1. This is a reference under the Companies (Profits) Surtax Act, 1964, at the instance of the Commissioner of Surtax. It relates to the assessment year 1969-70, in respect of which the previous years adopted by the respondent-company was the calendar year 1968.
2. In order to work out the statutory deduction available to the assessed, the capital of the company had to be computed in accordance with the rules contained in the Second Schedule. The present reference involves the interpretation of r. 3 of the above Schedule.
3. As on the first day of the previous year, i.e., the 1st January, 1968, the company had a share capital of Rs, 1,37,78,500 and there were credits in the following accounts to the extent indicated below.
Rs.Capital suspense account 46,506Development rebate reserves 29,45,000General reserves 20,96,502
4. These figures appear from the annexure to the assessment order which has been omitted from the paper books, but a copy of it has been supplied to us by the counsel for the assessed. That the company is entitled to a statutory deduction in respect of the above items of paid up capital and reserves is not in doubt.
5. However, during the accounting year, namely, on 12th September, 1968, the assessed-company capitalized a part of the amounts standing to the credit of the general reserves account. The capitalization was to the extent of Rs. 13,77,850 by the allotment of 1,37,785 shares of Rs. 10 each to the company's shareholders. The company, relying on r. 3 of the Second Schedule to the 1964 Act, contended that in respect of this increase in the paid up capital of the company, it was entitled to the paid up capital and reserves calculated as on 1st January, 1968, being stepped up proportionately to the extent of Rs. 4,19,018. The ITO did not accept this plea but both the AAC and the Appellate Tribunal upheld the assessed's claim relying on a decision of the Bombay Bench of the Tribunal in the case of ITO v. Swan Mills Ltd., a case decided under the Super Profits Tax Act, 1963. At the instance of the Commissioner of Surtax, the following question has been referred to us for decision :
'Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that the capital of the company as computed in accordance with rule 1 of the Second Schedule of the Companies (Profits) Surtax Act, 1964, could be increased by the increase in the paid up capital which took place with effect from September 12, 1968 ?'
6. The assessed's claim is based on the terms of r. 3 earlier referred to, which, as it stood at the relevant time, reads as follows :
'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 or issue of debentures or borrowing of any moneys referred to in clause (v) of rule 1 or is reduced by any amount on account of reduction of paid-up share capital or redemption of any debentures or repayment of any such moneys, such capital shall be increased or reduced, as the case may be, 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 the total number of days in that previous year.'
7. In order to appreciate the import of this rule, it is necessary also to set out the provisions of r. 1 of the Second Schedule which, at the relevant time, stood as follows :
'Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of -
(i) its paid-up share capital; (ii) its reserves, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (XI of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961 (XLIII of 1961); (iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (XI of 1922), or the Income-tax Act, 1961 (XLIII of 1961); (iv) its debentures, if any; and (v) any moneys borrowed by it from Government or the Industrial Finance Corporation of India..........'
8. Reading the two rules together, the purport thereof is quite clear. A company is charged to surtax in respect of its chargeable profit of the previous year in so far as they exceed the statutory deduction. The statutory deduction is a percentage of the capital of the company. the capital of the company is calculated in the first instance as it stood on the first day of the previous year. The capital of a company as computed under r. 1 includes the paid-up capital of the company, its development rebate reserve its other reserves not allowed as deductions for income-tax purposes, the debentures issued by the company, if any, and the moneys borrowed by the company from certain sources indicated in clause (v). It is possible that in the course of the previous year the capital of the company might have been increased as a result of the increase in the paid up capital or on account of the company raising more money by way of debentures or borrowings indicated in clause (v). The Legislature, thereforee, considered that in respect of such an increase in capital during the previous year, the assessed should also be entitled to the statutory deduction being stepped up proportionately. That is the purpose of r. 3. It enables an assessed to claim that the capital as computed in accordance with r. 1 should be increased by a proportionate part of the increase in capital during the previous year.
9. At this stage, it may `be convenient to set out the provisions of the Second Schedule to the Super Profits Tax Act, 1963, which was in force before the companies (Profits) Surtax Act, 1964, came into force. Rule 1 of the Second Schedule to that Act was in terms similar though not identical with those of the present Act. But we are concerned here only with the provision enabling an increase in the capital computation on account of an increase in the capital during the previous year. This was provided for by r. 2 of the Second Schedule to the Super Profits Tax Act, 1963, which was in the following terms :
'Where after the first day of the previous year relevant to the assessment year, the paid up share capital of a company is increased or reduced by any amount during that previous year, the capital computed in accordance with rule 1 shall be increased or decreased, as the case may be, by a portion of that amount which is proportional to the portion of the previous year during which the increase or the reduction of the paid up share capital remained effective.'
10. It would be seen that there is a substantial difference between the provisions of r. 2 of the 1963 Act and those contained in r. 3 of the 1964 Act. Rule 2 of the 1963 Act laid down that if during the previous year the paid up share capital of the company was increased by any amount, the capital computation would be increased by a proportionate portion of that amount. It is this particular clause that was interpreted by the Tribunal in Swan Mills Ltd., the order in which they purported to follow in the present case. In fact, so far as the Super Profits Tax Act is concerned, there is also the decision of the Himachal Pradesh High Court in the case of CIT v. Mohan Meakin Breweries Ltd. . In that case, the company had during the previous year increased its paid-up capital by capitalizing a portion of the reserves and it was held that it was entitled to an increase in the capital computation to a corresponding extent notwithstanding the fact that the paid-up capital had been increased by depleting a portion of the reserves which had already been taken into account for capital computation purposes under r. 1. It would appear that r. 3 of the Second Schedule to the 1964 Act has been worded to get out of this situation in which the assessed could get a benefit twice over. The language of r. 3 is clearly different. It contemplates an increase in the capital computation only where there is an increase in the capital of a company as computed in accordance with the earlier rules, that is to say, an increase in the capital of the company as computed in accordance with r. 1. In a case, where the paid up capital is increased, but this is done by utilizing a portion of the reserves which have been taken into account in the capital computation as the first day of the previous year then it is clear that the capital of the company as computed in accordance with r. 1 has not increased at all. That being so, the assessed cannot invoke the aid of r. 3 to increase the capital computation proportionately to the increase in the paid up capital. This indeed, appears to be very clear from the language of r. 3 and, as pointed out by the learned counsel for the revenue, it has been so held by the Bombay High Court in the case of CIT v. Century Spg. and Mfg. Co Ltd. : 111ITR6(Bom) .
11. Mr. Ravinder Narain, learned counsel for the respondent-assessed, however, tried to save the situation in the present case by relying upon a small difference between the facts of the present case and those considered by the Bombay High Court in Century Spg. and Mfg. Co. Ltd.'s case  111 ITR 6. He points out that, though it is true that the company issued bonus shares by capitalization of the general reserves of the company, it also issued during the previous year equity shares of the value of Rs. 30 lakhs on December 16, 1968. He does not deny that in respect of this increase in capital as result of the issue of equity shares he has been given appropriate relief under the provisions of r. 3. But what he contends is that as a result of the equity shares issued on December 16, 1968, the present company fulfillls the initial requirement in r. 3, namely, that there should be an increase in the amount of the capital as computed under r. 1. His argument is that since this part of the rule (which he would characterize as something in the nature of a condition precedent for its application) is attracted, the amount of relief available to the assessed should be calculated not on the amount of increase in the capital as computed under r. 1 but by reference to the amounts of increase in (a) paid-up share capital, (b) the amount of debentures issued by the company during the previous year, and (c) the amount of moneys borrowed by the company during the previous year within the meaning of clause (v) or r. 1. His contention is, thereforee, that since in the present case there is an increase in the capital as computed under r. 1, the assessed should be entitled to the benefit of r. 3 to the extent of the increase in the paid-up share capital. In this context, learned counsel points out that r. 3 refers to an increase in the paid-up share capital, to the issue of debentures and to the borrowing of moneys referred to in clause (v) of r. 1 but avoids any reference to the reserves dealt with in cls. (ii) and (iii) of r. 1. The point made by him is that it is immaterial that the paid up share capital is increased at the cost of the reserves.
12. The argument of the learned counsel, though attractive, is not borne out by the language of the rule. The rule, in its opening words, no doubt, envisages an increase in the capital of the company as computed under r. 1. We agree with the learned counsel that unless there is an increase in the capital as already computed under r. 1, r 3 will not come into operation. But we are unable to agree with the second step suggested by the learned counsel. The enclosing words of the rural make it clear that in any case where there is an increase in the capital as contemplated by the opening words, the increase available to the assessed will be a proportionate part of 'that amount'. The words 'that amount' clearly refer to words 'any amount' referred to in the opening part of the rule. In other words, it is only to the extent of surplus or excess over the capital as computed at the beginning of the previous year that the assessed gets the relief as envisaged in 3. That it has already got in respect of the share issued on December 16, 1968. On a plain reading of r. 3, it is clear that the assessed cannot claim any stepping up of the capital computation in respect of an amount which is already included in the capital computation as on the first day of the previous year.
13. Much emphasis was placed by the learned counsel on the middle portion of the rule in which reference is made to the increase in the capital on account of certain specified categories of receipts. He points out that the rule specifically refers to the paid-up capital, debentures and borrowings and avoids a reference to the word 'reserves'. We are, however, unable to agree with the learned counsel for the assessed that the omission of the word 'reserves' is significant in this context. The three categories of paid-up share capital, issue of debentures or borrowing of moneys are mentioned by way of reference to the ways of possible increase of the capital computed under r. 1. Normally speaking, a company's reserves would be added to only at the time of appropriation of the profits of a previous year and not in the middle of a year. That is perhaps the reason why the word 'reserves' does not find a place in the various categories which are referred to in the rule. Moreover, reserves by themselves cannot go to increase the share capital beyond the amount which has already been calculated under r. 1; hence no reference to this particular source or category was necessary to be made in the rule. That apart, even assuming that some significance, can be attached to these words, the relief available to the assessed can be determined only on the basis of the operative portion of the rule. As we have already pointed out, the relief available to the assessed is only a proportionate part of that amount which means the amount by which the capital computed under r. 1 goes up. In view of this, we do not find any force in the learned counsel's contention that the decision in the present case should be different from the decision in the Bombay case.
14. In the result, we answer the question referred to us in the negative by saying that the Tribunal was not correct in holding that the capital of the company as computed under r. 1 could be increased by a proportionate amount of the increase in the paid up share capital which took place on 12th September, 1968. As the Commissioner has succeeded, he will be entitled to the costs of this reference. Counsel's fee Rs. 300.