Surtax capital computation: bonus shares and proposed dividends were excluded from capital, while Chapter VI-A deductions were treated as part of total income.

Capitalisation of reserves by issue of bonus shares did not amount to a fresh increase in capital for rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, because no new funds entered the company and the transaction was only an internal reclassification; that issue was decided for the Revenue. Provision for proposed dividends was not a reserve for capital computation under the Surtax Act, following binding precedent, and that issue also went to the Revenue. By contrast, deductions or rebates under Chapter VI-A of the Income-tax Act, 1961 were treated as part of total income for the rule 4 computation, so capital was not required to be reduced on the Revenue's contention; that issue was decided for the assessee.

---

---

Issues: (i) Whether capitalisation of reserves by issue of bonus shares increased the company's capital for the purpose of rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964; (ii) Whether provision for proposed dividends constituted a reserve for computation of capital under the Surtax Act, 1964; (iii) Whether amounts deducted or rebates allowed under Chapter VI-A of the Income-tax Act, 1961 formed part of total income so that the capital was not required to be reduced under rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Issue (i): Whether capitalisation of reserves by issue of bonus shares increased the company's capital for the purpose of rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Rule 3 applies only where the capital, as computed under the Second Schedule, is increased during the previous year by a fresh addition to capital. A mere transfer of part of the reserves into paid-up share capital through bonus shares does not bring in any new capital into the company and does not increase the aggregate capital already computed at the beginning of the year. The conversion is only an internal rearrangement on the liabilities side of the balance-sheet.

Conclusion: The issue was answered against the assessee and in favour of the Revenue.

Issue (ii): Whether provision for proposed dividends constituted a reserve for computation of capital under the Surtax Act, 1964.

Analysis: The question was covered by binding precedent of the Court holding that a provision for proposed dividends is not to be treated as a reserve for purposes of capital computation under the Surtax Act.

Conclusion: The issue was answered in favour of the Revenue and against the assessee.

Issue (iii): Whether amounts deducted or rebates allowed under Chapter VI-A of the Income-tax Act, 1961 formed part of total income so that the capital was not required to be reduced under rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The question was governed by the Court's earlier decision on the effect of Chapter VI-A deductions in computing total income for surtax purposes. Applying that precedent, such deductions were not to be excluded from the relevant total income in the manner suggested by the Revenue for reducing capital under rule 4.

Conclusion: The issue was answered against the Revenue and in favour of the assessee.

Final Conclusion: The reference was disposed of with two questions decided in favour of the Revenue and one question decided in favour of the assessee, resulting in a mixed outcome on the surtax computation issues.

Ratio Decidendi: For rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 to operate, there must be a real increase in capital by fresh influx of funds during the previous year; mere capitalisation of reserves through bonus shares does not qualify.

---