Leila Seth, J.
(1) These two income-tax references at the instance of the assessed pertain to assessment years 1967-68 and 1968-69, the relevant previous years having ended on 30th June, 1966 and 30th June, 1967 respectively.
(2) M/S. Escorts Farms (Ramgarh) Ltd., New Delhi, the assessed, is a private limited company. It derives income from investments, agriculture and brick kiln business.
(3) On 1st August, 1965 the assessed sold 15,000 shares of Escorts Ltd. and declared a capital gain of Rs. 2,418 for the assessment year 1967-68. During the next assessment year the assessed sold 5000 shares on 31st January. 1967 and another 10,000 shares on 1st March, 1967 of the same company and declared a capital gain for that year of Rs. 11,700. The assessed worked out the capital gain by deducting the actual price paid at the time of purchase from the sale price. The assessed ignored the fact that it had also received bonus shares issued by Escorts Ltd.
(4) With regard to the shares sold the Income-tax Officer observed that the assessed could not pin point which of these shares had been actually purchased and for what value. He averaged the cost of the shares by spreading out the purchase price of the original shares on both the original and the bonus shares. As on 1st August. 1965 the assessed had 1,03,012 shares in Escorts Ltd. The total amount paid for these shares was Rs. 9.87,668. As such the average cost worked out to Rs. 9.59 per share. Since the assessed sold 15,000 shares on 1st August, 1965 at the rate of Rs. 11.73 per share the capital gain per share was held to be Rs. 2.14: the total capital gain working out to Rs. 32.100. Similarly. for the assessment year 1968-69, the average cost of the shares worked out at Rs. 9.32 per share. As the shares were sold at Rs. 10.15 there was a capital gain per share of Re. O.83. The total capital gain being Rs. 12,450.
(5) On appeal by the assessed, the Appellate Assistant Commissioner confirmed the order of the Income-tax Officer. On further appeal to the Tribunal it found on facts in favor of the assessed and opined that it had 'been able to correlate the sale of shares with the original shares in both the years of account and no bonus shares were sold in either year'. But .applying the principle of averaging out as enunciated in Commissioner of Income-tax, Bihar v. Dalmia Investment Co. Ltd. : 52ITR567(SC) , it upheld the order of the Income-tax Officer and dismissed the appeal.
(6) Thereafter, at the instance of the assessed, the Tribunal referred the following two common questions of law for our opinion for both the assessment years : '1. Whether on the facts and in the circumstances of the case the Tribunal was justified in determining the cost of acquisition of the original shares by spreading the original cost over the original and the bonus shares and then averaging the same and on that basis working out the capital gain at Rs. 32,100 and Rs. 12,450 for the assessment years 1967-68 and 1968-69 respectively ?'. 2. If the answer to question No. I is in the negative' whether the assessed was Justified in taking the value of the shares at their original cost under section 45 of the Income-tax Act, 1961?
(7) The point in issue is : how is the cost of the acquisition of the original shares to be determined, when bonus shares have been issued subsequently
(8) Section 45 provides for capital gains on the transfer of a capital asset to be chargeable to income tax. Section 48 deals with the mode of computation and deductions applicable to capital gains. The 'capital gains' are to be arrived at after deducting from the consideration received for the transfer : (i) the expenditure incurred wholly and exclusively in connection with the transfer ; and (ii) the cost of acquisition of the capital asset and the cost of improvement thereto.
(9) Section 55(2) gives the meaning to be attached to the cost of acquisition in certain circumstances. Section 55(2)(i) says that if the capital asset was acquired before 1st of January. 1.954, the assessed has an option to either take the cost of acquisition of the asset or to take the fair market value as on 1st January, 1954.
(10) We are here concerned with the 'cost of acquisition' of the original shares and not the cost of acquisition of the bonus shares. It is the original shares that have been sold. They were admittedly purchased after 1954. thereforee, the option of taking the fair market value as on 1st January, 1954 is not available to the assessed. The cost and date of acquisition of these shares is known. The sale price is known. In such a case it would appear to us. normally, that the cost of acquisition of the original shares should be the actual price paid ; and the capital gains should be, arrived at after deducting this price from the sale price. But what happens when bonus shares have been issued after acquisition and before sale Is not the actual cost of acquisition affected by the subsequent event, e.g. the issue of bonus shares The issue of bonus shares certainly affects the market value of the existing shares, which diminishes as a result. How then is the cost of the bonus shares and the original shares to be determined
(11) The cost of acquisition of an asset is normally the actual cost. However, if an assessed receives an asset 'for free' a question arises as to the cost to be estimated. The nature of the asset and the reason why the assessed has received it without any payment has to be examined. A share in a company is a bundle of rights permitting the holder to participate in the capital and management of the company. Bonus shares are issued to the holder of the original shares. Once bonus shares have been issued they are treated exactly as other shares. If they rank 'pari passu' with the other shares. Thereafter bonus shares can be issued also in relation to these earlier bonus shares which are now ranking 'pari passu'. thereforee, on the issue of bonus shares what happens, is, that though the participation of the holder is not increased the number of shares is ; all 14 HCD/82--4 holders of original shares being entitled to the bonus. As such the shares are split up. In the words of Justice Holmes in Henry R. Towne Mark. Eisner, Collector of United States Internal Revenue for the Third District of the State of New York, (1917) 245 U.S. 418 62 Law Ed. 372. 'what has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new'.
(12) In Commissioner of Income-tax, Bihar v. Dalmia Investment Co. Ltd. : 52ITR567(SC) , the Supreme Court dealt with the question of the cost of acquisition of bonus shares which were subsequently sold by a dealer in shares. Hidayatullah, J. (as he then was) speaking for the court considered four possible methods of calculation. The first was to take the cost as equivalent to the face value of the bonus shares. The second, to take the cost as nil. The third, to take the cost of the original shares and to spread that over the original and the bonus shares collectively. The fourth method was to find out the fall in the price of the original shares on the stock exchange and attribute this to the bonus shares. After complete consideration, the court's opinion was that the third method was the correct method.
(13) However, in that case what was being considered was the cost of acquisition of the bonus shares and not the cost of acquisition of the original shares. As such. Mr. Bishamber Lal for the assessed, submitted that the principle enunciated therein should not be applied to the present case. In fact, he contended that the decision of the Supreme Court in Emarald & Co. Ltd. v. Commissioner of Income-tax, Bombay; (1959) 36 1. T. R. 257 would be more apposite; especially as the Tribunal had found as a fact that no bonus shares had been sold in either of the two assessment years.
(14) In Emerald & Co. Ltd. (supra), the facts were that at the beginning of the accounting year the assessed held 100 shares in a company, which it had purchased for the sum of Rs. 48,359 and 50 bonus shares of the face value of Rs. 250 each. During that year the assessed purchased 200 more shares of the company for Rs. 99,939 and later sold the 300 shares for a total sum of Rs. 1,20,550. At the end of the accounting year the bonus shares remained with the assessed. The assessed claimed a loss of Rs. 35,801 for that year by valuing the bonus shares at their face value, whereas the Income-tax Officer arrived at a loss of Rs. 27,766 by the method of averaging the price of the shares. The Appellate Tribunal adopted a third method by which the 50 bonus shares were completely ignored and the loss was arrived at by considering solely the purchase value of the 300 shares and the proceeds realised by their sale. On a reference, the High Court held that the method adopted by the Appellate Tribunal was erroneous and upheld the method of valuation adopted by the Income-tax Officer.
(15) The Supreme Court held that the method of valuation adopted by the Appellate Tribunal was correct and in accordance with law. Hidayatullah, J. (as he then was) speaking for the court opined that for purpose of assessing the loss for the accounting year the question of the proper method of valuing the bonus shares was not relevant as they were not sold and were still retained by the assessed.
(16) If matters had rested here, then on the basis of this decision, it would be apparent that the contention of learned counsel for the assessed is correct. But in Commissioner of Income-tax. Calcutta v. Gold Mohore Investment Co. Ltd. : 74ITR62(SC) , the Supreme Court had occasion, once again, to consider the matter of valuation or cost of bonus shares. Both bonus shares and original shares had been sold. Once again, it was Hidayatullah, C. J. who speaking for the court. Dealing with the case of Emerald & Co. Ltd. (supra), he observed:
'IN other words, this court did not go into the question of the valuation of the bonus shares at all but decided the case on the basis of the original holding, its cost price and its sale price. The matter was gone into more closely in the Dalmia's case and every method of calculation was considered there. We were invited to depart from the decision in the Dalmia's case and to take the view which appeared to have been taken in the Emerald's case. We have considered the matter once again and are of opinion that the method followed in the Dalmia's case is tile correct method and there seems to be some error in staling that the method of the Tribunal in Emerald's case was finally accepted. Perhaps the court intended saying that the method of the Income-tax Officer was preferable but by error put down the name of the Income-tax Appellate Tribunal. In any case that case did not decide the matter fully because, as the court itself observed, the difference in the two methods only resulted in Rs. 18 being either added to or deducted from the ultimate result.'
(17) Following this decision in Commissioner of Income-tax, Central Calcutta v. Gold Co. Ltd., : 78ITR16(SC) Hidayatullah, C. J. observed that the correct method of valuing the shares was by 'spreading the price of the old shares over the old and the new'. In that case, however. it was the original shares that were sold. Though the actual cost of acquisition of those original shares was Rs. 61,200 they Were valued at half i.e. Rs. 30,600 because of the subsequent issue of bonus shares and the principle of averaging out being applied in arriving at the dealers profit and loss for the year.
(18) In Shekhawati General Trader Ltd. v. Income-Tax Officer, Company Circle-1, Jaipur, : 82ITR788(SC) the Supreme Court while considering the question of the validity of reassessment proceedings under section 147 of the Act had to, advert to, the question of the cost of acquisition of original shares with reference to the provisions pertaining to capital gains. The revenue contended before the Supreme Court that in view of the decision in Dalmia Investment Co. Ltd., after the issue of bonus shares the cost of the original shares had to be spread over all the shares inclusive of the bonus or right shares acquired on the original holding. The Supreme Court dealing with the case of Dalmia Investment Co. Ltd. observed at page 793 :
'.. . .We have set out the facts of this case in detail in order to demonstrate that that decision was not at all apposite for the purpose of deciding the point which has arisen in the present case. No question arose there of the calculation of the capital gain or loss in accordance with the statutory provisions in pari materia with sections 48 and 55(2) of the Act. In the present case we are confined to the express provisions of section 55(2) relating to the manner in which the cost of acquisition of a capital asset has to be determined for the purpose of section 48. Where the capital asset became the property of the assessed before the first day of January, 1954, the assessed has two options. It can decide whether it wishes to take the cost of the acquisition of the asset to it as the cost of acquisition for the purpose of section 48 or the fair market value of the asset on the first day of January, 1954. The word 'fair' appears to have been used to indicate that any artificially inflated value is not to be taken into account. In the present case it is common ground that when the original assessment order was made the fair market value of the shares in question had been duly determined and accepted as correct by the Income-tax Officer. Under no principle or authority can anything more be read into the provisions of section 55(2)(i) in the manner suggested by the revenue based on the view expressed in the Dalmia Investment Co.s case. The High Court completely overlooked the fact that for the ascertainment of the fair market value of the shares in question on January 1, 1954, any event prior or subsequent to the said date was wholly extraneous and irrelevant and could not be taken into consideration. If the contention of the revenue were to be accepted the acquisition of bonus shares subsequent to January 1, 1954, will have to be taken into account which on the language of the statute it is not possible to do....'.
(19) The decision in Shekhawati General Traders Ltd. (supra) makes it clear that where an assessed elects to exercise his option and substitute the market value as on 1st January, 1954 in place of the actual cost of acquisition of the original shares, this statutory cost of acquisition cannot be affected by the subsequent issue of bonus shares. But, it would appear to us, that the same principle is not intended to apply when the assessed has not so elected.
(20) From a laymen's point of view, the cost of the original shares is the price paid for them; and the cost of the bonus shares is nil. But once the principle of averaging is accepted as it certainly has to be in respect of bonus shares, at least, it necessarily implies that for the original cost the assessed must be taken to have acquired both the bonus and the original shares. In other words, the issue of the bonus shares, though subsequent has the effect of altering the original cost of acquisition of the shares. There is nothing illegal in this, as the price paid by the assessed originally was not only for the shares themselves but also for such shares that it may yield subsequently, if any.
(21) The right to acquire bonus shares is a right embedded in the original shares, and they are a legal accretion thereto. The method of spreading over on both the bonus and the original shares the cost of acquisition of the original shares would appear to be the proper method of determining the value of the asset. For there is no doubt that on the issuance of the bonus shares, the value of the original shares is proportionately diminished. In simple language it is 'split up'. As such the cost of acquisition of the original shares and their value is closely interlinked and interdependent on the issue of bonus shares. thereforee, once the bonus shares are issued, the averaging out formula has to be followed with regard to all the shares. But in view of the specific language of section 55(2)(i) regarding the substituted market value of 1st January, 1954, this cannot be done where the assessed has elected to exercise an option as decided in Shekhawati General Traders Ltd.'s case (supra).
(22) For the reasons outlined above and harmonizing the principles enunciated in the various decisions of the Supreme Court, it would appear to us that question No. I has to be answered in the affirmative and in favor of the revenue.
(23) Before concluding it would be pertinent to mention that the Calcutta High Court in Sutlej Cotton Mills Ltd. v. Commissioner of Income-tax, West-Bengal-l, : 119ITR666(Cal) . has in a similar situation taken a contrary view to the one indicated above. In a recent decision of the same court in Commissioner of Income-tax (Central-ll), West Bengal v. General Investment Co. Ltd., : 131ITR366(Cal) , the abovementioned decision has been distinguished. But in a subsequent decision in Commissioner of Income-tax, West Bengal v. Steel Group Ltd., : 131ITR234(Cal) , the Calcutta High Court has followed Sutlej Cotton Mills Ltd. (supra) and has not relied on the decision of the Bombay High Court in W. H. Brady & Company Ltd. v. Commissioner of Income-tax, Bombay, (1979) 19 I.T.R. 359. With respect we feel that the Calcutta High Court has not appreciated correctly the ratio of the decision of the Supreme Court in Shekhawati General Traders Ltd.'s case (supra).
(24) As above indicated, question No. 1 is answered in the affirmative and in favor of revenue. In the circumstances, question No. 2 does not arise. The revenue will be entitled to costs. Counsel's fee Rs. 350. Question No. 1 answered in the affirmative. Question No. 2 does not arise.