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Judgment
Mrs. Sujata Manohar J.
In this reference, the applications of the assessee as well as the Department are consolidated. The following questions are referred to us u/s 256 (1) of the Income Tax Act, 1961, read with section 18 of the Companies (Profit) Surtax Act, 1964, at the instance of the Department :
"1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in directing the Income Tax Officer to increase the assessee company''s capital by the amount of the dividend declared in an annual general meeting held later than the first day of the ''previous year'' ?
Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the investment on shares shown by the assessee-company at Rs. 15,41,825 was includible in the computation of its capital and that no deduction could be made under rule 2 of the Second Schedule to the Companies (Profits) Surtax Act ?
Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in not deciding whether the amount of the bonus shares issued by the assessee-company out of its reserves was a free reserve, which could be treated as part of its capital ?
Without prejudice to the fourth (sic) question, whether, on the facts and in the circumstances of the case, the Appellate Tribunal, was right in law in holding that rule 3 of the Second Schedule to the Companies (Profits) Surtax Act could not be invoked in the assessee-company''s case by the Surtax Officer, having regard to the fact that it issued bonus shares of the amount of Rs. 8 lakhs by capitalising a sum of Rs. 8 lakhs out of its reserves ?"
The following two questions are referred to us at the instance of the assessee. There is some controversy as to whether the second question is rightly referred to us or not because, in paragraph 14 of its order, the Tribunal has stated that the assessee does not press question No. 2 at the time of hearing of the application and as such the same is rejected. Question No. 2 is however, set out by the Tribunal as a question which is referred to us. We are setting out both these questions because, in any case, the issue raised in question No. 2 at the instance of the assessee is also the issue raised in question No. 4 at the instance of the Revenue :
"1. Whether the Tribunal exceeded its jurisdiction by adjudicating upon a matter which was not in dispute by holding that the increase granted by the Surtax Officer under rule 3 was not warranted in law, whereas such increase was granted by the Surtax Officer himself and the ground of appeal before the Hon''ble Tribunal specifically prayed for restoration of the Surtax Officer''s own order ?
Whether the Tribunal erred in holding that in respect of the bonus shares issued by the applicant, the provisions of rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, were not applicable and that accordingly, the capital as computed in accordance with rule 1 of the said Schedule was not liable to be increased under the said rule 3 ?"
The assessment years involved in this reference are 1971-72 to 1973-74 for which the previous years ended on October 31, 1970, October 31, 1971, and October 31, 1972, respectively. Questions Nos. 3 and 4 are at the instance of the Revenue and both the questions raised by the assessee, however, pertain only to the assessment year 1971-72 when certain bonus shares were issued by the assessee-company as set out in the assessment order.
As far as question No. 1 at the instance of the Revenue is concerned, we are not setting out the facts in detail because it is an accepted position that, in view of the decision of the Supreme Court in the case of Indian Tube Co. P. Ltd. Vs. Commissioner of Income Tax, , the question must be answered in the negative and in favour of the Revenue.
The question is answered accordingly.
Question No. 2 at the instance of the Revenue relates to the inclusion of Rs. 15,41,825 in the capital base of the company for the purpose of working out the statutory deduction under the Companies (Profits) Surtax Act for the assessment year 1971-72. There are similar amounts involved for the assessment years 1972-73 and 1973-74 also.
Under the Companies (Profits) Surtax Act, 1964, in the Second Schedule, rules are provided for computing the capital of a company for the purposes of surtax. Under rule 2, certain amounts are to be excluded while computing the capital of a company. Where a company owns any assets the income from which in accordance with clause (iii) or clause (vi) or clause (viii) of rule 1 of the First Schedule is required to be excluded from its total income in computing its chargeable profits, the amount of its capital as computed under rule 1 shall be diminished by the cost to it of the said assets as on the first day of the previous year relevant to the assessment year in so far such cost exceeds the aggregate of (i) moneys borrowed (other than those specified in the rule) and remaining outstanding, and (ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under rule 1.
The amounts in question in the present case were by way of investment in shares in certain Indian companies. By virtue of rule 1 (viii) of the First Schedule to the said Act, income by way of dividends from such shares is to be excluded while computing chargeable profits. Hence, under rule 2 of the Second Schedule, such investment is to be excluded from the capital base of the company. However, as per rule 2, such exclusion or diminution is confined to the extent to which the cost of such assets as on the first day of the previous year exceeds the aggregate of borrowed moneys as set out therein and any fund, any surplus and any reserve as is not to be taken into account in computing the capital under rule 1. In the present case, while the cost of investment is Rs. 15,41,825 the general reserves which have not been taken into account computing the assessee company''s capital under rule 1 are to the extent of Rs. 21,60,000 for the assessment year 1971-72, Rs. 24,00,000 for the assessment year 1972-73 and Rs. 26,40,000 for the assessment year 1973-74. Since these reserves far exceed the cost of investment, there is no question of the capital of the company (for the purpose of the said Act) being reduced by the cost of investment.
The company also had current liabilities and provisions which were ignored in arriving at the capital of the company for the purposes of the said Act. These were to the extent of Rs. 1,67,02,120 for the assessment year 1971-72, Rs. 2,28,06,069 for the assessment year 1972-73 and Rs. 2,29,26,000 for the assessment year 1973-74. There was some dispute before the Tribunal as to whether these provisions should also be taken into account while applying rule 2 (ii) of the Second Schedule. We need not, however, go into this question at all because, admittedly, the general reserves which have to be taken into account in the present case far exceeded the cost of investment in question. In view of this factual position, question No. 2, which is raised at the instance of the Revenue is answered in the affirmative and in favour of the assessee.
As far as questions Nos. 3 and 4 raised at the instance of the Revenue and question No. 2 raised at the instance of the assessee are concerned, the relevant facts are as follows :
These questions pertain to the assessment year 1971-72 only. The accounting period of the assessee ended on October 31, 1970. On February 27, 1970, the assessee-company issued bonus shares of the value of Rs. 8 lakhs out of its general reserves, with the result that the paid-up share capital of the assessee-company increased by Rs. 8 lakhs with a corresponding reduction of Rs. 8 lakhs in its general reserves.
Under rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, "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..... such capital shall be increased.... 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 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." The Income Tax Officer held that there was a proportionate increase in the paid-up capital of the assessee-company from February 27, 1970, to October 31, 1970, that is, by 246 days. He worked out the proportionate increase in the capital at Rs. 5,39,178 by multiplying the figure of Rs. 8 lakhs by 246/365. The Income Tax Officer also held that, to the extent the reserve. In appeal before the Appellant Assistant Commissioner, the Appellate Assistant Commissioner said that there was no provision under rule 3 for deduction of Rs. 8 lakhs from the general reserves on the first day of the previous year. He, therefore, added back Rs. 8 lakhs to the general reserves. He also recomputed the increase of share capital under rule 3 to Rs. 5,41,370. Both the assessee as well as the Department filed appeals before the Tribunal. The Tribunal, by its common judgment, held that rule 3 had no application to a situation such as the present one where capital in the form of general reserve was converted to company''s shares. In such a situation, there was no increase or decrease in the capital of the company as computed under the Companies (Profits) surtax Act, 1964. Hence, rule 3 was not attracted. As a result, the sum of Rs. 8 lakhs continues to from part of the general reserves on the first day of the relevant previous year while no addition is required to be made under rule 3.
The findings of the Tribunal are now supported by a decision of the Division Bench of this court in the case of Commissioner of Income Tax, Bombay City III Vs. Century Spg. and Mfg. Co. Ltd., . In the case before the Division Bench also, during the course of the previous year, a part of the amount standing to the credit of the general reserve of the assessee-company was capitalised by issue of fully paid-up bonus shares. The Division Bench considered rule 3 of the Second Schedule to the Companies (Profits) Surtax Act. It held that, in such a situation, it cannot be said that the capital of the company computed in accordance with rule 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 rule 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 reserves, the capital, as computed in the manner provided by rule 1 of the said Second Schedule, is not increased in any manner whatsoever. The ratio of this decision directly applies to the present case.
It has been urged by Mr. Dalvi, learned counsel for the assessee, that the Tribunal had no jurisdiction the question as to whether rule 3 was attracted in the present case, because both the assessee as well as the Department were of the view that rule 3 was attracted. In the first place, we do not have the memoranda of appeal filed by the assessee as well as the Department before the Tribunal. Secondly, it would not be correct to say that the question of application of rule 3 did not arise in the present case. Both the deduction of Rs. 8 lakhs from the general reserves and the addition of the proportionate value of bonus shares are interconnected and both are directly connected with the application of rule 3. The Tribunal has, in terms, dealt with the application of rule 3, because the question before the Tribunal related to the deduction of Rs. 8 lakhs from the value of the general reserves as also the addition of the proportionate value of the bonus shares issued during the course of the previous year. This is, therefore, not a case where the Tribunal has dealt with the interpretation of a section or a rule which was not before it at all the interpretation of rule 3 was directly before the Tribunal.
The assessee has relied upon a decision of the Calcutta High Court in the case of Income Tax Officer, "A" Ward and Others Vs. R.L. Rajghoria, . The question there before the Tribunal was whether the loss in question was speculation loss or not. The Tribunal was not called upon to decide whether this was a capital loss or revenue loss. The Tribunal remanded the matter to the Appellate Assistant Commissioner to decide whether the loss was a capital loss or a revenue loss. The court said that such a question was not within the scope of the appeal before the Tribunal. This judgment has no application to the present case where the application of rule 3 was directly before the Tribunal. In the premises, questions Nos. 3 and 4 at the instance of the Revenue and question No. 2 at the instance of the assessee are answered as follows :
Rule 3 of the Second Schedule to the Companies (Profits) Surtax Act cannot be invoked in the assessee-company''s case having regard to the fact that it issued bonus shares of the amount of Rs. 8 lakhs by capitalising a sum of Rs. 8 lakhs out of its general reserves. Therefore, the general reserves of the company on the first day of the previous year are not affected in any manner by the application of rule 3.
Question No. 1 which is referred to us at the instance of the assessee is answered in the negative and against the assessee.
The questions are answered accordingly.
No order as to costs.