Holding

The Court held that when bonus shares are issued, the cost of acquisition of the original shares must be apportioned over both the original and bonus shares (average‑cost method), and the character of the shareholder (investor or dealer) is irrelevant.

Summary

Escorts Farms (Ramgarh) Ltd., a private limited company, sold shares it had purchased after 1954 and claimed capital gains by treating the actual purchase price of the original shares as the cost of acquisition, ignoring the effect of subsequently issued bonus shares. The Income‑Tax Officer, the Appellate Assistant Commissioner and the Income‑Tax Appellate Tribunal rejected this claim and computed gains by spreading the original cost over both the original and bonus shares, applying an average‑cost method. The High Court upheld the revenue’s view, and the matter was appealed to the Supreme Court. The Court held that the issuance of bonus shares alters the original cost of acquisition and that the cost must be apportioned over the combined holding of original and bonus shares, irrespective of whether the assessee is an investor or a dealer. Consequently, the Supreme Court dismissed the appeal, confirming the High Court’s decision.

Issues considered

Whether the tribunal was justified in determining the cost of acquisition of the original shares by spreading the original cost over the original and the bonus shares and then averaging the same.
If not, whether the assessee was justified in taking the value of the shares at their original cost under Section 45 of the Income‑Tax Act, 1961.

Legislation cited

Income Tax Act, 1961s. 2(14), s. 256(1), s. 45(1), s. 48, s. 55(2)

Subjects

capital gainsbonus sharescost of acquisitionaverage cost methodIncome Tax ActSection 45Section 48Section 55investor vs dealerstatutory costactual cost

Judgment

A MIS ESCORTS FARMS {RAMGARH) LTD.
v.
THE COMMISSIONER OF INCOME TAX, NEW DELHI

SEPTEMBER 26, 1996

B [B.P. JEEVAN REDDY AND K.S. PARIPOORNAN, JJ.]

Income Tax Ac~ 1961-Sections: 2(14),45 (1), 48 and 55 (2}-Capital
gain~omputation of-Capital assets-Shares-Shares purchased after
1954--Subsequently, bonus shares issued in respect of the original
C shares-Declaration of capltal gains by treating the actual cost of the original . '"
shares as its cost of acquisitio~on-acceptance of the declaration by the
Reve11ue Authoritie~on~putation of the original shares by ITO co11finned
by the Appellate Tribu11a~n refere11ce, High Court answered infavour of
Reve11ue--Decision of the High Court assailed-Held, the principles of averag-
D i11g by spreadi11g the cost over the old shares and the new bonus shares as
enunciated in Dalmia Investment Co.'s case will apply as general rule-The
subsequent issue of the bonus shares has the effect of altering the original cost
of acquisition of the shares-171e character of owner of the shares as an
'investor' or as a 'dealer' is of no consequence.

E 'lbe appellant purc:hased the original shares after 1954. Bonus
shares were also issued in respect of the original shares. Subsequently the
appellant sold its shares aiad declared the capital gains accrued therefrom,
by treating the actual cost of the original shares as its cost of acquisition.
The Income Tax Officer did not accept the declaration of the appellant and
worked out the capital gains on its own.
F
The Computation made by the Income Tax Officer regarding the
original shares was confirmed by the Appellate Assistant Commissioner
and the Appellate Tribunal. At the instance of the appellant, the Appellate
Tribunal referred two questions of law for the decision of the High Court.
G The questions are as under:

"l. Whether on the facts and in the circumstances of the case the
tribunal was justified in determining the cost of acquisition of the original
shares, by spreading the original cost over the original and the bonus
shares and then averaging the same and on that basis working out the
H capital gain at Rs.32,100 and Rs.12,450 for the assessment years 1967-68
18
ESCORTS FARMS (RAMGARH) LID. v. C.I.T. 19
and 1968-69 respectively ? A
2. If the answer to question No.1 is in the negative, whether the
assessee was justified in taking the value of the shares at their original
cost under Section 45 of the Income Tax Act, 1961 ?"

The High Court answered the Question No.1 in favour of the B
Revenue holding that the valuation made by the Revenue regarding the
cost of the original shares is proper and valid in the facts and circumstan-
ces of the case. The High Court declined to answer Question No.2. Hence

- ,.
this appeal.

Dismissing the appeal, this Court c
HELD: 1. When bonus shares were issued by a company, it has its
impact on the original shares. The market value of the company's shares
may get reduced to a figure nearer their normal value. The value of the
original shares acquired get automatically reduced, notwithstanding the
D
)- fact that the total holding of the shareholder may be larger. (29-B-C]

Robert R. Pennington's "Company Law'~ 5th Edition (1985); Dr. A.N.
-" Agarwala's "171e Higher Science of Accountancy" (1972 Edition); British
Master Tax Guide, (1988-89); William Pickles's ''Accountancy" and M.C.
Shukla and T.S. Grewal's ''Advanced Accounts" (1989), referred to. E
C.I. T. v. Dalmia Investment Co. Ltd., 52 ITR 567 and C./. T v. Gold
Company Ltd., 78 ITR 16, referred to.

2. The principle of averaging by spreading the cost over the old
shares and the new bonus shares as enunciated by this court in Dalmia F
Investment Co. 's case (supra) and other cases, will apply as general rule in
cases where the assessee claims to deduct the actual cost of acquisition,
instead of the statutory cost of acquisition. It also stands to reason since
the fair market value as per the 'statutory cost of acquisition' will be a
notional or fictional figure-mostly inflated-having no connection with the
. original or actual cost. The real cost to the assessee of the bonus shares G

. cannot be taken to be nil or their face value and they have to be valued by
spreading the cost to the old shares over the old shares and the new issue
(bonus shares), taken together etc. The principle so laid down is one of the
general application and the character of the owner of the shares as an
'investor' or as a 'dealer' is of no consequences. (32-D-G] H
20 SUPREME COURT REPORTS [1996] SUPP. 7 S.C.R.

A 2.2 There is no 'dichotomy' as to whether the shares are held by an
'investor' or 'dealer' in shares. In both the cases, it is surplus receipt that
is brought to tax, either as ''capital gains' or 'profit or loss', as the case
may be, and in accordance with relevant statutory provisions. [32-G]

C.l.T. v. Dalmia Investment Co. Ltd., 52 ITR 567, applied.
B
Madura Mills Co. Ltd. v. CIT, 86 ITR 467-Madras; D.M. Dahanukar
v. CIT, 88 ITR 454-Bombay; W.H. Brady & Company Ltd. v. CIT, Bombay,
119 ITR 359-Bombay and Alembic Chemical Works Ltd. v. CIT, 194 ITR
497-Gujarat, approved.
-.
c Sutlej Cotton Mills Ltd. v. CIT, 119 ITR 666; CIT v. Steel Group Ltd.,
ITR 234 and Smt. Protima Roy v. CIT, 139 ITR 536, over ruled.

3. The principles laid clown in Shekhawati General Traders Ltd. 's case
cannot be applied to a case where the assessee did not and could not
D exercise the option of the sltatutory cost of acquisition in the place of the
actual cost of acquisition. Where bonus shares are issued and some of the <
original shares are sold subsequently, their actual cost has too be reckoned
only on the basis of "averag1~ value" (as held in Dalmia Investment and other
cases) except in rare cases, where "actual cost" is notionally adopted or
determined as it existed on the relevant statutory date. [33-D-E]
E
Shekhawati General 1!;aders Ltd. v. I.T.O., Company Circle 1, Jaipur,
(1971) 82 ITR 788, explained· & distinguished.

4. The High Court was justified in law in holding that the valuation
made by the Revenue regarding the cost of the original shares is proper
F and valid in the facts and circumstances of the case and in further holding
that the subsequent issue of the bonus shares has the effect of altering the
original cost of acquisition of the shares. [33-F]

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 1124-25
G of 1987.
From the Judgment and Order dated 23.1.92 of the Gujarat High
Court in I.T.A. No. 152 of 1991.

B.B. Ahuja, Dr. V. Gaurishankar, Dr. R.R. Mishra, Ms. Geetanjali
H Mohan, S. Rajappa, C. Ramesh, P. Parmeswaran, M.S. Syali, M.N. Shroff
ESCORTS FARMS (RAMGARH) LID. v. C.l.T. [PARIPOORNAN, J.] 21

and Ms. Reema Bhandari for the appearing parties. A
The Judgment of the Court was delivered by

PARIPOORNAN, J. 1. The appellant, a private limited company, is
an Assessee to income tax. It derives income from investment, agriculture
and brick kiln business. It is an investor in shares. In the assessment years B
1967-68 and 1968-69, the relevant previous years ending on 30th June 1966
and 30th June 1967, the assessee sold shares of Escorts Limited and
declared the capital gains that accrued therefrom. The Income Tax Officer
did not accept the cost of acquisition of the shares, as returned by the
assessee and worked out the capital gains in a different manner. The C
computation made by the Income Tax Officer regarding the original shares
was confirmed by the Appellate Assistant Commissioner and the Appellate
Tribunal. In so doing, the Appellate Tribunal relied upon the decision of
this Court in Commissioner of Income-tax, Bihar v. Dalmia Investment Co.
Ltd. (1964) 52 ITR 567. At the instance of the appellant- assessee, the
Income Tax Appellate Tribunal referred the following two questions of law D
for both the Assessment Years under Section 256( 1) of the Income-tax Act
for the decision of the High Court of Delhi.

"l. Whether on the facts and in the circumstances of the case the
Tribunal was justified in determining the cost of acquisition of the E
original shares, by spreading the original cost over the original and
the bonus shares and then averaging the same and on that basis
working out the capital gain at Rs.32,100 and Rs.12,450 for the
assessment years 1967-68 and 1968-69 respectively?

2. If the answer to question No.1 is in the negative, whether the F
assessee was justified in taking the value of the shares at their
original cost under section 45 of the Income-tax Act, 1961 ?"

2. The question that arose for decision was, how the cost of the
acquisition of the original shares should be determined for the purposes of
capital gains tax. After referring td'the relevant decisions, the High Court G
.... held that the valuation made by the revenue regarding the cost of the
original shares is proper and valid in the facts and circumstances of the
case. Question No.1 was answered in the affirmative and in favour of the
revenue. The High Court declined to .answer question• No.2. It is the
aforesaid decision of the High Court dated 23.4.1982, which the assessee H
22 SUPREME COURT REPORTS [1996] SUPP. 7 S.C.R.

A has assailed in these appeals. The decision of the High Court is reported
in (1983) 143 ITR 749.

3. We heard counsel. A1t oJr request, Dr. Gaurishanker Senior
Advocate also addr;:ssed us and brought to our notice certain decisions
and passages from various text-books. The short question that arises for
B consideration is, how the cost of acquisition of the original shares is to be
determined when bonus shares are issued subsequently ? It is common
ground that the appellant admittedly purchased the original shares after
1954. Such shares were sold subsequently. Since the acquisition was after
1954, the option of taking the fair market value as on 1.1.1954 does not
C arise. According to the appellant, for determining the capital gains that
accrued when the original shares were sold, the cost of acquisition should
be taken. at "actual cost". The subsequent issue of bonus shares is of no
consequence and will not have the effect of altering the original cost of
acquisition of the shares. The High Court declined to accept this plea. It
D was held that once the bonus shares are issued, it has impact on the original
shares; it has the effect of altering the cost of original shares. It was so held
by placing reliance on the decisions of this Court reported in C./. T v.
Dalmia Investment Co. Ltd., 52 ITR 567; C.I. T. v. Gold Mohare, Investment
Co. Ltd., 74 ITR 62; C.I.T. v. Gold Company Ltd., 78 ITR 16 and distin-
guishing. the cases of this Court reported in Emerald & Co. Ltd. v. C.I. T.,
E 36 ITR 257 and Shekhawati General Traders Ltd. v. I.T.O., 82 I.T.R. 788.

4. Before 'JS, counsel for the appellant-assessee, vehemently argued
that the High Court was in error in holding that the subsequent issue of
bonus shares has the effect of altering the cost of acquisition of the original
F shares. Stress was laid on the fact that in the instant case, the shares sold
were original shares and by an "investor", whereas in the decisions of this
Court dealt with by the High Court, the shares sold were "bonus shares",
and the assessees in those cases were "dealers in shares". It was further
argued that the question in those cases, is not the computation of capital
gains, as a result of the sale of the shares (whether original or bonus shares)
G but the computation of "the profits and gains" in the business. The said vital
difference was omitted to be noticed by the High Court. On the other hand,
counsel for the revenue submitted that the High Court was justified in its
reasoning and conclusion in holding that the subsequent issue of bonus
shares has the effect of altering the original cost of acquisition of the
H shares, irrespective of the fact whether the assessee is an investor or dealer
ESCORTSFARMS(RAMGARH)LID.v. C.l.T.[PARIPOORNAN,J.) 23

in shares and shares sold are original shares or bonus shares. A
5. In order to resolve the controversy in this case, it will be useful to
bear in mind the relevant statutory provisions, as they stood at the relevant
time:-
'•
Section 2(14) of the Income-tax Act. B

"2(14) "capital asset" means property of any kind held by an
} assessee, whether or not connected with his business or profession,
but does not include--

(i) any stock-in-trade, consumable stores of raw materials held for
c
the purpose of his business or profession;"

Section 45(1) of the Income-tax Act

"45. Capital gains.-- (1) Any profits or gains arising from the D
transfer of a capital asset effected in the previous year shall, save
as otherwise provided in sections 53 and 54, be chargeable to
income-tax under the head Capital gains', and shall be deemed to
be the income of the previous year in which the transfer took
place." E
(In this case, Section 45(2) TO 45(4) added by Section 12 of the
Finance Act, 1964 and omitted by Finance Act, 1966 are not relevant)

Section 48 of the Income-tax Act.
F
"48. Mode of computation and deductions-The income chargeable
under the head "Capital gains" shall be computed by deducting
from the full value of the consideration received or accruing as a
result of the transfer of the capital asset the following amounts,
G

-
namely:-

(i) expenditure incurred wholly and exclusively in connection with
such transfer;

(ii) the cost of acquisition of the capital asset and the cost of any
improvement thereto." H
24 SUPREME COURT REPORTS (1996] SUPP. 7 S.C.R.

A Section 55(2)

"55. Meaning of "adjusted", "cost of improvement" and "cost of
acquisition".

(1) xxxx xxxx xxxx
B
(2) For the purposes of sections 48 and 49, 'cost of acquisition', in
relation to a capital asset,--

(i) Where the capital asset became the property of the assessee
before the 1st day of January, 1954, means the cost of acquisition
c of the asset to the assessee or the fair market value of the asset
on the 1st day of Janrnuy, 1954, at the option of the assessee;

xxxx xxxx xxxx"

D 6. It will also be useful to note what is meant by "bonus shares", the
circumstances under which they are issued and its impact on the original
shares. Robert R. Pennington in his book Company Law 5th edition {1985)
at pages 467, 468 and 469 deals with the matter thus:--

"It is common, however, for articles to contain a power for the
E company by ordinary resolution in general meeting on the recom-
mendation of its directors (a) to set free for distribution any part
of its distributable profits or reserves and to apply them in paying
up in whole or part th1: is5ue price of partly paid shares held by
members, or in paying in fall the nominal value of new shares or
debentures to be issued to members in the same manner and
F proportions as a cash dividend of the same amount would have
been distributed; and (b) to capitalise any part of the amounts
standing to the credit of the company's profit and loss accounts or
to reserve accounts which are not available for distribution (i.e.
capital reserves and unrealised profits) and to apply the amount
so capitalized in paying in full the nominal value of new shares to
G
be issued to members in the same manner and proportions as a cash
dividend of the same amount would have been distributed. Under
such provisions in the articles it is possible for a company to
capitalise the net amount of its realised and unrealised profits or
the amount or reserves representing them in order to issue bonus
H shares, but only the company's accumulated balance of realised
ESCORTSFARMS(RAMGARH)LID.v. C.l.T.(PARIPOORNAN,J.) 25

profits may be used to issue bonus debentures or to pay up any A
unpaid part of the issue price of shares which have already been
issued. New Shares or debentures issued in this way 011 a capitalisa-
tion of profits or reserves are known as bonus shares or debentures,
but the name is misleading in that it implies that they are a gift
from the company. It they were a gift, they would not be paid up
at all, and in the case of bonus shares, the company could call on B
their holders to pay for them in cash. Infact they are not a gi,ft, for
their nominal value is paid in full or in part by the capitalised profits
or reserves which could otherwise have been distributed to the
shareholders as a cash dividend, or in the case of unrealised profits,
retained as a reserve. On the other hand, since no cash dividend C
is declared, bonus shares are n.ot paid for in cash by the
shareholder himself, because there is at no point of time any debt
owing to him by the company which he can set off against his
liability to pay for the shares. Consequently, an issue of bonus shares
must be treated as an issue for a consideration other than cash, and
an appropriate retum and written contract for the allotment must be D
delivered to the Registrar of Companies.

xxx xxx xxx

(a) They enable the company to retain money required for its
business which it would otherwise have to raise by issuing new E
shares or debentures on the market or by borrowing;

(b) The market value of the company's shares is reduced to a figure
nearer their nominal value, and this makes them more saleable.
But a bonus issue increases the total market value of a
shareholder's holding only marginally; he merely has more F
shares of a correspondingly lower value each."

(Emphasis supplied.)

Dr. A.N. Agarwala in his book "The Higher Science of Accountancy" (1972
edition) at page 632 deals with bonus shares thus:-- G
"8. BONUS SHARES

Bonus Shares out of Profits : Capitalisation of Profits.

Bonus shares are shares issued to existing shareholders out of H
26 SUPREME COURT REPORTS (1996] SUPP. 7 S.C.R.

A profits. This is a case of capitalisation ofprofit, that is to say, instead
of being distributed as dividends, profits are turned into shares.
Bonus shares are distributed among shareholders in proportion to
their share holdings. What the company, in effect, does in such a
case is that it :-

B (i) Declares a bonus (extra dividend) out of undistributed
profits:

(ii) Issues a corresponding number of new (bonus) shares;

(iii) Applies the bonus in payment of the amount due on these
c shares: and

(iv) Distributes bonus shares among existing shareholders.

Shareholders, in other words, get their dividends in the shape
,J
of shares. The advantage of this procedure is that shareholders get
D . back undistributed profits which was hitherto withheld from them.
So far as the company is concerned, it pays the shareholders not
in cash but in the form of bonus shares to that its financial position
ifi in no way impaired. It will mean that the future rate of dividend
will come down since the same amoullt of profit will now have to
E be distributed over a larger number of shares .....

(Emphasis supplied.)

In the book "British Master Tax Guide" (1988-89) under the head "Bonus
and rights issues" at page 598, bonus issues are dealt with as hereunder:-
F
"Bonus issues

Bonus issues are free distributions of shares (e.g. two new shares
for each share already held).

G Example: In 1970, A purchased 300 ordinary shares in S Ltd. at
Pound 3 per share, total cost pound 900 (ignoring expenses for the .....,,..
purposes of the example).

In 1980, A received a bonus issue of 300 shares.

H He then held 600 shares at Pound 1.50 per share.
ESCORTS FARMS (RAMGARH) LID. v. Cl.T. [PARIPOORNAN,J.] 27

They are all as purchased in 1970." A

(Emphasis supplied.)

William Pickles in his book "Accountancy" dealing with bonus shares at
pages 23245-23246, states thus:--
B
''Advantages and Disadvantages. The advantages and disadvantages
of an issue of bonus shares are briefly summarized (a) as regards
the company, a!ld (b) as regards the shareholders.
)

xxx xxx xxx
c
(b) The Shareholder's Viewpoint. (i) Surtax and Capital Gains Tax
may be payable on a bonus share distribution.

(ii) Unless the company makes increased profits, the fall in rate
of dividend or depletion of reserves will cause the market price per D
share to fall-though the total value of the large holding may be
greater."

(iii) Speculative dealings in the shares may be caused.

4. A bonus issue of debentures or redeemable preference shares E
ranks as a distribution, and so also will payments of interest or
dividends. An issue of irredeemable bonus shares, however, unless
related to a previous repayment, does not rank as a distribution.
It should be appreciated that distributions are chargeable to In-
come Tax Schedule F, and in the hands of the recipients (the
shareholders), distributions are liable to surtax. This includes capi- F
tal dividends.

5. If the bonus is applied in reducing or extinguishing the uncalled
Capital (e.g. marking shares of pound 1 each, pound 0.75 paid into
fully-paid pound 1 shares) there is a distinct tangible benefit to the G
shareholder and therefore the amount is taxable.

A bonus share dividend is merely a book entry effected by a
transfer from General Reserve or Profit and Loss Appropriation
Account to Share Capital-- each shareholder receiving a share
certificate proportionate to his holding-- instead of cash. Thus, if H
28 SUPREME COURT REPORTS (1996) SUPP. 7 S.C.R.

A the share capital is pounds 8,000 in fully-paid ordinary shares of
pound 1 each and pounds 3,000 is transferred thereto, each
shareholder will have the right to an allotment of three new shares
for every eight old shares that he holds. He is usually given the
option of taking up the .shares or selling his right of allotment to
another person, that is, 'renouncing'.
B
As shareholders are entitled to CASH dividends, the sanction
of the Articles or special resolution is required for any dividend
otherwise than in cash, whether it is: (a) an actual distribution of
other assets; or (b) a 'notional' distribution by way of a bonus share
c dividend. Income Tax is normally charged on a bonus share
dividend.

Although the issue of bonus shares to ordinary shareholders is
generally regarded as a 'book entry', it may confer a substantial
advantage to such holders where there are preference shares which
D carry a right in a winding-up to share pari passu in a surplus, as
the bonus issue, by absorbing such part of the reserves of the
company as is necessary for such purpose, diminishes the 'surplus'.
In other words, such 'surplus' has. been utilized solely to increase
the claims of the ordinary shareholders by the additions of the
E relevant amount of reserves ........."

(Emphasis supplied)

M.C. Shukla and T.S. Grewal in their book "Advanced Accounts" (1989)
at page 823, have dealt with the impact of the bonus shares on the original
F shares, thus:--

"It should be remembered that when bonus shares are dis-
tributed, the shareholders may not gain at all. This is because of
the fact that the market value of the shares depends upon the
dividend received. If the company issues bonus shares, the profits
G (which do not increase) will have to be distributed over a larger
number of shares, thus reducing the dividend per share. This will
result in a fall in the value of the shares in the market. Thus the
shareholder will have a larger number of shares but the total value
of his holding will not increase because each share now is of a smaller
H value. Hence the shareholder makes no entry in his books on receipt
ESCORTS FARMS (RAMGARH) LID. v. C.I.T. [PARIPOORNAN,J.] 29

of bonus shares. However, the shareholder will benefit in the form A
of capital appreciation if there is a net increase in the amount of
dividend received by him."

(Emphasis supplied)

7. On a reference to the above standard text book, it is evident that B
when bonus shares are issued by a company, it has its impact on the original
shares. The market value of the company's shares may get reduced to a figure
nearer their nominal value. The value of the original shares acquired get
automatically reduced, notwithstanding the fact that the total holding of the
' ./ shareholder may be larger. In this context, it will be useful to refer to the C
law laid down by this Court in C.!. T. v. Dalmia Investment Co. Ltd. (52 ITR
567). The headnote as extracted herein below, accurately states the law laid
down in the said decision.

''Where bonus shares are issued in respect of ordinary shares held
in a company by an assessees who is a dealer in shares, their real D
cost to the assessee cannot be taken to be nil or their face value.
They have to be valued by spreading the cost of the old shares
over the old shares and the new issue (viz., the bonus shares) taken
together if they rank pari passu, and if they do not, the price may .
have to be adjusted either in proportion of the face value they E
bear {if there is no other circumstance to differentiate them) or
on equitable considerations based on the market price before and
after issue."
·'r

The above principle was affirmed by the Constitution Bench of this Court
in C./. T. v. Gold Company Ltd. (78 ITR 16) wherein it was held thus:- F
"Where bonus shares are issued in respect of ordinary shares held
by a dealer in shares who values his stock at cost, and the bonus
shares rankpari passu with the ordinary shares, the correct method
of valuing the shares is to spread the cost of the original shares G
over the original shares and the bonus shares collectively and
ascertain the average price of all the shares."

8. The sheetanchor of the appellants case before the High Court and
still before us was, that the cost of acquisition of the original share, is its
actual cost. The fact that the bonus shares were issued subsequently cannot H
30 SUPREME COURT REPORTS (1996] SUPP. 7 S.C.R.

A be taken into account and it is not open to the revenue to alter the cost of
acquisition of the original shares. It was further contended that the assessee
is only an investor and in such a case what is to be determined is the capital
gains and not the computation of business income, as in the case of a dealer
in shares. Much stress was laid on the decision of this Court in Shekhawati
B General Traders Ltd. v. Income-Tax Officer, Company Circle 1, Jaipur,
(1971) 82 ITR 788. The counsel for the appellants argued that the facts of
the instant case are identical to the facts in the aforesaid decision of the
Supreme Court, where the original shares were sold by an investor, in a
case where bonus shares were issued subsequently and the matter came up
for consideration. The Court held that the capital gains or loss should be
C calculated in accordance with the statutory provisions of Sections 48 and
55{2) of the Income-tax Act and the subsequent issue of bonus shares was
completely irrelevant and extraneous which should not be taken into con-
sideration.

D 9. It is necessary to understand the scope and impact of the decision
in Shekhawati General Traders Ltd.~ v. Income-Tax Officer, Company Circle
1, Jaipur, {1971) 82 ITR 788. In the said case, the main issue posed was
with regard to the validity of the proceedings initiated under Section 147
of the Income-tax Act. The assessee therein acquired 12,000 ordinary
shares of Orient Paper Mills on 29.3.1949. It received 12000 bonus shares
E on 28.4.1951. Subsequently, on Jw1e 4, 1954 and June 26, 1961 it received
bonus shares. The assessee sold 22000 shares, which were out of the 24000
shares which it acquired prior to 1.1.1954. It calculated the cost price of
22000 shares sold by it (out of 24000 shares aforesaid) at the market value
prevailing on 1.1.1954. Similarly, the assessee acquired shares in Birla Jute
p Manufacturing Company before 1.1.1954 and also got bonus shares therein
after 1.1.1954. In other words, the original cost of the acquisition of the
said shares were taken into account for the purpose of computing the
capital gains or loss. It was common ground that the shares which were
sold, were acquired or received by the assessee prior to 1.1.1954. It is also
common ground that the assessee calculated the cost price of the shares sold
G at the market value prevalent on 1.1.1954 in accordance with the then relevant
statutory provisions. The Income Tax Officer by order dated 20.7.1964
accepted the statement made by the assessee and held that the assessee
had suffered a capital loss. Subs1~quently by notice dated 4.1.1967, the
Income Tax Officer informed the assessee that he had reasons to believe
H that income chargeable to tax for the assessment year 1962-63 had escaped
F.SCORTS FARMS(RAMGARH) LID. v. C.I.T. [PARIPOORNAN,J.) 31

assessment within the meaning of Section 147 of the Income-tax Act, and . A
initiated proceedings thereunder. The Income Tax Officer stated that while
working out the cost of the shares, the assessee had claimed the prevalent
market price as on 1.1.1954 disregarding the fact that the assessee had been
given bonus shares in the subsequent years after 1.1.1954. The assessee
objected to the above proceedings and contended that it has exercised the B
option under Section 55(2) of the Act, and the cost of acquisition was taken
at the fair market value as on the relevant date and the capital loss was
computed accordingly, and there is no error in the matter. Subsequently
the assessee moved the High Court under Article 226 of the Constitution
of India challenging the validity and legality of the notice issued under
.J Section 147 of the Act. The High Court dismissed the writ petition. When C
the matter came up before this Court, it adverted to Sections 45, 48, 53, 54
and 55(2) of the Income-tax Act, and distinguishing the earlier Constitution
Bench decision of this Court in Commissioner of Income-Tax v. Dalmia
Investment Co. Ltd. (1964) 52 ITR 567, held thus:-
D
"..... that decision was not at all apposite for the purpose of deciding
the point which has arisen in the present case. No question arose
there of the calculation of the capital gain or loss in accordance with
the statutory provisions in pari materia with sections 43 and 55(2) of
the Act. Jn the present case we are confined to the express provisions
of section 55(2) relating to the manner in which the cost of acquisi- E
tion of a capital asset has to be determined for the purpose of section
48. Where the Capital asset became the property of the assessee
before the first day of January, 1954, the assessee ha~ two options.
It can decide whether it wishes to take the cost of the acquisition
of the asset to it as the cost of acquisition for the purpose of Section F
48 or the fair market value of the asset on the first day of January,
1954. The word "fair" appears to have been used to indicate that any
artificially inflated value is not to be taken into accoullt. In the
present case it is common ground that when the original assessment
order was made the fair market value of the shares in question had G
been duly determined and accepted as correct by the Income-tax
Officer. Under no principle or authority can anything more be read
into the provisions of section 55(2)(i) in the manner suggested by
the revenue based on the view expressed in the Dalmia Investment
Co's case. The High Court completely overlooked the fact that for
the ascertainment of the fair market value of the shares in question H
32 SUPREME COURT REPORTS [1996] SUPP. 7 S.C.R.

A on January 1, 1954, any event prior or subsequent to the said date
was wholly extraneous and irrelevant and could not be taken into
consideration. If the contention of the revenue were to be accepted
the acquisition of bonus shares subsequent to January 1, 1954, will
have to be taken into account which on the language of the statute
it is not possible to do ........"
B
(Emphasis supplied)

10. A close analysis of the facts of the above case, and the ultimate
conclusion reached by this Court, will go to show that the learned judges
C laid stress on the fact that the assessee had opted to take the cost of '
acquisition as provided by the relevant Statute, i.e., statutory cost of acquisi-
tion and thus substituting the market value as on 1.1.1954 in the place of
actual cost of acquisition, and only in such a case, the subsequent issue of
bonus shar(:s cannot affect the iissue. It is implicit from the above decision
D that the principle of averaging by spreading the cost over the old shares
and the new bonus shares as enunciated by this Court in Dalmia Investment
Co. 's case (supra) and other cases, will apply as a general rule in cases
where the assessee claims to deduct the actual cost of acquisition, instead
of the statutory cost of acquisition. It also stands to reason since the fair
market value as per the "statutory cost of acquisition" will be a notional or
E fictional figure - mostly inflated - having no connection with the or~ginal
or actual cost. We should bear in mind that it is after discussing the effect
or impact of the issue of the bonus shares, on the value of the original
shares generally and also the various possible methods for determining the
cost of the bonus shares, this Court in Dalmia Investment Co.'s case (52
F ITR 567) stated that the real cost to the assessee of the bonus shares cannot
be taken to be nil or their face value and they have to be valued by
spreading the cost of the old shares over the old shares and the new issue
(bonus shares), taken together etc. The principle so laid down is one of
the general application. We should also state that the character of the
owner of the shares as an "investor" or as a "dealer" is ofno 'Consequence.
G
There is no 'dichotomy', as to whether the shares are held by an
'investor' or 'dealer' in shares. In both the cases, it is surplus receipt that
is brought to t3x, either as "capital gains" or "profit or loss", as the case may
be, and in accordance with relevant statutory provisions. The decisions
H reported in Madura Mills Co. Ltd. v. CIT, 86 ITR 467-Madras; D.M.
ESCORTS FARMS (RAMGARH) LID. v. C.l.T. [PARIPOORNAN,J.] 33

Dahanukar v. CIT, 88 ITR 454-Bombay; W.H. Brady & Company Ltd. v. A
CIT, Bombay, 119 ITR 359-Bombay; Albemic Chemical Works Ltd. v. CIT,
· ~· 194 ITR 497-Gujarat are in accord with the above view and they represent
the correct law. The decisions (in Sutlej Cotton Mills Ltd. v. CIT, 119 ITR
666; CIT v. Steel Group Ltd., 131 ITR 234; Smt. Protinia Roy v. CIT, 138
ITR 536, etc. etc.) cited before us, misapplied the rule enunciated in B
Shekhawati General Traders Ltd. v. ITO (supra) and failed to bear in mind
the proper principles to be applied in the matter and do not lay down the
corect law.

,/
11. In this case, the High Court has found that the original shares
sold were admittedly purchased after 1954 and, therefore the option of C
taking the fair market value as on 1.1.1954 (the statutory cost) was not
available to the assessee. It appears to us that the principles laid down in
Shekhawati General Traders Ltd. v. Income-Tax Officer, Company Circle 1,
Jaipur, (1971) 82 ITR 788, cannot be applied to a case where the assessee
did not and could not exercise the option of the statutory cost of acquisi-
tion in the place of the actual cost of acquisition. The said decision is D
distinguishable. In view of the larger Bench decisions of this Court, it is
fairly clear that where bonus shares are issued and some of the original
shares are sold subsequently, their actual cost has to be reckoned only on
the basis of "average value" (as held in Dalmia Investment & other cases)
except in rare cases, where "actual cost" is notionally adopted or deter- E
mined as it existed on the relevant statutory date, (Shekhawati General
Traders Ltd. v. I. T.O. ). In the instant case, the High Court was justified in
law in holding so and in further holding that the subsequent issue of the
bonus shares has the effect of altering the original cost of acquisition of
the shares as held by this Court in Commissioner of Income-Tax v. Dalmia
Investment Co. Ltd. (1964) 52 ITR 567 and other cases. F

12. We hold that the judgment of the High Court answering question
No. (1) referred to it in favour of the Revenue and against the assessee
does not merit interference and these appeals should be dismissed. We do
so. However, there shall be no order as to costs. G
K.H.N.S. Appeal dismissed.