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Income‑tax Reference No. 12 of 1961, decided on 25th August 1962.

Capital gains----

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‑Company ‑ Offer of new shares to share holders‑Sale of right to apply for new shares‑Computation of capital gains‑Whether depreciation in value of existing shares or notional value of the right to new shares can be deducted ‑Indian Income tax Act, 1922, S. 12‑B.

Where a company resolves to issue new shares and offers the new shares to the existing shareholders and a shareholder sells the right to apply for new shares which are offered to him, in computing the capital gains which accrue to him by the sale, the value of the right to the new shares according to accountancy principles, or the depreciation in value of the existing shares, cannot be deducted.

The assessee held 710 shares in the Tata Iron & Steel Co. Ltd. The company resolved to issue new shares and offered one new share to each existing share. The assessee chose to renounce her right to apply for the 710 new shares by selling the right to a third party in open market at the rate of Rs. 63,75 per share right, and realised a sum of Rs. 45,262,50 by the sale. The income‑tax authorities sought to levy tax on the whole of this amount as capital gains. The market value of the old shares had depreciated by Rs. 53 per share and the value of the right to get new shares according to accountancy principles was Rs. 73 per share right. The assessee contended (i) that the loss in the value of the old shares at Rs. 53 per share amounting to R s. 37,630 should be deducted from the sum of Rs. 45,262,50 ; (ii) at any rate, as the value of the share right itself was Rs. 73 per share and she had sold the right at the rate of Rs. 63'75, there was in fact a capital loss instead of a capital gain:

Held, (i) that, as the existing shares were not sold by the assessed, the depreciation in the shares was not a matter for consideration in the computation of capital gains ;

(ii) whatever might be the value of the right to apply for new shares according to accountancy principles, capital gains had to be computed on the .basis of the "actual cost" of capital asset to the assessed, as laid down in section 12‑B of the Income‑tax Act ; "actual cost" meant what the assessed had in fact expended or laid out for acquiring the asset and as the assessee had not expended any amount for acquiring the right, the entire amount of Rs. 45,262.50 was assessable as capital gains.

[Case‑Law referred].

STATEMENT OF CASE

By this application, Miss Dhun D. Kapadia, the assessee, requires the Appellate Tribunal to refer to the High Court some questions said to be of law and which are said to arise out of its order under section 33 (4) made on 29th April 1960, in I. T. A. No. 10836 of 1958‑59. Inasmuch as, in our opinion a question of law does arise out of the aforesaid order, we hereby draw up a statement of the case, agreed to by the parties, and refer it to the High Court of Judicature at Bombay under section 66 (1) of the Indian Income‑tax Act, 1922.

2. This reference arises out of the assessment made upon the assessed for the assessment year 1957‑58, the previous year being the corresponding financial year 1956‑57. The assessee derives income from investments (as distinguished from stock -in‑trade) in securities and shares and interest on fixed deposits, etc. The assessee has never been treated as a dealer in shares. Amongst the shares held by her as investments, she had inherited some time prior to 1st January 1954, 710 ordinary shares of Tata Iron & Steel Co. Ltd. In accordance with a special resolution passed at an extraordinary general meeting of the said company held on 12th March 1956, the assessee as holder of the said 710 ordinary shares, became entitled to be offered new ordinary shares issued in the ratio of one new ordinary share for one existing ordinary share held as on 26th April 1956. According to the offer made to the assessed shareholder, by the company by its circular dated 15th May 1956, a copy of which is marked Annexure "A" and forms part of the case, she was informed that "you are, therefore, in terms of the said resolution entitled to apply for 710 new ordinary shares". The payment to be made was Rs. 105 per new ordinary share made up of the face value of Rs. 75 and the premium of Rs. 30. Clause 5 of the said circular letter also informed her that she might apply for the said shares either wholly or partly or "renounce them either wholly or partly, in favour of any other person or persons". The assessee chose to renounce her right to all the 710 new ordinary shares by completing the form of renunciation. A copy of the said form is marked Annexure "B" and forms part of the case. It provided that the renunciation shall be in favour of some other person and the assessee chose to renounce the said right to apply for 710 shares at the preferential price of Rs. 105 by selling it in the open market on June 12, 1956, at the rate of Rs. 63.75 per share right. She, thus, actually realised a sum of R s. 45,262.50 by selling her said rights, which, it was common ground before the income‑tax authorities and also the Tribunal, is capital asset within the meaning of section 12‑B(1). It was stated before the Tribunal that for the purpose of facilitating operations in the shares of this company, the board of directors of the Native Stock and Share Association Ltd: passed a resolution that the transactions in these shares would be cum‑right up to and including June 12, 1956, and from June 4, 1956 (the intervening days being official holidays), ex‑rights. The market quotation of the old Tata ordinary shares (as distinguished from the new issue) was Rs. 253 on 1st June 1956, and it was Rs. 198'75 on 4th June 1956, thus there bang a fall in the market quotation of old share of Rs. 54'25 per share. The case of the assessee before the income‑tax authorities was that though undoubtedly a certain capital gain arose, from the full value of the consideration amounting to Rs. 45,262'50 should be deducted a sum of Rs. 37,630 at the rate of Rs. 53 per share on 710 old Tata shares "as loss on account of depreciation in the value of her original shares". It appears that the said figure of Rs. 53 was on a rough calculation and really corresponds to the figure of Rs. 54'25 mentioned earlier. The income‑tax authorities rejected this contention.

3. Being aggrieved, the matter was brought in appeal to the Tribunal and before it, two contentions were raised:

(i) That from the full value of the consideration received, namely, Rs. 45,262'50 the assessee was entitled to deduct the suns of Rs. 37,630 ;

(ii) That the said figure of Rs. 53 or Rs. 54.25 should be considered as cost of the right, i.e., capital asset which was sold at Rs. 63'75 and should be deducted in accordance with the provisions of section 12‑B (2) (ii).

The said figures of Rs. 53 or Rs. 54.25 were also variously stated to be Rs. 73 or Rs. 77 according to certain computations placed before the Tribunal.

The Tribunal rejected both these contentions, for reasons given by it in its order dated 29th April 1960, a copy of which is marked Annexure "C" and forms part of the case, and hence it did not find it necessary to go into the merits of the alternative figures of Rs. 73 or Rs. 77 mentioned.

4. On these facts, the assessee now requires the Tribunal to refer to the High Court the following two questions:

"(1) Whether the computation of capital gains at Rs. 45,262'50 on sale of rights by the applicant is correct and proper in law

(2) Whether the Tribunal was right in rejecting the claim of the applicant to deduct from the computation in capital gains the cost of the right determined in accordance with accepted principles of accountancy in ‑the light of the provisions of section 12‑B of the Act "

In our opinion, on the facts of the present case, the following question of law arises :

"Whether, having regard to the provisions of sec tion 12‑B (2) (ii), the assessee is entitled to claim a deduction from the full value of the consideration of Rs. 45,262'50 received for the capital asset, the sum of Rs. 37,630 or any similar sum "

5. We refer the question accordingly.

R. J. Kolah with S. P. Mehra, Y. P. Trivedi, U. T. Shah, S. J. Mehra and S. J. Mahispurkar for the Assessee.

G. N. Joshi with R. J. Joshi for the Commissioner.

JUDGEMENT

TAMBE, J.

‑This is a reference under subsection (1) of sec tion 66 of the Act. We are here concerned with the assessment year 1957‑58, the corresponding accounting year ended 31st March 1957. The assessee, Miss Dhun Dadabhoy Kapadia; derives income from various investments in securities and shares and interest on fixed deposits. She, however, is not a dealer in shares: Amongst the shares held by her, she held 710 ordinary shares of the Tata Iron & Steel Company Limited. We are here concerned with these, shares and the rights acquired by the assessee to subscribe to the additional share capital floated by the Tata Iron & Steel Co. Ltd. (hereinafter referred to as the Tat a Company). The said 710 shares were acquired by the assessee by inheritance some time before the 1st of January 1954.

At an extraordinary general meeting of the Tata Company held on March 12, 1956, special resolutions were passed-

(1) for increase of the capital of the company ; and

(2) for the issue of 12,85,000 new ordinary shares of Rs. 75 each resulting from such increase, to be offered in the first instant at a premium of Rs. 30 per share to the holders of the existing ordinary, shares on the register of members of the company on such date as may be fixed by the directors in the ratio of one new ordinary share for one existing ordinary share held by such holders respectively and upon the other terms and conditions mentioned in the said special resolutions.

The directors resolved that the shareholders, whose names appeared on the register of members on April 26, 1956, would be entitled to the aforesaid offer. On 15th May 1956, the managing agents of the Tata Co. addressed a circular letter to all the members, whose names appeared on the register of members on 26th of April 195.6. The assessee was one of those members to whom this‑ circular letter was addressed. It is Exh. A on the record and it shows that an option was given to the assessee either to subscribe to the new issue or renounce her right to so subscribe in favour of any other person of her choice. In the event she chose to renounce her right, she was directed to fill up and sign the renunciation state ment in Form B, which was enclosed along with the letter. The 2nd of July 1956, was the date fixed by which a member had to either make an application for the new issue in Form A or renounce it in favour of any other person by filling in Form B. Paragraph 8 of the circular letter stated:

"Please note that if the application Forms A' and/or B' are not received by the company's bankers on or before the 2nd day of July 1956, together with the amounts aforesaid, the offer will be deemed to be declined."

It appears that for the purpose of facilitating operations in the shares of the Tata Company, the board of directors of the Native Stock and Share Association Ltd. passed a resolution that the transactions in these shares would be cum‑right up to and inclusive of June 1, 1956, and from June 4, 1956 (the intervening days being official holidays), ex‑rights. The market quotation of the old Tata ordinary shares (as distinguished from the new issue) was Rs. 253 on the 1st of June 1956, and it was Rs. 198.75 nP. on the 4th of June 1956, the fall in the market quotation being of Rs. 54.25 nP. per share. On 12th of June 1956, the assessee sold her right to subscribe for 710 shares in the new issue to some person at Rs. 63.75 nP. per share and thereby obtained an amount of Rs. 45,262'50 nP. as the sale price of the right. The dispute between the assessee and the Income‑tax authorities centered round this amount. According to the income‑tax authorities the entire amount of Rs. 45,262.50 nP. is capital gain to the assessee under section 12‑B of the Act, while according to the assessee, the entire amount is not the capital gain to the assessee but from it the value of the right will have to be deducted. Contentions of the assessee in this respect had not been uniform throughout the different stages of the case.

The case of the assessee before the Income‑tax officer and the Appellate Assistant Commissioner was that though undoubtedly a certain capital gain arose to the assessee, it did not amount to Rs. 45,262.50 nP. It was contended that from that amount should be deducted a sum of Rs. 37,630 at the rate of Rs. 53 per share on 710 old shares as "loss on account of depreciation in the value of her original shares." The said figure of Rs. 53 was a rough calculation of the difference between the quotation of the shares cum‑right at Rs. 253 and ex‑right at Rs. 198'75 nP. (the actual difference being Rs. 54‑25 nP.). In addition to this contention, before the Income‑tax Appellate Tribunal two other contentions were also raised. On the authority of certain books on principles of accounting, it was claimed that the cost of the right, which was sold by the assessee, carne to about Rs. 73 per share and, therefore, no capital gain arose to the assessee, but on the, other hand, she, having sold the right at Rs. 63.75 nP. per share, there was, in fact, capital loss resulting to her. At any rate, it was contended that the cost of the right should be taken either at Rs. 53'00 or at Rs. 54'25 nP. and on that footing the capital gain resulting therefrom to the assessee should be calculated. None of these contentions have been accepted either by the income‑tax authorities or by the Tribunal. On an application made by the assessee under subsection (1) of section 66 the Tribunal has, after stating the case, referred to this Court the following question:

"Whether, having regard to the provisions of section 12‑B(2)(ii) the assessee is entitled to claim a deduction from the full value of the consideration of Rs. 45,262'50 nP. received for the capital asset, the sum of Rs. 37,630 or any similar sum "

Mr. Kolah, appearing for the assessee, contends that the said 710 shares have been inherited by the assessee earlier than January 1, 1954. The assessee, therefore, was entitled to exercise the option given to her of substituting the market value of the shares as on January 1, 1954, in place of the actual cost under the third proviso to subsection (2) of section 12‑B of the Act. She had exercised that option and the market price of each share on that date was Rs. 341. Referring us to the provisions of section 105‑C of the Indian Companies Act, which is in following terms:

"Where the directors decide to increase the capital of the company by the issue of further shares, such shares shall be offered to the members in proportion to the existing shares held by each member irrespective of class, and such offer shall be made by notice specifying the number of shares to which the member is entitled, and limiting the time within which the offer, if not accepted, will be deemed to have been declined ; and after the expiration of such time or on receipt of an intimation from the member to whom such notice is given that he declines to accept the shares offered, the directors may dispose of the same in such manner as they think most beneficial to the company."

Mr. Kolah further contends that in the said cost of Rs. 341 is included the cost of the right conferred on the assessee under section 105‑C of the Companies Act. When the board of directors of the company decided by passing the resolution of 12th March 1956, to issue additional capital, that right became crystallised. Referring us to certain observa tions in four books on principles of accountancy, viz. Accountancy by Pickles and Dunkerly, 2nd Edition, page 1167, Accountants Hand‑book by Rufus Wixon & W. G. Keel, 4th Edition, pages 13,22, A Dictionary for Accountants by Eric L. Kohler, 1951 Edition, at page 369, and Principles of Accounting Intermediate by Finney & Miller, 5th Edition at page 299, Mr. Kolah contended that the value of this right, according to the principles of accountancy stated in these four books would come to about Rs. 73 to Rs. 76 and this should be taken to be the actual cost of the right within the meaning of sub‑clause (ii) of subsection (2) of section 12‑B of the Act for the purpose of determining the capital gains arising to the assessee as a result of the transaction in question. Mr. Kolah further contends that when the computation of capital gains is so made, the result really is that there had been capital loss to the assessee and not capital gain. The assessee should be allowed to carry forward the capital loss to be adjusted in future years as and when she would be in a position to do so under the provisions of the Act. Mr. Kolah also referred us to certain observations in Emerald & Co. Ltd. v. Commissioner of Income‑tax ((1959) 36 I T R 257, 260), Dalmia (Now Rishab) Investment Co. Ltd. v. Commissioner of Income‑tax ((1961) 41 I T R 705) and Baijnath Chaturbhuj v. Commissioner of Income‑tax ((1957) 31 I T R 643).

Mr. Joshi, on the other hand, states that he does not dispute that according to the principles of commercial accounting, a value can be attributed to the right given to a shareholder to subscribe to the new capital but, according to him, these principles have no place in taxation matters. What is to be decided in the instant case is what is the actual cost to the assessee in acquiring these rights. The assessee is not a dealer in shares. The assessee is an investor. For obtaining these rights, the assessee has not to expend any amount. The assessee, therefore, is not entitled to claim any amount by way of actual cost for acquisition of these rights in the matter of computation of capital gains. The entire amount of Rs. 45,262'50 nP. has, therefore, rightly been calculated as capital gains resulting to the assessee from the transaction in question.

In our opinion the contentions raised on behalf of the revenue by Mr. Joshi are well founded. What generally happens when directors decide to increase the capital of the company by the issue of further shares has been stated by Finney & Miller in Principles of Accounting Intermediate, Fifth Edition, at page, 299. Similar also is the position under section 105‑C of the Indian Companies Act:

"When a corporation is about to issue additional shares, each holder of stock of the class to be issued may receive warrants (here Forms A & B) evidencing his right to subscribe for new shares in the ratio that his holdings bear to the total shares outstanding before the additional issuance. Such a stock right, subscription right, or purchase warrant frequently entitles the stockholder to purchase only a fraction of a share of new stock for each old share held (here one new share for one old share), and the number of rights is expressed in terms of the number of shares owned rather than the number of shares which may be acquired . . . . The announcement of the granting of the rights (here 12‑3‑1956) states the date when the stock records will be closed to determine the stockholders of record (here 26‑4‑1956) to whom the warrants will be issued, and also the later date when subscriptions will be payable (here 2‑7‑1956). Between the date of the announcement and the date of the issuing of the warrants (here 15‑5‑1956), the stock and the rights are inseparable, and the stock is dealt in rights‑on'. After the warrants are issued, the stock is dealt in 'ex‑rights', and the rights are dealt in separately."

Many shareholders do not wish to increase their holding and prefer to sell the rights obtained by them under the warrants. During the period in which the stock is selling rights‑on, no special problems arise, since the transactions involve the stock and the rights as a unit. After the warrants are issued and the stock is selling ex‑rights, problems arise which require an apportionment of the cost of the originally acquired stock between the stock and the rights ; this is done on tire basis of the market value of the right and the market value of the stock ex‑rights at the time of the issuance of the rights, and it is for this purpose that the aforesaid four authorities suggest different methods of theoretical valuation of the stock rights obtained by the shareholders on record. The reason for placing a theoretical value is that as a result of issuing additional capital, there is a dilution of the stock‑holder's investment in shares already held resulting in the depreciation in value of the stock already held. The theoretical value given to the right very nearly represents the fall in price of the old stock that entitles a share holder to subscribe to the new issue. Now, the necessity to so value arises in different ways. For instance, a person who is a trader or dealer in shares and securities, to appreciate the result of the trading of the year, has to value his stock in trade at the end of the year. The principles of accounting suggested in this matter in the four books on accounting give a method. To take another instance, a shareholder, to whom warrants have been issued, does not desire to subscribe to the new issue, but wants to sell it in the market He has, therefore, to know at what probable price the right would sell and at what probable price he should sell his right. The method gives him a theoretical value of the right at which, as Rufus Wixon and Walter Kee: say : "the rights can be expected to sell on the market". This, however, is merely a guide. Pickles and Duntcerly at page 1151 of their book Accountancy enumerate some more circumstances when the necessity for valuation arises It is not in dispute before us that, according to the principles stated in these four books, the value of the right to obtain one new share for one old share would come from Rs. 73 to Rs. 77. It is, therefore, not necessary to examine in detail the various methods suggested by these authors. The question, however, that arises for consideration is whether these principles could be called in aid in determining the issue as to capital gains or capital loss, under taxation laws, consequent on sale of these rights. Three out of the four authors say nothing about it. Rufus Wixon and Walter G. Keel, at page 13.22, of their book Accountants' Handbook, Fourth Edition, after giving the method of allocation of value between the old stock and the right, however, makes it clear that:

"Tax rules for stock rights differ from the accounting pro cedures described above."

They further proceed to deal with the rules then in force in America with which we are not concerned. In our opinion, therefore, those principles for theoretical allocation of cost between the stock rights and stock investment on receipt of stock right are of little assistance in determining the issue. On the other hand it will have to be decided in accordance with the law of the respective nation.

We have here to find out what is the position under the Indian Income‑tax Act. The relevant provision is section 12‑B, and omitting the unnecessary part, it reads:

"12‑B. (1) The tax shall be payable by an assessee under the head capital gains' in respect of any profits or gains, arising from the sale -------- of a capital asset effected after the 31st day of March 1956, and such profits and gains shall be deemed to be the income of the previous year in which the sale ------- took place---------

(2) The amount of a capital gains shall be computed after making the following deductions from the full value of the consideration for which the sale ------ of the capital asset is made namely:

(i) expenditure incurred solely in connection with such sale... (ii) the actual cost to the assessee of the capital asset, includ ing any expenditure of a capital nature incurred and borne by him in making any additions or alterations thereto, but exclud ing any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9, 10 and 12."

It is not in dispute that the right to subscribe to 710 new shares sold by the assessee for a consideration of Rs. 45,262'50 nP. was a capital asset. It is also not in dispute that she, having inherited the 710 shares prior to January 1, 1954, is entitled to substitute the market value of January 1, 1954, as the actual cost of the old shares. For the purpose of the case, it is not disputed that the market value was or quotation of the old Tata Shares stood at Rs. 341'00 on January 1, 1954. We have here, however, to ascertain what is the actual cost of those rights and not of the old shares. As already stated, the assessee claims that Rs. 73 to Rs. 77 per share should be allowed to her as actual cost on the basis of the principle of accounting stated in the four books referred to above. In our opinion, the theoretical value given to the right in accordance with the principles of accounting stated in these four books cannot be equated with the words "actual cost to the assessee" occurring in clause (ii) of subsection (2) of section 12‑B of the Act. We have recently construed the meaning of the expression "actual cost to the assessee" occurring in clauses (a) and (b) of subsection (5) of section 10 of the Act in considering the question of depreciation allowable to the assessee in Income‑tax Reference No. 2 of 1961, decided on 8th August 1962, wherein we have observed:

"Actual cost', however, is not defined in the Act. The ordinary dictionary meaning of the word actual' is 'existing in fact or fact as opposed to imaginary or past state of things'. The dictionary meaning of the word 'cost' is 'what is laid out or suffered to obtain anything' . . . . . In our opinion, therefore, the meaning of the expression 'actual cost to the assessee as used in subsection (5) of section 10 of the Act would be what the assessee has, in fact, expended or laid out for the purpose of acquiring the depreciable assets."

In our opinion the ratio of this decision would equally be applicable to the present case. The meaning of the expression "actual cost to the assessee" as used in clause (ii) of subsec tion (2) of section 12‑B of the Act would therefore be what the assessee has in fact expended or laid out for the purpose of acquir ing the capital asset.

Turning to the facts of this case, it is clear that the assessee has not expended any sum or laid out any expenditure for the purpose of acquisition of these rights. She got it by reason of her holding the 710 shares and by reason of the provisions of section 105‑C of the Indian Companies Act. It is not possible, therefore, to accept Mr. Kolah's contentions that in the actual cost to the assessee for acquiring the old 710 shares is also included the actual cost to the assessee in the acquisition of those rights. At the time the shares were acquired, the shares were not being sold cum‑rights and, therefore, it cannot be said that in that price any amount is included as costs of these rights. The ownership of the shares confers various privileges on the shareholder. He has a privilege to participate in the dividends as and when declared; he has a privilege to participate in the management of the company as provided in the Companies Act; he can share in the assets of the company if the company goes into liquidation and he has also a previlege of getting the right to subscribe to the issuance of new capital as and when issued. These rights are still with the assessee and none of them has been taken away.

In our opinion, therefore, the Tribunal was right in holding that the entire amount of Rs. 45,262'50 nP. was a capital gain resulting to the assessee from the transaction in question. The decisions, which we have been referred to by Mr. Kolah, in our opinion, are hardly of any assistance in deciding the question, which we have to consider. None of them deal with the question which we have to deal with in the present case. We, therefore, do not propose to examine these authorities in detail.

For reasons stated above, our answer to the question referred to us is in the negative. The assessee shall pay the costs of the Commissioner.

Question answered in the negative.

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