1. Claim for development rebate under Section 33, Income-tax Act — Withdrawal of allowance following issuance of bonus shares from development rebate reserve — Dispute over distribution of profits. (Para 1 )
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1997 Supreme(SC) 1487
1997(10) SUPREME 116
SUPREME COURT OF INDIA
(From Karnataka High Court)
Suhas C. Sen and V.N. Khare, JJ.
M/s. Hunsur Plywood Works Ltd. -Appellant
versus
Commissioner of Income Tax -Respondent
Civil Appeal Nos. 140-42 of 1988
Decided on 19-11-1997
Counsel for the Parties :
For the Appellant : Gopal Jain, Advocate for Mukul Mudgal, Advocate.
For the Respondent : J. Ramamurthy, Sr. Advocate, T.C. Sharma, N.K. Agarwal, B.K. Prasad, Advocates.
The issuance of bonus shares by capitalizing the Development Rebate Reserve does not constitute 'distribution by way of dividends or profits' under the Income-tax Act, 1961, as no funds are disbursed to shareholders and the company retains the money in its share capital account.
Headnote:TAXATION-Income Tax Act, 1961-Section 33-Development Rebate-Claim towards allowance of-Company had made a transfer of sums from development rebate reserve to share capitalisation account by issue of bonus shares-Assessing authority concluded that issuance of bonus shares amounted to distribution of profits by capitalisation-Order passed u/s 154 of the Act withdrawing development rebate claim-Challenged-Whether, on facts and circumstances of the case, issuance of bonus shares will amounts to distribution of profits ?-(No).
Held that issuance of bonus shares does not amount to distribution of accumulated profit of a company. The shareholder derives some benefit by the process of capitalising of the accumulated profits but at the same time, the value of his original shareholding goes down. Viewed from any angle, it cannot be said that in this case, the assessee-Company had distributed any part of its Development Rebate Fund when it issued the bonus shares. The accumulated profit lying to the credit of the Development Rebate Reserve has been retained by the Company. The amount has been transferred to the share capital account. If that was not done the intrinsic value of the shares held by the shareholders would have been more. After the issue of the bonus shares, the intrinsic value of the original shares have gone down rateably. The accumulated profits of the Company have remained with the Company in one account or another. (Para 14)
In this case, neither in form nor in substance, has there been any distribution of profits by the company in making the bonus issue. If the substance and not the form of the transaction is looked to, the issue of a bonus shares was, in the language of Rowlatt, J. "a bare machinery" for capitalising profits and there was no distribution of profits to the shareholders. (Para 17)
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2. Whether the issuance of bonus shares by capitalizing a development rebate reserve amounts to distribution of profits under Section 34(3)(a)(i) and Section 155(5)(ii)(a) of the Income-tax Act. (Para 3 , 4 , 7 )
3. Issuance of bonus shares is a capitalization of profits where no assets are released to shareholders and the company retains funds within its share capital account. (Para 8 , 9 , 10 , 11 , 12 , 13 , 14 , 15 , 16 , 17 )
4. Capitalization of reserves through the issuance of bonus shares does not constitute distribution of profits as no disbursement of money occurs from the company to the shareholders. (Para 11 , 14 , 17 )
5. Appeals allowed — High Court judgment set aside — Withdrawal of development rebate allowance held unjustified. (Para 18 )
6. Does the issuance of bonus shares from a development rebate reserve constitute distribution of profits under the Income-tax Act?
No. The issuance of bonus shares is a capitalization of profits. Because no money is disbursed from the company to the shareholders and the funds are retained within the company's share capital account, it does not amount to a distribution of profits. (Para 10 , 11 , 14 , 17 )
7. How does the effect of bonus shares on a shareholder's value impact the determination of profit distribution?
While shareholders receive more shares, the intrinsic and market value of the original shares decreases proportionally. The shareholder is not richer and the corporation is not poorer, meaning no actual distribution of assets has occurred. (Para 12 , 13 , 14 )
8. Why is the capitalization of reserves in a company distinct from the transfer of reserves to partners' accounts in a partnership firm?
In a partnership, transferring reserves to partners' accounts allows them to withdraw funds for personal use. In a company, shareholders cannot withdraw money from the share capital account, ensuring the funds remain with the company. (Para 15 )
JUDGMENT
Sen, J.-The appellant is a public limited company. The assessment years involved are 1972-73, 1973-74 and 1974-75. In regard to the above assessment years, in the returns of Income filed by the appellant before the assessing authority, a claim towards allowance of development rebate under Section 33 of the Income-tax Act, 1961 (hereinafter referred to as the Act ) was made. The assessing authority allowed the claim as made by the company. Subsequently, the assessing authority noticed from the balance sheet of the appellant company that the company had made a transfer of sums from the development rebate reserve to share capitalisation account by issue of bonus shares. The assessing authority concluded that the issuance of bonus shares amounted to distribution of profits by capitalisation and thus the assessing authority was of the view that the provisions of Section 155(ii)(a) of the Act applied to the instant case, as the development rebate reserve has been utilised for distribution by way of dividend or profits. Accordingly, the assessing authority passed an order under Section 154 of the Act wihdrawing the development rebate claim allowed earlier.
2. The Company went up on appeal. The appellate authority allowed its appeal. The claim of the appellant for development rebate was sustained.
3. The Appellate Tribunal on the Revenue s appeal concurred with the view taken by the first appellate authority and concluded that there was no distribution by way of dividend or profits in the issue of bonus shares.
Thereafter, on the application by the Commissioner of Income-tax, the following questions of law were referred to the High Court :
"(a) whether on the facts and in the circumstances of the case the ITAT is right in law in holding that issue of bonus shares from out of the development rebate reserve did not amount to distribution of profits within the meaning of Section 34(3)(a)(i)?
(b) whether on the facts and in the circumstances of the case the ITAT is right in law in holding that the ITO is not justified in withdrawing the development rebate?"
4. The High Court after examining the provisions of Section 34(3)(a)(i) and Section 155(5)(ii)(a) of the Income Tax Act held that the issue of bonus shares resulted in distribution of profits and therefore, the statutory requirement of Section 34(3)(a)(i) of the Act had been violated. The High Court answered both the questions in the negative and in favour of the Revenue. The assessee has come up on appeal to this Court.
5. Section 33 of the Act deals with allowance of development rebate in respect of a new ship or new machinery or plant owned by the assessee, if it was wholly used for the purpose of business carried on by him. The allowance is given subject to a number of conditions. We are concerned in this case with the condition laid down in Section 34, which is as under :
"34(3)(a). The deduction referred to in Section 33 shall not be allowed unless an amount equal to seventy five per cent of the development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of eight years next following for the purpose of the business of the undertaking, other than-
(i) for distribution by way of dividends or profits."
Section 155(5)(ii)(a) which is also relevant in this case is as under :
"(5) Where an allowance by way of development rebate has been made wholly or partly to an assessee in respect of a ship, machinery or plant installed after the 31st day of December, 1957 in any assessment year under Section 33 of the Indian Income-tax Act, 1922 (XI of 1922), and subsequently-
(i) xx xx xx xx
(ii) at any time before the expiry of the eight years referred to in sub-section (3) of Section 34, the assessee utilised the amount credited to the reserve account under clause (a) of that sub-
