Commissioner of Income Tax, Tamil Nadu-II vs Sundaram Clayton Ltd.

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 profit over the

statutory deductions. The statutory deductions 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 rule 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. Clauses (i) refers to the

paid up shares capital Clause (ii) refers to the general reserves, Clauses (iii) refers to the order reserves, Clause (iv) refers to the debenture, and,

Cl.(v) refers to moneys borrowed from Government convers. It is the sum total of the pairs up shares capital the reserves, debenture and the

moneys borrowed, which makes up the capital for the purposes of the statutory deduction. Rules 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 he 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 previews 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 debenture,

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, andtheDepartment 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-

The relevant previous year is the year beginning from August 1, 1969 and ending July 31, 1970. For the purpose of asserting the 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

sum of Rs. 1,43,39,462. There is also no doubt that this figure of computation of capital included, among to 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 bones issue was brought about by capitalizing part of the company general reserves. In other words, a sum

of Rs. 20,40,000 was transferred from the general reserves and covered 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 there basis for an increase inthecapital 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 climbed that a proportionate amount worked out on a time basis, viz.

Rs. 8,84,237 must be added to the capita as on August 1, 1969 for the purpose of capital computation.

The ITO rejected this contention, but the Tribunal in appeal accepted the assessee 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,theshare 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 ?

The answer to the question bears on proper understanding of what happens when a part of the company reserve is capitalized 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

liability column of the balance-sheet ofthecompany is concerned, what happens is that a sum equivalent to the value of the bonus shares is carved

out from the emote of reserves and placed in the earlier column of paid up capita, of the company, on the very liability side of the balances-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 reserve does not undergo any

charge merely because a part of the reserves is capitalized into bonus shares. What r. 3 of the Second Schedule to the Act contemplates is that

quiet apart from the figure of capital as onthefirst day of the previous year (which includes in its computation both the paid up capital as onthefirst

day as well as the general reserves of the company as on the same day) the capital must, subsequent thereto, during the previews year, whether the

increase be to the paid up capital or whether it be to the reserves or to any other item figuring one liabilities side of the balances-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 capitalizing part of the reserves and issuing bonus shares does not means that the 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 reserve, 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 balance-sheet, e contention put

forward by the assessee must be rejected as untenable.

A question of this kind was considered by the Bombay High Court in Commissioner of Income Tax, Bombay City III Vs. Century Spg. and

Mfg. Co. Ltd., . The learned judges of the Bombay High Court posed the question, and have 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 provision 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 share or by issue of right shares upon payment of cash, provision of rule 3 are

attracted. In our opinion, mere increase of paid up capital is not sufficient to attract the provision of rule 3. The provision 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.

Proceedings to discuss what happens when reserve are capitalized 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 of the 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 an amount whatsoever. It is merely a transfer of a particular sum

included in one item into another item, but as a result of such alternation or transfer the capital to be computed in accordance with rule 1 will no the

increased by any amount whatsoever.

A decision rendered by the Delhi High Court in Additional Commissioner of Surtax, Delhi-II Vs. Food Specialities Ltd., , 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.

Reference however, was made in the course of arguments to a decision rendered by the Himachal Pradesh High Court, Commissioner of

Income Tax Vs. Mohan Meakin Breweries Ltd., . 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 provision of r. 32 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 statues, namely, the Super Profits Tax Act, 1963. There is a slight different between the language of r. 2 of he 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

Commissioner of Income Tax, Bombay City III Vs. Century Spg. and Mfg. Co. Ltd., , there is a distinction between the rule 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 provision contained in the Second Satchel 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 capitalized can really add to the

sum-total of the capital as on the first day of the preface year. It may very well be that under r. 2 of the Second Schedule what is mentioned is any

an increase in the paid up capital and not an increase in the overall capital as computed under the entire gamut of the provision of the Second

Schedule. Even so, a mere conversion of the reserves, or a portion of the reserves into fully paid bonus shares cannot be really and 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 obtained 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 question which has 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 effects and in the circumstances of the

case, a provision for proposed dividend should be treated as 1964. The answer to this question is covered by a decision rendered by is court in

Southern Roadways Ltd. Vs. Commissioner of Income Tax, Tamil Nadu-IV, following that decision, we answer this question in favour of the

Revenue and against the assessee.

The last question for our consideration is, whether, on the facts and in the circumstances of the case, the amounts deducted or rebates allowed

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 decision of this court in Additional

Commissioner of Income Tax Vs. Bimetal Bearings Ltd., . According to that decision, this question has got to be answered against the Revenue

and we answer this question accordingly.

Having regard to the nature of the findings rendered by us in allthethree question referred to above, there will be no order as to costs.