IMPORTANT POINT
Before Rule 3 of Schedule II of the Companies (Profits) Surtax Act, 1964 can be made applicable, an increase in the capital base as computed under Rule 1 has to be shown to have taken place and such increase should be on account of increase of paid up share capital or issue of debentures or borrowing of any moneys.

Headnote:TAXATION-Companies (Profits) Surtax Act, 1964-Rule 3 of Schedule II-Computation of capital under -Claim of-Conditions to be satisfied-Appellant-company issued bonus shares-Claim made that bonus shares were in addition to paid up capital of company and proportionate amount must be added to capital for purpose of capital computation-Rejected-High Court held that there must be fresh influx of capital to attract Rule 3-Process of conversion of reserves into bonus shares did neither reduce overall capital of company nor increase it-Appeal against-Whether assessee-company was entitled to get benefit contemplated by second part of Rule 3 of Schedule II ?-(No).
Held : That by issuing the bonus shares in the assessment year in question there had only been a conversion of the reserves into fully paid bonus shares, which conversion did not add up to the capital or reserve case which was not there on the first day of the previous year. We feel no hesitation in approving the view taken therein that before Rule 3 of Surtax Act, 1964 can be made applicable, an increase in the capital base as computed under rule 1 has to be shown to have taken place. In order that Rule 3 could apply the capital base of the company, as computed in accordance with rule 1 of Schedule II of Surtax Act, 1964, must have increased during the previous year and such increase should be on account of increase of paid up share capital or issue of debentures referred to in clause (iv) or borrowing of any moneys referred to in clause (v) of rule 1. Unless these conditions are sastisfied, there would be no occasion for the assessee-company to get benefit contemplated by the second part of rule 3 of Schedule II of Surtax Act, 1964. (Para 11)

JUDGMENT

G.N. Ray, J.-Civil Appeal Nos. 1360-61 of 1981 are directed against judgment dated October 21, 1981 passed by the Division Bench of Madras High Court in Tax Case Nos. 743-744 of 1977 arising out of Reference Nos. 495-496 of 1977. Civil Appeal No. 1705 of 1980 is directed against judgment dated November 12, 1986 passed by the Division Bench of Madras High Court in Tax Case Petition No. 367 of 1986. It may be stated here that the Tax Case Petition No. 367 of 1986 was disposed of by the High Court following its judgment passed by the Madras High Court in the said Tax Case Nos. 743- 744 of 1977. It will, therefore, be appropriate to refer to the relevant facts relating to Tax Case Nos. 743-744 of 1977. Which were disposed of by the Madras High Court on October 21, 1981.

2. Tax Case Nos. 743-744 of 1977 arose out of the reference made under Section 256 (1) of the Income Tax Act, 1961. The reference before the High Court raised a short question about the computation of capital under Rule 3 of the Schedule II of the Companies (Profits) Surtax Act, 1964. The origin of the Companies (Profits) Surtax Act, 1964 may be traced back to the Surtax Act, 1940, which was enacted for the purpose of moping up unreasonable and extra profits earned in the business during the second world war. Later on, Super Profits Tax Act, 1963, and the Companies (Profits) Surtax Act, 1964. were enacted for similar purpose. The rationale behind these Acts is that any profit over and above the reasonable profit expected in the commercial and productive activities would be taxed at a special rate.

3. It will be appropriate to note the relevant facts for the purpose of appreciating the rival contention made before the Madras High Court and also at the hearing of these appeals. In the assessment year 1971-72, corresponding to previous year beginning from August 1, 1996 and ending on July 31, 1970, the appellant-Company, M/s Sundaram Clayton Ltd., issued 20400 bonus shares of the face value of Rs. 100/- each. This bonus issue was brought about by capitalising part of the Company s general reserves. Accordingly, a sum of Rs. 20,40,000/- was converted into bonus shares. The assessee-Company claimed that the said amount of Rs. 20,40,000 which represented the bonus issue as on February 23, 1970 became the basis for increase in the capital determined at Rs. 1,43,39,462/- as on the first day of the previous year i.e. August 1, 1969. It was claimed by the Company that the bonus shares were in addition to the paid up capital of the Company. Since any "increase" in the paid up capital of the Company was to be properly reckoned for the purpose of computation of capital under Rule 3 of Schedule II of the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as Surtax Act, 1964), it was claimed that the proportionate amount, worked out to Rs. 8,84,237, must be added to the capital as on August 1, 1969 for the purpose of capital computation.

4. The Income Tax Officer rejected the said contention of the assessee-Company. but the Income Tax Appellate Tribunal accepted the assessee s case. A reference was made by the taxing department under Section 256(1) of the Income Tax Act, 1961 before the Madras High Court for answering, inter alia, the following question :--

"Whether on the facts and in the circumstances of the case and having regard to Rule 3 of Schedule II of the Companies (Profits) Surtax Act, 1964 the share capital of the Company should be increased proportionately on account of the issue of bonus shares for the purpose of computation of capital under the Companies (Profits) Surtax Act, 1964 ?"

5. The Madras High Court held that when bonus shares were issued, the paid up capital of the Company increased, but so far as the column of liabilities in the balance sheet of the Company was concerned, a sum equivalent to the value of the bonus shares was carved out from the amount of reserves and placed in the column of paid up capital of the Comp

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