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Messrs Emerald & Co. Ltd., Bombay v. Commr. Of Income-Tax, Bombay City
Factual and Procedural Background
The assessee purchased 50 shares of the Bombay Dyeing and Manufacturing Co. Ltd. on 11-11-1950 for Rs. 49,101/-. On 9-1-1951 Bombay Dyeing issued one bonus share for each share held, and the assessee received 50 bonus shares of face value Rs. 50/- each. After various intermediate transactions, at the beginning of the assessment year 1952-1953 (financial year 1951-1952) the assessee held 350 shares, including the 50 bonus shares. Out of these 350 shares the assessee sold 300 shares and realized Rs. 1,20,550/-. For the sale the assessee claimed a loss of Rs. 35,801/-, valuing the bonus shares at Rs. 250/- (face value) for cost attribution. The Income Tax Department computed the loss as Rs. 27,766/- by applying an averaging method previously laid down in Commr. of Income-tax v. Manecklal Chunilal & Sons Ltd., I.T Ref. No. 16 of 1948 (Bom) (A). The Tribunal proposed a different approach (ignoring the 50 bonus shares for the current computation). The court was called upon to resolve which method of computation of loss was correct.
Legal Issues Presented
- What is the correct method for attributing cost when bonus shares are received free and some shares (out of a holding that includes bonus shares) are sold — specifically, whether the cost should be averaged over all shares held including bonus shares?
- Whether bonus shares received free may be assigned a cost equal to their face value (as contended by the assessee) for the purpose of computing profit or loss on the sale?
- Whether the bonus shares may be ignored for the purpose of computing the loss on the sale of a subset of the holding (as proposed by the Tribunal), deferring consideration of profit or loss on bonus shares until they are sold?
Arguments of the Parties
Assessee's Arguments
- The assessee valued the bonus shares at Rs. 250/- (face value) and computed the loss on the sale accordingly, arriving at a claimed loss of Rs. 35,801/-.
- Mr. Kolah for the assessee argued that although the bonus shares were given free, if they had not been given the shareholder would have received a larger dividend and that the bonus shares had been effectively paid out of the company's profits (advanced as a reason to attribute value to them).
Income Tax Department's Position
- The Department applied the averaging method set out in the Court's earlier decision (Commr. of Income-tax v. Manecklal Chunilal & Sons Ltd., I.T Ref. No. 16 of 1948 (Bom) (A)) to allocate the cost of the paid shares across the total holding including the bonus shares, arriving at a loss of Rs. 27,766/-.
Tribunal's View (as reported)
- The Tribunal suggested ignoring the 50 bonus shares for the purpose of computing the loss on the sale of the 300 shares, calculating loss based only on the purchase cost and sale proceeds of those 300 shares, and deferring computation of profit or loss on the bonus shares until they are sold.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commr. of Income-tax v. Manecklal Chunilal & Sons Ltd.’, I.T Ref. No. 16 of 1948 (Bom) (A) | The averaging method for allocating the cost of shares where bonus shares have been received free — i.e., spreading the cost of the paid shares over the total number of shares held (including bonus shares). | The Court relied on this decision to hold that the Department's averaging method was correct and that the loss should be assessed according to that method rather than the assessee's valuation or the Tribunal's approach. |
Court's Reasoning and Analysis
The court began by referring to its earlier decision in Commr. of Income-tax v. Manecklal Chunilal & Sons Ltd., I.T Ref. No. 16 of 1948 (Bom) (A), which laid down the averaging method. It noted the factual position that at the beginning of the relevant year the assessee held 350 shares, of which 50 were bonus shares received free, and that the assessee had actually paid only for 300 shares. The court explained the averaging method: the total amount paid for the 300 shares (X rupees) must be regarded as the cost of the entire 350-share holding because the 50 bonus shares were received free; thus the cost per share is the averaged figure obtained by dividing X over 350 shares.
The court rejected the assessee's contention that bonus shares should be assigned a notional value equal to face value (Rs. 250/-) on the basis that the bonus shares were received free and the assessee paid nothing for them. It also rejected the Tribunal's suggested method of ignoring the bonus shares when computing the loss on the sale of 300 shares, calling it erroneous: the Tribunal's approach rests on an impermissible assumption that the 300 shares sold were other than the bonus shares. The court held that because the holding during the year comprised 350 shares including the bonus shares, the correct inquiry is to determine the cost to the assessee of those 350 shares, which can only be done by averaging the cost over all shares held, taking into account that the 50 bonus shares were free.
On that basis, and by application of the precedent, the court concluded that the Department's method of valuation and computation of the loss was correct.
Holding and Implications
The loss computed by the Income Tax Department using the averaging method is upheld.
Implications:
- The assessee's method of assigning face value to bonus shares for cost attribution and the Tribunal's method of ignoring bonus shares for the current computation were both rejected.
- The direct effect is that the loss assessed by the Department (Rs. 27,766/- as computed by the Department) is held to be according to law.
- The assessee is ordered to pay the costs.
Note: The opinion expressly relies on the earlier cited precedent; it does not purport to set a new principle beyond applying that precedent to the facts. The record concludes with the brief notation "D.S.P — Answered accordingly."
Chagla, C.J:— In view of our decision in — ‘Commr. of Income-tax v. Manecklal Chunilal & Sons Ltd.’, I.T Ref. No. 16 of 1948 (Bom) (A), the contention which has been raised by the assessee on this reference cannot be accepted.
2. It appears that the assessee purchased 50 shares of the Bombay Dyeing and Manufacturing Co. Ltd. on 11-11-1950 for Rs. 49,101/- and on 9-1-1951 the Bombay Dyeing issued bonus shares of the face value of Rs. 50/- one bonus share being issued for one Company's share held by the share-holder, and therefore the assessee company received 50 bonus shares of the face value of Rs. 50/- each.
3. Then there were various transactions with which we are not concerned till we come to the assessment year 1952-1953 corresponding to the financial year 1951-1952 which is the previous year of the assessee company. At the beginning of the assessment year 1952-1953 the assessee company held 350 shares of the Bombay Dyeing including 50 bonus shares. Out of these it sold 300 shares and the price realised by the sale of these 300 shares was Rs. 1,20,550/-.
4. According to the assessee company, by this transaction the assessee company had made a loss of Rs. 35,801/-. The assessee company arrived at this loss by valuing the bonus shares at Rs. 250/- which was the face value of the shares. On the other hand, Department arrived at a loss of Rs. 27,766/- and this loss was arrived at by resorting to the method of averaging the price of the shares. This is the method which we have laid down in the decision just referred to, and the method is a very simple one.
5. At the beginning of the assessment year the assessee company had 350 shares which included 50 bonus shares. For these 350 shares the assessee company had only paid the price for 300 shares; the 50 bonus shares it had received free. Therefore, what one must do is to take the price of the 300 shares and average it with regard to all the 350 shares, in other words, if the 300 shares cost X rupees to the assessee, by reason of getting 50 bonus shares free the X rupees would be the cost not of 300 shares but of 350 shares.
6. The contention of Mr. Kolah is that although the bonus shares were given free, if these shares had not been given he would have received a larger dividend and these bonus shares have been paid out of profits of the company. We are not concerned with the reason which induced the company to issue these bonus shares.
7. The fact remains that the bonus shares were received free and the assessee company paid nothing for the bonus shares. Therefore the contention of the assessee company that it should be allowed to put a price of Rs. 250/- on these bonus shares is obviously untenable.
8. The Tribunal has suggested a third method which in our opinion, is equally, with respect, erroneous, and the method it has suggested is that the 50 bonus shares should be completely ignored and that the value of the purchase of these 300 shares on the one hand and the sale proceeds realised by the sale of these 300 shares should be taken into consideration and the loss should be arrived at on that basis, the Tribunal takes the view that when these 50 bonus shares are sold then the time would arrive to consider what profit or loss the assessee company has made on these 50 shares.
9. But the clear fallacy underlying the argument of the Tribunal is that the 350 shares held by the assessee company during the year of account included the 50 bonus shares and we cannot predicate that the 300 shares which were sold were shares other than the bonus shares, and you have to determine what the cost to the assessee was with regard to these 350 shares, and that cost can only be arrived at by averaging the cost by taking into consideration the fact that the 50 bonus shares were received free of cost.
10. It is only by that method that the proper profit or loss can be arrived at. In our opinion, therefore, by reason of the decision that we gave in I.T Ref. No. 16 of 1948 (Bom) (A), the method of valuation adopted by the Income Tax Department was right and the loss should be assessed according to the method of the Department and not according to the assessee company or to the Tribunal.
11. The answer therefore must be that the loss by the assessee company computed by the Department is according to law. The assessee to pay the costs.
D.S.P
Answered accordingly.
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