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Shashibala Navnitlal Vs. Commissioner of Income-tax, Gujarat - Court Judgment

LegalCrystal Citation
SubjectCompany;Direct Taxation
CourtGujarat High Court
Decided On
Judge
Reported in[1964]54ITR478(Guj)
ActsIncome-tax Act, 1922 - Sections 2(6A); Companies Act, 1956; Indian Companies Act, 1913
AppellantShashibala Navnitlal
RespondentCommissioner of Income-tax, Gujarat
Cases ReferredNicholas v. Commissioner of Taxes
Excerpt:
direct taxation - assessment - section 2 (6a) of income tax act, 1961 - assessee received amount on redemption of redeemable preferential shares - such amount liable to be assessed at hands of assessed as dividend. - - 3,84,000 transferred a like amount from the profit appearing in the profit and loss account for the year 1955 to the credit of a new fund called the preference capital redemption fund. the appellate assistant commissioner, however, took the view that all the ingredients of section 2(6a)(a) were satisfied and that the amount of rs. 38,000 constitutes dividend and even though it may not be liable to be regarded as dividend under section 2(6a)(a), if it can be regarded as dividend under section 2(6a)(d) and such conclusion clearly arises from the facts stated in the.....p.n. bhagwati, j.1. the short question that arises on this reference is whether a sum of rs. 38,000 received by the assessee in redemption of 380 redeemable preference shares held by her in a company called sakarlal ballabhai and company ltd., ought to be included in the assessment made upon the assessee for the assessment year 1957-58, the accounting year being samvat year 2012. the determination of the question rests upon the proper construction of section 2(6a)(a) of the income-tax act, 1922. a highly ingenious argument has been advanced by mr. kaji on behalf of the assessee in an attempt to persuade us to answer the question in favour of the assessee and though the argument has been presented with skill and ability, we find there is no merit in it and it must be rejected. 2. the.....
Judgment:

P.N. Bhagwati, J.

1. The short question that arises on this reference is whether a sum of Rs. 38,000 received by the assessee in redemption of 380 redeemable preference shares held by her in a company called Sakarlal Ballabhai and Company Ltd., ought to be included in the assessment made upon the assessee for the assessment year 1957-58, the accounting year being Samvat Year 2012. the determination of the question rests upon the proper construction of section 2(6A)(a) of the Income-tax Act, 1922. A highly ingenious argument has been advanced by Mr. Kaji on behalf of the assessee in an attempt to persuade us to answer the question in favour of the assessee and though the argument has been presented with skill and ability, we find there is no merit in it and it must be rejected.

2. The material facts giving rise to the reference may be summarized as follows : Sakarlal Ballabhai and Company (hereinafter referred to as the company), at all material times carried on business as managing agent of another limited company called Sarangpur Cotton Manufacturing Company Limited, which owned a cotton textile mill situate in the Cith of Ahmedabad. On or about 13th December, 1951, the company capitalised its accumulated profits to the extent of Rs. 3,84,000 and issued 3,840, 4% redeemable preference shares of Rs. 100 each, credited as fully paid up to the holders of ordinary shares in the company. The assessee was not one of the ordinary shareholders in the company and she did not, therefore, receive any of these redeemable preference shares without payment of cash consideration. But on or about 14th September, 1955, the assessee purchased 380 shares from her brother-in-law who was the original allottee of those shares by paying the price of Rs. 38,000 and those shares were transferred to her name in the records of the company. Prior to this date, however, a resolution was passed by the board of directors of the company on 23rd August, 1955, that the aforesaid 3,840 redeemable preference shares be redeemed as on 31st December, 1955, after giving to the holders thereof a notice in writing of at least one month and that the amount Rs. 3,84,000 required for the purpose be paid from the preference capital redemption fund of Rs. 3,84,000 created out of the earnings of the year 1955. This resolution was subsequently confirmed and passed as a capital resolution by the shareholders at a general meeting of the company held on 29th September, 1955. Though the resolution directed that the amount of Rs. 3,84,000 required for the purpose of redemption be paid out of the preference capital redemption fund to be created out of the profits of the year 1955, in fact no amount was paid out of the preference capital redemption fund. As a matter of fact as we shall point out a little later, it would have been illegal to do so. What the company did pursuant to the resolution was to pay out of its general funds through the managed company a sum of Rs. 3,84,000 in redemption of the aforesaid 3,840 redeemable preference shares and in consequence the assessee who was the holder of 380 shares received a sum of Rs. 38,000 from the company. The company after effecting redemption by paying out the sum of Rs. 3,84,000 transferred a like amount from the profit appearing in the profit and loss account for the year 1955 to the credit of a new fund called the preference capital redemption fund. The sum of Rs. 38,000 which was received by the assessee in redemption of 380 redeemable preference shares held by her in the company was sought to be taxed by the revenue as dividend in the assessment for the assessment year 1957-58. It appears that before the Income-tax Officer the assessee did not dispute that the amount of Rs. 38,000 was dividend but she claimed a deduction of an identical amount representing the price paid by her for acquisition of the said 380 redeemable preference shares. The Income-tax Officer disallowed the deduction claimed by the assessee and brought the amount of Rs. 38,000 received by the assessee and brought the amount of Rs. 38,000 as dividend. The Appellate Assistant Commissioner and in the appeal the assessee challenged the inclusion of the amount of Rs. 38,000 as dividend. The Appellate Assistant Commissioner, however, took the view that all the ingredients of section 2(6A)(a) were satisfied and that the amount of Rs. 38,000 was, therefore, dividend within the meaning of that section. The claim for deduction of the price paid by the assessee for the acquisition of 380 redeemable preference shares was also made by the assessee in the alternative, but that claim was also rejected by the Appellate Assistant Commissioner. The assessee then preferred an appeal before the Tribunal. It appears that before the Tribunal the revenue sought to uphold the inclusion of the amount of Rs. 38,000 in the assessment not only under section 2(6A)(a) but also under section 2(6A)(d). The Tribunal, however, did not go into the question of applicability of section 2(6A)(d) since on a consideration of the true legal position the Tribunal took the view that the amount of Rs. 38,000 represented distribution of capitalised accumulated profits entailing release of assets of the company and was, therefore, liable to be regarded as dividend within the meaning of section 2(6A)(a). The Tribunal having found that the amount in question constituted dividend within the meaning of section 2(6A)(a) proceeded to consider whether the assessee was entitled to claim the price paid by her for the acquisition of the said 380 redeemable preference shares as allowable expenditure. The Tribunal came to the conclusion that this claim of the assessee was unsustainable inasmuch as the expenditure representing the payment of the price of the said 380 redeemable preference share was in the nature of capital expenditure and was in any event expenditure not incurred in the year of account so as to be allowable as a deduction in computing the income of the year of account. The assessee being dissatisfied with the decision of the Tribunal on both the points made an application to the Tribunal for a reference and the Tribunal accordingly made the present reference to this court.

3. The first question referred for our opinion formed the main subject matter of controversy between the parties and raised the point whether the amount of Rs. 38,000 received by the assessee on redemption of the said 380 redeemable preference shares held by her in the company was liable to be assessed in her hands as dividend. the question of course is confined only to section 2(6A)(a) being the section relied on by the Tribunal for holding the amount in question to be dividend, but the learned Advocate General appearing on behalf of the revenue stated that he proposed to justify the inclusion of the said amount as dividend also under section 2(6A)(d). Now there can be no doubt that the learned Advocate-General is entitled to rely on section 2(6A)(d) in support of the conclusion reached by the Tribunal through the question refers only to section 2(6A)(a), for the real controversy between the assessee and the revenue is whether the amount of Rs. 38,000 constitutes dividend and even though it may not be liable to be regarded as dividend under section 2(6A)(a), if it can be regarded as dividend under section 2(6A)(d) and such conclusion clearly arises from the facts stated in the statement of the case, it would be open to us to say that the amount in the question is dividend under section 2(6A)(d) (vide Commissioner of Income-tax v. Breach Candy Swimming Bath Trust (1) [1955] 27 I.T.R. 279. ; Ismailia Grain Merchants' Association v. Commissioner of Income-tax (2) [1957] 31 I.T.R. 433.). But it is not necessary for us to go into the question of the applicability of section 2(6A)(d) since we are of the view, of reasons which we shall presently state, that the present case falls within section 2(6A)(a) and the amount of Rs. 38,000 has been rightly taxed in the hands of the assessee as dividend under section 2(6A)(a).

4. Now ordinarily when a company earns profits and distributes them amongst the shareholders, the amount received by the shareholders being dividend, would be taxable in their hands. But there may be diverse ways in which accumulated profits of a company may reach the hands of the shareholders without being dividend stricto sensu and in such a case they would escape taxation in the hands of the shareholders. the legislature, therefore, enacted section 2(6A) extending the connotation of 'dividend' so as to comprise items of distribution or payment by a company which may not normally be regarded as dividend. By the various clauses of section 2(6A) the legislature sought to bring within the net of taxation cases of distribution or payment out of or to the extent of accumulated profits of the company, whether capitalised or not. There are five clauses of section 2(6A) which deal with distribution or payment under different circumstances so as to make the ambit of taxation wide and extensive, but we are here concerned only with the first of those clauses, namely, clause (a), which runs as follows :

'2. In this Act, unless there is anything repugnant in the subject or context,--...

(6A) `dividend' includes--

(a) any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company...'

5. The argument on behalf of the revenue which found favour with the Tribunal and which was repeated before us here by the learned Advocate-General appearing for the revenue was that when the redeemable preference shares issued by the company out of accumulated profits which were capitalised were redeemed pursuant to the resolution passed by the company on 29th September, 1955, there was a distribution of those capitalised accumulated profits entailing the release by the company of its assets pro tanto to the holders of redeemable preference shares and the amount received by each of them on such distribution in redemption of the redeemable preference shares held by him was, therefore, dividend within the meaning of section 2(6A)(a). This argument was sought to be met by the assessee by a two-fold contention. The first head of the contention was that when the accumulated profits were capitalised by the company and redeemable preference shares were issued to the shareholders credited as fully paid up by applying the capitalised accumulated profits in paying up the capital sums which the shareholders would otherwise have had to contribute in respect of the redeemable preference shares allotted to them, what took place was a distribution of the capitalised accumulated profits among the shareholders and though such distribution did not amount to dividend within the meaning of section 2(6A)(a) inasmuch as the capitalised accumulated profits remained where they were in the coffers of the company and no part of them went into the pockets of the shareholders and consequently there was no release of the assets of the company as required by the section, such distribution having already been made once, no second distribution of the same capitalised accumulated profits could in law or fact take place again when the redeemable preference shares were redeemed. The contention under the second head was--and this contention was really complementary to the first contention and at first blush almost seemed to reinforce it--that when the redeemable preference shares were redeemed, what were distributed were the current profits of the company for the year `1955, since it was out of those profits that the amount required for the purpose of redemption was provided and the distribution being thus a distribution of current profits and not of accumulated profits, the terms of section 2(6A)(a) were not satisfied and the amount received by the assessee could not be regarded as dividend within the meaning of that section. The revenue disputed the validity to both these contentions and adopted the position that when the accumulated profits were capitalised and the redeemable preference shares ;were issued credited as fully paid up, there was no distribution at all of the capitalised accumulated profits even apart from the requirement that the distribution must be of such a character as would entail release of the assets of the company and the distribution of the capitalised accumulated profits took place for the first time when the redeemable preference shares were redeemed. It was also urged on behalf of the revenue that it was not true that the current profits of the company for the year 1955 were utilised for the purpose of redemption but, even if such was the position, that did not make it a distribution of current profits, for the current profits merely provided the fund utilised for the purpose of redemption, the distribution involved in redemption being a distribution of the capitalised accumulated profits constituting the preference share capital. These were the rival contentions urged before us and they raised a question of some nicety and importance.

6. The question depends for its determination on a true interpretation of section 2(6A)(a). This section artificially extends the connotation of the word 'dividend' and brings within its ambit and coverage a distribution which might not be liable to be regarded as dividend according to the accepted connotation of that word. A distribution in order to fall within the section must satisfy two conditions : (i) it must be a distribution of accumulated profits, whether capitalised or not ; and (ii) it must be such as entails the release of all or any of the assets of the company. These two conditions are manifestly cumulative and it is only if both these conditions are satisfied that a distribution can be said to be dividend within the meaning of the section. Now the insistence by the legislature on the fulfillment of the second condition clearly shows that the first condition might be fulfilled without the second which of course should not be enough to constitute the distribution a dividend. The postulate of the second condition is that there might be a distribution which does not entail release of assets of the company and the second condition, therefore, requires that the distribution must, in order to come within the extended meaning of dividend, be a distribution which entails release of assets of the company. The distribution referred to in the first condition is, therefore, not confined to a distribution in the narrow and limited sense of a physical distribution which would necessarily involve release of assets of the company in favour of the shareholders but would also include a distribution which does not involve such release of assets. Of course the latter distribution would not be dividend within the meaning of section 2(6A)(a) but that would be so not because it is not distribution as required by the first condition but because it does not entail release of assets of the company as required by the second condition. If 'distribution' in the first condition is construed to mean physical distribution of accumulated profits among the shareholders, that would necessarily entail release of assets of the company but in that event the prescription of the second condition would be rendered superfluous, for the second condition would then be always implied in the first condition. Now it must be remembered that though a parliamentary enactment (like parliamentary eloquence) is capable of saying the same thing twice over without adding anything to what has already been said once, this repetition in a legislative enactment is not to be assumed. When a legislature enacts a particular phrase in a statute, the presumption is that it is saying something which has not been said immediately before. The rule that a meaning should, if possible, be given to every word in the statute implies that, unless there is good reason to the contrary, the words add something which has not been said immediately before. We must not, therefore, construe the word 'distribution' occurring in the first condition in such a manner as to render the second condition otiose and a mere futile repetition. We asked the learned Advocate-General whether he could point out to us a single case where there would be physical distribution of accumulated profits among shareholders without entailing release of assets, but he was not in a position to point out any. And indeed there could not be any, for if accumulated profits are physically distributed, there must necessarily be release of assets of the company. The word 'distribution' in the first condition must, therefore, be given a broad and expansive meaning to include not only a distribution involving payment of accumulated profits in cash but also a distribution not involving such payment. What can be this latter kind of distribution will appear from the following discussion.

7. Whilst on the question of construction, we must refer to a decision cited by the learned Advocate-General, namely, Punjab Distilling Industries Ltd. v. Commissioner of Income-tax (1) [1963] 48 I.T.R. 288. The provision which came up for construction before the Punjab High Court in this case was section 2(6A)(d). The question which arose was as to when distribution on reduction of capital within the meaning of section 2(6A)(d) takes place. Does it take place when the certificate of registration of the order of the court confirming reduction is issued by the registrar or does it take place when pursuant to the order debits of refund are actually made in the account of the shareholders and refunds are granted The Full Bench of the Punjab High Court held and, if we might respectfully say so, rightly, that there is no distribution when the order is registered and a certificate of registration is issued by the registrar but the distribution takes place when refunds are actually given to the shareholders. The Full Bench relied on the dictionary meaning according to ;which the word 'distribute' connotes 'to deal out or bestow in portions or shares among many ; to allot or apportion as one's share' and said that a resolution or decision to distribute is not distribution within that connotation. Now there can be no doubt that a mere resolution or decision to distribute can never amount to distribution. In order to amount to distribution there must be allotment or apportionment of the amount in different shares amongst many but at the same time we do not see why we should introduce the further requirement that there must be physical handing out of the ;amount coming to the share of each on distribution. Such a requirement does not appear to be an essential element of distribution even according to its dictionary meaning. It is true that there are certain observations in the judgment in this case which at first sight seems to suggest that according to the Full Bench the concept of distribution necessarily involves physical payment or delivery but if those observations are read in their context, we do not think that the Full Bench intended to lay down any such absolute definition of the meaning of 'distribution' application in all cases. That was case a case under section 2(6A)(d) and it was in the context of that section which talks of distribution on reduction of capital that these observation were made and they cannot, therefore, be relied on by the revenue as laying down a construction of the word 'distribution' applicable in all cases. That was a case under section 2(6A)(d) and it was in the context of that section which talks of distribution on reduction of capital that these observations were made and they cannot, therefore, be relied on by the revenue as laying down a construction of the word 'distribution' in section 2(6A)(a). This decision does not, therefore assist the argument of the revenue.

8. It is, therefore, clear that all that the first condition requires is that there should be a distribution of accumulated profits, whether capitalised or not. Such distribution may entail release of assets of the company or may not. In either case the first condition would be satisfied. But the second condition requires that the distribution must be such as entails release of assets of the company and if, therefore, the distribution does not entail release of assets of the company, though the first condition would be satisfied, the second would not be and the distribution would not, therefore, be dividend within section 2(6A)(a). This ground being clear, we will proceed to examine whether there was any distribution of accumulated profits entailing release of assets of the company when the redeemable preference shares were redeemed. Now admittedly there was release of assets of the company on redemption since moneys were actually paid out of the coffers of the company and received by the shareholders. The only question which, therefore, requires to be considered is whether there was any distribution of accumulated profits in the process of redemption. If there was, then manifestly the amounts received by the shareholders on redemption would be dividend within the meaning of section 2(6A)(a). In order to properly determine this question it is necessary to analyse the mechanics of issue of redeemable preference shares as bonus shares and redemption of such shares.

9. We will first examine what really happens when a company issues bonus shares. A company must state in its memorandum of association the amount of capital with which the company desires to do business and the number of shares into which that capital is to be dividend. The company need not issue all its capital at one time. It may issue only a part of its capital initially and issue the rest of the unissued capital or a part of it at a later date. Now if a company prospers and earns profits it may do one of two things with the profits. It may either distribute the profits by way of dividend among the shareholders or accumulate them. Generally, when a company accumulates profits it carries them to various reserves which appear on the liabilities side of the balance-sheet. Ordinarily, these undistributed profits are employed in the business either in acquisition of fixed assets or as working capital and really represent an increase in the capital employed in the business. When these increase to a considerable extent, the issued capital of the company ceases to bear a true relation to the real capital employed in the business. The company may, in such a case, decide to bring its issued capital into a truer relationship with the capital actually employed in the business or, to use the words of Gower, 'more into line with the true excess of assets over liabilities' and may for that purpose capitalise its accumulated profits and issue fully paid up bonus shares of a nominal value equal to the amount capitalised to its shareholders. These bonus shares may be either ordinary or preference shares on the one hand or redeemable preference shares on the other. The company may also instead of issuing bonus shares issue bonus debentures by capitalising its accumulated profits. In all these cases the accumulated profits which are capitalised remain in the coffers of the company and no part of them actually goes into the pockets of the shareholders : the only change that takes place is that the accumulated profits which prior to capitalisation were employed in the business as accumulated profits are thenceforth employed as part of the issued or loan capital of the company according as the issue is of bonus shares or bonus debentures. The accumulated profits which might have been dividend among the shareholders as dividend are impounded to increase the capital of the company and what the shareholders get is not any payment out of the accumulated profits but bonus shares or bonus debentures credited as fully paid up. The transaction, to use the words of Viscount Cave in Commissioners of Inland Revenue v. John Blott (1) (1921) 8 Tax Cas. 101, 135., takes 'nothing out of the company's coffers and' puts 'nothing into the shareholders' pockets' but what happens is that the accumulated profits which are capitalised are applied in paying up the amounts due on bonus shares or debentures to be issued to the shareholders as fully paid up bonus shares or debentures. This analysis of the mechanism of issue of bonus shares or debentures is, apart from the abundance of authority to support it, clearly based on sound principle. We are here concerned only with bonus shares and we will, therefore, confine our attention to an examination of the position in regard to bonus shares but in principle there is no difference between bonus shares and bonus debentures so far as the mechanics of their issue is concerned and what we say in regard to bonus shares will, therefore, also as a matter of principle apply to bonus debentures. It is clear law that when shares are issued and allotted by a company the liability for the amount due on the shares is always on the allottee and that liability must be satisfied from some source external to the company in money or money's worth. The allottee may pay the amount due on the shares in money or if the allottee has to his credit any amount due by the company, such credit may, with his consent, be applied in discharge of the allottee's liabilities on the shares : vide Ooregun Gold Mining Company of India v. Roper (2) [1892] A.C. 125. Now admittedly no moneys are paid by the shareholders for the bonus shares issued to them and it must, therefore, follow that when bonus shares are issued credited as fully paid up, the liability for payment in full on allotment which the shareholders would otherwise have had to discharge is paid by the company by applying the accumulated profits to the discharge of such liability for the benefit of the shareholders. There is of course no payment of the accumulated profits to the shareholders since no part of the accumulated profits is liberated to them : the company does not part with any of the accumulated profits not do the shareholders receive any part of them. But the accumulated profits are applied in paying up the capital sums which the shareholders would otherwise have had to contribute for the purchase of new shares. The shareholders receiving bonus shares credited as fully paid up are given credit for the capital sums which they would otherwise have had to contribute in respect of the bonus shares allotted to them if those shares had no been issued credited as fully paid up and this credit is given by application of the capitalised accumulated profits in payment of such capital sums. As observed by Hidayathullah J. in Commissioner of Income- tax v. Dalmia Investment Co. Ltd. (1) [1964] 52 I.T.R. 567 (S.C.) after the accumulated profits are converted into capital and bonus shares are issued credited as fully paid up 'the company employs that money not as reserves of profits, but as its proper capital issued to and contributed by the shareholder'. If this be the correct legal analysis of what happens when bonus shares are issued by company, it is clear that at that stage there is a distribution of capitalised accumulated profits, though that distribution does not take the form of payment of accumulated profits in cash to the shareholders and does not, therefore, entail release of any assets of the company so as to fall within section 2(6A)(a).

10. This view which we are taking is amply supported by authorities but, more than the authorities, there is a statutory enactment which clearly shows that when bonus shares are issued credited as fully paid up out of capitalised accumulated profits, there is distribution of capitalised accumulated profits though such distribution does not entail release of assets of the company. We are referring to regulation 96 in Table A of the companies Act, 1956, the material portion of which is in the following terms :

'96. (1) The company in general meeting may, upon the recommendation of the board, resolve--

(a) that it is desirable to capitalise any part of the amount for the time being standing to the credit of any of the company's reserve accounts, or to the credit of the profit and loss account or otherwise available for distribution ; and

(b) that such sum be accordingly set free for distribution in the manner specified in clause (2) amongst the members who would have been entitled thereto, if distributed by way of dividend and in the same proportions.

(2) The sum aforesaid shall not be paid in cash but shall be applied, subject to the provision contained in clause (3), either in or towards......

(ii) paying up in full, unissued shares or debentures of the company to be allotted and distributed, credited as fully paid up, to and amongst such members in the proportions aforesaid;......'

11. It is no doubt true that this regulation was not to be found in Table A of the Indian Companies Act, 1913, which was the statute relating to companies in force at the time when the redeemable preference shares in the present case were redeemed as well as issued, but as observed by Buckley in his famous work on Company Law, thirteenth edition, while discussing the corresponding regulation 128 of the English Companies Act, 1948, this was a common article in use even prior to the enactment of the English Companies Act, 1948. It was, therefore, common in legal parlance to speak of accumulated profits as distributed when they were capitalised and applied in issue of bonus shares credited as fully paid up. The enactment of regulation 96 shows that even according to the legislature what takes place when accumulated profits are capitalised and applied in paying up in full bonus shares issued and allotted credited as fully paid up to the shareholders, is distribution of accumulated profits. Now if the legislature in enacting regulation 96 regards capitalisation of accumulated profits by issue of bonus shares credited as fully paid up as distribution of accumulated profits by a company, we do not see why 'distribution' in section 2(6A)(a) should be read in a narrow and constricted manner so as to exclude what the legislature had called 'distribution' in regulation 96. Both section 2(6A)(a) and regulation 96 refer to distribution of accumulated profits by a company, the former to distribution in general while the latter to one particular mode of distribution and the latter would certainly be included in the former. It is, therefore, clear that there is distribution of capitalised accumulated profits when bonus shares are issued credited as fully paid up and it is precisely because of this that the second condition has been introduced by the legislature in section 2(6A)(a) requiring that the distribution in order to fall within the section must entail release of assets of the company. If the second condition had not been introduced, bonus shares issued credited as fully paid up would have been liable to be regarded as 'dividend' within section 2(6A)(a), but the legislature obviously did not want to tax such bonus shares as dividend and it, therefore, introduced the second condition in section 2(6A)(a).

12. Turning now to the authorities we find that not only decided cases but also well-known text-book writers on company law have described capitalisation f accumulated profits and issue of bonus shares credited as fully paid up out them as distribution of capitalised accumulated profits. Gorebrowne in his book on Joint-Stock Companies states at page 29 :

'Fully paid bonus `bonus' shares shares are not a gift, they are merely a distribution of capitalised undivided profits.'

13. Palmer, whose book still holds sovereign sways in the field of company law, says in regard to bonus shares issued credited as fully paid up that they are :

'...fully paid up out of profits of the company available for distribution by way of dividend or otherwise available.'

14. These observations of Palmer, though not as direct as those of Gorebrowne clearly suggest that he also regards capitalised accumulated profits as distributed by issue of bonus shares credited as fully paid up. So far as the decided cases are concerned, the decision most apposite is that of the Division Bench of the Bombay High Court in S.C. Cambatta v. Commissioner of Income-tax (1)[1952] 21 I.T.R. 121., where Chagla C.J. (as he then was), delivering the judgment of the court, observed :

'...Therefore, a company may distribute its profits by bonus shares, in which case a shareholder is entitled to a share in the increased capital of the company. By that method the company capitalises its profits and to the extent that capital is increased it issues bonus shares and distributes them amongst its shareholders. Such a distribution does not entail a release of any of the company's assets because the assets which were represented by the accumulated profits continue to remain as part of the company's assets, the only difference being that instead of the assets being profits they are capitalised and become part of the capital of the company. But when the company distributes its profits by declaring dividends to its shareholders which dividends are made payable by the company then undoubtedly when the dividends are paid the company release part of its assets. This distinction is clear and well-settled.'

15. It is clear from the passage quoted above that Chagla C.J. regarded issue and allotment of bonus shares credited as fully paid up to the shareholders as distribution of accumulated profits within the meaning of the first condition in section 2(6A)(a), but took the view that, since such distribution did not entail release of assets of the company, it did not constitute dividend within the meaning of the section. We find that to the same effect there are observations of M.C. Desai C.J. in Kunjilal Gupta v. Commissioner of Income-tax (1) [1964] 52 I.T.R. 27, 34 (F.B.)., where the learned Chief Justice said :

'Though in one sense it may be said that the issue of bonus shares by the companies is distribution of their accumulated profits because they are issued in lieu of accumulated profits, it cannot be said that the distribution entails the release by the companies to their shareholders of any part of their assets.'

16. Not only the Bombay High Court and the Allahabad High Court in the cases just cited but also the Court of Appeal in England has taken the same view and we cannot do better than quote the following passage from the judgment of Lord Hanworth M.R. in Commissioners of Inland Revenue v. Wright (2) (1926) 11 Tax Cas. 181. at pages 205 and 206 :

'Lord Justice Atkin, when we were dealing with a different case, but incidentally considering the effect of Blott (3) (1921) 8 Tax CAs. 101, says this--I refer to Burrell's case (4) [1924] 2 K.B. 52. at page 68. Referring to Blott's case (3) (1921) 8 Tax Cas. 101, Lord Justice Atkin says: `There the intention of the company is dominant for all purposes. Did the company intend to distribute as profits or as capital It is true that in the later case, Fisher's case (5) (1925) 10 Tax Cas. 302, in my judgment in [1925] 1 K.B. on page 463, I called attention to the fact that in Fisher's case no option was left to the shareholder, but I also called attention to the fact that as in Blott's case (3) (1921) 8 Tax Ca. 101.-- just as here--the company had the dominant voice in what it gave and in what form it gave the undivided profits to the shareholders.'

17. The learned Master of the Rolls also observed at page 207 :

'But if we are to treat it as a matter of law, then it seems to me that inasmuch as there was an option in Bouch v. Sproule (1) (1887) 12 A.C. 385., for effective purposes, as in the present case, we cannot hold that the mere existence of an option prevents the process adopted being one of the distribution of capital.'

18. In view of these observations of the learned Master of the Rolls, it is difficult to accept the contention that 'distribution' is an inapt expression to describe what happens when accumulated profits are capitalised and bonus shares are issued credited as fully paid up to the shareholders. It is clear that this process does involve distribution of accumulated profits though it is not distribution in the popular sense, namely, physical distribution entailing release of assets.

19. The learned Advocate-General relied very strongly on certain observations of Viscount Haldane and Viscount Finlay in Commissioner of Inland Revenue v. Blott (2) (1921) 8 Tax Cas. 101., in support of his contention that there is no distribution of capitalised accumulated profits when bonus shares are issued credited as fully paid up. It is not necessary to refer to these observations for all that these observations declare is that when the accumulated profits are capitalised, they are impounded to increase the capital of the business and they can no longer be distributed amongst the shareholders as dividend and there can be no dispute about it. The accumulated profits when capitalised certainly remain with the company as part of its paid up capital and cannot be physically distributed amongst the shareholders except by following the procedure for reduction of capital on redeeming the bonus shares, if they are redeemable preferences shares, but that does not mean that there is no distribution of accumulated profits otherwise than by payment in cash when bonus shares are issued credited as fully paid up. As a matter of fact, it is clear from the speeches of Viscount Haldane and Viscount Finlay that they did recognise that there would be distribution of accumulated profits otherwise than by payment in cash when bonus shares are issued credited as fully paid up. The learned Lords took the view that although in that case, in form, a dividend was declared, it was invincibly at once applied to payment of the capital sums which the shareholders would otherwise have had to contribute and the shareholders were credited with the discharge by such payment of their liability for payment in full on allotment. Viscount Haldane referred to the application of the accumulated profits 'in paying up the capital sums which the shareholders electing to take up unissued shares would otherwise have to contribute' and in another passage he referred to 'the case of a company using a reserve over which it had full power of disposition, in order to make payments out of it for the benefit of the existing shareholders of capital sums which they would otherwise have had to contribute for the purchase of new shares'. Viscount Finlay referred to the satisfaction of the bonus by distribution of the shares credited as fully up'. These observations make it clear that the learned Lords treated the shareholders as credited with the amounts of the bonus shares issued and allotted to them out of capitalised accumulated profits and this clearly and indubitably constituted distribution of capitalised accumulated profits of the company otherwise than by payment in cash to the shareholders : vide Lord Thankerton's judgment in Nicholas v. Commissioner of Taxes (State of Victoria). (1) [1940] A.C. 744, 755-758 ; [1941] 9 I.T.R. (Suppl.) 53.

20. Though in the present reference we are concerned only with the question as to whether there is any distribution of accumulated profits (whether capitalised or not) entailing release of assets of the company when bonus shares issued as redeemable preference shares are redeemed by the company, we have examined the question as to what happens when bonus shares are issued by the company in some detail for two reasons. The first is that it throws considerable light on the question as to what happens when bonus shares being redeemable preference shares are redeemed by the company. As a matter of fact issue and redemption of redeemable preference shares constitute one single transaction, the former marking its commencement and the latter its conclusion and it is not possible to appreciate and arrive at a correct analysis of the mechanics of redemption without understanding the mechanics of issue. Secondly, an argument was advanced on behalf of the assessee that since there is a distribution of capitalised accumulated profits when accumulated profits are capitalised and redeemable preference shares are issue, there cannot be a second distribution of the same capitalised accumulated profits once again when the redeemable preference shares are redeemed and it was, therefore, necessary to find out whether there is any distribution of capitalised accumulated profits when redeemable preference shares are issued as bonus shares and, if so, what is the nature or character of such distribution. We must, therefore, now proceed to examine in the light of this discussion as to what happens when redeemable preference shares issued as bonus shares are redeemed by the company. When accumulated profits are capitalised and redeemable preference shares are issued as bonus shares credited as fully paid up, the capitalised accumulated profits are converted into preference shares capital. The balance-sheet thereafter shows the profit and loss account or reserves at a reduced figure and the issued capital at a correspondingly increased figure, the only effect being that one item on the liabilities side of the balance-sheet becomes replaced in whole or part by another item, namely, preference share capital, while the assets side of the balance-sheet remains unaffected. Now it is a fundamental principle of company law that the capital of a company must me maintained intact, for the company being a mere abstraction of law distinct from its members and the liability of the members being limited, it is the capital of the company which provides a minimum safeguard to their parties dealing with the company and the law, therefore, requires that no part of the capital shall be returned to the shareholders except under certain circumstances and by following a certain procedure requiring the scrutiny of the court and, it is only if the court sanctions, that there can be repayment to the shareholders in reduction of the capital. But notwithstanding this fundamental principle of maintenance of capital, redeemable preference shares can be repaid in accordance with the terms of issue otherwise than on a formal reduction of capital approved by the court. The preference share capital collected from the holders of redeemable preference shares or credited as fully paid up out of capitalised accumulated profits can be returned to the shareholders without going through the procedure of reduction of capital, though such return of preference share capital would amount to reduction of capital. This would appear to constitute a departure from the fundamental principle of maintenance of capital, but if we look at section 105B of the Indian Companies Act, 1913, which was the section which governed redemption at the time when the redeemable preference shares in the present case were redeemed, we find that the purity of this principle is not only not violated but is, on the contrary, preserved in effect, if not in name, by the stringent provisions contained in the section. Redeemable preference shares, according to these provisions, can be repaid out of profits or out of the proceeds of a fresh issue of shares made for the purpose of redemption or out of sale proceeds of any property of the company. If they are redeemed out of the proceeds of a fresh issue, the capital raised on that issue will obviously replace the capital redeemed and, consequently, the capital of the company will be maintained at the original yardstick. If on the other hand they are redeemed out of profits or out of sale proceeds of any property of the company, them out of profits an amount equivalent to the nominal amount of the shares redeemed is required to be transferred to a reserve fund to be called 'The capital redemption reserve fund' which is to be treated as equivalent to paid up capital. Hence, although the redeemable preference shares disappear on redemption, the capital which they represent is retained for accounting purposes and there is no reduction of the capital yardstick. This analysis of the mechanics of redemption clearly shows that when redeemable preference shares are redeemed, the preference share capital is returned to the shareholders and since such return of the preference share capital would deplete the capital of the company and consequently affect the sanctity of the principle of maintenance of capital which is regarded as a principle of paramount importance, the law requires that the preference share capital so returned should be replaced by other capital either provided by a fresh issue of shares made for the purpose of redemption or transferred out of the profits of the company in case redemption is made out of profits or out of sale proceeds of any property of the company. It is undoubtedly true that redemption cannot be made except out of profits of the company or out of proceeds of a fresh issue of shares made for the purpose of redemption or out of sale proceeds of any property of the company, but these merely indicate the sources of the moneys which may be utilised for the purpose of returning the preference share capital to the shareholders. The only inhibition is that if a company wants to return the preference share capital to the shareholders the company must do so out of moneys earned by the company as profits or derived by the company from a fresh issue of shares or obtained by the company by selling any property belonging to it and if there are no such moneys, the company cannot return the preference share capital to its shareholders. But it must be remembered that what is returned to the shareholders on redemption, what is distributed amongst them, is the preference share capital and not the profits of the company or proceeds of the fresh issue of shares made for the purpose of redemption or sale proceeds of the property belonging to the company which merely provide the moneys for return of the preference share capital. To illustrate what we say, suppose redemption is made out of the proceeds of a fresh issue of shares made for the purpose of redemption, can it be said that there is distribution of share capital obtained from such fresh issue ; as a matter of fact such share capital cannot be distributed at all. Even from the accountancy point of view, when preference shares are redeemed, the cash or the bank, as the case may be, is credited and the preference share capital is debited resulting in the wiping out of the item of preference share capital on the liabilities side of the balance-sheet which would show that the preference share capital is repaid to the shareholders.

21. Now, if this be the correct legal position, as we think it is, it is clear that where the preference share capital is constituted by the application of capitalised accumulated profits in paying up in full preference shares issued to the shareholders as bonus shares credited as fully paid up, the return of the preference share capital involved in the redemption of the preference share must amount to distribution of the capitalised accumulated profits representing the preference share capital. In such a case when the company redeems the preference shares, the company pays back to the shareholders in cash the amounts on the preference shares treated by the company as fully paid up on behalf to the shareholders out of capitalised accumulated profits at the time of the issue of the preference shares. The amounts which are returned to the shareholders on redemption are the amounts paid up on the preference shares and since the amounts paid up on the preference shares are capitalised accumulated profits, it must follow as a necessary consequence that capitalised accumulated profits reach the hands of the shareholders when redemption takes place and consequently there is distribution of capitalised accumulated profits on redemption. It was contended on behalf of the assessee that since there is a distribution of capitalised accumulated profits when the accumulated profits are capitalised and redeemable preference shares are issued, there cannot be a second distribution of the same capitalised accumulated profits once again when the preference shares are redeemed. The argument was stressed in the form of the proposition that what is already distributed once cannot be distributed over again. Now undoubtedly put in this form the proposition appears to be almost axiomatic but a little scrutiny will show that it suffers from the fault of over-simplification. If distribution referred to in both the limbs of the proposition is of the same kind, then of course the proposition would be true, but if the distribution referred to in the first limb is distribution otherwise than by payment in cash, that is, by application of the capitalised accumulated profits in payment in full of the capital sums which the shareholders would have to contribute if the preference shares were not issued credited as fully paid up and the distribution referred to in the second limb is physical distribution by payment in cash, that is, by application of the capitalised accumulated profits in payment in full of the capital sums which the shareholders would have to contribute if the preference share were not issued credited as fully paid up ant the distribution referred to in the second limb is physical distribution by payment in cash, the proposition cannot hold good. In the latter case it cannot be said that the first kind of distribution having taken place, the second kind of distribution would be impossible. As a matter of fact precisely because in the first kind of distribution the capitalised accumulated profits remain in the coffers of the company and are not paid over to the shareholders that the second kind of distribution can take place where those capitalised accumulated profits may be physically distributed in cash to the shareholders. There is no contradiction involved in saying that the capitalised accumulated profits which were distributed otherwise than by payment in cash when the preference shares were issued are physically distributed by payment in cash to the shareholders when the preference shares are redeemed. When preference shares are issued by a company credited as fully paid up out of capitalised accumulated profits, a distribution of capitalised accumulated profits does undoubtedly take place but that distribution is not a physical distribution of the capitalised accumulated profits by payment in cash to the shareholders inasmuch as the capitalised accumulated profits remain in the coffers of the company and no part of them goes into the pockets of the shareholders and a physical distribution of those capitalised accumulated profits by the company parting with them and paying them over in cash to the shareholders can, therefore, certainly take place at a subsequent point of time and that happens when the preference shares are redeemed. The capitalised accumulated profits which, when the preference shares are issued, are applied in giving credit to the shareholders for the amounts of the preference shares allotted and distributed to them and are thus converted into preference share capital or released by the company and distributed in cash amongst the shareholders when the preference shares are redeemed. It is, therefore, clear that, though a distribution of capitalised accumulated profits takes place when accumulated profits are capitalised and preference shares are issued credited as fully paid up, it is a distribution which does not entail release of assets of the company and it is only when the preference shares are redeemed that a distribution of the capitalised accumulated profits takes place entailing release of assets of the company.

22. This being the position were cannot accept the contention of the assessee that the capitalised accumulated profits having been distributed when redeemable preference shares were issued by the company, there could not be a second distribution of the same capitalised accumulated profits over again when the preference shares were redeemed and that what were distributed to the shareholders in the process of redemption were, therefore, not those capitalised accumulated profits which were already distributed at the time of issue of the preference shares but the current profits for the year 1955 which were utilised for the purpose of redemption. There was in our opinion a distribution of capitalised accumulated profits entailing release of assets of the company when the preference shares were redeemed by the company and the amount of Rs. 38,000 received by the assessee on redemption, therefore, clearly fell within the definition of 'dividend' contained in section 2(6A)(a). Our answer to the first question referred to us is, therefore, in the affirmative.

23. The second question relates to the claim for deduction of the amount of the purchase price paid by the assessee for the acquisition of the said 380 preference shares in respect of which she received the amount of Rs. 38,000 on redemption. This claim for deduction is obviously unsustainable and for two very good reasons. In the first instance the said 380 preference shares were purchased by the assessee on or about 14th September, 1955, prior to the commencement of the year of account and the purchase price paid for the acquisition of those shares cannot, therefore, be claimed as an allowable expenditure while computing the income of the assessee in respect of the year of account. Secondly, the purchase price was clearly in the nature of capital expenditure and cannot, therefore, possibly be claimed as an allowable expenditure under section 12 which is the section under which income from dividend is liable to be taxed. The assessee was, therefore, not entitled to claim any deduction of the purchase price paid by her in computing the income from dividend and the claim for deduction made by her was rightly rejected. Our answer to the second question referred to us is, therefore, in the negative.

24. Since the assessee has failed in getting an answer in her favour in respect of both the questions referred for our opinion, the assessee must pay the cost of the reference to the Commissioner.


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