The following Judgment of the Court was delivered: SEN,J.
The appellant is a public limited company. The assessment years involved are 1972-73, 1973-74 and 1974-75. In regarded to the above assessment years, in the returns of Income filed by the appellant before the assessing authority, a claim towards allowance of development rebate under section 33 of the Income-tax Act, 1961 (hereinafter referred to as ’the Act’) was made., The assessing authority allowed the claim as made by the company. Subsequently, the assessing authority noticed from the balance sheet of the appellant company that the company had made a transfer for sums from the development rebate reserve to share capitalisation account by issue of bonus shares. The assessing authority concluded that the issuance of bonus shares amounted to distribution of profits by capitalisation and thus the assessing authority was of the view that the provisions of section 155(5)(ii)(a) of the Act applied to the instant case, as the development rebate reserve has been utilised for distribution by way of dividend or profits. Accordingly, the assessing authority passed an order under section 154 of the Act withdrawing the development rebate claim allowed earlier.
The Company went up on appeal. The appellate authority allowed its appeal. The claim of the appellant for development rebate was sustained.
The appellate Tribunal on the Revenue’s appeal concurred with the view taken by the first appellate authority and concluded that there was no distribution by way of dividend or profits in the issue of bonus shares.
Thereafter, on the application by the Commissioner of Income-tax, the following questions of law were referred to the High Court :
"(a) Whether on the facts and in
the circumstances of the case the
ITAT is right in law in holding
that issue of bonus shares from out
of the development rebate reserve
did not account to distribution of
profits within the meaning of
section 34(3)(a)(i) and section
155(5)(ii)(a)?
(b) Whether or the facts and in the
circumstances of the case the ITAT
is right in law in holding that the
ITO is not justified in withdrawing
the development rebate?"
The High Court after examining the provisions of Section 34(3)(a)(i) and Section 155(5)(ii)(a) of the Income Tax Act held that the issue of bonus shares resulted in distribution of profits and therefore, the statutory requirement of Section 34(3)(a)(i) of the Act had been violated. The High Court answered both the questions in the negative and in favour of the Revenue. The assessee has come up on appeal to this Court.
Section 33 of the Act deals with allowance of development rebate in respect of a new ship or new machinery or plant owned by the assessee, if it was wholly used for the purpose of business carried on by him. The allowance is given subject to a number of conditions. We are concerned in this case with the condition laid down in Section 34, which is as under:
"34(3)(a). The deduction referred
to in Section 33 shall not be
allowed unless an amount equal to
seventy five per cent of the
development rebate to be actually
allowed is debited to the profit
and loss account of the relevant
previous year and credited to are
reserve account to be utilised by
the assessee during a period of
eight years next following for the
purposes of the business of the
undertaking, other than-
(i) for distribution by way of
dividends or profits."
Section 155(5)(ii)(a) which is also relevant in this case is as under :
"(5). Where an allowance by way of
development rebate has been made
wholly or partly to an assessee in
respect of a ship, machinery or
plant installed after the 31st day
of December, 1957 in any assessment
year under Section 33 of the Indian
Income-tax Act, 1992 (XI of 1922),
and subsequently-
(ii) at any time before the expiry
of the eight years referred to in
sub-section (3) of Section 34, the
assessee utilised the amount
credited to the reserve account
under clause (a) of that sub-
section-
(a) for distribution by way of
dividends or profits."
The assessee created a development rebate fund to avail of the deduction under Section 33. Section 34(3)(a) does not prohibit the assessee from using any amount credited to the fund for the purpose of the business but he cannot utilise the amount for eight years for "distribution by way dividends or profits". If the Income-tax Officer finds that the assessee had utilised any amount out of the reserve fund for distribution by way of dividends or profits, he can withdraw the allowance given under Section 33 by shareholders entitling them to participate in the amount of the reserve but only as part of the capital.
The mechanism and effect of issue of bonus shares have been explained by the English Courts in a number of cases. Lord Haldane in the case of Inland Revenue Commissioners vs. Blott (1921) AC 171 held:
"My Lords, for the reasons I have
given I think it is as matter of
principle, within the power of an
ordinary joint stock company with
articles such as those in the case
before us to determine conclusively
against the whole world whether it
will withhold profits it has
accumulated from distribution to
its shareholders as income, and as
an alternative not distribute them
at all, but apply them in paying up
the capital sums which shareholders
electing to take up unissued shares
would otherwise have to contribute.
If this is done, the money so
applied is capital and never
becomes profits in the hands of the
shareholder at all. What the
latter gets is no doubt a valuable
thing. But it is a thing in the
nature of an extra share
certificate in the company."
In that case, Viscounts Haldane, Finally and Cave held that an amount equal to the face value of the shares could not be regarded as received by the shareholders. A contrary view was taken by Lord Dunedin and Lord Summer who held that the word "capitalisation" was somewhat hazy and the amount that was capitalised had to be treated as to have been paid to the shareholders.
In the case of Commissioners of Inland Revenue v. fisher’s Executors, (1926) A.C. 395, Viscount Cave dealt proceeding under Section 155.
In this case there is no allegation that the assessee has distributed any dividend out of the amounts standing to the credit of the fund. But the assessee issued bonus shares and for that purpose transferred the amount standing to the credit of the fund to the share capital account. The question is whether under these circumstances issuance of bonus shares will amount to distribution of profits.
The answer to the question is not easy. One view is that issue of bonus shares to the shareholders involves a dual operation by which an amount is released to the shareholders from a reserve fund but was retained by the Company and applied in payment of the bonus shares which were issued as fully paid up. The shareholders are treated as having paid for the bonus shares and the supposed payments by the shareholders are taken to share capital account from reserve fund of the Company. In effect, the shareholders have paid the face value of the bonus shares. It was to all intents and purposes equivalent to distribution of accumulated profits in cash by the Company.
The second view is that when bonus shares are issued an amount equal to the face value of the shares cannot be regarded as having been received by the shareholders. The issuance of bonus shares was nothing but mere capitalisation of the profits of the company in respect of which certificates are issued to the with a case of company which had large undistributed profits. It decided to capitalise a part of these profits and distribute it pro rata among the ordinary shareholders as a bonus in the form of five per cent debenture stock. The stock was duly issued, conditions providing that the Company might redeem the stock after a certain time and in certain events. The question that came up for decision was whether the bonus paid in the form of debenture stock was income in the hands of the shareholders and was, therefore, liable to super tax. Viscount cave held:
"The whole transaction was "bare
machinery" for capitalizing profits
and involved no release of assets
either as income or as capital."
In coming to this conclusion, Viscount Cave relied upon the following observation of Lord Finlay in Blott’s case:
"The general scope and effect of
these transactions is beyond
dispute. There was an increase in
the capital of the company by the
retention of the amounts available
for dividends.....The use of the
sums which had been available for
dividend to increase capital would
enable the company to carry on a
larger and more profitable
business, which might be expected
to yield larger dividends. The
dividends, however, were to be in
the future. So far as the present
was concerned there was no dividend
out of the accumulated profits;
these were devoted to increasing
the capital of the company. The
company had power to do what it
pleased with any profits which it
might make. It might spend the
accumulated profits in the
improvement of the company’s works
and buildings and machinery. These
improvements might lead to a great
accession of business and increase
of profits by which every
shareholder would benefit, but of
course it could not for a moment be
contended that such a benefit would
render him liable to super tax in
respect of it. The benefit would
not be in the nature of income, and
super tax can be levied only on
income."
In our view, the principle stated by Lord Finlay really resolves the controversy raised in this case. The profits made by the Company may be distributed as dividends or retained by the Company as its reserve which may be used for improvement of the company’s works, buildings and machinery. That will enable the company to make larger profits. There cannot be any dispute that the shareholders will benefit from the improvements brought about in the profit making apparatus of the Company. Likewise, if the accumulated profits are capitalised and capital base of the Company is enlarged, this may enable the Company to do its business more profitably. The shareholders will also benefit if the share capital is increased. They may benefit immediately by issue of bonus shares. But neither in the case of improvement in the profit making apparatus nor in the case of expansion of the share capital of the Company, can it be said that the shareholders have received any money from the Company. They may have benefited in both the cases. But this benefit cannot be treated as distribution of the amount standing to the credit of any reserve fund of the Company to its shareholders.
In fact, the transfer of the amounts standing to the credit of Development Rebate Reserve to the share capital account, does not involve any disbursement of money by the Company. Nothing comes out of the till of the Company to the shareholder. The entire amount of money shown as development rebate reserve is retained by the Company in another account. It cannot be said that by the issue of bonus shares, the company had distributed its reserve fund to the shareholders even though it had retained the entire amount with it in the share capital account.
It must also be noted that while dealing with the question of valuation of bonus shares in the case of Commissioner of Income-Tax, Bihar vs. Dalmia Investment Co.Ltd. 52 ITR 567, Hidayatullah, J. (as His Lordship then was) after referring to Blott’s case (supra), preferred the view expressed by Viscounts Haldane, Finlay and Cave to the dissenting view taken by Lord Dunedin and Lord Summer. Dealing with effect of issue of bonus shares, Hidayatullah, J. held that "the floating capital used in the company which formerly consisted of subscribed capital and the reserves now becomes the subscribed capital of the Company". The certificates in the hands of the shareholders were property from which income will be derived in future.
Hidayatullah, J. in Dalmia’s Case, also quoted with approval a passage from a decision of the Supreme Court of United States, Eisner v. Macomber (1920) 252 U.S. 189:
"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
interest 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
interests that the original shares
represented before the issue of the
new ones.....In short, the
corporation is no poorer and the
stock-holder is no richer than they
were before....If the plaintiff
gained any small advantage by the
change, it certainly was not an
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."
When a shareholder gets a bonus share the value of the original share held by him goes down. In effect, the shareholder gets two shares instead of the one share held by him and the market value as well as the intrinsic value of the two shares put together will be the same or nearly the same as the value of the original share before the bonus issue.
It appears from the various decisions cited hereinabove, that issuance of bonus shares does not amount to distribution of accumulated profit of a company. The shareholder derives some benefit by the process of capitalising of the accumulated profits but at the same time, the value of his original shareholding goes down. Viewed from any angle, it cannot be said that in this case, the assessee-Company had distributed any part of its Development Rebate Reserve Fund when it issued the bonus shares. The accumulated profit lying to the credit of the Development Rebate Reserve has been retained by the Company. The amount has been transferred to the share capital account, If that was not done the intrinsio value of the shares held by the shareholders would have been more. After the issue of the bonus shares, the intrinsio value of the original shares have gone down rateably. The accumulated profits of the Company have remained with the Company in one account or another.
On behalf of the Revenue, our attention was drawn to the judgment in the case of Leader Engineering Works vs. Commissioner of Income Tax, Amritsar-II 124 ITR 44. That was a case of partnership firm. The amount standing to the credit of development rebate reserve account was debited and the capital accounts of the partners in the partnership account were correspondingly credited. It was held that the identity of the development rebate reserve account had completely disappeared. The amount standing to the credit of that reserve was placed at the disposal of the partners who were free to withdraw the same for their own purposes. In that case it was held that the transfer of the amount standing to the credit of the development rebate reserve in the individual’s account of the partners amounted to distribution of profits. We fail to see how this decision helps the Revenue in the facts of this case. The shareholders are not entitled to draw any money from the share capital account of the company. The money standing to the credit of the Development Rebate Reserve is retained by the Company in another account. A shareholder cannot claim that any part of the share capital of the company belongs to him or make use of its.
The question as to the substance of the transaction was also raised. The case, however, has to be decided on the basis of the language of the statute. There has been no distribution from the development rebate fund. The result might have been different had the statute been differently worded but we shall have to take the stature as it is and not in any other sense. Moreover, as was pointed out by Lord Summer in Fisher’s case that desires and intentions are things of which a company is incapable. These are the mental operations of its shareholders and officers. The only intention that the company has is such as is expressed in or necessarily follows from its proceedings. It is hardly a paradox to say that the form of a company’s resolutions and instruments is their substance.
In this case, neither in form not in substance, has there been any distribution of profits by the company in making the bonus issue. If the substance and not the form of the transaction is looked to, the issue of a bonus shares was, in the language of Rowlatt, J. "a bare machinery" for capitalising profits and there was no distribution of profits to the shareholders.
We are unable to uphold the view expressed by the High Court that the issue of bonus shares in the facts of this case amounted to distribution of accumulated profits of the Company shown as Development Rebate Reserve Fund. The appeals are allowed. The judgment under appeal is set aside. There will be no order as to costs.