Bonus share capitalisation does not increase surtax capital base, while Chapter VI-A exempt income is reduced in computation.

Rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 permits an upward adjustment in capital only when the capital computed under the Schedule is actually increased during the previous year; issue of fully paid bonus shares out of general reserves does not, by itself, create such an increase because the higher paid-up share capital is offset by a corresponding reduction in reserves. The capital base therefore is not enhanced to the extent of the bonus shares. Exempt income under Chapter VI-A of the Income-tax Act, 1961 must be reduced while computing the surtax capital base, and that position was affirmed on the basis of binding authority.

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Issues: (i) Whether, for the purpose of rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, capital should be increased when bonus shares are issued out of general reserves; (ii) Whether income exempt under Chapter VI-A of the Income-tax Act, 1961, should be reduced in computing the capital base for surtax assessment.

Issue (i): Whether, for the purpose of rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, capital should be increased when bonus shares are issued out of general reserves.

Analysis: Rule 3 operates only where the capital of the company, as computed under the preceding rules of the Second Schedule, is actually increased by any amount during the previous year on account of increase of paid-up share capital or other specified events. A mere capitalisation of reserves by issue of fully paid bonus shares does not produce an increase in the capital computed under the Schedule, because the increase in paid-up share capital is matched by a corresponding reduction in reserves. The relevant computation therefore does not permit a proportionate upward adjustment merely because bonus shares were issued.

Conclusion: The question was answered against the assessee and it was held that the capital was not to be increased to the extent of the bonus shares issued out of general reserves.

Issue (ii): Whether income exempt under Chapter VI-A of the Income-tax Act, 1961, should be reduced in computing the capital base for surtax assessment.

Analysis: The question was covered by binding authority and the earlier decision applied the relevant surtax computation principles to hold that exempt income under Chapter VI-A must be reduced while determining the capital base. On that basis, the Tribunal's view was sustained and the Revenue's challenge was rejected.

Conclusion: The question was answered in favour of the assessee and against the Revenue by holding that the exempt income under Chapter VI-A is to be reduced in computing the capital base.

Final Conclusion: The reference was answered by rejecting the assessee's claim on bonus-share capitalisation while upholding the reduction of Chapter VI-A exempt income in the surtax capital computation.

Ratio Decidendi: Under rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, an upward adjustment in capital arises only from an actual increase in capital as computed under the Schedule, and capitalisation of reserves through issue of bonus shares does not by itself create such an increase.

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