Income-tax---

----Capital gains---Shares and securities---Computation of capital gains---Issue of right shares---Sale of right to purchase right shares---Depreciation in value of original shares should be taken into account in computing capital gains-- Indian Income Tax Act, 1961, S.45.

Where right shares are issued, the value of the right shares may be measured by setting off against the appreciation in the face value of the new shares the depreciation in the old shares. A concomitant of the acquisition of the new right is the depreciation in the value of the old share. The capital gain would be represented only by the difference between the money realised on the transfer of the right and the amount lost in the form of depreciation in value of the original shares.

The assessee-company held certain shares of E as investment. E declared bonus shares as well as right shares in the proportion of one share for every five shares held in both the cases. Simultaneously, it also issued new equity shares for the public. The assessee sold its right to purchase 29,000 right shares at Rs.3.50 per right share. The assessee found that the quotation of the shares of E went down from Rs.42.75 to Rs.30.25 per share as a result of the issue of the aforesaid right shares and bonus shares. The depreciation in the value amounted to Rs.12.50 per share. The assessee claimed that it suffered a short-term capital loss of Rs.9 per share. The Income-tax Officer calculated the cost of acquisition at Rs.1.79 per share and computed the capital gain. The Tribunal, however, held that the cost of acquisition of the right shares should be taken at Rs.6.25 per share. On a reference:

Held, that in the instant case, after the issue of right shares, the quoted price of the right shares fell to Rs.30.25. Thus, there was a depreciation in the value of the right shares to the extent of Rs.12.50 per share. However, the computation of the cost of acquisition of right shares as made by the Tribunal at Rs.6.25 per share could not be interfered with since the assessee was prepared to accept it.

Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651 (SC) applied.

CIT v. Patch (KA.) (1971) 81 ITR 413 (Bom.) and Gafoorunnisa Begum v. CTT (1988) 172 ITR 193 (AP) ref.

Mr. Bagchi for the Commissioner.

Dr. Pal for the Assessee.

JUDGMENT

SHYAMAL KUMAR SEN, J.---Pursuant to the direction of this Court under section 256(2) of the Income Tax Act, 1961, the Tribunal has referred the following question:

"Whether on the facts and in the circumstances of the case, the Tribunal was justified in computing the cost of acquisition of right shares issued by Messrs East India Hotels Limited at Rs.6.25 per share as against Rs.1.79 taken by the Income Tax Officer?"

The facts relevant for the said question as found by the Tribunal are as follows;

The assessee is a company deriving income from business and other sources. It held certain shares of Messrs East India Hotels Limited as investment. During the previous year under consideration, Messrs East India Hotels Limited declared bonus shares as well as right shares in the holding of one share for every five shares held in both the cases. Simultaneously, it also issued new equity shares for the public. The assessee sold its right to purchase 29,000 right shares at Rs.3.50 per right share. As these shares were held in the investment portfolio, the surplus of the sale proceeds over the cost, if any, was assessable as short-term capital gains. On the contrary, if the cost of the right shares sold exceeded the sale proceeds, the deficit would constitute short-term capital loss. The assessee found that the quotation of the shares of Messrs East India Hotels Limited went down from Rs.42.75 to Rs.30.25 per share as a result of the issue of the aforesaid right shares and bonus shares. The depreciation in the value amounted to Rs.12.50 per share. The assessee claimed that it suffered a short-term capital loss of Rs.9 per share.

The Income Tax Officer, however, did not agree with the said view of the assessee. He spread the cost of original shares held by the assessee over a large number of shares including the bonus shares. Thereafter, he calculated the depreciation in value at Rs.5.37 per share. Out of the same, he attributed only one-third of the value to the right share. Thus, the Income-tax Officer calculated the cost of acquisition at Rs.1.79 per share so that there was a profit of Rs.1.71 per share instead of Rs.2.50 per share taken by the assessee. Accordingly, he computed the capital gain at Rs.49,590.

Assessment

yearIncome returned

and acceptedTax paid under

section 140ATax assessedRs.Rs.Rs.1971-72 28,8206,7076,0811972-7329,0006,2796,44019he assessee preferred an appeal before the Commissioner of Income-tax (Appeals) who held that there could be no profit or loss on the sale of the shares under consideration.

Thereafter, both the Revenue and the assessee preferred appeals. The Tribunal, following the decision in the case of ITO v. Oberoi Properties (P.) Ltd. (1986) 16 ITD 206 (Cal.) (I.TA. No.370/(Cal.) of 1984), held that the cost of acquisition of right shares would be taken at Rs.6.25 per share and the short-term capital gain or loss should be computed accordingly. The income tax appeal of Oberoi Properties (P.) Limited which had decided the said question did not come up by way of reference.

Mr. Bagchi, learned Advocate, for the Revenue, also relied upon the judgment and decision in the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651 (SC), and submitted that the Tribunal was not correct in making the said calculation and according to him the reasoning of the Tribunal in arriving at its finding cannot be sustained in the aforesaid judgment of the Supreme Court. He also relied upon the decision in the case of Gafoorunnisa Begum v. CIT (1988) 172 ITR 193 (AP), and in the case of CIT v. K.A. Patch (1971) 81 ITR 413 (Bom.) in support of his aforesaid contention.

Dr. Pal, learned Advocate for the assessee, on the other hand submitted that the decision in the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651 (SC), really supports his case.

It has been argued by Dr. Pal on behalf of the assessee that the Tribunal came to its finding on the basis of the reasoning stated hereinafter.

The calculation of the value of right shares which had been enunciated by the assessee for 4,000 right shares is very simple. The right and bonus issues were made in the same general meeting on August 29, 1979. The record date for right and bonus was the same as October 27, 1979. Thereafter, it was clear that the right and bonus shares both are allotted to the shareholders in the ratio of one for every five shares held on the original shares. According to the Tribunal, this could be explained by way of an example. A shareholder of East India Hotels Limited was holding 100 shares on October 27, 1979. Therefore, by virtue of the resolution, dated August 29, 1979, the said shareholder was entitled for 20 right shares and 20 bonus shares. After the issuance of right and bonus shares, the total holding of the shareholder would become 140 shares. The right and bonus price in the stock exchange was Rs.42.75 on October 29, 1979. The ex-right bonus price in the stock exchange on October, 29, 1979, was quoted at Rs.30.25 per share. Therefore, the difference between the two, i.e. Rs.12.50 was attributable to the right as well as the bonus shares. The right and bonus shares were issued in the same proportion. Under the circumstances, the value which the public-at-large dealing on the stock exchange determined for right and bonus shares at Rs.12.50 per share was attributable to right as well as bonus equity. Under the said circumstances, Rs.6.25 cad be attributed to the value of the right and the same amount can be attributed to the value of bonus shares. Hence, the cost of the bonus shares would' be taken at value of Rs.12.50 i.e., Rs.6.25 per share and the capital gain or loss would be determined on that basis. The Tribunal pointed out that the view that they are taking is supported by the decision of the Supreme Court in the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651, and the facts of the case and the points to be decided are fully covered by the said decision of the Supreme Court.

Dr. Pal has further submitted that the question of taking half of the loss at Rs.6.25 per share is not correct in view of the decision of the Supreme Court in the aforesaid decision. In other words, for obtaining the right to purchase 29,000 right shares, the assessee had to own 1,45,000 original shares because, in terms of the resolution of the board of directors, East India Hotels Limited declared the right shares in the holding of one share for every five shares held by the original holder. Therefore, the assessee realised by selling the right to obtain 29,000 shares at Rs.3.50 per share; i.e. Rs.1,01,500. From the said amount, depreciation in the value of the original shares of 1,45,000 at the rate of Rs.12.50 per share is to be deducted i.e., Rs.18,12,500. Even if, according to the Tribunal's view, 50 per cent of the amount being the depreciation in the value of the shares is to be taken, the same would come to Rs.9,06,250.

Dr. Pal relied upon the decision in the case of CIT, v. KA. Patch (1971) 81 ITR 413 (Bom.). In that case, during the accounting year, the assessee had, under the terms of offer of the "rights issue" of ordinary shares by a company, a right to subscribe for 350 new shares of the rights issue by paying the face value of the shares or to renounce the right and sell his right to the new shares offered to him. The assessee exercised the option to sell his right to subscribe to the new shares and by the sale he realised a sum of Rs.27,500. The Income Tax Officer held that the said sum of Rs.27,500 was business profit and was liable to tax. The Appellate Tribunal held that, as against the above realisation, the fall in the original value of the original shares should be set off and, on that basis, there was a loss and no profit. On a reference to the High Court at the instance of the Department, it was held that the proper method of calculating the profit, if any, to the assessee in this case where the rights issue of shares were to rank pari passu with the original ordinary shares would be to find out the aggregate of the ex-right value of the holding of the original shares and the actual cash received by the sale of the right to the new rights issue shares and deduct therefrom the cum-right value of the holding of the old shares, i.e., the amount realised by the sale of the right should be set off by the amount of the depreciation in the old shares on account of the rights issue of shares. For this purpose, the market rates of the shares cum-right and ex-right immediately before and after the issue of the rights shares should be ascertained.

Dr. Pal, accordingly, submitted that, on the principle laid down by the Supreme Court, the assessee will gain further benefit or advantage. However, he has not challenged the finding of the Tribunal and he is prepared to accept the benefit given to the assessee by the Tribunal.

We have considered the submissions of the learned Advocates for the parties and the decisions cited from the Bar.

In the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651 (SC), the appellant held by way of investment 710 ordinary shares in the Tata Iron and Steel Company Limited. The company made an offer to her by which she was entitled to apply for 710 new ordinary shares at a premium with an option of either taking the shares or renouncing them, wholly or partly, in favour of others. The appellant renounced her right to all the 710 shares on June 12, 1956, and realised Rs.45,262.50. When the said amount was sought to be wholly taxed as a capital gain, the appellant claimed that, on the issue of the new shares, the value of her old shares depreciated, since the market quotation of the old shares which was Rs.253 per share on June 1, 1956, fell to Rs.198.75 on June 4, 1956, and that, as a result of this depreciation, she suffered a capital loss in the old shares to the extent of Rs.37,630 which she was entitled to set off against the capital gain of Rs.45,262.50. In the alternative, she claimed that the right to receive the new shares was a right which was embedded in her old shares and, consequently, when she realised the sum of Rs.45,262.50 by selling her right, the capital gain should be computed after deducting from that amount the value of the embedded right which became liquidated.

The Supreme Court, on the above facts, upheld both the contentions of the assessee.

On the first contention raised in that case as upheld by the Supreme Court, the reasoning appears at pages 654 and 655 of the report. The Supreme Court pointed out that the right to purchase the right shares was possessed by Dhun Dadabhoy because of the ownership of the old 710 ordinary shares and when the board of directors of the company passed a resolution for issue of new shares, the right of the appellant, i.e., Miss Kapadia, matured to the extent that she became entitled to receive 710 new shares. This right could be exercised by her by actually purchasing those shares at the prescribed rate or by renouncing those shares in favour of another person and obtaining monetary gain in that transaction. At the time, therefore, when the appellant renounced her right to take these new shares, the capital asset which she actually possessed consisted of her old 710 shares plus this right to take 710 new shares. At the time of her transaction, her old shares were valued at Rs.253 per share, so that the capital asset in her possession can be treated to be the cash value of 710 multiplied by Rs.253 of the old shares plus this right to obtain new shares. After she had transferred this right to obtain new shares, the capital assets that came into her hands were 710 old shares, which became valued at Rs.198.75 per share, together with the sum of Rs.45,262.50. The net capital gain or loss to the appellant obviously would be the difference between the value of the capital asset and the cash in her hands after she had renounced her right and realised the cash value in respect of it, and the value of the capital asset including the right which she possessed just before these new shares were issued and before she realised any cash in respect of the right by renouncing it in favour of some other person.

Thus, the Supreme Court pointed out that the value of the capital asset, after renouncement, would be 710 multiplied by Rs.198.75 plus the sum of Rs.45,262.50, while the value of the asset, immediately before the renouncement, would be 710 multiplied by Rs.253, there being no cash value at that time of the right to be taken into account. Thus, according to the Supreme Court, the capital gain or loss would be worked out at Rs.45,262.50 after deducting from it the sum worked out at ,710 multiplied by the difference between Rs.253 and Rs.198.75.

Accordingly, the net capital gain or loss would be determined by following the principle as laid down by the Supreme Court in the aforesaid case in the instant case, after the issue of right shares, the quoted price of the right shares fell to Rs.30.25. Thus, there was a depreciation in the value of the right shares to the extent of Rs.12.50 per share. The short-term capital gain arising therefrom would be worked out at 29,000 right shares which were surrendered at Rs.3.50 per share after deducting from the said sum the depreciation in the value of the original shares at Rs.12.50 per share.

The question of taking half of the loss at Rs.6.25 per share is not correct in view of the decision of the Supreme Court in the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651.

The Supreme Court also accepted the alternative contention in the case of Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651. The Supreme Court observed at page 655 of the said report as follows:

"The value of the right may be measured by setting off against the appreciation in the face value of the new shares the depreciation in the old shares and, consequently, to the extent of the depreciation in the value of her original shares, she must be deemed, to have invested money in acquisition of this new right. A concomitant of the acquisition of the new right was the depreciation in the value of the old shares, and the depreciation may, in a commercial sense, be deemed to be the value of right which she subsequently transferred. R The capital gain made by her would, therefore, be represented only by the difference between the money realised on transfer of the right, and the amount which she lost in the form of depreciation of her original shares in order to acquire that right. Looked at in this manner also, it is clear that the net capital gain by her would be represented by the amount realised by her on transferring the right to receive new shares, after deducting therefrom the amount of depreciation in the value of her original shares, being the loss incurred by her in her capital asset in the transaction in which she acquired the right for which she realised the cash."

In our opinion, the submissions of the learned Advocate for the assessee cannot be said to be without any substance. However, we are not inclined to interfere with the computation of the cost of acquisition of right shares as made by the Tribunal at Rs.6.25 per share as against Rs.1.79 taken by the Income Tax Officer, since it has been submitted on behalf of the assessee that the assessee is prepared to accept it.

Accordingly, the question is answered in the affirmative and in favour of the assessee.

There will be no order as to costs.

AJIT K. SENGUPTA, J.---I agree.

M.BA./170/T.F.

Reference answered.