1. The question in this reference made by the Income-tax Appellate Tribunal is about the cost valuation of bonus shares.
2. The assessee was a shareholder of a general insurance company. General insurance companies were nationalised under Central Act 57 of 1972. The scheme of nationalisation under this Act was peculiar. Under that scheme, the Central Govt. did not take over the assets of the general insurance companies. The Government took over, instead, all the shares held by the entire body of shareholders in all these general insurance companies at a valuation. This value was set out in a schedule appended to that Act. The valuation was fairly liberal such that capital gains resulted practically to everyone of the shareholders.
3. The assessee held 21,507 shares in a general insurance company called the Madras Motor and General Insurance Company Ltd. Under the Schedule to the Act, a sum of Rs. 1,77,69,600 was the amount payable to all the shareholders of this company in the aggregate. So far as the assessee was concerned, for its entire shareholdings in this company numbering 21,507 shares, the assessee was paid Rs. 42,46,342 as consideration for the compulsory transfer of those shares in favour of the Central Govt.
4. When it came to a question of computing the net capital gains derived by the assessee from the Central Govt. out of the compulsory acquisition of its shares for Rs. 42,46,342 it was necessary to deduct from that figure the assessee's cost of acquisition of the shares. The assessee's position in this regard was that out of its total holding of 21,507 shares, there were 8,109 bonus the shares. The actual cost to the assessee to the shares was known only with respect to the original (or non-bonus) shares numbering 13,398, because the assessee had been out of pocket only as respects those shares. The ITO was prepared to accept that the actual cost of these non-bonus or original shares amounted to Rs. 14,47,254. Deducting this amount from the total value of consideration paid by the Central Govt. amounting to Rs. 42,46,342, the officer arrived at a taxable capital gain of Rs. 27,99,088.
5. The assessee, however, contended that the sum of Rs. 14,47,254 represented only the cost of acquisition of the original shares numbering 13,398 shares, and it did not reckon with the cost of 8,109 bonus shares which were issued to the assessee by the Madras Motor and General Insurance Company Ltd. The assessee invoked the theory of ascertaining the cost of bonus shares by the Well-known method of averaging by spreading the actual cost of original shares and treating that cost as the cost of original shares plus bonus shares. Following this method, the assessee derived the figure of Rs. 6,58,250 as the cost of the 8,109 bonus shares. The assessee claimed that this amount of Rs. 6,58,250 must be added to the sum of Rs. 14,47,254, which was the actual cost of the original shares, and that the resultant figure of Rs. 21,05,504, must properly be regarded as the total cost of the entire holding g of 21,507 shares. According to the assessee, it is this amount of Rs. 21,05,504, which must be deducted from the total value of the consideration paid by the Central Govt. in the sum of Rs. 42,46,342 and the capital gains must be arrived at in the sum of Rs. 21,40,838 as against the figure of Rs. 27,99,088 proposed to be assessed to capital gains tax by the ITO.
6. The officer, however, did not accept these submissions of the assessee. The result was that the assessee had to take the matter in appeal. The AAC allowed the appeal holding that the ITO must include Rs. 6,58,250 as the cost of acquisition of the shares. In further appeal by the Department, the Tribunal agreed with the order of the AAC and allowed the claim of the assessee. The Tribunal held that the cost attributable to the bonus shares must be added to the actual cost of acquisition of the original shares and the aggregate must be deducted from the value of the consideration paid by the Central Govt. in order to arrive at the assessee's taxable capital gains.
7. In this reference made by the Tribunal at the instance of the Commissioner, the question is whether the Tribunal was right in holding that Rs. 6,58,250 representing the figure to be att ributed to the cost of bonus shares must be added to Rs. 14,47,254 representing the actual cost of the original shares, for the purpose of arriving at the total cost of the assessee's shareholdings as a whole for the purpose of computation of capital gains.
8. We do not see how any question of adding the sum of Rs. 6,58,250 at all could arise under any computation under any method. We start with the position that all the shares of the company were compulsorily acquired by the Central Govt. and in that wholesale take-over of all the shares of the general insurance company, 21,507 shares held by the assessee were also taken away, by compulsory transfer, by the Central Govt. The compensation paid for by the Central Govt. was thus payable and actually paid for all the 21,507 shares en bloc. The compensation was not paid at so much for the bonus shares. There might be some meaning in people siting at a table and working out the cost of bonus shares, where bonus shares alone are the subject of transfer, either voluntary or compulsory, at a gain. But, in the present case, there was no distinction made between the two kinds of shares and all the assessee's shares, whether they were original shares or bonus shares, were acquired compulsorily by the Central Govt. The question is what in such an event, is precisely the cost of all the assessee's 21,507 shares en bloc. To our minds the one and the only answer is Rs. 14,47,254.
9. Reference was made by the Tribunal in their order to the well-known case of Dalmia Investment Co. Ltd. : 52ITR567(SC) , decided by the Supreme Court. We think we have to be quite clear as to what was laid down in that judgment about bonus shares and what was the occasion for the Supreme Court ruling in that regard. The Supreme Court said that where bonus shares are issued to holders of existing shares, although in one sense the bonus shares are acquired without the shareholders having to pay for them, yet on the principle of costing it would be not only possible but legitimate to arrive at the average cost of bonus shares. It is in this context that the Supreme Court laid down the principle that the average cost of bonus shares can be arrived at by spreading the actual cost of the original shares over not only the original shares but also the bonus shares. The purpose of arriving at the average cost of bonus shares may be either in the context of the closing stock valuation of such bonus shares or in the context of arriving at the element of profit in the event of the particular bonus shares alone being dealt with by way of sale. In the Dalmia case : 52ITR567(SC) , the Supreme Court were concentrating on the average value of the bonus shares alone and the method of arriving at that value. They did not examine the method of averaging and the reckoning of the cost of bonus shares would at all arise for consideration in a case where the totality of the shareholder's holdings are sold as one block or otherwise acquired in a single transaction.
10. It must be clear, as a principle of elementary arithmetic, that by getting at the average cost of bonus shares which are included in the total holdings consisting of original shares and bon us shares, the average cost of original shares must inevitably get reduced pro tanto. To take a very simple illustration, if a shareholder holds a single share which he has purchased at Rs. 100 and subsequently a bonus share is issued to him, then, on the theory of averaging and of obtaining the notional cost of the bonus shares, the purchase cost of Rs. 100 for the single original share must be divided by two, one for the original share and the other for the bonus share. The result of this averaging is that the cost of each share would be Rs. 50. There are two consequences of the principle of averaging, namely, (i) to attribute to the bonus share a cost when for that share there is no actual cost of acquisition, and (ii) to reduce the actual cost of the original share to the extent that a notional cost is attributed to the bonus share. In other words, the cost of the original share will be reduced pro tanto to the extent of the cost attributed to the bonus share.
11. The simple arithmetic, which we have illustrated above, applies to the present case. The sum of Rs. 6,58,250 which was arrived at as the cost attributable to 8,109 bonus shares was so arrived at only from the actual cost of Rs. 14,47,254 for 13,398 original shares. In other words, Rs. 6,58,250 is very much a part of Rs. 14,47,254 for all the trouble taken to arrive at that figure, There is, therefore, neither principle not logic in adding to Rs. 14,47,254 representing the actual cost of 13,398 shares the sum of Rs. 6,58,250 in order to arrive at the total cost of the acquisition of all the shares (both original and bonus) aggregating to 21,507 shares. To return to our simple illustration, if the actual cost of the assessee's share were Rs. 100 and with the issue of a bonus share, the average cost of the bonus share is calculated at Rs. 50, still the total cost would remain only at Rs. 100. If you add the notional average cost of the bonus share which is arrived at in the sum of Rs. 50 to the actual cost of Rs. 100, the result will be Rs. 150, which will raise the average cost of the bonus share to Rs. 75. This is scarcely a result which is consistent even with the very principle of averaging adopted by the assessee in order to arrive at the cost of bonus shares. We must, therefore, hold that to add to the actual cost the notional cost of bonus shares would result in an absurdity because by that process you not only raise the actual cost fictionally but also raise the notional or average fictional cost of bonus shares itself by another fiction.
12. We earlier observed that the average cost of bonus share comes to be calculated, and is meant, for certain limited purposes such as closing stock valuation and the like. The valuation of bonus shares on the averaging method is not intended to distort the total outlay on shares in the purchase account. The theory of averaging is a mere principle of costing. It is resorted to whenever it is found necessary to get to know the average cost of bonus shares with a view to reckoning the results of any separate transaction in which the bonus shares alone figured to the entire exclusion of the original shares. But where the entire block of shares held by a shareholder is sold or otherwise disposed of and in that sale also figure all the bonus shares held by that shareholder, there can be no occasion for entering into the exercise of costing of bonus shares. That is because the whole cost of shares including bonus shares is already a known figure, and it would be an unnecessary refinement to get to know the individual cost of each share. It is enough that we know the actual cost of all the original shares held by the assessee and since the whole block is sold, the actual cost of acquisition of the original shares alone will have to be taken. If, however, you follow a fastidious or an over-sophisticated method of calculation taking note of only the average cost of the bonus shares, then you must also take into account the average cost of the original shares, in which even also there cannot be a separate addition to the actual cost, the average or notional cost of bonus shares.
13. In their order the Tribunal said that the Dalmia case : 52ITR567(SC) , only laid down the principle of averaging as a method of attributing to the bonus shares some cost which may be justified on principle. The Tribunal also said that the Dalmia case did not deal with any other situation. The Tribunal further noticed that in the Dalmia case, the Supreme Court was aware that this method of averaging resulted in not only attributing to the bonus shares a cost which they did not actually incur but also have the effect of reducing the cost of the original shares. Nevertheless, the Tribunal observed that for the purpose of capital gains, the notional cost of bonus shares must be added to the actual cost of the original shares. They dismissed the Dalmia case : 52ITR567(SC) , out of hand, by observing that it was not a capital gains case. They then addressed themselves to the question on hand, namely, whether, in the exercise of averaging for the purpose of attributing some cost to the bonus shares, the cost of original shares has got to be pro tanto reduced. They answered this question in the negative. They accepted the argument addressed on behalf of the assessee that the cost of the original shares has got to be pro tanto reduced, they answered this question in the negative. They accepted the argument addressed on behalf of the assessee that the cost of the original shares should be retained intact and to that value must be added the notional cost of the bonus shares. They justified their conclusion on the basis that bonus shares have some value independent of the cost of acquisition of the original shares.
14. This last observation of the Tribunal is destructive of the very principle of averaging by attributing to the bonus share a notional cost. As we earlier stated, there is neither principle not logic nor any statutory warrant for the decision of the Tribunal.
15. We, therefore, uphold the decision of the ITO as the correct one. The question of law framed at the instance of the Department is as follows :
'Whether, on the facts and in the circumstances of the case, the method adopted by the Tribunal for valuing the cost of the shares for purpose of arriving at the taxable capital gains is correct in law ?'
16. For the reasons already stated, our answer to the question of law is in favour of the Department and against the assessee. The assessee will pay the costs of the Department. Counsel's fee Rs. 500.