Cost of bonus shares treated as appropriation of profits, not nil, so sale does not create taxable profit.

Whether bonus shares carry a cost for capital gains depends on their legal character: the HC applied Regulation 96 and 97 of Table A of the Companies Act to treat allotment of fully paid bonus shares as paid for by appropriation of undistributed profits rather than as gratuitous gifts, concluding the consideration equals at least the face (par) value because allottee loses dividend participation; on that legal basis the tax authority's treatment of the bonus shares as having nil cost (and the resultant taxable computation) was incorrect and relief was allowed to the assessee.

---

---

Issues: Whether on the facts and circumstances the income tax authorities were right in holding that Rs. 3,11,646 or any other sum was legally taxable in the assessee's hands on the sale of Rohtas Industries Ltd. shares; specifically whether the cost of bonus shares should be taken as nil or at face value.

Analysis: Regulation 96 and Regulation 97 of Table A of the Companies Act, 1956 provide the statutory machinery for capitalisation of undistributed profits by allotment of fully paid bonus shares, whereby the declared bonus is appropriated and applied in payment of the shares issued. Under that scheme the consideration for allotment of bonus shares is the appropriation of undistributed profits (a set off of dividend entitlement) rather than a gratuitous gift by the company. Authorities discussing similar principles establish that when fully paid shares are issued for a consideration other than cash, the consideration must be at least equal in value to the par value of the shares and is satisfied by the allottee's loss of participation in the declared profits. The approach of valuing bonus shares on an "average" basis, as suggested in Emerald and Co. Ltd., was left open by the Supreme Court on appeal in that matter; on the facts before this Court the correct legal characterization is that bonus shares are not issued free of cost but are paid for by appropriation of profits and therefore carry a real cost equivalent to their face value.

Conclusion: In favour of the assessee; no legally taxable profit arises on the sale of the shares by treating the bonus shares as having nil cost, and the income tax authorities' computation of taxable profit is incorrect.

---