Court rules bonus shares do not dilute cost of acquisition in capital gains calculation

The High Court held that the cost of acquisition of original shares should not be diluted by bonus shares, following the principles in Shekhawati General Traders Ltd. The court emphasized that the cost of acquisition remains unchanged by subsequent events, such as the issuance of bonus shares. Therefore, the court ruled in favor of the assessee, rejecting the averaging method for computing capital gains. The decision emphasized that the cost of acquisition is either the actual cost or market value as of January 1, 1954, and bonus shares do not impact this cost. No costs were awarded.

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Issues Involved:
1. Computation of capital gains on the sale of shares.
2. Determination of the cost of acquisition of original shares when bonus shares are issued.
3. Interpretation of sections 48 and 55(2) of the Income-tax Act, 1961.

Detailed Analysis:

1. Computation of Capital Gains on the Sale of Shares:
The dispute arose from the computation of capital gains on the sale of 20,000 shares of Gwalior Rayon & Silk Mfg. Co. Ltd. by the assessee, Sutlej Cotton Mills Ltd., in the assessment year 1970-71. The Income Tax Officer (ITO) computed the capital gains by spreading the initial cost of acquisition of the original shares over both the original and bonus shares. This approach was upheld by the Appellate Assistant Commissioner (AAC) and the Income-tax Appellate Tribunal (ITAT).

2. Determination of the Cost of Acquisition of Original Shares when Bonus Shares are Issued:
The core issue was whether the cost of acquisition of the original shares should be determined by averaging the cost between the original and bonus shares. The assessee argued that the cost of acquisition should be based on the state of events at the time of acquisition, not subsequent events like the issuance of bonus shares. The revenue, however, relied on the Supreme Court's decisions in CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 and CIT v. Gold Mohore Investment Co. Ltd. [1969] 74 ITR 62, advocating for the spreading out of the initial cost over both original and bonus shares.

3. Interpretation of Sections 48 and 55(2) of the Income-tax Act, 1961:
The Tribunal upheld the revenue's approach, leading to the reference of the following question to the High Court: "Whether, on the facts and in the circumstances of the case and on a proper interpretation of the provisions of sections 48 and 55(2) of the Income-tax Act, 1961, the Tribunal was justified in holding that the 'cost of acquisition' of 20,000 shares (original shares) in Gwalior Rayon & Silk Mfg. Co. Ltd., during the previous year relevant to the assessment year 1970-71, should be determined on the basis of averaging the cost of original shares on the original shares and the bonus shares received thereonRs."

Relevant Statutory Provisions and Case Law:
- Section 45 of the I.T. Act, 1961, deals with the chargeability of capital gains.
- Section 48 outlines the mode of computation and deductions for capital gains.
- Section 55(2) defines the 'cost of acquisition' for capital assets acquired before January 1, 1954.

Several landmark decisions were considered:
- CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC): The Supreme Court approved the method of spreading the cost of original shares over both original and bonus shares.
- Miss Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 (SC): The Supreme Court held that the capital gains should account for the depreciated value of old shares due to the issuance of new shares.
- CIT v. Gold Mohore Investment Co. Ltd. [1969] 74 ITR 62 (SC): The court reiterated the spreading method for valuing bonus shares.
- Shekhawati General Traders Ltd. v. ITO [1971] 82 ITR 788 (SC): The Supreme Court distinguished the earlier cases, holding that the cost of acquisition should not be affected by subsequent events like the issuance of bonus shares.

Court's Decision:
The High Court, following the principles laid down in Shekhawati General Traders Ltd., held that the cost of acquisition of the original shares should not be diluted by the issuance of bonus shares. The court emphasized that the cost of acquisition could either be the actual cost or the market value as of January 1, 1954, at the assessee's option, and subsequent issuance of bonus shares would not alter this cost. Consequently, the question was answered in the negative, favoring the assessee's contention.

Conclusion:
The High Court concluded that the Tribunal was not justified in averaging the cost of original shares with bonus shares for computing capital gains. The cost of acquisition of the original shares remains immutable, unaffected by the issuance of bonus shares. There was no order as to costs.

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