EBRAHIM BROTHERS LIMITED--- VS COMMISSIONER OF INCOME TAX, KARACHI---, 1992 PTD-SUPREME-COURT 1693 (1992)

(On Appeal from. the judgment. passed by the High Court of Sindh, Karachi, dated 10-1-1991 in Income Tax Reference No.83 of 1982).

(a) Income Tax Act (XI of 1922)---

----Ss.12(g)(2)(ii)---Constitution of Pakistan (1973), Art.185(3)---Leave to appeal was granted to consider the question whether High Court was justified in answering the question in the negative which was "whether in the facts and in the circumstances of the case Tribunal was justified in holding that for computation of capital gain the cost of bonus shares should be taken on its face value and not average cost of all shares including bonus shares".

(b) Income Tax Ordinance (XXXI of 1979)---

----Ss.26 & 27---Bonus shares---Method of computing cost of bonus shares-- Only reasonable and rational method to calculate the cost of the bonus shares is the cost of shares held by the shareholder on the basis of which bonus shares have been a1lotted,be spread over on all such shares taken together if they rank pari passu and then average price per share be calculated on that basis.

Capital Gain-tax is charged under sections 26 and 27 of the Income Tax Ordinance, 1979. It charges profit or gain arising from transfer of capital asset which is deemed to be income of the income year in which the transfer took place. In order to assess the profit or gains arising from such transaction two prices viz. cost price which the assessee had to pay for acquiring the capital asset and the price which he has received on transfer of such capital asset have to be taken into consideration. A shareholder has not to pay any amount for the bonus shares. The dividend which on distribution may have come to' the hands of the shareholder or the bonus share is converted as a stock capital of the company in which a share holder has no interest. Thus, the bonus share at the time of allotment does not cost anything to the shareholder. However, it has a value in the market but in order to calculate its value neither it can be termed as nil nor at the market value. The only reasonable and rational method to calculate the cost of the bonus shares is that the cost of the share held by the share-holder on the basis of which bonus shares have been allotted be spread over on all such shares taken together if they rank pari passu and then average price per share be calculated on that basis. A shareholder acquires a bonus share in the stock, if he holds a certain number of shares in the company. Therefore, it is the original investment which he has made on which he gained profit.

Commissioner of Income Tax v. Dalmia Investment Co. Limited (1964) 10 Taxation 75; Commissioner of Income Tax Lahore v. Umer Saigal 1973 PTD 450; 1972 PTD (Trib.) 8; C.I.T. v. Umer Saigal and Mark Collector US Internal Revenue v. Myrtle Macomber 1 Us Tax Cases 1077 and C.I.T. Madras v. Athi V. Hamchandra Chattiar (1964).52 ITR 96 ref.

Naseem Ahmad Khan, Advocate Supreme Court with M. Shabbir Ghaury, Advocate-on-Record for the Appellant.

Nasrullah Awan, Advocate . Supreme Court with S.M. Abbasi, Advocate-on-Record for Respondent.

Date of hearing: 9th March, 1992.

JUDGMENT

SALEEM AKHTAR, J.-The appellant has challenged with special I leave to appeal the judgment of the High Court of Sindh whereby in al reference made to it under section 66(1) of the Income Tax Act, 1922, the following question was answered in the negative:-

"Whether in the facts and in the circumstances of the case the Tribunal was justified in holding that for computation of capital gain the cost of bonus shares should be taken at its face value and not average cost of all shares including bonus shares."

A contrary view was taken in Commissioner of Income Tax, Lahore v. Umer Saigal 1973 PTD 450 which has not been followed by the learned Judges of the High Court of Sindh in the impugned judgment. Leave to appeal was granted to resolve the above conflict and to consider the question whether the High Court was justified in answering the above question in the negative.

2. The facts are simple and brief. The appellant a private limited company, deals in imported crockery and local goods. For the assessment year 1972-73 the appellant declared capital gain of Rs.9,96,000 on the sale of shares paid and sold during the year but the I.T.O. determined the capital gain of Rs.15,96,000. The difference arose due to different modes of calculation of the cost of bonus shares adopted by the appellant and the I.T.O. The method of calculation by both the parties has been stated in the impugned judgment as follows:

"The assessee (appellant) determined the cost of bonus shares at their face value whereas the Income Tax Officer worked out the cost of bonus shares by adopting the basis of average value i.e. by spreading the cost of old shares over the old shares plus the bonus shares taken together. The Income Tax Officer had followed the principle of valuation laid down by the majority opinion in the judgment of the Supreme Court of India in the case of Commissioner of Income Tax v. Dalmia Investment Co. Limited (1964) 10 Taxation 75. This view of the Indian Supreme Court had earlier been followed by the Income Tax Appellate Tribunal in Pakistan and reported in 1972 PTD (Trib.) 8."

In appeal the Income Tax Appellate Tribunal relying on a judgment of the High Court of Lahore in Commissioner of Income Tax v. Umer Saigal, 1973 PTD 450 held that the cost of bonus shares was their face value. On an application made by the department aforestated question was referred to the High Court which was answered in the negative.

3. Dr. Nasim Ahmad Khan, the learned counsel for the appellant, has referred to C.I.T. v. Umer Saigal and Mark Collector US Internal Revenue v. Mystle Macomber 1 US Tax Cases 1077, a judgment of the Supreme Court of US while Mr. Nasrullah Awan, the learned counsel for the respondent, has relied on. Dalmia Investment Company Limited. In the impugned judgment the observation of the Court made in Umer Saigal has been quoted and commented as follows:-

"The Lahore High Court answered the question in the affirmative for the following reasons:

Share as defined in section 2(16) of the Companies Act, means share in the share capital of the company and includes stock except stock when a distinction made 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 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 shares in any case. It cannot consequently follow that when a share of the company is allotted to somebody it is not the company but the allottee or somebody 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 profit amongst the shareholders in the shape of dividend can be paid in cash or instead of making a cash allocation the company value to the shareholders and credit the amount to the capital account of the company which would have otherwise been paid as dividend to the shareholders. 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 issued on a cost basis. Their face value is their cost.

The Tribunal based its finding upon the decision reported as C.I.T. Madras v. AN v. Hamchandra Chattiar (1964) 52 ITR 96 wherein it was held that the valuation of the bonus shares for the purpose of computing the capital gain should be the face value and following this decision the Tribunal held that the cost of bonus shares should be fixed at Rs.10 each. The Department has placed reliance on the decision reported as Commissioner of Income Tax, Bihar v. Dalmia Investment Company Limited (1964) 10 Tax 75 which has also been reported in (AIR SC 1964). We fully agree with the Tribunal that the decision in this case does not support the case propounded by the Department. It was not held in that case that the bonus shares were to be deemed to have been acquired at no cost. Their Lordships of the Supreme Court of India only laid down the criterion for determining the cost. That case, therefore, need not be referred to in detail.

Lahore High Court held that, for purposes of capital gain, the face value of the bonus shares is the cost to the assessee. As noticed, the Lahore High Court did not refer in detail to the decision of the Indian Supreme court in the case of Dalmia Investment Co. Limited observing that the Indian Supreme Court has not held in that case that bonus shares were to be deemed to have been acquired at no cost and that it had only laid down the criterion for determining the costs."

The impugned judgment relied upon the judgment of the Supreme Court of India in Dalmia Investment Co, which propounded that there are four methods for determining the cost of bonus shares:

(1) To take the cost as the equivalent of the face value of the bonus shares.

(2) As the shareholders pay nothing in cash for the bonus shares, cost should be taken as nil.

(3) To take the cost of the original shares and to spread it over the original shares and bonus shares taken collectively.

(4) To find out the fall in the price of the original shares on the Stock Exchange and to attribute this to the bonus shares.

Finally the Supreme Court of India approved the third method of evaluation of bonus shares and it was held that the bonus shares can be valued by spreading the cost of old shares over the old shares and the new issue taken together if the shares rank pare passu and where they do not the price may have to be adjusted either in the proportion of the face value they bear or on equitable consideration based on the market price before and after the issue. The learned Judges of the High Court observed as follows:-

"The method of computing the cost of bonus shares approved by Hidayatullah, J. in the case of Dalmia Investment Company Limited, is in accord with principles of business accountancy and based on good reasoning as well. The basis that bonus shares be valued at nil or zero can be ignored without much debate. A shareholder who is allotted bonus shares against his shareholding does not get the bonus shares as a gift for free. On allotment of bonus shares, value of his original shares goes down and he suffers a loss in respect of his original shareholding. Therefore, even if the shareholder has not literally made any payment for the bonus shares, law will not presume that he got the bonus shares as a gift and these be valued at zero value."

The main question in this controversy seems to be whether the bonus shares are issued for consideration' paid by the shareholders in any form. Where a company earns profit and without distributing it among the shareholders keeps it in reserve and decides to transfer the same towards its capital it issues bonus shares to the shareholders. They are not required to pay any amount to the company. The profit is thus capitalized and not distributed amongst the shareholders as the dividend. In this situation the US Supreme Court in Eisner v. Macomber (1920) 252 US 189 = 1 US Tax Cases 1977 relied upon the High Court and Supreme Court of India observed as follows:-

"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished and their interests are not increased. The proportional interests of each shareholder 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. In short, the corporation is no poorer and the stockholder is no richer than they were before .. If the plaintiff gained any small advantage of 417.450 the sum upon which he was taxed .....What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new .... If a shareholder sells dividend stock, he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer future dividends as before the sale. His part in the control of the Company likewise is diminished."

It may be noticed that when the dividend is converted `in the share capital nothing is paid to the shareholders. `Share' has been defined in the Companies Act, 1913, as `share in the share capital of the company.' A shareholder acquires a right of participation in the profits of the company but he does not have any interest in its assets and properties. According to Halsbury's Laws of England a share is a right to a specified amount of the share capital of a Company carrying with it certain rights and liabilities while the company is a going concern and in its winding up. `Dividend is a share in the profits but instead of distributing it as dividend to the shareholders, applied it in paying up new shares issued and allotted proportionately to the shareholders entitled to receive it, if dividends were paid, such profit ceases to be divisible. The shares so issued are received as Corpous and not as income' Reference may be made to R.A. Hill v. Permanent Trustee Company, AIR 1930 PC 302.

4. Capital Gain tax is charged under sections 26, 27 of the Income Tax Ordinance, 1979. It charges profit or gain arising from transfer of capital asset which is deemed to be income of the income year in which the transfer took place. In order to assess the profit or gains arising from such transaction two prices vii. cost price which the assessee had to pay for acquiring the capital asset and the price which he has received on transfer of such capital assets have to be taken into consideration. A shareholder has not to pay any amount for the bous shares. The dividend which on distribution may have come to the r hands of the shareholder or the bonus share is converted as a stock capital of the company in which a shareholder has no interest. Thus, the bonus share at the time of allotment does not cost anything to the share-holder. However, it has a value in the marker but in order to calculate its value neither it can be termed as nil nor at the market value. The only reasonable and rational method to calculate the cost of the bonus shares is as held by the High Court in the impugned judgment namely that the cost of the share held by the shareholder on the basis of which bonus shares have been allotted be spread over on all such shares taken together if they rank pari passu and then average price per share be calculated on that basis. A shareholder acquires a bonus e share in the stock, if he holds a certain number of shares in the company. Therefore, it is the original investment which he has made on which he has gained profit. In our view the reasonings and the conclusions reached by the High Court of Sindh in the matter are correct and proper which we approve. We, therefore, dismiss the appeal with no order as to cost.

M.B.A./E-29/S

Appeal dismissed.