 50 % of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such issue. The appropriate resolutions were adopted ; an amount equivalent to the par value of the proposed new stock was transferred accordingly; and the new stock was duly issued against it and divided among the stock-holders. The Defendant in error, being the owner of 2,200 shares of old stock, received certificates for 1,100 additional shares, of which 18.07% or 198.77 shares (per value $19,877) were treated as representing surplus earned between March 1, 1913 and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of $ 19,877 because of new shares. The U.S. Supreme Court has taken the view that a stock dividend really takes nothing from the property of the Corporation and adds nothing to the interests of the share-holders. Its property is not diminished, and their interests are not increased. The proportional interest of each share-holder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones (vide p. 527). In order to make the adjustment, a charge is made against surplus account with corresponding credit to the capital stock account, equal to the proposed ''dividend'', the stock is issued against this and the certificates delivered to the existing share-holders in proportion to their previous holdings. This, however, is merely book-keeping that does not affect the aggregate assets of the Corporation or its outstanding liabilities; it affects only the form, not the essence, of the liability'' acknowledged by the Corporation to its own share-holders, and this through a re-adjustment of accounts on one side of the balance-sheet only, increasing ''capital stock'' at the expense of ''surplus''. It does not alter the pre-existing proportionate interest of any stock-holder, or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increased the number of the shares with consequent dilution of the value of each share. The essential and controlling fact is that the stock-holder has received nothing out of- the company''s assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of other stock-holders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance, and not to form, he has received nothing that answers the definition of income within the meaning of the 16th amendment: vide p. 530.

Mr. Pal also referred to the case of TheCommissioner of. Inland Revenue v. Fisher''s Executors (1926) A.C. 395. A limited company with large undistributed profits resolved to capitalize part of these profits and to distribute them pro rata among its ordinary share-holders as a bonus in the form of 5 % debenture stock. The stock was duly issued, the conditions providing that the company might redeem the stock after a certain time and in certain events. The Respondents, who had received their due proportion of the debenture stock, were assessed to super-tax under the Finance Act, 1910, for a certain year in respect of their stock. It was held by the House of Lords that the bonus paid in debenture stock was not income in the hands of the Respondents and was, therefore, not liable to super-tax.

Mr. Pal then said that a company was not, like a partnership or a family, a mere collection or aggregation of individuals. In the contemplation of law it is a person distinct from its members or share-holders, a metaphysical entity or a fiction of law, with legal but not physical existence: Palmer''s Company Law (20th ed., pp. 127-12,9). The doctrine that no man can make a profit out of himself is not applicable to transactions between a person and a limited company, even though all the shares in the company are owned by that person, because from a legal point of view a company is an entity entirely distinct from its share-holders: Maharajadhiraj Sir Kameshwar Singh Vs. Commissioner of Income Tax, . The company, argues Mr. Pal, has to pass a Special Resolution for issue of bonus shares, and an individual share-holder, as such, has no control over the Special Resolution.

Learned Counsel then referred to the case of Lowry v. Consolidated African Selection Trust, Limited 23 Tax Cases 259. Here, the Directors of the Respondent company, acting under powers given to them by a Special Resolution of the company, issued at par to certain employees, in consideration of services, a number of its ordinary shares. The market value of the shares was considerably above par. In the Court of Appeal the company contended that the difference between the market and par values of the shares so issued was allowable as a deduction in computing its profits for income tax purposes. The House of Lords held that the company was not entitled to the deduction claimed. Viscount Caldecote, L.C. said:

Its capital was intact after the issue of shares: not a penny was in fact disbursed or expended. Its trading receipts were not diminished, nor do I think it is a right view of the facts to say that the Respondent Company gave away money''s worth to its pecuniary detriment. The Company was entitled to issue its shares at par. It did so, and the Company never received, and never elected to receive; anything more than the par value of the shares. Quite apart from any desire to let the employees have a share interest in the Company, the Directors might have had very good reasons for deciding not to issue shares to the Company''s employees at a price which could only be justified by an expectation of very high dividend over a long period of time. (Page 281) Viscount MaUgham gives his Lordship''s appreciation of Blott''s case in these words:

We are invited to consider something which did not take place; and it is to be remembered that in Blott''s case (1921) 2 A.C. 171, this House declined to be influenced by the argument that the case before it was the same as if shareholders had received the bonus and paid it back to the Company to be retained as capital. The simple answer was that they never received it at all; (Page 283)

Mr. Pal contends that this is a clear indication that in the case of issue of bonus shares the Assessee suffers nothing by way of cost. He submits that for the purpose of income tax, in cases like these, one has to take into consideration what the share had actually cost the Assessee. Water, for instance, a company resolves to issue new shares and offers the new shares to the existing share-holders and a shareholder sells the right to apply for new shares which are offered to him, in computing the capital gains which accrue to him by the sale, the value of the right to the new shares according to accountancy principles, or the depreciation in value of the existing shares, cannot be deducted. Capital gains have to be computed on the basis of the ''actual cost'' of the capital asset to the Assessee, as laid down in Section 12B of the income tax Act; ''actual cost'' means what the Assessee has in fact expended or laid out for acquiring the asset; and as the Assessee does not spend any amount for acquiring the right to apply for new shares, the entire amount that he receives by the sale of the right is assessable as capital gains: Miss Dhun Dadabhoy Kapadia v. Commissioner of income tax, Bombay City II (1963) 48 ITR 883.

Mr. Pal has relied on one other decision which should be mentioned in this judgment. In Indian Molasses Co. (Private) Ltd. Vs. Commissioner of Income Tax, West Bengal, the Supreme Court has observed, with reference to Section 10(2)(xv) that, ''expenditure'' is equal to ''expense'' and ''expense'' is money laid out by calculation and intention though in many uses of the word this element may not be present, as when We speak of a joke at another''s expense. But the idea of ''spending'' in the sense of ''paying out or away'' money is the primary meaning and it is with that meaning that we are concerned. ''Expenditure'' is thus what is ''paid out or away, and is something which is gone irretrievably. Mr. Pal has urged that unless the share-holder pays something ''out or away'' irretrievably to acquire a bonus share it cannot be said to have cost him anything.

In the foregoing paragraphs all the contentions of learned Counsel for the Respondent have been set out. Before we proceed any further it is necessary to consider the relevant provisions of the Companies Act, 1956, relating to the issue of bonus shares. Section 205(3) of the 1956 Act prescribes that no dividend shall be payable except in cash, provided that nothing in this Sub-section shall be deemed to prohibit the capitalization of profit or reserves of a company for the purpose of issuing fully paid-up bonus share or paying up any amount for the time being unpaid on any shares held by the members of the company. Regulation 96 in Table ''A'' in such I to the 1956 Act also provides that the company in General Meeting may, upon the recommendation of the Board, resolve that it is desirable to capitalize any part of the amount for the time being standing to the credit of any of the company''s reserve accounts, or to the credit of the profit and loss account or otherwise available for distribution; and that such sum be, accordingly, set free for distribution in the manner specified in Clause (2) amongst the members who would have been entitled thereto, if distributed by way of dividend and in the same proportions. Sub-clause (2) of this Regulation prescribes that the sum aforesaid shall not be paid in cash but shall be applied, subject to the provision contained in Sub-clause (3), either in or towards (i) paying up any amount for the time being unpaid on any shares held by such members respectively; (ii) paying up in full un-issued shares or debentures of the company to be allotted and distributed, credited as fully paid-up to and almost such members in the proportions aforesaid; or (iii) partly in the way specified in Clause (i) and partly in that specified in Clause (ii). Sub-clause (3) of this Regulation says that, a premium account and a capital redemption reserve fund may, for the purposes of this Regulation, only be applied in paying up the un-issued shares to be issued to members of the company as fully paid bonus shares. Lastly, Sub-clause (4) lays down that the Board of Directors shall give effect to the resolution passed by the company in pursuance of this Regulation. There were no such provisions in the earlier Act, but the same principles in those days governed the issue of bonus shares.

It is apparent, therefore, that instead of paying dividend in cash a company may provide for issue of bonus shares and Regulation 96 describes the procedure that is adopted for the issue of such shares. I have underlined those portions of the Regulation which are more relevant for our purposes.

Owing to economic and other circumstances it has become increasingly common in recent years for companies to capitalize profits. The capitalization of profits means that profits which otherwise are available for distribution among the share-holders are not divided between them in cash but that those share-holders are allotted shares�or debentures�which are paid up wholly or in part out of those profits. The amount paid by the company out of its divisible profits on account of these newly issued shares is known as the bonus, and the shares are referred to as bonus shares. Technically the transaction is carried out in the following manner: the bonus is provided out of the credit balance of the profit and loss account or out of reserves�both being items appearing on the liabilities side of the balance-sheet, so that the balance-sheet thenceforward shows the profit and loss account or reserve at a reduced figure and the issued capital at a correspondingly increased figure. As far as the balance-sheet is concerned the only effect of the transaction is that one item on the liabilities side of the balance-sheet and the company''s books becomes replaced (in whole or part by another): the assets side of the balance-sheet is unaffected. This process deduces the risk of any person gaining control of the company and distributing the liquid resources of the company against a reduction in the profit and loss account, for if the profits have been capitalized the assets can only be distributed by way of the capital reduction procedure which requires a special resolution and confirmation by the Court. The capitalization of profit may, thus, in appropriate cases provide an answer to a ''take over bids''. See Palmer''s Company Law (20th ed., p. 647).

This is how bonus shares are issued. The amount paid by a company out of its divisible profits�I repeat�on account of newly issued shares is known as the bonus, and the shares are referred to as bonus shares.

Incidentally, however, I may observe that in Blott''s case (Supra) and in Fisher''s Executors'' case (Supra) it was held that a bonus issued in the form of fully paid shares or debentures of the company was not income for income tax or super-tax purposes. It is interesting to note that in Section 2(6A) of the Indian income tax Act,- 1922, the definition of dividend has been framed so widely that a bonus comes within its scope for purposes of the taxes imposed by the statute.

I have said that the case on which very strong reliance was placed by learned Counsel for the Respondent was the decision of the United States Supreme Court in Eisner v. Macomber (Supra). This case was considered by the House of Lords in Commissioners of Inland Revenue v. Blott (Supra). In this case an assessment to supertax under the Finance Act, 1910, was made upon the Respondent for a certain year in respect of an allotment to him of bonus shares in a limited company. In the previous year the company, in exercise of a power in that behalf conferred by its Article, had passed a resolution declaring that out of its undivided profits a bonus should be paid to its share-holders and authorising in satisfaction of that bonus a distribution among the share-holders of certain of its un-issued shares credited as fully paid up and the Respondent''s said shares had been allotted to him pursuant to that resolution. The majority of the House of Lords held that, for the purpose of the super-tax the shares so allotted to the Respondents could not be treated as part of his total income from all sources for the previous year inasmuch as they were not part of his income but were an addition to his capital in that year. Viscount Haldane, Viscount Finlay and Viscount Cave were of this view. Lord Dunedin and Lord Sumner dissented there from. Viscount Haldane at the end of his Lordship''s judgment says:

�I have not allowed myself to treat the decision of the Supreme Court, of the United States in the case of Eisner v. Macomber as a reason for the conclusions at which I have arrived. For the taxing statute then in question was of a different order and the jurisprudence invoked was also on certain points different, but nonetheless I have read with great pleasure and instruction the judicial discussion in which the varying opinions of the eminent Judges who decided the case occur....(Page 188) The conclusion that his Lordship had arrived at was that both on principle and on authority, the transaction was one in which the company was in law, dominant on the question whether the money in question was to be capital or income for all purposes, and his Lordship did not think that, in the circumstances of the case, the Respondent received any income or profits at all. (Vide p. 188) His Lordship, however, was definitely of opinion, as we have seen earlier in this judgment, that what the share-holder got in the case of issue of a bonus share, was a valuable thing. Similar observations have been made by Viscount Finlay:

The preference shares are in themselves valueless. They are merely part of the machinery for carrying out the capitalization, and if that capitalization could have been carried out without their issue the Respondent would have been just as well off without them as he is with them. What he gained was that the business in which he had the same proportionate interest had become more valuable owing to the increase of capital. Super-tax cannot be levied on such an increase in the capital value of the business. It will be received from time to time on the larger dividend, which it is hoped will be yielded by the increase in the capital put into the business. (Page 196) Viscount Finlay says:

In the case of Eisner v. Macomber there is a most interesting and instructive judgment delivered by Pitney, J. as representing five out of the nine members of the Court.... That judgment is, of course, not binding on us as an authority, but it contains a most instructive review of the principles which have been discussed in the present case, and the conclusion, which was arrived at by seven out of the nine Judges is in entire harmony with that which appears to me to be the true view of the present case. (Page199)

The conclusion referred to by Viscount Finlay is that there is no ground for saying that the bonus was ever received as income. But both Viscount Haldene and Viscount Finlay have clearly stated that a bonus share is a ''valuable thing''.

Earlier in this judgment I have made a reference to the case of Fisher''s Executors (Supra, p. 408). This is also a decision of the House of Lords. Viscount Cave was a party to the majority judgment in Blott''s case (Supra). His Lordship as the Lord Chancellor has delivered the leading judgment in the case of Fisher''s Executors. His Lordship observes:

The Company was, therefore; master of the situation, and it elected definitely and irrevocably not to distribute the fund as income, but to impound and apply it as income-producing capital ; and that election, if made (as I do not doubt that it was made) in good faith was binding on the share-holders and could not be questioned by the Crown. No doubt, the share-holders got debenture stock which, like the shares in Blott''s case was a valuable thing; but they had no power to call in the stock, which gave them no present right to receive any part of the Company''s assets either in money or in money''s worth, but only entitled them to a sum to be carved out these assets if and when the stock was paid off. (Page 403)

Lord Sumner who gave a dissenting judgment in Blott''s case has said in the case of Fisher''s Executors:

Shortly stated, I understand that Blott''s case was decided on this principle. To attract super-tax to a bonus distributed to him by a Company in which he is a shareholder, what reaches the tax-payer must at that moment bear the character of income, impressed upon it by the Company which distributes it and by it alone. Provided that the Company violates no statute and also keeps within its article, it can call the subject-matter of the distribution what it likes, and, I think this involves the corollary, that it can either call it by a new name or simply discard its old one. After all, it is natural for the creature to be named by its creator. Further, what the Company says it is> that it is as against all the world. What the Company says it shall no longer be, that it is no longer for any purpose. How this is effected and by what resolutions, confirmations and instruments does not matter for such things are ''bare machinery''. In what the Company has said and done is found the answer to the question: What has the subject-matter of the distribution now become or ceased to be, when first it reaches the tax payer ?....

Transmuted by this alchemy, profits in hard-earned gold became extra-share certificate, and yet the share-holders, who receive them, may be greatly the gainers. (Pages 407-8)

The reason why I have quoted extensively from the learned Law Lords is that they have not only applied their minds to the decision in Eisner v. Macamber (Supra), but have held that what the share-holder gets by reason of capitalization cannot be said to have no value at all. On the contrary it is a ''valuable thing''.

Turning now to decisions in our country the first case which has to be noted is that of the Bombay High Court in Emerald and Co. Ltd. Vs. Commissioner of Income Tax, Bombay City, Bombay, . In this case, at the beginning of the assessment year the Assessee held 350 shares in a company which included 50 bonus shares of the face value of Rs. 250 each. The Assessee sold 300 shares and claimed a loss of Rs. 35,801 by valuing the bonus shares at their face value. The bonus shares at the end of the accounting year remained with the Assessee. The Department arrived at a loss of Rs. 27,766 by the method of averaging the price of the shares: The Tribunal suggested a third method by which the 50 bonus shares were completely ignored and the loss was arrived at by considering the purchase value of the 300 shares and the proceeds realised by their sale. The High Court held, (i) that as the Assessee paid nothing for the bonus shares the price of Rs. 250 each could not be put on these shares; (ii) that the method suggested by the Tribunal was erroneous; and (iii) that the proper profit or loss could only be arrived at by averaging the cost of the 350 shares taking into consideration the fact that 50 bonus shares were received free; and (iv) that the method of valuation adopted by the Department was right.

The case went up to the Supreme Court. It was held there that, (i) for the purpose of assessing. the loss for the accounting year the question of the proper method of valuing the bonus shares was not relevant as they were not sold and were still retained in the hands of the Assessee; and (ii) the method of valuation adopted by the Appellate Tribunal was the correct method and the loss as calculated by the Tribunal was correct and according to law. The Supreme Court did not decide whether the bonus shares had any value or not. It is observed:

What the bonus shares cost is not the question at the present moment. They may have cost Rs. 12,500 as the Assessee company claims, or nothing as stated by the income tax Officer or even something else according to some other principles. The bonus shares are still there and have not been sold. When they are sold, the question will arise as what they cost. (Pages. 261-62)

The Allahabad High Court also considered the question of the value of bonus shares in L. MOTILAL Vs. COMMISSIONER OF Income Tax, U. P. and V. P., . The Assessee was a Hindu undivided family carrying on the business, inter alia, of dealing in shares. It transferred on the last day of the accounting period relevant to the assessment year 1943 44 certain shares Out of its stock-in-trade to an account styled investment account. The shares transferred to this investment account included 975 ordinary shares of Kanpur Textiles ; 500 ordinary shares of Kanpur Textiles, however, remained as part of its stock-in-trade. In June, 1943, the Assessee received one bonus share for every ordinary share held by it. The result was that the investment shares increased by 975 and those in the stock-in-trade by 500. The Assessee made a gift of 200 shares of the investment account and in the accounting period relevant for the assessment year 1945-46 sold the remaining 775 ordinary shares and all the 975 bonus shares at a profit of Rs. 19,415. It also sold the 500 bonus shares received by it as part of its stock-in-trade for the sum of Rs. 7,156. The Allahabad High Court has held, (a) that the bonus shares received by the Assessee were accretions to ordinary shares held by it and could not be treated as dividend; (b) that the 975 bonus shares in the investment account must be treated as capital gain earned by the Assessee and the sum of Rs. 19,415 could not be added to the Assessor�s income for the purposes of charging to income tax; and (c) that the 500 bonus shares received in respect of the shares which were part of the stock-in-trade must be treated as addition to the stock-in-trade on the date on which they were received by the Assessee. For purposes of charge to income tax these 500 shares should, therefore, have been taken into account as additional stock-in-trade received by the Assessee without any cost on the day on which they were received by the Assessee. When so taken into account, these bonus shares could yield profit in the year of account in which they were received if the method of accounting was to value the opening and the closing stock at market rate. In the alternative, if the method of accounting was based on valuation of the opening and the closing stock at cost price, they might not show any profit in that year and would only yield profit in the year in which it might be sold, so that their proceeds would be taken into account in calculating the taxable income in that year.. It is stated:

We consider that, by their very nature, all these bonus shares should be treated as accretions to the ordinary shares in respect of which the bonus shares were issued by the Company. These bonus shares would not have been received by the Assessee if the Assessee had not been holding the ordinary shares. It was because he was holding those ordinary shares that the Company gave these bonus shares to the Assessee. There is, of course, no doubt that these bonus shares cannot be treated as dividend received by the Assessee from the Company, because in issuing him the bonus shares the Company did not give away any cash or any part of its assets. Whatever profits had been earned by the Company remained in the hands of the Company as capital. In such cases all that a shareholder receives are paper certificates showing his interest in the additional capital and such a transaction puts nothing in the shareholder''s pocket as profit. {Page 392)

It is not disputed before us that the transaction does not put anything in the share-holder''s pocket as profit or income that is taxable when it takes place except under the extended definition of ''dividend'' noted above; but the question that arises for our consideration is: have these bonus shares any value or have they no value at all ?

This question arose before the Patna High Court (in the same manner as it has arisen before us) in DALMIA INVESTMENT CO. LTD. (NOW SHRI RISHAB INVESTMENT CO. LTD.) Vs. COMMISSIONER OF Income Tax, BIHAR., . The Assessee company dealt in shares and also held investments of shares. On January 1, 1948, the Assessee had 1,10,747 shares of Rohtas Industries valued at Rs. 15,57,902. If these 31,909 shares were bonus shares issued by the Rohtas Industries in 1945 at the face value of Rs. 10 each, and the Assessee had debited the. share account in respect of the bonus shares by Rs. 3,19,090 with a corresponding entry in the capital reserve account for the same amount. On January 29, 1948, the Assessee sold the entire lot of 1,10,747 shares for Rs. 15,50,458 and claimed a loss of Rs. 7,444. The Appellate Tribunal (as in the present Reference) valued the bonus shares at nil and held that the Assessee had made a profit of Rs. 3,11,646. The Patna High Court has held that the bonus shares were not issued by the company free to its share-holders: the consideration for the issue of the bonus shares was the dividend or bonus which was provided and declared by the company out of its undistributed profits! Although no cash was paid by the share-holders for the allotment of the bonus shares the consideration given by the share-holder for the bonus shares was something in the nature of a set off for the dividend which was due to be paid to the share-holder out of the undistributed profits of the company. The real cost of the bonus shares to the Assessee was the face value of the shares and the Tribunal was wrong in holding that the Assessee had made a profit of Rs. 3,11,646.

Upon close consideration of the relevant authorities cited before Us we are of opinion that the Patna High Court''s view should, with great respect, be accepted by us. Learned Counsel for the Commissioner submits that it is one thing to say that bonus shares have a value ; it is another thing to say that the share-holders spent anything by way of expenditure for getting these shares. The company is the master of the situation and the issue of bonus shares is a bare machinery for capitalization of profits of the company. The relevant provisions in English law which have now been incorporated in Section 205(3) of the Companies Act, 1956, and Reg. 96 in Table A, in such. I thereto have been fully discussed in this judgment. It is manifest that bonus shares are created by depriving the share-holders of their rights to receive from the company profits kept in reserve or profits which constitute the balance in the profit and loss account. The company gives to the share-holders in lieu of this deprivation another bundle of rights in the shape of bonus shares. (The shareholders are not, however, entitled to withdraw any moneys from the company on the basis of these shares except on liquidation or reduction of capital). The share-holder in a case like this gives up any claim to the income. What might have been paid as income went to increase the capital of the company. The share-holder gets his proportionate share in the business of the company as increased by the additional capital. The benefit which the share-holder derives is that the business in which he has a share is a larger one with more capital embarked in it, precisely as might, have been the case if the accumulated profits had been applied in the improvement of the company''s works and machinery. Instead of getting any dividend, or anything in the nature of a dividend, the fund which might have been'' divided was impounded to increase the capital of the business: vide Discount Finlay''s Speech in Bldtt''s case (Supra, p. 175).

The share-holders at a General Meeting decide whether they would have the profits distributed amongst them as dividend or they would surrender their rights to dividend and accept bonus shares to be issued by the company upon capitalization of profits. In the words of Lord Sumner (Supra, p. 408) ''profits in hard earned gold become extra-share certificates''. The cost to the share-holder, therefore, is the value of the right that he had given up�the amount he would have got if he had not surrendered his right and that is the face-value of the bonus share.

Let us test the proposition from another point of view. Can a share-holder upon liquidation of the company be called upon by the Liquidator to make contributions to the extent of the face value of his bonus share inasmuch as he had paid nothing at the time it was issued ? The obvious answer to this question is in the negative as the bonus shares are fully paid-up shares. They became fully paid-up by reason of the sacrifice that the: share-holder made at the time of capitalization of profits, instead of distribution in dividends, was decided upon.

In this view of the matter it cannot be said that the cost of the bonus shares to the Assessee in the instant case was nil. The answers to the questions shall be as follows:

(1) No.

(2) Yes.

(3) Does not arise in view of the answer to Q. No. 2.

The Respondent will pay to the applicant the costs of this Reference. Certified for counsel.

K.C. Sen, J.

I agree.