1. This is an appeal filed by the assessee, the Trustees of HEH the Nizam's Dependents & Khanazad's Trust, Hyderabad objecting to the order of the AAC, for the assessment year 1976-77.
2. The assessee-trust had sold 1,500 right shares in Motor Industries Co. Limited (known as Mico shares). They were sold at Rs. 181 per share while the amount paid on the shares as on the date of sale worked out to Rs. 150 per share. The ITO was of the view that the assessee should be taxed on the difference between the sale value of the shares and the amount paid on such shares. The difference worked out to Rs. 61,500.
The assessee, however, had worked out the loss on the basis that the issue of right shares affected the price of his existing holding of original as well as bonus shares and that the loss suffered in the original holding should pro rata go to increase the cost or reduce profit. It was claimed that such a position was accepted by the Supreme Court in the case of Miss Dhun Dadabhoy Kapadia v. CIT  63 ITR 3. The first appellate authority found that there was a fall in price consequent on issue of right shares. Since there was also simultaneous declaration of bonus shares, he was of the view, that it is difficult to identify [that] the fall is attributable to the issue of right shares only. He was of the view that the fall due to issue of right shares should have been marpinal only. He, therefore, rejected the assessee's claim. The assessee had originally claimed a capital loss of Rs. 81,000 and had given a different working before us allocating the fall in value between the bonus shares and the right shares. This resulted in capital gains of Rs. 15,525 as against the profit of Rs. 61,500 computed by the ITO and the loss of Rs. 81,000 claimed by the assessee before the authorities below. Even the revised working was not acceptable to the learned departmental representative. He relied upon the grounds of appeal though it did not specify the ground for its objection. The learned representative for the assessee repeat ed the claim that rule in the case of Kapadia (supra) fully supported the revised working given by the assessee.
4. The learned departmental representative, on the other hand, claimed that there was hardly any conspicuous effect on price as solely attributable to issue of right shares. it was secondly claimed that such loss is not allowable even if it had actually occurred.
5. We have carefully considered the records as well as the arguments.
The Gujarat High Court in the case of CIT v. Chunilal Khushaldas  93 ITR 369 had pointed out that each block of shares has separate identity. Bonus shares arising out of original holding could be treated as short-term capital gains with reference to the date of issue of bonus shares and not with reference to the date of acquisition of original shares. The reason for this is that the rights in respect of each type of shares need not necessarily be same. For ascertaining the cost of bonus shares, the Supreme Court in CIT v. Dalmia Investment Co.
Ltd.  52 ITR 567 held that the bonus shares, if they are ranked pari passu with original shares, should be valued on the basis of averaging the cost of original shares. However, the Calcutta High Court in CIT v. General Investment Co. Ltd.  131 ITR 366 applied this principle even when the loss with reference to the original cost of the original shares had been fully allowed on the basis of substitution of value as on 1-1-1954. The Bombay High Court in W.H. Brady and Co. Ltd. v. CIT  119 ITR 359 held that where both the original and bonus shares have been sold at the same time, the actual cost has to be reckoned subject only to substitution of market value of those shares in existence as on 1-1-1954. We are, however, faced with the sale of right shares. The ITO has treated the right shares as though it is a different category ignoring that the concession which it got in terms of price was attributable to the existing shareholding. To this extent, the ITO was in error. At the same time, we have to see whether the reliance placed by the assessee in the case of Kapadia (supra) is justified. In that case mere right to subscribe to the right share was sold as such. In ascertaining the profit therefrom, the ITO wanted to bring to tax the entire receipt. It was found that such a treatment cannot be justified with reference to the method of working of the profits, on the basis of commercial practice. Since the value of the present holding of the assessee diminished on account of the issue of right shares, it was considered that it is not proper to tax the entire receipt as though it represented the full profits realisable in the transaction. When the shares have been subscribed and became part of the holding of the assessee, it will not be correct to say that the rule in Kapadia's case (supra) would apply. Miss Dhun Dadabhoy Kapadia was an investor in shares. The question of valuation of cost of option to subscribe to right shares had again come up in the case of CIT v.K.A. Patch  81 ITR 413 (Bom.). The Bombay High Court held that it makes no difference that the assessee was a dealer. In this context the counsel for the revenue pointed out certain anomalies in following the decision in Kapadia's case (supra) and wanted the principle of averaging accepted by the Supreme Court in respect of bonus shares to be applied for right shares as well. The examples given by the counsel for the revenue in that case are available in K.A. Patch's case (supra). The High Court repeated the comments made by the counsel for the assessee in the following words: Mr. Dastur, the learned counsel for the assessee, tried to explain that the difficulties and anomalies, sought to be pointed out by Mr.
Joshi to exist, arise by reason of ignoring what according to Mr.
Dastur is the correct position. He pointed out that when bonus shares are issued what a shareholder gets by way of bonus is a share, but when rights shares are issued, what the shareholder gets is an option either to accept the offer and by paying the necessary amount to the company actually obtain the share, or, in the alternative, to sell his right to apply for the rights share. He pointed out that the two modes available under this option are totally different and independent of each other. In the first case he exercises his option and gets the actual share itself. In the latter case, however, he does not get any share at all, but sells the right to obtain a share, the right to obtain a share being different from the obtaining of the share itself. He contended that when a shareholder sells his right, he effects a totally different and independent transaction uncorrelated to his holding of the original or old share. He contended that the real profit or loss and the amount thereof resulting in the case of each holder of the old shares should be ascertained at the time when he sells his old shares but, of course, after the actual cost of the old shares is reduced by the depreciation suffered in respect of the old share at the time of the sale of the right which sprang out of the old share, the depreciation being the short-fall ascertained by deducting the ex-right price from the cum-right price at the time of the issue of the rights shares. Mr. Dastur contended that the method suggested by Mr. Joshi, which is the method of averaging out as laid down in the said three cases dealing with bonus shares, may, with some reservations, apply only if, in the case of a rights issue, the share-holder actually applied for the share offered to him, pays to the company the money payable in respect of those shares and obtains the shares from the company. (pp. 421-22) The High Court applied the rule in Kapadia's case (supra) as Shri K.A.Patch had sold the options themselves and had not subscribed to the shares. The principle of averaging would have to be extended to right shares if the shareholder exercises such rights and holds these right shares along with the original shares and bonus shares as had been done by the assessee before us. We, therefore, are not in a position to accept the assessee's claim that the rule in Kapadia (supra) will apply. We are of the view that the principle of averaging has to be reckoned if the original shares, bonus shares and right shares have some claim pari passu for right to dividend. Though their identities to remain separate for pur poses of ascertaining whether they are long-term or short-term capital gains, it would appear that the method of ascertaining the cost of the bonus shares and right shares have to be based upon the same averaging principle. The only difference is that the contribution made by a shareholder for bonus shares is nil while the contribution made for right shares is something less than the market value of the share. Hence, it is not correct to work out the cost of right shares merely with reference to the contribution paid for it as had been done by the ITO. At the same time it is not possible to accept the principle that the depreciation in value in the existing shareholding should be allocated to right shares or distributed pro rata so as to enhance the cost of other shares to the same extent. No doubt the principle of averaging approved by us would ensure that the assessee gets benefit of part of the cost paid for the existing holding of the shares. Any higher benefit that is sought to be obtained by the assessee on the basis of rule in Kapadia's case (supra) is not only unjustified in law besides being complicated but also would have the effect of complicating the process of ascertaining the cost of other shares in the event of their sale. As the Courts have pointed out in a number of cases of this type, what we have to look into is the commercial practice. The assessee has a common shares fund account.
Ordinary commercial practice suggests that all the shares which have a similar prospect in respect of the dividends have a uniform value to the shareholder. Such uniformity is assured by averaging the entire outlay by the taxpayer subject only to adjustment for any contribution towards right shares remaining unpaid on date of sale. The decision which we have taken allows for partial relief to the assessee. We have not worked out the actual profit assessable because the assessee had been acquiring shares from time to time, has received bonus shares thrice and also got right shares on which a part of the contribution remains on date of sale. The principle of averaging in respect of partly paid right shares for ascertaining the cost has been illustrated in K.A. Patch's case (supra). It is in the light of this principle that the cost has to be ascertained. We consider it expedient to remit the matter back to the ITO to work out the cost and ascertain the profits on the basis of the principles for ascertaining the cost of acquisition of right shares stated in this paragraph.