Bonus share cost of acquisition fixed at face value; capital gains tax applies only to sale proceeds above that amount.

Bonus shares issued out of capitalised profits are not treated as gratuitous accretions, because shareholders give up a distributable entitlement in exchange for fully paid shares. For capital gains computation, the cost of acquisition of such bonus shares cannot be taken as nil, nor determined by averaging the original and bonus share costs or by market value at issue. The proper basis is the face value of the bonus shares, so only the excess realised on sale over that face value is taxable as capital gains under section 12B of the Indian Income-tax Act, 1922.

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Issues: Whether the entire sale proceeds realised on sale of bonus shares could be taxed as capital gains on the footing that the bonus shares had nil cost of acquisition, or whether the cost of acquisition had to be taken at the face value of the bonus shares.

Analysis: Bonus shares issued by a company out of accumulated profits are not gifts or gratuitous accretions in the hands of shareholders. They are issued against capitalised profits which would otherwise have been distributable, so the shareholder gives up a valuable entitlement in return for the fully paid shares. For the purpose of computing capital gains, the value of the bonus shares at the time of allotment cannot be treated as nil. Nor is averaging the cost of the original and bonus shares or adopting market value at the date of issue an appropriate method on the facts. The proper basis is the face value of the bonus shares, because that is the real cost attributable to the shares when they are issued and allotted as fully paid shares.

Conclusion: The entire sum realised on sale of the bonus shares could not be taxed as capital gains under section 12B of the Indian Income-tax Act, 1922. Only the excess, if any, over the face value of the 94 bonus shares could be brought to tax. The answer was therefore rendered in favour of the assessee in part.

Ratio Decidendi: Fully paid bonus shares issued out of capitalised profits have a real cost of acquisition equal to their face value, and capital gains on their sale must be computed only by reference to the excess realised over that value.

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