High Court rules bonus shares not subject to capital gains tax under Income-tax Act, citing Escorts Farms case

The High Court ruled against the assessee, favoring the Revenue in a case involving the taxation of capital gains from the sale of bonus shares. The court held that bonus shares were not considered capital assets under the Income-tax Act, thus not attracting capital gains tax. The court emphasized the application of the principle outlined in the Escorts Farms case over the B. C. Srinivasa Setty judgment, clarifying the cost of acquisition for taxing capital gains on bonus shares.

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Issues:
1. Interpretation of the legal position regarding capital gains on the sale of bonus shares post the judgment in B. C. Srinivasa Setty's case.
2. Application of the principle laid down in the case of Escorts Farms (Ramgarh) Ltd. v. CIT [1996] 222 ITR 509 on the taxation of capital gains arising from the sale of bonus shares.

Analysis:

Issue 1:
The case involved a company, Harsh Chemicals Ltd., holding 55,000 equity shares in Russell Industries Ltd., which were allotted bonus shares in the ratio 1:1. The bonus shares were sold in two lots for a total consideration of Rs. 3,91,82,000. The Assessing Officer treated the gains from the sale of bonus shares as short-term capital gains due to the short holding period and average cost. The Commissioner of Income-tax (Appeals) upheld this view. However, the Tribunal, relying on the Supreme Court judgment in B. C. Srinivasa Setty's case [1981] 128 ITR 294, held that bonus shares were not capital assets under section 2(14) of the Income-tax Act, 1961. Consequently, the sale of bonus shares did not attract capital gains tax under sections 45 and 48 of the Act.

Issue 2:
The Revenue contended that the Tribunal erred in applying the B. C. Srinivasa Setty judgment and should have considered the decision in Escorts Farms (Ramgarh) Ltd. v. CIT [1996] 222 ITR 509. The Supreme Court in the Escorts Farms case analyzed the cost of acquisition for taxing capital gains on bonus shares. The court emphasized the significance of opting for statutory cost of acquisition and spreading the cost over old and new shares when determining the tax implications of bonus shares. The court clarified that the principle of averaging applies when the actual cost of acquisition is claimed instead of the statutory cost. The judgment highlighted that the character of the owner of shares as an investor or dealer is immaterial in this context. Consequently, the Tribunal's reliance on the B. C. Srinivasa Setty judgment was deemed erroneous, leading to a ruling in favor of the Revenue against the assessee on both questions raised.

In conclusion, the High Court ruled against the assessee, answering both questions in the negative, favoring the Revenue. The judgment clarified the legal position regarding the taxation of capital gains arising from the sale of bonus shares, emphasizing the application of the principle established in the Escorts Farms case over the precedent set by the B. C. Srinivasa Setty judgment.

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