Companies Act Case Law Commissioner of Income Tax, Mumbai Vs M/s General Insurance Corporation

Companies Act Case

Law Commissioner of Income Tax, Mumbai

Vs M/s General Insurance Corporation

CASE NO.:

Appeal (civil) 4422 of 2001

PETITIONER:
Commissioner of Income Tax, Mumbai

RESPONDENT:
M/s General Insurance Corporation

DATE OF JUDGMENT: 25/09/2006

BENCH:
ASHOK BHAN & Markandey Katju

JUDGMENT:
J U D G M E N T

Bhan, J.
The question which arises for consideration in this
appeal is, as to whether the expenditure incurred in
connection with the issuance of bonus shares is a capital
expenditure or revenue expenditure. The question of law
framed in the High Court was:

(i) Whether on the facts and in the circumstances of the
case and in law the Tribunal was right in holding that
the expenditure incurred on account of share issue is
allowable expenditure?
The Assessee is an Insurance Company which has four
subsidiaries. For the assessment year 1991-92 the assessee
filed a return of income of Rs. 58,52,80,850/- along with the
audit report. The assessing Officer disallowed a few expenses
incurred as revenue expenditure, one of them being in the
sum of Rs. 1,04,28,500/- incurred towards the stamp duty
and registration fees paid in connection with the increase in
authorized share capital. The respondent-assessee had during
the accounting year, incurred expenditure separately for:
(i) The increase of its authorized share capital and
(ii) The issue of bonus shares.

The Assessing Officer disallowed both the items of
expenditure as revenue expenditure. According to him, the
expenses incurred were towards a capital asset of a durable
nature for the acquisition of a capital asset and, therefore, the
expenses could only be attributable towards the capital
expenditure.

The assessee being aggrieved filed an appeal under
Section 143 (3) before the CIT (Appeals). Disallowance of Rs.
1,04,28,500/- in respect of stamp duty and registration fees
incurred in connection with the increase in the authorized
share capital were bifurcated by the CIT (Appeals) into two
categories, one relating to the increase in authorized share
capital from Rs. 75 crores to Rs. 250 crores and second
relating to issue of bonus shares. In respect of the first
category of expenditure it was held that the same was not
allowable in terms of the judgments of the Bombay High Court
in the case of Bombay Burmah Trading Corporation, vs.
CIT, (1984) 145 ITR 793 and Richardson Hindustan Limited
Vs. CIT, (1988)169 ITR 516. The expenditure falling under
second category was allowed as revenue expenditure being
directly covered by the decision in Bombay Burmah Trading
Corporation’s case (supra).

The revenue being aggrieved challenged the order passed
by the CIT (Appeals) before the Income Tax Appellate Tribunal
(for short “the Tribunal”). The Tribunal upheld the decision of
the CIT (Appeals) treating the expenses incurred towards the
issue of bonus shares as revenue expenditure by observing
inter alia as under:

“We have carefully considered the rival
submissions. The basis for the judgment by
Hon’ble Supreme Court in the case of Brooke
Bond India Limited vs. CIT, (1997) 225 ITR
798 (SC), has been that the expenditure was
connected with the expansion of the capital
base of the Company and therefore such
expenditure was capital expenditure.
However, in the case of issue of bonus shares
there does not take place an expansion of the
capital base of the company but only re-
allocation of the existing funds. We, therefore,
hold that the Learned CIT (Appeals) rightly
decided this issue in favour of the assessee.
This ground of appeal is therefore rejected.”

The revenue thereafter filed an appeal under Section 260-
A of the Income tax Act (for short “the Act”) before the High
Court of Bombay, raising two questions of law. The High
Court in its judgment has affirmed the Tribunal’s judgment by
following its earlier decision in the case of Bombay Burmah
Trading Corporation (supra). This Court granted leave qua
the question of law as reproduced in para 1 of this judgment.

On the question, as to whether the expenses incurred in
connection with the issue of bonus shares is a revenue
expenditure or a capital expenditure, there is a conflict of
opinion between the High Courts of Bombay and Calcutta on
the one hand and Gujarat and Andhra Pradesh on the other.
Bombay and Calcutta High Courts have taken the view that
the expenses incurred in connection with the issue of bonus
shares is a revenue expenditure whereas Gujarat and Andhra
Pradesh High Courts have taken the view that the expenses
incurred in connection with the bonus shares is in the nature
of capital expenditure.

Learned counsel for the appellant relying upon the
commentary to the Companies Act by A Ramaiya, Sixteenth
Edition 2004, which occurs in the commentary to Section 81
of the Indian Companies Act, – “When a company prospers and
accumulates a large surplus it converts this surplus into
capital and divides the capital among its members in
proportion to their rights. This is done by issuing fully paid
shares representing the increased capital. The shareholders to
whom the shares are allotted have to pay nothing. The
purpose is to capitalize the gains which may be available for
division or utilize quasi-capital gains. Bonus shares go by the
modern name “capitalization of shares”. AND the judgments
of the Gujarat High Court in Ahmedabad Manufacturing and
Calico Pvt. Ltd. Vs. Commissioner of Income-Tax, (1986)
162 ITR 800, CIT Vs. Mihir Textiles Limtied, (1994) 206 ITR
112 (Gujarat), Gujarat Steel Tubes Limited Vs. CIT, (1994)
210 ITR 358, CIT Vs. Ajit Mills Limited, (1994) 210 ITR 658
and the two judgments of the Andhra Pradesh High Court in
Vazir Sultan Tobacco Co. Ltd. Vs. CIT, (1990) 184 ITR 70
and Vazir Sultan Tobacco Co. Ltd. Vs. CIT, (1988) 174 ITR
689 wherein it has been held that the issuance of bonus
shares increases the issued and paid up capital of the
company and the bonus shares of the company are directly
connected with the acquisition of capital and an advantage of
enduring nature. CONTENDS that the expenses incurred
towards issue of bonus shares confers an enduring benefit to
the company which has a resultant impact on the capital
structure of the company and therefore, it should be regarded
as the capital expenditure. Reliance has also been placed
upon the judgments of this Court in Punjab State Industrial
Development Corporation Ltd. Vs. CIT, (1997) 225 ITR 792
(SC) and Brooke Bond India Ltd. Vs. CIT, (1997) 225 ITR 798
(SC). He also relied upon in CIT vs. Motor Industries Co.
Ltd., (1998) 229 ITR 137 of Karnataka High Court, in CIT vs.
Ajit Mills Limited, (1994) 210 ITR 658, Gujrat Steel Tubes
Ltd., vs. CIT, (1994) 210 ITR 358 of Gujarat High Court &
Union Carbide India Ltd., vs. CIT, (1993) 203 ITR 584 of
Calcutta High Court.

As against this, learned senior counsel appearing for the
respondent contends that undoubtedly increase in share
capital by the issue of fresh shares leads to an inflow of fresh
funds into the company expands or adds to, its capital
employed resulting in expending its profit making apparatus,
but THE ISSUE OF BONUS SHARES by capitalization of
reserves is merely a reallocation of a company’s funds. There
is no inflow of fresh funds or increase in the capital employed,
which remains the same. The issue of bonus shares leaves
the capital employed unchanged and therefore, does not result
in conferring an enduring benefit to the company and the
same has to be regarded as revenue expenditure. He has
relied upon the judgment of this Court in CIT vs. Dalmia
Investment Co. Ltd., (1964) 52 ITR 567 (SC), Bombay
Burmah Trading Corporation Ltd. Vs. CIT, (1984) 145 ITR
793, Richardson Hindustan Limited Vs. CIT, (1988) 169 ITR
516 (Bombay) and the subsequent judgments of the same
Court taking the same view and the judgment of the Calcutta
High Court in Wood Craft Products Limited Vs.
Commissioner of Income-Tax, (1993) 204 ITR 545.

We may at the outset indicate that this Court has laid
down the test for determining whether a particular
expenditure is revenue or capital expenditure in the case of
Empire Jute Co. Ltd. Vs. CIT, 1980 (4) SCC 25. This Court
after considering the law on the subject in detail observed at
page 8 as under:

“The decided cases have, from time to
time, evolved various tests for
distinguishing between capital and
revenue expenditure but no test is
paramount or conclusive. There is no all
embracing formula which can provide a
ready solution to the problem; no
touchstone has been devised. Every case
has to be decided on its own facts
keeping in mind the broad picture of the
whole operation in respect of which the
expenditure has been incurred. But a few
tests formulated by the courts may be
referred to as they might help to arrive at
a correct decision of the controversy
between the parties. One celebrated test
is that laid down by Lord Cave, L.C. in
Atherton vs. British Insulated and
Helsby Cables Ltd., 10 TC 155, where
the learned Law Lord stated :

When an expenditure is made,
not only once and for all, but with a
view to bringing into existence an
asset or an advantage for the
enduring benefit of a trade, there is
very good reason (in the absence of
special circumstances leading to an
opposite conclusion) for treating
such an expenditure as properly
attributable not to revenue but to
capital.”
[Emphasis supplied]

In short, what has been held in this case is that if the
expenditure is made once and for all with a view to bringing
into existence an asset or an advantage for the enduring
benefit of a trade then there is a good reason for treating such
an expenditure as properly attributable not to revenue but to
capital. This is so, in the absence of special circumstances
leading to an opposite conclusion.

Decisions of this Court in Punjab State Industrial
Development Corporation Ltd. (supra) and Brooke Bond
India Ltd. (supra) and CIT Vs. Motor Industries Co. Ltd.,
(1998) 229 ITR 137 of Karnataka High Court, CIT Vs. Ajit
Mills Limited, (1994) 210 ITR 658, Gujrat Steel Tubes Ltd.,
vs. CIT, (1994) 210 ITR 358 & Union Carbide India Ltd., vs.
CIT, (1993) 203 ITR 584 of Calcutta High Court are of not
much assistance to us. All these cases relate to the issue of
fresh shares which lead to an inflow of fresh funds into the
company which expands, or adds to its capital employed in the
company resulting in the expansion of its profit making
apparatus. Expenditure incurred for the purpose of increasing
company’s share capital by the issue of fresh shares would
certainly be a capital expenditure as has been held by this
Court in the cases cited above.

Effect of issuance of bonus share has been explained by
this Court in Dalmia Investment Co. Ltd., (supra) where the
question of valuation of bonus share was considered. After
quoting the decision in the case of Eisner Vs. Macomber,
(1920) 252 U.S. 189, of the Supreme Court of United States of
America, Mr. Justice Hidayatullah explained the
consequences of issue of bonus shares by observing thus:

“. In other words, by the issue of bonus
shares pro rata, which ranked pari passu with
the existing shares, the market price was
exactly halved, and divided between the old
and the bonus shares. This will ordinarily be
the case but not when the shares do not rank
pari passu and we shall deal with that case
separately. When the shares rank pari passu
the result may be stated by saying that what
the shareholder held as a whole rupee coin is
held by him, after the issue of bonus shares, in
two 50 nP. coins. The total value remains the
same, but the evidence of that value is not in
one certificate but in two.”
It is further observed at pages 577-578:

“It follows that though profits are profits
in the hands of the company, when they are
disposed of by converting them into capital
instead of paying them over to the
shareholders, no income can be said to accrue
to the shareholders because the new shares
confer a title to a larger proportion of the
surplus assets at a general distribution. The
floating capital used in the company which
formerly consisted of subscribed capital and
the reserves now becomes the subscribed
capital.”
[Emphasis supplied]

 

The Gujarat High Court in Ahmedabad Manufacturing
and Calico Pvt. Ltd. Vs. Commissioner of Income-Tax,
(1986) 162 ITR 800 has held, that the expenses incurred
towards the issuance of bonus shares is a capital expenditure.
Bonus shares issued by the assessee company also constitute
its capital bonus shares, as right shares are an integral part of
the permanent structure of the company and are not in any
way connected with the working capital of the company which
is utilized to carry on day to day operations of the business.
Negativing the contention of the assessee that no benefit
whatsoever is derived by the assessee company when its
profits and/or reserves are converted into paid-up shares, it
was held that as a result of the increase in the paid up share
capital the creditworthiness of the assessee-company would
increase which would be a benefit or advantage of enduring
nature. That the bonus shares are an integral part of the
permanent structure of the assessee-company. The
bonus shares are not different from rights shares as,
according to it, in the case of bonus shares a bonus is first
paid to the shareholders who pay it back to the company to
get their bonus shares. This reasoning of the Gujarat High
Court was evident from the following extracts from its
judgment:
At page 808:
“It is clear that when bonus shares are
issued, 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.
In our opinion, therefore, it would not
make any difference whether paid-up share
capital is augmented by issuance of right
shares or bonus shares to the shareholders.
 .
 .
As already pointed out above, bonus
shares are not different from rights
shares..”
The above observation is completely contrary to the
observation of this Court in Dalmia Investment Co. Ltd.,
(supra), which judgment had not been referred to by the
Gujarat High Court. In the case of Dalmia Investment Co.
Ltd., (supra) this Court has held that floating capital used in
the company which formerly consisted of subscribed capital
and the reserves now becomes the subscribed capital. The
conversion of the reserves into capital did not involve the
release of the profits to the shareholder; the money remains
where it was, that is to say, employed in the business. In the
face of these observations the reasoning given by the Gujarat
High Court cannot be upheld.

We do not agree with the view taken by the Gujarat High
Court that increase in the paid up share capital by issuing
bonus shares may increase the creditworthiness of the
company but that does not mean that increase in the credit
worthiness would be a benefit or advantage of enduring nature
resulting in creating a capital asset.

The Andhra Pradesh High Court has in Vazir Sultan
Tobacco Co. Ltd. Vs. CIT, (1990) 184 ITR 70 (AP), taken the
view that the expenditure incurred on the issue of bonus
shares was capital in nature because the issue of bonus
shares led to an increase in the company’s capital base.

The observations and conclusions are erroneous as they
run contrary to the observation made by this Court in Dalmia
Investment Co. Ltd., (supra). The capital base of the
company prior to or after the issuance of bonus shares
remains unchanged.

Issuance of bonus shares does not result in any inflow of
fresh funds or increase in the capital employed, the capital
employed remains the same. Issuance of bonus shares by
capitalization of reserves is merely a reallocation of company’s
fund. This is illustrated by the following hypothetical
tabulation which establishes that bonus shares leaves the
capital employed untouched, because in the hypothetical
example, the capital employed remains the same (i.e. Rs. 600)
both pre and post issuance of bonus shares.
Sl.No.
Particulars
Pre-Bonus
Issue

Rs.
On Bonus Issue

Rs.
Post Bonus
shares
Rs.
1.
Pre-paid share
capital
100
100+100=200
200
2.
Reserve
500
500-100=400
400
3.
Total
600
600
600
As observed earlier, the issue of bonus shares by
capitalization of reserves is merely a reallocation of company’s
funds. There is no inflow of fresh funds or increase in the
capital employed, which remains the same. If that be so, then
it cannot be held that the Company has acquired a benefit or
advantage of enduring nature. The total funds available with
the company will remain the same and the issue of bonus
shares will not result in any change in the capital structure of
the company. Issue of bonus shares does not result in the
expansion of capital base of the company.

The case Wood Craft Products Limited (supra) of the
Calcutta High Court is similar to the case of the respondent.
In that case as well there was increase of authorized share
capital by the issue of fresh shares and a separate issue of
bonus shares. The Calcutta High Court drew a distinction
between the raising of fresh capital and the issue of bonus
shares and held that expenditure on the former was capital in
nature as it changed the capital base. On the other hand, in
the case of bonus shares, was held to be revenue expenditure
following the decision of the Supreme Court in Dalmia
Investment Co. Ltd., (supra) on the ground that there was no
change in the capital structure at all.

In our considered opinion, the view taken by the Bombay
and Calcutta High Courts is correct to the effect that the
expenditure on issuance of bonus shares is revenue
expenditure. The contrary judgments of Gujarat and Andhra
Pradesh High Courts are erroneous and do not lay down the
correct law.

For the reasons stated above, the question referred to us,
is answered in the affirmative, i.e., in favour of the assessee
and against the revenue.

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