Surtax capital computation: reserve-to-bonus share conversion does not create an increase in capital under the Second Schedule.

Rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 does not require exclusion of share investments from the capital base where existing general reserves already exceed the cost of those investments. Rule 3 applies only when there is an actual increase in paid-up share capital during the previous year; conversion of general reserves into bonus share capital is merely an internal reclassification and does not by itself increase capital under the Schedule. A later declaration of dividend at an annual general meeting does not increase capital for surtax computation where the point is governed by the applicable Supreme Court position. The overall effect is that reserve-to-capital transfers do not automatically enlarge surtax capital, and asset exclusion depends on the statutory computation framework.

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Issues: (i) Whether the amount of investment in shares was liable to be excluded from the company's capital base under rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. (ii) Whether rule 3 of the Second Schedule applied where bonus shares were issued by capitalising general reserves, and whether the Tribunal had acted within jurisdiction in so deciding. (iii) Whether the assessee's capital could be increased by the amount of dividend declared at a later annual general meeting.

Issue (i): Whether the amount of investment in shares was liable to be excluded from the company's capital base under rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The computation under rule 2 requires diminution of capital only to the extent that the cost of the relevant assets exceeds the aggregate of borrowed moneys and reserves not already excluded under rule 1. The investment in shares was covered by the exclusionary scheme because dividend income from such shares was excluded in computing chargeable profits. However, the company's general reserves were admittedly larger than the cost of the investment, so no further reduction of capital was warranted.

Conclusion: The investment was not required to be excluded from the capital base, and the issue was decided in favour of the assessee.

Issue (ii): Whether rule 3 of the Second Schedule applied where bonus shares were issued by capitalising general reserves, and whether the Tribunal had acted within jurisdiction in so deciding.

Analysis: Rule 3 applies only where the capital computed under the earlier rules is increased during the previous year on account of an actual increase in paid-up share capital. When bonus shares are issued by converting a part of general reserves into share capital, there is only a transfer between components already includible in the capital computation under rule 1, and no increase in capital as computed under the Schedule. The Tribunal's consideration of rule 3 was within the scope of the dispute because the adjustment to reserves and the corresponding addition to share capital were directly linked to that rule.

Conclusion: Rule 3 was not applicable to the bonus share issue, and the Tribunal's decision on that point was upheld in favour of the assessee.

Issue (iii): Whether the assessee's capital could be increased by the amount of dividend declared at a later annual general meeting.

Analysis: The question stood covered by the Supreme Court decision followed by the Court, and no contrary factual distinction was shown.

Conclusion: The capital was not to be increased on that basis, and the issue was answered against the assessee.

Final Conclusion: The reference was answered by accepting the assessee's contentions on the surtax computation issues concerning investment exclusion and bonus share capitalisation, while rejecting the assessee's challenge on the dividend-related question.

Ratio Decidendi: For surtax computation, reserves converted into bonus share capital do not generate an increase in capital under rule 3, and an asset-based reduction under rule 2 is not made where existing eligible reserves already exceed the asset cost.

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