Bonus shares do not create fresh capital for surtax computation under rule 3 of the Second Schedule.

Rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 applies only when capital computed under rule 1 is increased during the previous year through paid-up share capital, debentures, or borrowings. Capitalisation of reserves by issuing fully paid bonus shares does not introduce fresh capital and does not, by itself, increase the capital base existing on the first day of the previous year. The Court also noted that rule 2 of the Second Schedule to the Super Profits Tax Act, 1963 could not control the interpretation of rule 3 under the Surtax Act. On that basis, no proportionate increase in capital was available for the bonus issue.

---

---

Issues: Whether the issue of bonus shares by capitalising reserves entitled the assessee to a proportionate increase in capital for computation under rule 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Rule 3 applies only where the capital, as computed under rule 1, is increased during the previous year on account of increase of paid-up share capital, issue of debentures, or borrowings. A mere conversion of existing reserves into fully paid bonus shares does not bring in fresh capital and does not, by itself, increase the capital base that existed on the first day of the previous year. The Court approved the view that the incidence of rule 3 of the Surtax Act is different from rule 2 of the Second Schedule to the Super Profits Tax Act, 1963, and that the latter could not govern the former.

Conclusion: The assessee was not entitled to a proportionate increase in capital on account of the bonus issue, and the issue was decided against the assessee.

---