Gujarat H.C : Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in admitting the additional ground raised by the assessee that the ITO was not justified in rectifying the order so as to reduce the capital computed by Rs. 9,53,220 for asst. yr. 1967-68 as there was no mistake rectifiable under s. 13 of the Companies (Profits) Surtax Act, 1964 ?

High Court Of Gujarat

Commissioner Of Surtax vs. New India Industries Limited

Section 254, Surtax SCH. II, Surtax Rule 1, Surtax Rule 3

Asst. Year 1967-68, 1968-69, 1969-70, 1970-71

S.B. Majmudar & S.D. Shah, JJ.

IT Ref. Nos. 217, 217A, 217B and 217C of 1978

9th September, 1992

Counsel Appeared

Mihir Thakore i/b M.R. Bhatt of M/s R.P. Bhatt & Co. for the Revenue : D.A. Mehta and R.K. Patel for K.C. Patel, for the Assessee

S.B. MAJMUDAR, J. :

Though this IT Ref. is registered as IT Ref. No. 217 of 1978 only as proceedings arising out of common judgment of the Appellate Tribunal concerning appeals for four asst. yrs. 1967-68, 1968-69, 1969-70 and 1970-71 and as there were separate appeals before the Tribunal for these years and there were also cross appeals therein, these references are ordered to be split up and are ordered to be registered as IT Ref. Nos. 217, 217A, 217B and 217C of 1978. Office is directed accordingly.

2. Though different questions have been referred for our opinion assessment yearwise, we have thought it fit to reproduce hereinbelow the referred questions topic wise. Topic I The question pertaining to legality of rectification order passed by the Assessing Officer.

Asst. yr. 1967-68

1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in admitting the additional ground raised by the assessee that the ITO was not justified in rectifying the order so as to reduce the capital computed by Rs. 9,53,220 for asst. yr. 1967-68 as there was no mistake rectifiable under s. 13 of the Companies (Profits) Surtax Act, 1964 ?

Topic II Question pertaining to deduction of proposed dividend from general reserve.

Asst. yr. 1967- 68

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs.

9,53,220 proposed dividend should not be deducted from the general reserve while computing the capital employed by the assessee ?

Asst. yr. 1968-69

1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 12,28,110 proposed dividend should not be deducted from general reserve while computing the capital employed by the assessee? Asst. yr. 1969-70

3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 14,68,022 representing proposed dividend for the year should not be deducted from the general reserve while computing the capital employed by the company ?

Asst. yr. 1970-71

1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 15,94,620 proposed dividend should not be deducted from the general reserve while computing the capital employed by the assessee ? Topic III Question pertaining to loan taken by the assessee-company from Bank of Baroda. Asst. yr. 1968-69

2. Whether, on the facts and in the circumstances of the case, the loan taken by the assesseecompany from Bank of Baroda, qualifies for inclusion in computation of its capital for the purposes of surtax chargeable under the Act ?

Asst. yr. 1969-70

2. Whether, on the facts and in the circumstances of the case, the loan taken by the assesseecompany from the Bank of Baroda qualifies for inclusion in computation of its capital for the purposes of surtax chargeable under the Act ? Topic IV Question regarding giving of credit for proportionate value of bonus shares. Asst. yr. 1967-68

3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee has to be given credit for proportionate value of bonus shares in view of r. 3 of the Second Schedule of the Surtax Act and that for this purpose no adjustment should be made to the general reserve ?

Asst. yr. 1969-70

1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee has to be given credit for the proportionate value of the bonus shares in view of r. 3 of Second Schedule of the Surtax Act and that for this purpose no adjustment could be made to the general reserve ?

3. Before we proceed to deal with the aforesaid questions topic-wise, it would be necessary to note a few introductory facts leading to these proceedings : These proceedings pertain to assessment of the assessee which is a public limited company under the provisions of Companies (Profits) Surtax Act, 1964 (`the said Act’ for short). The assessee company adopted calendar year as its previous year. Its assessment for asst. yr. 1967-68 was made under s. 6(2) of the said Act on 19th Feb., 1970 by the Assessing Officer. The capital employed by the assessee during the relevant year was determined by the Assessing Officer at Rs. 1,56,72,702. He took into consideration the following three items as per r. 1 of the Second Schedule to the said Act : Subsequently, by his order dt. 13th Dec., 1973, the ITO rectified the assessment under s. 13 of the said Act holding that the general reserve should have been taken at Rs. 52,81,682 as against Rs. 60,75,000 as the sum of Rs. 7,93,318 which was added to the paid-up capital in the original order for the reason that it represented proportionate increase for 158 days of Rs. 18,32,600 but was also a part of the general reserve of Rs. 60,75,000 inasmuch as the paid-up capital had been increased by the company to the extent of Rs. 18,32,600 by issuing bonus shares after capitalising the sum of Rs. 18,32,600 from the general reserve account. By another order dt. 12th Feb., 1974, the ITO again rectified the assessment under s. 13, this time, on the ground that the company had paid a dividend of Rs. 9,53,220 out of the general reserve of Rs. 60,75,000 as on 1st Jan., 1966 and the dividend was not to be treated as a part of the reserve in the light of the express provision contained in the Explanation to r. 1 of the Second Schedule to the said Act. Both these orders passed by the ITO under s. 13 were challenged by the assessee-company before the AAC. So far as appeal against the order dt. 13th Dec., 1973 was concerned, it was allowed by the AAC by taking the view that once the ITO had shown increase in the paid-up capital on account of bonus shares issued by applying r. 3 of the Second Schedule to the Act, as there was no provision for reducing the general reserve, even though bonus shares were issued out of general reserve, rectification by way of reduction in the general reserve as effected by the order dt. 13th Dec., 1973 was not justified. So far as appeal against the second rectification dt. 12th Feb., 1974 was concerned, that appeal was dismissed on the ground that in the light of the Explanation to r. 1, as the assessee had not provided for a separate reserve or a provision through dividend was nonetheless paid by the assessee out of the general reserve, it cannot be considered in computing the assessee’s capital and as the ITO had earlier considered it, he was entitled to rectify the mistake. Accordingly, the appeal against order dt. 12th Feb., 1974 was dismissed by the AAC. Thereafter, the matter was carried to the Tribunal. Against the AAC’s order in connection with asst. yr. 1967-68, two cross appeals were filed by the assessee and the Revenue. The assessee had also filed three other appeals for asst. yrs. 1968-69, 1969-70 and 1970-71 raising questions regarding computation of capital. All these appeals were heard together by the Tribunal. The Tribunal at the time of final hearing of these appeals, allowed the assessee to raise an additional ground for asst. yr. 1967-68 to the effect that the ITO was not justified in rectifying the order so as to reduce the capital computed by Rs. 9,53,220 for asst. yr. 1967-68 as there was no mistake rectifiable under s. 13 of the Act. That decision of the Tribunal resulted in the first question posed for our opinion as mentioned at the outset of this judgment.

So far as question of dividend was concerned, the Tribunal took the view that Rs. 9,53,220 by way of proposed dividend cannot be deducted from the general reserve while computing capital employed by the assessee. On the question of giving credit for proportionate value of bonus shares, the Tribunal held on interpretation of r. 3 of the Second Schedule to the said Act that the assessee had to be given credit for proportionate value of bonus shares and no adjustment was possible in the general reserve by reducing the amount of general reserve which was taken in computation under r. 1 by the ITO. So far as the loan taken by the assessee-company from Bank of Baroda was concerned, it was held that it had qualified for inclusion in computation of its capital for the purpose of the said Act. As all these findings were rendered against the Revenue and in favour of the assessee, as noted earlier, at the instance of the Revenue, four types of questions covering these topics have been referred by the Tribunal for our opinion. Question on Topic 1.—So far as this question is concerned, it concerns only asst. yr. 1967-68. So far as this question goes, it becomes obvious that as rectification of earlier order passed by the ITO was on the anvil before the Tribunal, by way of additional ground as a legal submission, it could always be urged by the assessee that the said rectification was not covered by s. 13 of the Act as it was not a mistake rectifiable, according to the assessee. Whether such contention was right or wrong on merits, was a different matter. It cannot be said that such an additional ground could not have been permitted to be raised by the assessee as the tenor of the question suggests. In this connection, we may also mention that in para 11 of the judgment of the Tribunal, answer to the

said question is kept open by the Tribunal and the Tribunal did not think it fit to deal with the additional ground as the Tribunal took the view on merits of the main question that the ITO could not have reduced the figure of the general reserve earlier taken into consideration while computing the capital of the assessee under r. 1 only because of operation of r. 3 whereunder paid-up capital was increased by the ITO. As we will discuss hereafter when we consider this question on merits while dealing with questions at topic IV, in view of the fact that we are inclined to answer questions at topic IV against the assessee and in favour of the Revenue, the additional ground referred to in this question will have to be decided by the Tribunal on merits. So far as this question is concerned, it will have to be answered in the affirmative, in favour of the assessee and against the Revenue. Question on Topic II.—That takes us to questions covered by this topic. They refer to deduction of proposed dividends from the general reserve. To recapitulate facts leading to these questions, it is necessary to note that for asst. yr. 1967-68, as on 1st Jan., 1966, there was general reserve of Rs. 60,75,000. Capital computation for the purpose of surtax obviously started with reference to capital on the first date of accounting year. In the original assessment, the ITO had accepted the assessee’s contention that the entire general reserve would form part of capital employed as on 1st Jan., 1966. Later on, an order under s. 13 passed by the ITO on 12th Feb., 1974, he held that the sum of Rs.

9,53,220 represented dividend proposed and formed part of current liabilities and provisions which had to be deducted in arriving at capital employed. For that purpose, Explanation I was pressed in service. The AAC also relying upon the said Explanation, negatived the claim of the assessee and dismissed its appeal against rectification order of 12th Feb., 1974. The Tribunal took the view that till the shareholders approved of the proposal of the directors to distribute dividends, there was no current liability or provision as contemplated by Explanation I of the Second Schedule to the Act and, therefore, the ITO was not justified in deducting Rs. 9,53,220 from the general reserve while computing the capital employed by the assessee.

6. In order to appreciate the reasoning which weighed with the Tribunal, it is necessary to have a look at the relevant provisions of r. 1 in the Second Schedule to the said Act. But before we do so, it would be profitable to have a look at the relevant provisions of the Act itself. The said Act was enacted in 1964 with a view to imposing a special tax on the profits of certain companies. It is not in dispute that the assessee company is covered by the sweep of the said Act. Sec. 4 thereof provides that there shall be charged on every company for every assessment year commencing on and from the 1st day of April, 1964, a tax (in this Act referred to as the surtax) in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule. `Chargeable profits’ are defined by s. 2(5) to mean the total income of an assessee computed under the IT Act, 1961 (XLIII of 1961) for any previous year or years, as the case may be and adjusted in accordance with the provisions of the First Schedule. `Statutory deduction’ is defined by s. 2(8) as under : “Statutory deduction” means an amount equal to ten per cent of the capital of the company as computed in accordance with the provisions of the Second Schedule or an amount of two hundred thousand rupees, whichever is greater : Provided that where the previous year is longer or shorter than a period of twelve months, the aforesaid amount of ten per cent or, as the case may be, of two hundred thousand rupees shall be increased or decreased proportionately; Provided further that where a company has different previous years in respect of its income, profits and gains, the aforesaid increase or decrease, as the case may be, shall be calculated with reference to the length of the previous year of the longest duration.” It becomes obvious, therefore, that computation of capital of the company in accordance with the provisions of Second Schedule would become very relevant for deciding the question of surtax liability of the concerned assessee for the relevant assessment year. The Second Schedule deals with rules for computing the capital of a company for the purposes of surtax. It is framed as per s. 2(8) of the Act. For the purpose of the present discussion, it will be necessary to reproduce r. 1 of this Schedule as applicable at the relevant time. It reads as under : “1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of— (i) its paid-up share capital. (ii) its reserves, if any, created under the proviso (b) to cl. (viB) of sub-s. (2) of s. 10 of the Indian ITAct, 1922 (XI of 1922) or under sub-s. (3) of s. 34 of the IT Act, 1961 (XLIII of 1961). (iii) its other reserves as reduced by the amounts created to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian IT Act, 1922 (XI of 1922) or the IT Act, 1961 (XLIII of 1961). (iv) the debentures, if any, issued by it to the public : Provided that according to the terms and conditions of issue of such debentures, they are not redeemable before the expiry of a period of seven years from the date of issue thereof; and (v) any moneys borrowed by it from Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which the Central Government may notify in this behalf in the Official Gazette or any banking institution (not being a financial institution notified as aforesaid) or any person in a country outside India : Provided that such moneys are borrowed for the creation of a capital asset in India and the agreement under which such moneys are borrowed provided for the repayment thereof during a period of not less than seven years. Explanation : For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading `Reserve and surplus’ or of any item under the heading `Current liabilities and provisions’ in the column relating to `liabilities’ in the `form of balance sheet’ given in Part I of Schedule VI to the Companies Act, 1956 (I of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule”.

It becomes obvious that as per r. 1 of the Second Schedule, computation of capital employed by the company will have to be done as on the first day of the previous year relevant to the assessment year. For asst. yr. 1967-68, the first date of the previous year was 1st Jan., 1966. For asst. yr. 1968-69, the first date of the previous year was 1st Jan., 1967. For asst. yr. 1969-70, the first date of the previous year was 1st Jan., 1968 and for last asst. yr. 1970-71, the first date of the previous year was 1st Jan., 1969. For computing capital as on the first date of the concerned previous year paid-up share capital along with reserve and also general reserve would become relevant. Explanation to r. 1 provides that any amount standing to the credit of the account in the book of a company as on the first day of the previous year by way of reserves and surplus and current liabilities and provisions cannot be regarded as a reserve for the purpose of computation of the capital of a company under the provisions of r. 1 of this Schedule and such amount had to be deducted from the general reserve balance which can be taken into consideration for computation of capital as per r. 1(iii). The short question is whether the proposed dividend to be paid to the shareholders can be considered to be provision so as to get excluded from the amount of general reserve while considering the balance of general reserve as per r. 1(iii) for the purpose of computation of capital employed by the company for the purpose of surtax to be charged from the company. It is true that the Tribunal following the decision of Bombay Tribunal has held this point against the Revenue and in favour of the assessee. However, this question is no longer resintegra as it has been set at rest by the decision of the Supreme Court in Vazir Sultn Tobacco Co. Ltd. vs. CIT (1981) 25 CTR (SC) 186 : (1981) 132 ITR 559 (SC). Tulzapurkar, J., speaking for the Supreme Court laid down as under : “The expression `reserve’ has not been defined in the Super Profits Tax Act, 1963 or the C. (P) S.T. Act, 1964. The dictionaries do not make any distinction between the two concepts `reserve’ and `provision’ while giving their primary meanings, whereas in the context of those Acts a clear distinction between the two is implied. Though the expression `reserve’ is not defined, since it occurs in taxing statutes applicable to companies only and to no other assessable entities, the expression has to be understood in its popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to the words `reserve’ and `provisions’ in the Companies Act, 1956 dealing with the preparation of the balance sheet and the profit and loss account would govern their construction for the purposes of the two enactments. The broad distinction between the two is that whereas a `provision’ is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a `reserve’ is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business.” “Though the term `provision’ is defined in cl. 7 of Part III of Sch. VI to the Companies Act, 1956, positively by specifying what it means, the definition of `reserve’ is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term `reserve’. The effect of reading the two definitions together is that if any retention or appropriation of a sum falls within the definition of `provision’ it can never be a reserve, but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sums so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made, because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term `reserve’ may have to be availed of. If any retention or appropriation of a sum is not a provision, i.e., it is not designed to meet depreciation, renewals or diminution in the value of assets or any known liability, the same is not necessarily a reserve. The question whether the concerned amounts constitute `reserves’ or not will have to be decided by having regard to the true nature and character of the sums to be appropriated depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriation had been made.

The true nature and character of the appropriation must be determined with reference to the substance of the matter. This means that one must have regard to the intention with which and the purpose for which the appropriation has been made, such intention and purpose being gathered from the surrounding circumstances. The following aspects provide some guidelines : (a) a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve, (b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion, and (c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve.

An amount set apart by the Board of Directors of a company for liability to taxation in respect of the profits which it has earned during the year will have to be regarded as a provision for a known and existing liability, the quantification whereof has to be done later. It is, therefore, a `provision’ and cannot be regarded as a `reserve’.

Sec. 217 of the Companies Act, 1956 and regulation 87 of Table A in Sch. I to that Act, read together, clearly show that creating reserves out of the profits is a stage distinct in point of fact and anterior in point of time to the stage of making a recommendation for the payment of dividend and the scheme of the provisions suggests that an appropriation made by the Board of Directors by way of recommending a payment of dividend cannot, in the nature of things, be a reserve. Appropriations made by the directors for the proposed dividend do not constitute `reserves’ and the concerned amounts so set apart would have to be ignored or excluded from capital computation.”

It has further been held applying the aforesaid principles to the facts before the Supreme Court that : “Where after the accounts for the calendar year 1972 were finalised the directors transferred out of the profits a sum of Rs. 61,03,352 of the year, to the general reserve of the company and the directors did not make any provision for the proposed dividend but recommended a dividend and at the annaul general meeting held on 30th June, 1973, a dividend of Rs. 3,10,450 was declared and was paid thereafter, the sum of Rs. 3,10,450 had to be excluded from the general reserve while computing the capital of the assessee as on 1st Jan., 1973 for the asst. yr. 1974-75.”

In view of the authoritative pronouncement of the Supreme Court on the point, all the aforesaid questions under

Topic II will have to be answered in the negative, i.e., against the assessee and in favour of the Revenue.

Questions covered by Topic III.—So far as this topic is concerned, the two questions referred for our opinion pertain to asst. yrs. 1968-69 and 1969-70 and they deal with the character of loans taken by the assessee-company from Bank of Baroda. For earlier assessment years for the same assessee-company this Court in New India Industries Ltd. vs. CIT (1977) 108 ITR 181 (Guj) has already held that the said loan qualified for inclusion in computation of the assessee’s capital for the purposes of surtax chargeable under the Act. As the said decision is rendered in connection with the very same loans taken by the assessee company from Bank of Baroda and which has been held to be includible in the capital computation of the company for earlier yeArs under the very same Act, the ratio of the decision of this Court in (1977) 108 ITR 181 (Guj) (supra) will squarely get attracted for answering similar and identical questions covered by topic III. Consequently, question No. 2 for asst. yr. 1968-69 and question No. 2 for asst. yr. 1969-70 under the same topic will have to be answered in the affirmative, in favour of the assessee and against the Revenue. Questions covered by Topic IV .—That takes us to consideration of the last topic IV. To recapitulate, these questions pertain to giving of credit for proportionate value of bonus shares and they arise in connection with the asst. yrs. 1967-68 and 1969-70. So far as these questions are concerned, it is necessary to have a look at r. 3 of the Rules found in the Second Schedule. Rule 3 reads as under : “Where after the first day of the previous year relevant to the assessment year the capital of a company as computed in accordance with the foregoing rules of this Schedule is increased by any amount during that previous year on account of increase of paid-up share capital or issue of the debentures, referred to in cl. (iv) or borrowing of any moneys referred to in cl. (v), of r. 1 or is reduced by any amount on account of reduction of paid-up share capital or redemption of such debentures or repayment of any such moneys, such capital shall be increased or reduced, as the case may be, by a sum which bears to that amount the same proportion as the number of days of the previous year during which the increase or the reduction remained effective bears to the total number of days in that previous year.”

Before we go to various decisions to which our attention was invited by both the sides on this aspect, it must be made clear at the outset that bonus shares were issued by capitalising part of the general reserve and that happened after the first day of the previous year relevant to the assessment year in question. It also cannot be disputed that when bonus shares are issued, the paid-up capital of the concern gets augmented by the value of the bonus shares. However, before r. 3 can be pressed in service by the assessee-company, the following requirements of r. 3 have to be satisfied as a matter of fact by the concerned assessee-company : (1) Capital of the company as computed in accordance with r. 1, as we are not concerned with r. 2 in such case, must have got increased by any amount during that previous year. (2) Such increase should be on account of increase of paid-up share capital or issue of the debentures referred to in cl. (iv) or borrowing of any moneys referred to in cl. (v) of r. 1. If these conditions are satisfied, then only, there would remain occasion for the company to get benefit contemplated by second part of r. 3 to the effect that such capital computed as per r. 1 in such eventuality will be permitted to be increased by a sum which bears to the amount of such increase of paid-up share capital or issue of debentures or borrowings the said proportion as the number of days of the previous year during which the increase in the paid-up share capital or issue of debentures or borrowings of any money as the case may be bears to the total number of days in that previous year. The aforesaid analysis of r. 3, therefore, makes it clear that before r. 3 can be pressed in service by the assessee-company, it must be shown that capital base for the said company as on the first day of the previous year relevant to the assessment year as per r. 1 undergoes a hike after that day, of course during the relevant assessment year. If this basic condition is not satisfied, r. 3 will not be attracted at all and consequently, there will be no occasion for the concerned assessee-company to claim benefit of consideration of increase in the capital base so computed to the extent indicated by the last part of r. 3. In other words, r. 3 will not click at all and would be out of picture for computing the capital of the company for the purpose of surtax as per the Second Schedule.

In the light of the aforesaid clear statutory scheme of r. 3, let us see whether factually, in the present case, there was any increase in the capital base of the company as computed on the first day of the previous year relevant to the assessment year, by any increase in that capital base under the contingencies contemplated by r. 3. In order to focus attention on this question, we may mention the main relevant heads which were taken into consideration for computing capital of the assessee-company during the relevant assessment year which by way of illustration, is taken as asst. yr. 1967-68. For this year, as noted earlier, the first day of the previous year is 1st Jan., 1966. As per r. 1, total capital base of the company as on 1st Jan.,1966 as per r. 1 of Second Schedule comprised amongst others of the following items : Its paid-up capital was Rs. 69,97,800. Its general reserve being items contemplated by r. 1(iii) was Rs. 60,75,000. The total of these two figures works up to Rs. 1,30,72,800. In order to highlight the real controversy between the parties, we may not take into consideration the other sub-heads of r. 1 for computing the aggregate of the amounts which entered the computation of the total capital base as on 1st Jan., 1966 as there is no dispute about the same. Now, this was the situation regarding the aforesaid two items which entered computation of the aforesaid capital base as on 1st Jan., 1966 as per r. 1(i) and (iii). According to the assessee company, on 27th July, 1966, i.e., during the same previous year, paid-up share capital of the company got a hike as company’s bonus shares to the tune of Rs. 18,32,600 were issued out of general reserve by capitalising the general reserve to that extent. For the purpose of second part of r. 3, proportionate increase which could be taken into consideration was for 158 days which were remaining part of the previous year during which this hike in the paid-up capital remained in force. That proportionate increase worked up to Rs. 7,93,318. Now, if this amount is to be added to the paid-up capital as on 1st Jan., 1966, the paid-up capital as on 1st April, 1966 viz., Rs. 69,97,800 will get augmented by Rs. 7,93,318, i.e., Rs. 77,91,118. It is obvious that this hike in the paid-up capital by issuance of bonus shares was matched by corresponding reduction in the general reserve as earlier computed as on 1st Jan., 1966 as per r. 1(iii) for the simple reason that this figure of Rs. 7,93,318 was taken out of general reserve and was capitalised for the purpose of computation as per r. 3, for 158 days by issuance of total bonus shares of Rs. 18,32,600. Consequently, what happened on 27th June, 1966 by way of issuance of bonus shares had the following two effects. (1) Rs. 7,93,318 got added to the paid up share capital of the company as earlier existing on 1st Jan., 1966 and (2) to the same extent, general reserve of Rs. 60,75,000 got depleted with the result that general reserves were reduced to Rs. 52,81,682. In short, what was added to the paid-up share capital was reduced from the general reserve figure. Consequently, original amount of capital base as on 1st Jan., 1966 considering paid-up share capital and general reserve figures remained the same even on 27th July, 1966. As shown earlier, by adding two figures of paid-up capital of Rs. 77,91,118 and reduced general reserve figure of Rs. 52,81,682, the aggregate of capital base again works up to Rs. 1,30,72,800. Consequently, there was no increase in the capital base as computed under r. 1 as on 1st Jan., 1966 even on 27th July, 1966 when part of the general reserve was capitalised and was converted into bonus shares. On these facts, therefore, the conclusion becomes inevitable that capital of

the company as computed as per r. 1 as on 1st Jan., 1966 for the relevant previous year did not increase even by a rupee, after that date, during the relevant previous year at any time. As the very first condition for applicability of r. 3 did not exist in fact, there was no occasion for the company to contend that it was entitled to the benefit of r. 3 as contemplated by second part of r. 3. For coming to this conclusion, no question of reducing figure of general reserve as utilised for the purpose of coming to the total capital base as per r. 1 as on 1st Jan., 1966 arises. For applicability of r. 3, it was to be found out whether in fact, there is any hike in the total capital base as contemplated by r. 1 at any time subsequently during the last previous year. If the answer is `no’ as in the present case, r. 3 will not start clicking at all. The general reserve figure that had entered computation under r. 1 as on 1st Jan., 1966 is not being reduced for finding out the correct figure of general reserve as obtained on 1st Jan., 1966. Reduction of that figure for the purpose of r. 3 is on account of undisputed position that general reserves were pro tanto reduced and capitalised to the extent of amount of bonus shares issued therefrom. Therefore, hike in the paid-up capital gets its mirror image in the automatic pro tanto reduction in the general reserve figure as obtaining on the date when such exercise of issuance of bonus shares by reducing to that extent the general reserve takes place. It is almost automatic and logical corollary of issuance of bonus shares out of general reserve. If this consideration is kept out of picture and r. 3 is read in isolation and if it is accepted that only hike in paid-up capital should be taken into consideration and corresponding automatic decline in the figure of general reserve as obtaining on the date of issuance of bonus shares should be kept out of picture, then absolutely wrong result would follow and very operation of r. 3 would be rendered topsy turvy. It is, therefore, not possible on a clear language of r. 3 to accept the contention of the learned advocate for the assessee that for applicability of r. 3, while deciding the question of increase in the capital base as earlier computed on 1st Jan., 1966 only one side of the picture should be taken into account, viz., increase in the paid-up capital as on 27th July, 1966 by adding Rs. 7,93,318 to the figure of paid up capital as on 1st Jan., 1966 and corresponding automatic deduction to the same extent in the figure of general reserve out of which this amount has flown should be ignored. That would be contrary to accepted principle of accountancy and even simple airthmetic. In this light, it would be profitable to have a look at the earlier provision which was found in Second Schedule of r. 2 of Super Profits Tax Act, 1963. The said rule read as under : “2. Where, after the first day of the previous year relevant to the assessment year, the paid-up share capital of a company is increased or reduced by any amount during that previous year, the capital computed in accordance with r. 1 shall be increased or decreased, as the case may be, by a portion of that amount which is proportional to the portion of the previous year during which the increase or the reduction of the paid-up share capital remained effective.” A mere look at the said rule as contrasted with present r. 3 of Schedule II of 1964 Act will show that as per earlier r. 2 of 1963 Act, all that was taken into consideration was increase in the paid-up share capital; while in the present rule, before it can apply, increase in the capital base as computed under r. 1 has to be shown to have taken place. Therefore, under earlier r. 2, when bonus shares were issued by capitalising the amount of reserve subsequent to the first day of the previous year relevant to the assessment year, the said increase only was to be taken into consideration and the fall in the general reserve to the extent of its being capitalised and converted into declaration of bonus shares was to be ignored. That is not the scheme as contemplated by r. 3. Under the circumstances, on facts, it has to be held that capital as computed as on 1st Jan., 1966 for the purpose of r. 1 did not get augmented even by a rupee and remained the same even on 27th July, 1966 when the bonus shares worth Rs. 18,32,600 were issued for the period covering the remaining 158 days of the previous year. Consequently, r. 3 was out of picture and cannot be of any avail to the assessee-company. It is now time for us to turn to consideration of various authorities on which reliance was placed by both the parties.

9. At the outset, we may turn to a decision of this Court in Ahmedabad Mfg. and Calico Pvt. Ltd. vs. CIT (1986)

57 CTR (Guj) 151 : (1986) 162 ITR 800 (Guj). In a different context whether expenditure incurred towards issuance of bonus shares was capital expenditure or revenue expenditure, the Division Bench speaking through R.C. Mankad, J. laid down as under : “It is clear that when bonus shares are paid, two things take place : (i) bonus is paid to the shareholders; and (ii) wholly or partly paid-up shares are issued against the bonus payable to the shareholders. The shareholders invest the bonus paid to them in the shares and that is how the bonus shares are issued to them. Bonus shares are no different from rights shares. The bonus shares issued by the assessee company also constitute its capital.” There cannot be any dispute that issuance of bonus shares out of its general reserve adds to the paid-up capital of the company. But the question with which we are concerned in the present case is entirely different. For the purpose of r. 3, the moot question is whether hike in paid-up share capital as earlier existing on first day of the previous year by issuance of bonus shares by capitalising part of the general reserve as might be existing on the first day of the previous year, would result in real increase in the capital base of the company or not. For deciding that question, the aforesaid decision relied upon by the learned advocate for the assessee would not be of any assistance.

10. The learned advocate for the Revenue on the other hand invited our attention to the decision of the Bombay High Court in CIT vs. Century Spg. and Mfg. Co. Ltd. 1977 CTR (Bom) 132 : (1978) 111 ITR 6 (Bom) considering this very question, it was held interpreting r. 3 of the rules by the Division Bench consisting of Kantawala C.J. and Tuzapurkar, J. (as he then was) that : “If, during the course of the previous year, a part of the amount standing to the credit of the general reserve is capitalised by issue of fully paid-up bonus shares, it cannot be said that the capital of the company computed in accordance with r. 1 of the Second Schedule is increased by any amount by such issue of bonus shares. What happens in such a case is that a part of the sum standing to the credit of one of the sub items to be included in the computation of capital is during the previous year transferred to another item to be included in the computation of capital under r. 1. Therefore, when bonus shares are issued as fully paid-up shares by capitalisation of a part of the amount standing to the credit of the general reserve, the capital as computed in the manner provided by r. 1 of the Second Schedule, is not increased in any manner whatsoever.”

The Division Bench also distinguished the decision of the Himachal Pradesh High Court in CIT vs. Mohan Meakin Breaweries Ltd. (1974) 95 ITR 586 (HP) on the ground that the said decision was rendered in the light of erstwhile r. 2 of 1963 Act which was differently worded as we have seen earlier. We respectfully agree with the aforesaid view of the Bombay High Court, as on construction of r. 3, in our view, it would be impossible to hold as we have seen earlier, that capital base had undergone increase after the first day of the relevant previous year only because any sub-item which has entered into computation has got an increase matched by proportionate deduction in other sub-items entering the very same computation as per r. 1.

The aforesaid decision of the Bombay High Court was followed by a later Division Bench of the Bombay High Court in CIT vs. Zenith Steel Pipes Ltd. (1990) 81 CTR (Bom) 174 : (1990) 181 ITR 291 (Bom) wherein the Division Bench consisting of S.P. Bharucha (as he then was) and T.D. Sugla, JJ. took the same view on this very question and fell in line with earlier view expressed in (1978) 111 ITR 6 (Bom) (supra). Mr. Shelat for the Revenue then took us to Deepak Insulated Cable Corpn. Ltd. vs. CIT (1990) 82 CTR (Kar) 260 : (1990) 187 ITR 436 (Kar) wherein the Karnataka High Court while considering the very same question, speaking through S. Rajendra Babu, J. observed that : “When a part of amount standing to the credit of a general reserve is, during the course of the previous year, capitalised by issue of fully paid-up free bonus shares there is no increase by any amount in the capital computed in accordance with the provisions of rr. 1 and 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964”.

For coming to the said view, reliance was placed on the aforesaid decision of the Bombay High Court as well as decisions of the Calcutta High Court in Alkali & Chemical Corpn. of India Ltd. vs. CIT (1980) 122 ITR 490 (Cal) and Indian Explosives Ltd. vs. CIT (1985) 49 CTR (Cal) 19 : (1985) 153 ITR 340 (Cal). We may, therefore, turn to the two decisions of the Calcutta High Court. In Alkali and Chemical Corporation of India Ltd. vs. CIT (supra) the Division Bench of the High Court speaking through Dipak Kumar Sen, J. made the following pertinent observations; while interpreting rule 3 firstly in isolation and then in the context of rr. 1 and 2, r. 3 of the Second Schedule : “Rule 3 of Sch. II to the Companies (Profits) Surtax Act, 1964 read in isolation from the other rules may suggest that any increase or decrease in the paid-up share capital by itself would lead to an increase or decrease of the capital. There is no indication in this rule that there has to be a further inquiry as to the depletion of the capital on the other items. But if r. 3 is read along with rr. 1 and 2, the matter becomes clear. What is ultimately to be computed under Sch. II is the amount of capital and in the computation of the amount of capital the amount of reserve is a necessary item. While taking note of the increase of share capital by issue of bonus shares out of reserves, the corresponding decrease in the amount of reserves cannot be overlooked. It may be possible to take two views of the matter but an alternative view can only be taken by misreading the rules. If by misreading a provision a mistake has been committed, such a mistake can be rectified”.

The aforesaid decision was later followed by another Division Bench of the Calcutta High Court to which also Dipak Kumar Sen, J. was a party. That decision was rendered in Indian Explosives Ltd. vs. CIT (supra). It has been held therein : “The amount representing the increase in the share capital of a company as a result of capitalisation of part of its reserves is not to be included in the capital base under r. 3 of Sch. II to the Companies (Profits) Surtax Act, 1964 and the inclusion of the said amount in the capital base in the original assessment is a mistake apparent from the record”.

13. We were then taken to the view expressed on similar lines by a Division Bench of the Madras High Court in CIT vs. Sundaram Clayton Ltd. (1982) 31 CTR (Mad) 3 : (1983) 140 ITR 235 (Mad). Balasubrahmanyan J. speaking for the Division Bench has made the following observations on this very question : “The mere act of capitalising part of the reserves and issuing bonus shares does not mean that there is any influx of additional capital into the company over and above what figured as the opening capital on the liabilities side of the balance sheet consisting of the paid-up capital and the reserves among other things. Though the process of issuing bonus shares would increase the paid-up capital of the company as far as the liabilities side of the balance sheet is concerned, what happens is that a sum equivalent to the value of the bonus shares is carved out from the reserves and placed in the earlier column of the paid-up capital of the company on the very liabilities side of the balance sheet and this process of conversion of reserves into bonus shares does not reduce or increase the overall capital of the company which remains the same as it was in the beginning of the year. The capital of the company according to the Surtax Act which includes the paid-up capital and reserves does not undergo any change merely because a part of the reserves is capitalised into bonus shares and shown as capital. What r. 3 of the Second Schedule to the Surtax Act contemplates is that quite apart from the figure of capital as on the first day of the previous year the capital must, subsequent thereto, get increased during the previous year by way of an addition to any part of the capital so computed, whether the increase is to the paid-up capital or whether it be to the reserves or to any other item figuring on the liabilities side of the balance sheet. In other words, there must be a fresh influx of capital into the company in order to attract r. 3”. The same view is taken by the Delhi High Court in Addl. Commr. of Surtax vs. Food Specialities Ltd. (1981) 23 CTR (Del) 65 : (1981) 129 ITR 731 (Del). Ranganathan, J. (as he then was) speaking for the Delhi High Court while interpreting r. 3 of Second Schedule made the following pertinent observations : “Rule 3 of Schedule II contemplates an increase in the capital computation only where there is an increase in the capital of the company as computed in accordance with the earlier rules, that is to say, an increase in the capital of the company as computed in accordance with r. 1. In a case where the paid-up capital is increased but this is done by utilising a portion of the reserves which have been taken into account in the capital computation as on the first day of the previous year, then it is clear that the capital of the company computed in accordance with r. 1 has not increased at all. That being so, the assessee cannot invoke the aid of r. 3 to increase capital computation proportionately to the increase in the paid-up capital. It is only to the extent of surplus or excess over the capital as computed at the beginning of the accounting period, that the assessee gets relief as envisaged in r. 3. On a plain reading of r. 3, it is clear that the assessee cannot claim any stepping up of the capital computation in respect of an amount which is already included in the capital computation as on the first day of the previous year”.

We respectfully concur with the aforesaid views on this question as propounded by the Bombay High Court, Calcutta High Court, Delhi High Court, Karnataka High Court and the Madras High Court. As we have already discussed earlier, on interpretation of r. 3 read with r. 1, the aforesaid conclusion almost automatically follows.

14. However, the learned advocate of the assessee tried to salvage the situation by inviting our attention to two decisions of the Bombay High Court which according to him, were taking a view contrary to the view propounded by other Division Bench of the Bombay High Court in (1978) 111 ITR 6 (Bom) (supra). It is, therefore, necessary to discuss these decisions. In CIT vs. Geofrey Manners and Co. Ltd. 1977 CTR (Bom) 607 : (1978) 112 ITR 334 (Bom), the very Division Bench of Kantawala, C.K. and Tulzapurkar (as he then was) considered the question whether increase of paid-up capital by issuance of bonus shares out of general reserve of the company would result in hike in the paid-up share capital. It is pertinent to note that the question posed for consideration before the Division Bench in the aforesaid case was in context of r. 2 of Second Schedule of 1963 Act. We have already shown the difference in the phraseology of that rule and present r. 3 of 1964 Act. On the language of r. 2 of Second Schedule of 1963 Act, it was noticed that when bonus shares were issued after first day of the previous year, out of general reserve and when r. 2 of 1963 Act contemplates taking into consideration only increase in paid-up share capital and not increase in total capital base as existing on the first day of the previous year, the conclusion was inevitable in the light of that rule that benefit of increase in paid-up share capital would accrue to the assessee company. In fact, that is precisely the reason why the Division B112 ITR 334 (supra), while interpreting r. 2 of 1963 Act took the view that in the light of the language of r. 2 in the Second Schedule to the 1963 Act, it is clear that by reason of the issuance of such bonus shares `the paid-up share capital’ of the company could be said to have been increased. The simple question that the Court was called upon to decide was whether the paid-up share capital of a company is increased or not, and it can never be disputed that by issuance of bonus shares, the paid-up capital of a company is increased. The assessee was, therefore, entitled to the proportionate increase of Rs. 2,14,495 in terms of the Second Schedule to the 1963 Act. The Division Bench, therefore, distinguished its own decision in (1978) 111 ITR 6 (Bom) (supra). In fact, the decision in (1978) 112 ITR 334 (Bom) (supra) falls in line with Himachal Pradesh High Court decision in (1974) 95 ITR 586 (HP) (supra). We fail to appreciate how this decision of the Bombay High Court can be of any avail to the assessee as in the present case, we are not concerned with r. 2 of the Second Schedule to the 1963 Act but we are concerned with r. 3 of the Second Schedule to the 1964 Act which is entirely differently worded.

15. We were then taken to other decision of the Bombay High Court in CIT vs. New Swadeshi Sugar Mills Ltd. (1984) 41 CTR (Bom) 376 : (1985) 151 ITR 220 (Bom). The Division Bench consisting of Kania (as he then was) and Mrs. Sujata Manohar, JJ. was concerned with interpretation of r. 1 independently of r. 3. While considering r. 1 alone, it was observed by Kania, J. : “It is well settled in law that when the directors declare their decision to issue bonus shares, no liability is incurred by the company at least till a resolution for the issue of bonus shares is passed at an extraordinary general meeting of the shareholders. Hence, in the instant case till the resolution was passed on 30th Oct., 1966, it could not be said that the amount of the general reserves stood reduced by the amount intended to be capitalised for the issuance of bonus shares or that the amount required for the purpose of such capitalisation was converted from its character as general reserves to the character of a provision. The entire amount standing to the credit of the general reserves on the first day of the previous year had, therefore, to be included in the capital computation for purposes of surtax without reducing therefrom any sum in respect of the amount capitalised subsequently during the previous year for issuing bonus shares”. (Emphasis, italicized in print, supplied). So faras question pertaining to applicability of r. 3 for which proportionate increase in the bonus shares being capitalised from the reserve and to that extent reserves had to be reduced was concerned, on the wordings of questions referred for opinion, a view was taken that : “It was not open to the Department to raise the question that the ITO and the Tribunal should not have added Rs. 15,19,101 in the capital computation as the question referred was in the form of an alternative and pertained to the amount to be deducted from the general reserve and did not relate to computation of paid-up capital of the assessee”. Therefore, there was no occasion for the Division Bench to consider whether ratio of the Division Bench judgment of the Bombay High Court, in (1978) 111 ITR 6 (Bom) (supra) was right or not. If they had disagreed with that ratio, they would have referred the matter to a larger Bench. But they have not done so as they have concentrated only on interpretation of r. 1 de hors r. 3. Such is not the position in this case. The questions referred to us are widely worded and they include both positive and negative aspects viz. whether the Tribunal was right in law in holding that the assessee had to be given credit for proportionate value of bonus shares in view of r. 3 of the Second Schedule to the Act and that for this purpose, no adjustment should be made to the general reserve. Thus, aspects of both proportionate increase in the paid-up capital and corresponding deduction in the general reserves for the purpose of r. 3 are placed for our consideration in these questions and consequently, the entire working of r. 3 in juxtaposition with r. 1 is open on the anvil of consideration before us. It is, therefore, not possible to agree with the contention of the learned advocate for the assessee that (1985) 151 ITR 220 (Bom) (supra) takes a view which is contrary to earlier view taken in (1978) 111 ITR 6 (Bom) (supra).

So far as reliance placed on another decision of the Bombay High Court in CIT vs. Atlas Corporation (India) Ltd. (1989) 80 CTR (Bom) 154 : (1990) 181 ITR 151 (Bom) is concerned, it also falls in line with earlier decision in (1985) 151 ITR 220 (Bom) (supra) viz. that for computing capital of the company as per r. 1, general reserves cannot be reduced by value of bonus shares issued after first day of the previous year. The Division Bench speaking through T.D. Sugla, J. at page 153 made it clear that the question whether the proportionate amount of bonus shares issued during the previous year out of the general reserve should be added to the capital for the purpose of surtax was not before them. It was not the issue even before the Tribunal. The AAC had decided the issue in favour of the assessee and the Department had accepted the decision and not carried the dispute further in appeal before the Tribunal. Therefore, it is obvious that even before the later Bench of the High Court of Bombay, the only controversy centred round the question whether the amount of reserve as standing on the first day of the previous year could be reduced while computing capital base on the 1st day of the previous year. The question wheher for the purpose of r. 3 read with r. 1, any consequent increase in the paid-up capital had any effect on the capital base after the first day of the previous year was not before the Division Bench. So far as the present proceedings are concerned, this question has squarely arisen for our consideration in the light of the wordings of questions referred to us and, therefore, even the above decision of the Bombay High Court in (1990) 181 ITR 151 (Bom) (supra) will be of no assistance to the learned advocate for the assessee.

Before parting with discussion on this question, we may mention one submission of the learned advocate for the assessee. He submitted that the ITO in his original assessment had accepted proportionate increase to the paid-up share capital by the amount as contemplated by second part of r. 3. That in the rectification order, his only grievance was that proportionate reduction in the general reserves was not made and, therefore, he made proportionate deduction in the general reserve. Therefore, so far as increase in the capital was concerned, ITO having accepted the company’s case, now the Revenue cannot go behind the same and urge that there is no increase as per r. 3. This submission is totally misconceived for the simple reason that as discussed earlier, for applicability of r. 3, it must be shown that there was increase in the capital base as existing on the first day of the previous year and as computed as per r. 1, granting of proportionate increase in the paid-up share capital subsequently by issuance of bonus shares would not mean that the Revenue had conceded at any stage that r. 3 benefit will be available to the assessee. The submission of the learned advocate of the assessee wrongly assumed proportionate increase in the paid-up share capital for the purpose of r. 3 is equivalent to increase in the capital base as computed under r. 1. Such an argument in the light of clear language of r. 3 of the present Act cannot be sustained. It would have stood on a firmer footing if r. 3 of the present Act was framed on the same lines as r. 2 of the Second Schedule to the 1963 Act.

For all these reasons, it must be held on the facts of the present case and in the light of the aforesaid decisions of various High Courts on interpretation of r. 3 read with r. 1 with which we respectfully agree, that it is impossible to take the view that the capital base of the company had increased after the first day of the previous year because it had capitalised part of the general reserve and converted it into fully paid company’s bonus shares issued to its members. Consequently, both the questions in topic IV viz. questions No.3 for asst. yr. 1967-68 and question No. 1 for asst. yr. 1969-70 have to be answered in the negative that is in favour of the Revenue and against the assessee.

References disposed of accordingly with no order as to costs.

[Citation : 202 ITR 619]

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