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AMICUS AI
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Balasubrahmanyan
  • Padmanabhan, JJ.
Acts
  • r. 2 of the S.P.T Act, 1963, and r. 3 of the C. (P.) S.T Act,
  • provisions of rule 3. The provisions of rule 3
  • provisions of Ch. VI-A of the I.T Act, 1961,
  • COMPANIES PROFITS SURTAX ACT 1964
  • r. 2 of the S.P.T Act, 1963.
  • r. 2 of the C. (P.) S.T Act,
  • Profits Tax Act, 1963.
  • provisions of rule 3
  • Surtax Act, 1964.
  • Schedule. Rule 1
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Cites
Cited by
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Balasubrahmanyan
  • Padmanabhan, JJ.
Acts
  • r. 2 of the S.P.T Act, 1963, and r. 3 of the C. (P.) S.T Act,
  • provisions of rule 3. The provisions of rule 3
  • provisions of Ch. VI-A of the I.T Act, 1961,
  • COMPANIES PROFITS SURTAX ACT 1964
  • r. 2 of the S.P.T Act, 1963.
  • r. 2 of the C. (P.) S.T Act,
  • Profits Tax Act, 1963.
  • provisions of rule 3
  • Surtax Act, 1964.
  • Schedule. Rule 1
See more information ...
Smart Summary

Structured Summary of the Opinion Delivered by Balasubrahmanyan, J.

Factual and Procedural Background

This reference under the Companies (Profits) Surtax Act, 1964, arises from a dispute over the correct computation of "capital" for the purpose of the statutory deduction (10% of capital) under the Second Schedule to that Act. The assessment year in issue is 1971-72 and the relevant previous year runs from August 1, 1969 to July 31, 1970. Capital as computed on the first day of the previous year (August 1, 1969) was agreed to be Rs. 1,43,39,462.

During the previous year, on February 23, 1970, the assessee issued 20,400 bonus shares of face value Rs.100 each by capitalising a portion of its general reserves — i.e., Rs. 20,40,000 was transferred from general reserves to paid-up share capital. The assessee contended that this constituted an "increase" in paid-up capital during the previous year such that Rule 3 of the Second Schedule required a proportionate time-basis addition (calculated as Rs. 8,84,237 by the assessee) to be made to the capital figure determined as at the first day of the previous year.

The Income Tax Officer rejected the assessee's contention. On appeal the Tribunal accepted the assessee's case and referred the following question of law to this court:

“Whether, on the facts and in the circumstances of the case, and having regard to rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the share capital of the company should be increased proportionately on account of issue of bonus shares for the purpose of computation of capital under the Companies (Profits) Surtax Act, 1964?”

Two additional questions were referred to the court: (i) whether a provision for proposed dividends should be treated as a reserve for the computation of capital under the Surtax Act, and (ii) whether amounts deducted or rebates allowed under Chapter VI-A of the Income-tax Act, 1961, formed part of total income such that capital should not be reduced under Rule 4 of the Second Schedule.

Legal Issues Presented

  1. Whether, having regard to Rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the company's share capital should be increased proportionately on account of the issue of bonus shares (capitalisation of reserves) for computation of capital under the Act.
  2. Whether a provision for proposed dividends should be treated as a reserve for the computation of capital for purposes of the Surtax Act, 1964.
  3. Whether amounts deducted or rebates allowed under Chapter VI-A of the Income-tax Act, 1961, formed part of the total income for income-tax assessment and, accordingly, whether capital should not be reduced by amounts referable to such deduction under Rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Arguments of the Parties

Assessee's Arguments

  • The issue of bonus shares by capitalising general reserves increased the company's paid-up share capital during the previous year; therefore Rule 3 of the Second Schedule applies and requires a proportionate (time basis) addition to the capital as computed on the first day of the previous year.
  • The bonus shares constitute an addition to paid-up capital and should be treated, for the purposes of Rule 3, as an increase in capital during the previous year.

Revenue / Department's Position (as reflected in the proceedings)

  • The Income Tax Officer rejected the assessee's contention that the bonus issue triggered Rule 3; the Department contested the Tribunal's acceptance of the assessee's claim and referred the legal question to the High Court.
  • Implicit in the Department's challenge is the position that mere capitalisation of reserves into bonus shares does not constitute a fresh influx or increase of capital as contemplated by Rule 3.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
CIT v. Century Spg. and Mfg. Co. Ltd., [1978] 111 ITR 6 (Bombay High Court) Held that mere increase of paid-up share capital (for example, by bonus issue) does not automatically attract the provisions of Rule 3 unless the capital as computed under Rules 1 and 2 is actually increased. The court relied on and adopted this reasoning to support the view that a transfer from reserves to paid-up capital (bonus shares) does not increase overall capital and therefore does not invoke Rule 3.
Additional Commissioner Of Surtax, Delhi-II v. Food Specialities Ltd., [1981] 129 ITR 731 (Delhi High Court) Decision to the same effect as the Bombay High Court decision, supporting the proposition that mere increase of paid-up capital by conversion of reserves does not increase capital for Rule 3 purposes. The court noted that this Delhi High Court decision is consonant with the Bombay High Court authority and relied upon it in answering the referred question.
CIT v. Mohan Meakin Breweries Ltd., [1974] 95 ITR 586 (Himachal Pradesh High Court) Held (in relation to r.2 of the Second Schedule to the Super Profits Tax Act, 1963) that capitalisation of reserves into paid-up capital entitled the assessee to an increase in computation of capital. The court expressly rejected this decision as not correct for the present context, noting differences in statutory language and that the decision dealt with a different statute (SPT Act, 1963) and rule; the Himachal view was not followed.
Southern Roadways Ltd. v. Commissioner Of Income-Tax, Tamil Nadu-IV, [1981] 130 ITR 545 (Full Bench) Authority on whether provisions for proposed dividends should be treated as reserves for the computation of capital under the Surtax Act. The court followed this decision and answered the referred question in favour of the Revenue (i.e., treating proposed dividend provisions as reserves is governed by this authority).
Additional Commissioner Of Income-Tax, Madras-I v. Bimetal Bearings Ltd., [1977] 110 ITR 131 Authority addressing whether deductions/rebates under Chapter VI-A form part of total income for income-tax assessment and the consequential effect on capital computation under Rule 4. The court applied this decision and answered the referred question in the manner indicated by that authority (specifically stating that the question must be answered against the Revenue).

Court's Reasoning and Analysis

The court's principal analytical focus was on the proper construction and practical effect of Rule 3 of the Second Schedule vis-à-vis the mechanics of a company's balance-sheet when reserves are capitalised into bonus shares.

Key elements of the reasoning, as set out in the opinion, are:

  • Rule 1 prescribes that "capital" for the statutory deduction is the aggregate of listed items (paid-up share capital, general reserves, other reserves, debentures, moneys borrowed from Government concerns, etc.), computed as on the first day of the previous year.
  • Rule 3 operates as an addition to the figure of capital computed under Rule 1, but it contemplates an actual "increase" in the capital of the company during the previous year — meaning an influx or addition to the sum-total of items that constitute capital, and not merely a reclassification among those items.
  • When reserves are capitalised and bonus shares issued, what happens on the liabilities side of the balance-sheet is a transfer: an amount is taken out of reserves and shown instead as paid-up share capital. The court emphasised that this operation does not change the aggregate sum that constituted capital as at the opening of the previous year; it is merely a movement between two components of capital.
  • Therefore, a mere conversion of reserves into fully paid bonus shares does not create additional capital in the sense required by Rule 3. Rule 3 is attracted only where there is a genuine increase in the company's capital beyond what stood on the first day of the previous year (for example, fresh share subscriptions for cash or a fresh infusion of funds), not by an internal reallocation of existing capital items.
  • The court drew support from Bombay and Delhi High Court authorities that had interpreted like provisions to require an actual increase in capital as computed under the relevant rules, and it expressly declined to follow the contrary decision of the Himachal Pradesh High Court, in part because that decision concerned a different statute and a differently worded rule.
  • For the two other referred questions, the court did not undertake fresh factual analysis but answered them by reference to binding decisions of this court: (a) the treatment of proposed dividend provisions was resolved in accordance with Southern Roadways Ltd.; and (b) the question concerning Chapter VI-A deductions was resolved in accordance with the decision in Bimetal Bearings Ltd.

Holding and Implications

Holding:

On the principal question (Rule 3): The court answered the Tribunal's referred question in the negative and against the assessee. In other words, the issue of bonus shares by capitalising reserves did not amount to an "increase" in the capital as required by Rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and therefore no proportionate addition under Rule 3 was allowable on that account.

Other referred questions:

  • On whether a provision for proposed dividends should be treated as a reserve for computation of capital: the court answered in favour of the Revenue and against the assessee, following Southern Roadways Ltd.
  • On whether amounts deducted under Chapter VI-A formed part of total income so that capital should not be reduced under Rule 4: the court answered this question against the Revenue, following the decision in Bimetal Bearings Ltd.

Direct consequences:

  • The Tribunal's finding that the assessee was entitled to increase the capital computation under Rule 3 by reason of the bonus issue was not upheld by this court; the court's negative answer means the Tribunal's acceptance of that contention cannot stand.
  • The court applied existing authorities to resolve the subsidiary questions rather than developing a new rule of law; the opinion relies on and follows prior High Court and Supreme Court decisions cited in the text.
  • There will be no order as to costs in respect of the referred matters (i.e., costs were not awarded to either side).

No broader or novel precedent was declared beyond applying and distinguishing the earlier authorities cited in the opinion.

Show full summary ...

    Commissioner Of Income-Tax, Tamil Nadu-Ii v. Sundaram-Clayton Ltd.

    The Judgment of the Court was delivered by

    Balasubrahmanyan, J.:— This reference under the Companies (Profits) Surtax Act, 1964, raises a point about the computation of capital under the Second Schedule to that Act. Under the scheme of this Act, a company is liable to surtax on the excess of its chargeable profits over the statutory deductions. The statutory deduction itself is 10 per cent. of the capital of the company. The capital of a company, for the purpose of calculating the statutory deduction must be computed in accordance with the rules set out in the Second Schedule. Rule 1 of the Second Schedule lays down that the capital of a company shall be the aggregate of the amounts mentioned in cls. (i) to (v) mentioned therein. Clause (i) refers to the paid up share capital. Clause (ii) refers to the general reserves. Clause (iii) refers to the other reserves. Clause (iv) refers to the debentures, and, cl. (v) refers to moneys borrowed from Government concerns. It is the sum total of the paid up share capital, the reserves, debentures and the moneys borrowed, which makes up the capital for the purposes of the statutory deduction. Rule 3 to the Second Schedule is by way of an addition to the figure of capital computed in accordance with r. 1. It may be observed that under the scheme of the Second Schedule, the capital will have to be computed as on the first day of the previous year relevant to the assessment year in question. Rule 3, in that context, provides that where after the first day of the previous year, the capital of a company as computed in accordance with r. 1 (and other relevant rules) of the Second Schedule is “increased” by any amount during that previous year on account of increase in paid-up share capital or the issue of debentures, etc., then the capital as computed under r. 1 shall be increased by a sum worked out both on the time basis and the quantum basis. The reference in the present case has arisen because of a controversy between the assessee on the one hand, and the Department on the other, as to whether r. 3 of the Second Schedule can be invoked by the assessee in the events that happened which are as follows. The assessment year in question is 1971-72. The relevant previous year is the year beginning from August 1, 1969 and ending July 31, 1970. For the purpose of ascertaining the statutory deduction, in this case, the capital will have to be computed as on August 1, 1969, as provided for in r. 1 of the Second Schedule. There is no doubt as to the amount of capital as on August 1, 1969, which was computed in the sum of Rs. 1,43,39,462. There is also no doubt that this figure of computation of capital included, among other things,. the company's paid up share capital and its reserves. On February 23, 1970, during the middle of the account year in question, the assessee issued 20,400 bonus shares of the face value of Rs. 100 each. This bonus issue was brought about by capitalising part of the company's general reserves. In other words, a sum of Rs. 20,40,000 was transferred from the general reserves and converted into bonus shares. The assessee claimed that this amount of Rs. 20,40,000, which represented the bonus issue as on February 23, 1970, must be the basis for an increase in the capital as already determined at Rs. 1,43,39,462 as on the first day of the previous year, viz., September 1, 1969. It was claimed that the bonus shares really constituted an addition to the paid up capital of the company. Since any “increase” in the paid up capital was to be properly reckoned for the purpose of computation of capital under r. 3 of the Second Schedule to the Act, it was claimed that a proportionate amount worked out on a time basis, viz., Rs. 8,84,237 must be added to the capital as on August 1, 1969 for the purpose of capital computation.

    2. The ITO rejected this contention, but the Tribunal in appeal accepted the assessee's case. The correctness of the decision of the Tribunal is challenged by the Department in the following question of law which has been referred to us by the Tribunal:

    “Whether, on the facts and in the circumstances of the case, and having regard to rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the share capital of the company should be increased proportionately on account of issue of bonus shares for the purpose of computation of capital under the Companies (Profits) Surtax Act, 1964?”

    3. The answer to the question bears on a proper understanding of what happens when a part of the company's reserves is capitalised and bonus shares are issued. It is clear enough to see that this process of issuing bonus shares would increase the paid up capital of the company. But, so far as the liabilities column of the balance-sheet of the company is concerned, what happens is that a sum equivalent to the value of the bonus shares is carved out from the amount of reserves and placed in the earlier column of paid up capital of the company, on the very liabilities side of the balance-sheet. The process of conversion of reserves into bonus shares does not reduce the overall capital of the company, nor increase it. The overall capital just remains as it was as at the beginning of the year. The capital of the company, 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. What r. 3 of the Second Schedule to the Act contemplates is that quite apart from the figure of capital as on the first day of the previous year (which includes in its computation both the paid up capital as on the first day as well as the general reserve of the company as on the same day) the capital must, subsequent thereto, during the previous year, get increased by way of an addition to any part of the capital so computed, whether the increase be 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 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. In the present case, it cannot be denied that 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 in the liabilities side of the balance-sheet consisting of the paid up capital and the reserves, among other things. We are, therefore, satisfied that on a common sense understanding of the rules in the Second Schedule to the Surtax Act and on a proper reading of the various entries in the company's balance-sheet, the contention put forward by the assessee must be rejected as untenable.

    4. A question of this kind was considered by the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd., [1978] 111 ITR 6. The learned judges of the Bombay High Court posed the question, and gave the answer, in the following passage (p. 14):

    “The question is whether merely because during the previous year there was an increase of paid-up share capital, the provisions of rule 3 will be automatically attracted. Mr. Mehta, on behalf of the assessee, has submitted that when after the first day of the previous year the paid up capital is increased in any manner whatsoever, whether by issue of bonus shares or by issue of right shares upon payment of cash, provisions of rule 3 are attracted. In our opinion, mere increase of paid up capital is not sufficient to attract the provisions of rule 3. The provisions of rule 3 will be attracted on account of increase of paid-up capital only if by reason thereof the capital of a company as computed in accordance with rules 1 and 2 of the Second Schedule of the Act is increased by any amount.”

    5. Proceeding to discuss what happens when reserves are capitalised by the issue of fully paid bonus shares, the learned judges observed as follows (p. 15):

    “What has been done 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 computation of capital under rule 1. When such a thing is done the capital of a company computed in accordance with rule 1 is not increased by any amount whatsoever. It is merely a transfer of a particular sum included in one item into another item, but as a result of such alteration or transfer the capital to be computed in accordance with rule 1 will not be increased by any amount whatsoever.”

    6. A decision rendered by the Delhi High Court in Additional Commissioner Of Surtax, Delhi-Ii v. Food Specialities Ltd., [1981] 129 ITR 731, is to the same effect. Indeed, the decision of the Delhi High Court cites in support the decision of the Bombay High Court already referred to by us.

    7. Reference, however, was made in the course of arguments to a decision rendered by the Himachal Pradesh High Court, CIT v. Mohan Meakin Breweries Ltd., [1974] 95 ITR 586. In that decision it was held that an increase in paid-up capital by the simple process of capitalising a part of the existing reserves, would entitle the assessee to an increase in the computation of its capital under r. 3 of the Second Schedule to the S.P.T Act, 1963. With respect, we do not accept this view as correct, both on a construction of the provisions of r. 3 and on a proper understanding of what happens when there is a corporate exercise of discretion to effect a conversion of reserves and capitalisation thereof into fully paid bonus shares. Besides, this decision was rendered as a matter of construction and application of r. 2 of the Second Schedule to a different statute, namely, the Super Profits Tax Act, 1963. There is a slight difference between the language of r. 2 of the S.P.T Act, 1963, and r. 3 of the C. (P.) S.T Act, which is the provision under consideration in the present reference. As observed by the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd., [1978] 111 ITR 6, there is a distinction between the rules governing the computation of the capital as well as the provision for making an increase in the capital computation in the Second Schedule to the S.P.T Act and the relevant provisions contained in the Second Sechedule to the C. (P.) S.T Act. Even otherwise, we do not see how, on the language of r. 2 of the C. (P.) S.T Act, a mere capitalisation of the reserves and the issue of bonus shares from out of the amount so capitalised can really add to the sum-total of the capital as on the first day of the previous year. It may very well be that under r. 2 of the Second Schedule what is mentioned is only an increase in the paid up capital and not an increase in the overall capital as computed under the entire gamut of the provisions of the Second Schedule. Even so, a mere conversion of the reserves, or a portion of the reserves into fully paid bonus shares cannot really add up to the capital or result in a fresh influx of capital which was not there as on the first day of the previous year. It is, however, unnecessary to labour this point further, since in the present case we are not dealing with a rule of the kind which had been prescribed in r. 2 of the S.P.T Act, 1963. Whatever might be the interpretation of that rule, so far as the language of r. 3 of the Second Schedule to the Surtax Act is concerned, both as a matter of first impression and on the authorities we have earlier referred to, we have no doubt whatever that a mere capitalisation of the reserves and the issue of fully paid up bonus shares, subsequent to the first day of the previous year, cannot come within the ambit of the said rule, so as to enable the assessee to obtain an increase over the capital computed as on the first day of that previous year. Our answer to the question is, therefore, in the negative and against the assessee. There are two other questions which have been referred to us by the Tribunal in this very case. Those questions are, however, fairly easy of answer, because they are covered by direct decisions of this court. One of the questions is whether, on the facts and in the circumstances of the case, a provision for proposed dividends should be treated as a reserve for the computation of capital for the purpose of Surtax Act, 1964. The answer to this question is covered by a decision rendered by this court in Southern Roadways Ltd. v. Commissioner Of Income-Tax, Tamil Nadu-Iv., [1981] 130 ITR 545 [FB]. Following that decision, we answer this question in favour of the Revenue and against the assessee.

    8. The last question for our consideration is, whether, on the facts and in the circumstances of the case, the amounts deducted or rebates allowed under the provisions of Ch. VI-A of the I.T Act, 1961, formed part of the total income for I.T assessment and that, therefore, the capital should not be reduced by the amounts referable to such deduction under r. 4 of the Second Schedule to the C. (P.) S.T Act, 1964. The answer to this question has been furnished by a decision of this court in Additional Commissioner Of Income-Tax, Madras-I v. Bimetal Bearings Ltd., [1977] 110 ITR 131. According to that decision, this question has got to be answered against the Revenue and we answer this question accordingly.

    9. Having regard to the nature of the findings rendered by us in all the three questions referred to above, there will be no order as to costs.

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    Comments

    Commissioner Of Income-Tax, Tamil Nadu-Ii v. Sundaram-Clayton Ltd.
    (Oct 21, 1981)