MISS SHIRIN AYUB KHAN Versus COMMISSIONER OF INCOME-TAX, LAHORE

GUL MUHAMMAD KHAN, J.‑This order shall also dispose of T. R. 65 of 1967 and 66 of 1972 which involve the same questions of law.

2. This reference under section 66 (1) of the Income‑tax Act which arises out of the order dated 27th September, 1971, of the Income‑tax Appel late Tribunal, raises the following questions of law :‑

(1) Whether on facts and in the circumstances of the case the learned Tribunal was right in holding that for the purposes of computing capital gains under section 12‑B of the Income‑tax Act, 1922, arising on the sale of shares held by the as3essee as capital assets the cost of the bonus shares issued by Messrs Ghandhara Industries Ltd. as fully paid Bonus Shares was to be determined by spreading the cost of old shares over the old and new shares (Bonus Shares) taken together 7

(2) Whether on facts and in the circumstances of the case the learned Tribunal was right in holding that 1/3rd on the whole of the capital gains and not 1/6th of the capital gains arising upon the disposal of bonus shares would be exempt from tax under section 17 (5) of the Income‑tax Act, 1922?

3. The facts leading to this case are that the petitioner received as gift 5000 shares of Ghandhara Industries Limited, Karachi, from her father in the year 1963. She then received 4375 bonus shares from the Company. The entire holding comprising 9375 shares was sold away by her for a sum of

.is. 2,57,812 in the year 1968. In her income‑tax return relevant to the assess ment year 1969‑70 she declared a sum of Rs. 1,64,062 as the capital gains, being the difference between the sale price and the purchase price, i. e. the .face value of all the shares. The Income‑tax Officer who completed the assess ment did not accept the petitioner's contention of evaluating the bonus shares .at their face value. In his view these shares having been received without any ,payment, the entire sale price had to be considered as the capital gains and .assessed accordingly. This decision was maintained by the Appellate Tribunal .with the following observations :‑

"So far as the issue regarding Nil value of the bonus shares acquired was concerned the appellant's representative contended that these shares were not acquired at a Nil value and in this connection placed reliance on one of our decisions in I. T. A. No. 947 of 19‑9‑70 dated 18‑11‑1970 whereby by placing reliance on as Indian decision reported as (1964) 52 I T R 96 we had held that the value of bonus shares would be equated with their face value. We, however, find that this decision has since been overruled by the Supreme Court of India by majority decision reported as (1964) 52 I T R 567 wherein it' was held that the real cost to an assessee cannot be taken to be Nil or the fare value .of the bonus shares and the correct method to value the same would be by spreading the cost of the old shares over the old shares and the new issue viz. the bonus shares taken together. Same is the ratio of an other decision in the case of Commissioner of Income‑tax v. Gold & Co. Ltd. (1971) 24 Taxation 85. In this view of the matter we have no option but to direct the Income‑tax Officer to take the face value of the bonus shares by spreading over the cost of fold shares over the old shares and new shares taken together if the same rank pari passu.

5) In view of this actual position we cannot accept the appellant's logic that the capital gain on the bonus shares which were acquired sub sequent to the originally gifted shares should be calculated in the same manner as the capital gain tax in respect of the gain on the original shares. In our view there is no legal basis for this proposition and the provisions of section 17 (5) can in no manner be modified. This con tention of the appellant cannot therefore prevail.

The petitioner now prays for an advice to be rendered to the Tribunal on the two questions of law raised herein.

4. The relevant portion of section 12‑B which deals with the capital gains reads as under:‑

"12‑B. Capital gains.‑(1) The tax shall be payable by an assessee under the head 'Capital gains' in respect of any profits or gains arising from the sale, exchange or transfer of a capital asset effected after the 31st day of March, 1946 and before the 1st day of April, 1949 and after the seventh day of June 1963, and such profits and gains shall be deemed to be income of the previous year in which the sale, exchange or transfer took place

(2) The amount of a capital gain shall be computed after making the following deductions from the full value of the consideration for which the sale, exchange, or transfer of the capital asset is made, namely:‑

(i) expenditure incurred solely in connection with such sale, exchange or, transfer ;

(il) the actual cost to the assessee of the capital asset, including any ex penditure of a capital nature incurred and borne by him in making any additions or alterations thereto but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 10 and 12.

Provided . . . . . .

It is contended by the learned counsel for the petitioner that the income tax authorities erred in law in refusing to allow deduction of the face value of the bonus shares m working out the 'capital gains' as required under section 12‑B (2). His plea is that according to section 2(6‑C) read with Explana tion IV to section 4(1), the price paid for the bonus shares out of accumulated. profits is the income of the Company and, therefore, the Company and, not the shareholder was liable to pay the tax thereon. The Company having, fulfilled its obligation, the shareholder received the bonus shares price paid and tax paid. This plea of the learned counsel is supported by law only to the extent that the amount Of the bonus shares is the income of the Company. There is, however, no provision of law implying that it is not the income of the shareholder. In fact the law is in conflict with it. The definition of the terms 'dividend' and 'income' as reproduced hereinafter would clearly show that whereas the amount appropriated by the Company towards its paid‑A, up capital against issuance of b6nus shares is the income of the Company it is also income of the shareholder. Section 2(6‑A) of the Income‑tax Act which defines the term 'dividend', reads as follows‑.‑

"2(6‑A) 'dividend' includes‑

(a) any distribution by a Company of accumulated profits, whether capitalised or not, if such distribution entails the release by the Company to its shareholders of all or any part of the assets of the Company;

(b) any distribution by a company of debentures or debenture‑stock, to the extent to which the company possesses accumulated profits, whether capitalised or not;

(c) any distribution made to the shareholders of a company out of accumulated profits of the company on the liquidation of the company;

(d) any distribution by a company on the reduction of its capital to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933, whether such accumulated profits have been capitalised or not:

Provided that 'dividend' does not include a distribution in respect of any share issued for full cash consideration which is not entitled in the event of liquidation to participate in the surplus assets, when such. distribution is made in accordance with sub‑clause (c) or (d):

Provided further that the expression 'accumulated profits', wherever it occurs in this clause, shall not include capital gains arising before the. 1st day of April, 1946 or after the 31st day of March, 1949."

Section 2(6‑C) defines the term 'income' and reads as under :‑‑

".2(6‑C) 'income' includes in anything included 'dividend' as defined in clause (a), perquisites whether convertible into money or not which, under subsection (1) of section 7, are due or are paid to an assessee in lieu of, or in addition to any salary or wages and anything, which under Explanation 2 to subsection (1) of the said section 7 is a profit received in lieu of salary for the purposes of that subsection and any sum deemed to be profits under clause (vii) of subsection (2) of section 10 and any capital gain chargeable according to the provisions of section 12‑B and, in the case of a company having its registered office in Pakistan, the amount of bonus or bonus shares, declared, issued or paid by it to its shareholders and the profits of any business of Insurance carried on by a mutual insurance association computed in accordance with Rule 9 in the First Schedule."

The payment of tax by the Company or its liability to pay tax would not automatically absolve the petitioner to pay tax under section 12‑B read with section 2(6‑A) and (6‑C). This being also income of the petitioner she would be liable to pay her tax separately. The question involved in this reference does not rest on the payability or the liability on this income of the Company.

5. According to law the receipt of bonus shares is equal to receipt of dividend which is an income. Companies which are doing well in their busi ness generally do not distribute their entire profits to the shareholders. The undistributed profits of a year or the accumulated profits of the Company are generally used for its business either by capitalising it or as floating capital. But whenever the Company intends to increase its paid‑up capital, it may instead of investing outside capital, issue shares at the face value to its existing share holders in proportion to their existing holdings and appropriate an equal amount from the undistributed profits of a year or the accumulated profits of previous years to its paid‑up capital. The shares issued against such a fund are called bonus shares. When issuance of such shares is a result of the dis tribution of the profits of that year or the accumulated profits of the Company, the face value thereof would be a 'dividend' within the definition of sec tion 2(6‑A)(a) and 'income' under section 2(6‑C) of the shareholder. Under Explanation 4 to section 4(1). read with the above provisions, the; amount appropriated by the Company, having its registered office in Pakistan, towards its paid‑up capital for issuance of the bonus shares to its shareholders in any year wholly or partly out of its reserves, or profits of that year or the accumulated profits, shall also be deemed to be the income of the Company for that year. The full text of Explanation 4 is reproduced below for ready reference :‑

"Explanation 4.‑Any bonus or bonus shares declared, issued or paid by a company having its registered office in Pakistan to its shareholders in any year wholly or partly out of reserves or profits of the company of that year or accumulated profits of the company of earlier years, whether capitalised or not, or the share premium or other account shall be deemed to be income accruing to the company during that year."

Section 4 is subject to the provisions of the Act. Section 2(6‑C), section 4(1), Explanation 4 and section. 2 (6‑A) when read together would go to show that none of these provisions exclude the liability of the shareholder if the amount in question is the income of the company under the above Explana tion. There is no exemption either. True, the same amount would be taxed three times i.e. once when it was declared as profit in a particular year, was received by, the shareholder in the form of bonus share under section 2 (6‑A) (a)~ but there is nothing to suggest that it is illegal or prohibited by law. However, this income shall be referable to the year when the bonus shares were received and not to the year when sold.

6. The accumulated profits of a company whether capitalised or not represent the proportionate interest of the shareholder to which be might b entitled either as a 'dividend' or on liquidation. Whenever these profits ar distributed amongst the shareholders to the form of a 'dividend', this `income' would be fictionally received by the shareholders and then paid back to the company for the purchase of the bonus shares. The shareholders, therefore, do not get these shares free of cost but on payment. In support of this view we rely on the observations of Lord Dunedin of the' House of the Lords in Commissioner of Inland Revenue v. Blots (I) and quote with advantage the following portion of the judgment:‑

. . . . My Lords, the way the question presents itself to my mind is this: The company accumulate a large sum of profits on which they duly pad‑ income‑tax. What would they do with it? They might have done nothing, in which case the money would just have remained part of the assets of the company. The expression `floating capital' is rather a convenient form of description than a legal definition of the fund. It might have paid it to its shareholders as dividends, in which case it is obvious that the recipient shareholder, if his income was above the minimum figure, would have had to include the dividend in his speci fication of his income for super‑tax. Lastly, however, it is said the company might and did `capitalize its profits. I confess I am shy of the word `capitalize'. It seems to me to leave one in a hazy state of mind as to what is the legal operation which is so described. Un doubtedly it is to add something to capital. Now how can a company add to its capital? It has an authorized capital. There are certain ways in which authorized capital may be increased, but assuming the company has not taken advantage of what it can do in this way it can only issue shares to the extent to which it still has shares authorized but rot issued. If, however, it does so it cannot issue the shares for nothing. They must be paid for in money or under certain conditions in moneys worth. Further, it cannot itself provide the money to pay for the new shares. Ii' it did so it would do what is equivalent to buying its own shares, and that it cannot do : Trevor v. Whitworth 12 App. Cas. 409, It must therefore get the money from some one else. It may, get it from the public or it may say to its shareholders : 'We will give you the option of subscribing before we apply to the public', and when I say 'it may,' I always mean the same thing‑namely, that the company can do and must do what the majority of the shareholders decide it shall do. In the present case the company did neither of these things, but it did a thing which it was in its power to do. It may say, and it did say to the shareholders : 'There is a large; sum of undivided profits. We shall allot to each shareholder his proportional amount of these profits, but we will not pay that amount in cash, but will impute it to the payment of the shares we are issuing, and give each shareholder the shares for which his allotted amount effectuated payment. 'I cannot myself escape from, the feeling that that is just cash but in the shape of paid‑up shares, and if that is so it seems to me to fall within the description of taxable income. Let me by way of illustration put the following possibilities. Undivided profits distributed as dividend in cash‑there is no question. Next, suppose that profits are in the shape of some chattels, and that the chattels are distributed; here, again, it is conceded in argument that these chattels would be income. Next, let me suppose that a company had power to acquire shares of another company, that it has used its profits to buy such shares and distributed these shares to its own share holders. There, again, would be something which was the equivalent of profit, though viewed in the light of the other company's affairs it would be capital. The last step is to do what was done here, to use its own profits to pay up the shares which it then gave to its share holders. I fail to see any difference in this position."

The learned counsel for the respondent relied on the case of Dalmia investment Co. Ltd. ( A I R 1964 S C 1464 ) to plead that the entire sale price is the capital gains and hence the Department acted lawfully in assessing the same as such. The Indian Supreme Court case rather helps the petitioner as will be seen from the following observations made in para. 28 of that judgment :‑

" . It follows that the bonus shares cannot be said to have cost nothing to the shareholder because on the issue of the bonus shares, there is an instant loss to him in the value of his original holding. The earning capacity of the capital employed remains the same, even after the reserve is converted into bonus shares. 8y the issue of the bonus shares there is a corresponding fall in the dividends actual or expected and the market price moves accordingly. The method of calculation which places the value of bonus shares at nil cannot be correct"

The same point has been considered recently by this Court in the case of Commissioner of Income‑tax, Lahore v. Umar Saigol ( 1973 P T D 450 ) with the following .,observations :‑

'" 'Share' as defined in section 2(16) of the Companies Act, 1913, means 'share in the share capital of the company and includes stock except when a distinction between stock and shares is expressed or implied.' Under the Companies Act; therefore, a share whether allotted on the basis of cash payment or on account of bonus stands on the same footing. Every share allotted by the company has to be paid for in cash or kind because the shares are shares in the share capital of the company. Every share, therefore, represents a part of the capital and is relatable to it. When a share is allotted a certain amount of money has to be credited to the capital account of the company on account of the price of that share. It is axiomatic that a company cannot deal in its own shares. It cannot purchase its own shares in any case. It consequently follows that when a share of the company is allotted to somebody it is not the company but the allottee or somebod3 else on its behalf who has to pay the corresponding amount for being credited to the capital account of the company.

When a company makes profit it divides a part of the profit amongst the shareholders in the shape of dividend. This dividend can either be paid in cash or instead of making a cash allocation the company can allocate shares of the same value to the shareholder and credit the amount to the capital account of the company which would have otherwise been paid as dividend to the shareholder. Shares so allotted are known as bonus shares. They have perforce to be relatable to the capital of the company and the payment for it is, therefore, made by a person other than the company to it.

It is, therefore, incorrect to say that bonus shares are issued on a no cost, basis. Their face value is their cost."

7. Even the principle embodied in section 12‑B(3) as given below supports the view that we have taken in this case.

"12‑B.‑(3) Where any capital asset became the property of the assessee by succession, inheritance or devolution or under any of the circum stances referred to in the third proviso to subsection (1), its actual cost allowable to him for the purposes of this section shall be its actual, cost to the previous owner thereof, and the provisions of subsection (2) shall apply accordingly; and where the actual cost to the previous owner cannot be ascertained, the fair market value at the date on which the capital asset became the property of the previous owner shall be deemed to be the actual cost thereof."

In the situations enumerated in this subsection the recipient gets the shares free of cost but the capital gains are to be calculated not on this basis but on the basis of the actual cost of the previous owner. Undoubtedly the company cannot purchase its own shares and it is not the owner of the shares either but in issuing the bonus shares it acts on the decision of the Directors or resolution of the shareholders passed under the Articles of Association of the company. The actual cost of the shares would thus be allowed under this section.

8. The next point that needs determination is whether the actual cost is the face value of the shares or it is to be calculated in accordance with the cost accounting method laid down by the Indian Supreme Court in para. 29 of its judgment in Dalmia Investment Company's case already referred to above. The Tribunal also considered that case while determining the actual cost. It is to be noted here that the term 'dividend' has been differently defined in the Indian Income‑tax Act and the issuance of bonus shares is not a 'dividend'. There the issuance of bonus shares is not a release of reserve as profits so that it could be included in the income. This definition is more akin to the English Law. Under that law no income accrues to a shareholder when he receives bonus shares. The process amounts to capitalising the profits in the hands of company with a corresponding or a proportionate decrease in the market value of the original shares of the company. In other words the parti cular interest. of a particular shareholder in the surplus assets of the company at the general distribution remains the same though it has to be divided at larger number of shares t e. original plus bonus shares after the bonus shares are issued. The part under discussion in the Indian Supreme Court judg ment was bow to determine the value of the bonus shares after they are issued and it was with a view to decide this proposition that Supreme Court wag considering the three/methods :‑

(i) Free of cost method;

(ii) The cost accounting method; and

(iii) The prevailing market price method.

That Court held that the price to the shareholder of bonus shares is not .nil. It then proceeded to consider the other two methods. We however, are not faced with any such difficulty in this case as our law specifically lays down in section 12‑B (2) that the value of the bonus shares shall be the face value. The tribunal, therefore. misdirected itself in relying on the Indian Supreme ,Court case discussed above in giving a judgment against the petitioner.

The first question is, therefore, answered in the negative.

9. We now proceed to consider the 2nd question raised in the reference. It was contended by the learned counsel that as the bonus shares are in the nature of accretion to the original shares, their acquisition should be reckoned from the date of the original acquisition irrespective of their actual receipt. Apart from the fact that this argument was very half‑heartedly advanced there is no merit in it. The profits of a year or the accumulated profits of a Company are profits of the Company in the hands of the Company and no shareholder can claim any interest in them. A shareholder derives an interest in them indirectly as the market value of his shares generally goes up with mounting assets of the company. In the other case a shareholder is only entitled to these profits on general distribution in pursuance to winding

.up. There is thus no acquisition of interest at any time prier to the issuance of the bonus shares. This aspect of the case has also been discussed in paras. 25 to 28 of the judgment of the Indian Supreme Court, discussed above. There was thus no legal basis that the petitioner was liable to be charged tax at 1/6 of the amount of capital gains than at 1/3 as done by the Income‑tax Officer.

This question is, therefore, awarded in the affirmative.

S.Q Reference answered