Holding

Allotment of rights shares is a creation of new shares, not a transfer of existing property, and bonus shares are a capitalisation of profits; consequently, no gift arose under the Gift Tax Act, 1958.

Summary

Khoday Distilleries Ltd issued a rights issue; twenty of its twenty‑seven shareholders did not subscribe and the unissued shares were allotted to seven existing investment‑company shareholders. The company also issued fully paid bonus shares in a 1:23 ratio. The Assessing Officer treated both the rights‑issue allotment and the bonus shares as deemed gifts under the Gift Tax Act, 1958 and levied gift tax on the company. The Commissioner of Income Tax (Appeals) held the company liable, but the Tribunal reversed, holding that the allotment was a creation of new shares, not a transfer of existing property, and that bonus shares are merely a capitalisation of undistributed profits. The Department appealed, the High Court reinstated liability on the company, and the Supreme Court allowed the appeal, holding that no gift arose in either case; liability, if any, would rest on the renouncing shareholders, not the company.

Issues considered

Whether the allotment of rights issue shares to shareholders constitutes a "gift" within the meaning of Section 2(xii) of the Gift Tax Act, 1958.
Whether the issuance of fully paid bonus shares in the ratio 1:23 amounts to a "gift" under the Gift Tax Act, 1958.

Legislation cited

Companies Act, 1956s. 81
Gift Tax Act, 1958s. 2(xii), s. 2(xxiv), s. 4(1)(a)

Subjects

Gift TaxAllotmentRights IssueBonus SharesTransferDeemed GiftCompanies ActTax Planning vs Tax EvasionCapitalisation

Judgment

- [2008] 15 S.C.R. 1133

~

KHODAY DISTILLERIES LTD. A
v.
COMMISSIONER OF INCOME TAX AND ANR.
(Civil Appeal No. 6654 of 2008)

NOVEMBER 14, 2008
B
[S.H. KAPADIA AND 8. SUDERSHAN REDDY, JJ.]

Gift Tax Act, 1958:

ss. 2(xii), 4(1) - Rights issue by Company - Not c
subscribed by shareholders - Allotment to remaining
shareholders-investment companies - Liability of Company
to pay gift tax - Held: Such allotment was not transfer -
There was no element of existing right - Thus, no 'gift' arose
in terms of s. 2(xii)- Deemed gift uls. 4(1)(a) also not attracted D
..:
- In any event, liability to: pay gift tax would be on donor-
shareholder who exercised the option to renounce and. not
on the company - Despite decision of Appellate Authority,
Department did not initiate gift tax proceedings against
renouncer shareholder - As regard, evasion of tax,
E
submission of Department was conflicting - Thus, order of
High Court that Company was liable to pay gift tax for transfer
of shares to investment companies, set aside.
-" s. 2(xii) - Bonus shares - Exigibility to gift tax - Held:
Fully paid bonus shares are merely distribution of capitalized F
undivided profit - Recipients of bonus shares cannot be
called donees of shares from the company - Thus, there is
no element of 'gift' as defined u/s. 2(xii).

Word and Phrases: 'Allotment' of shares' - Meaning of G
- Held: Word 'allotment' indicates creation of shares by
1- appropriation out of the unappropriated share capital to a
particular person - Company Law.

There were twenty seven shareholders of the
1133 H
1134 SUPREME COURT REPORTS [2008] 15 S.C.R.

A appellant company including the seven investment
companies. Appel!ant company announced issue of
rights. Twenty shareholders did not subscribe to the
rights issue. Appellant company allotted the shares to the
remaining shareholders-seven investment companies.
B Thereafter, appellant also issued bonus shares in the ratio
of 1:23. The Assessing Officer(AO) held that the allotment
by way of rights issue being without adequate .,_
consideration, was a deemed gift u/s. 4(1) of the Gift Tax
Act, 1958 and the difference between the value of shares
c on yield basis and the face value of Rs. 10/- at which
sh~res were allotted was to be taxed. AO also levied gift
tax Qn the bonus shares issued by the appellant. In
appeal, CIT (A) held that the entire exercise undertaken
by the appellant was to avoid payment of wealth tax,
~
0 thus, the company was liable to pay gift tax for transfer
of the said shares to the seven investment companies,·
despite observing that the Department should initiate gift
tax proceedings against the renouncer shareholders and
not against the appellant company. Appellant company·
filed appeal which was allowed. The tribunal held that the
E allotment of rights_ by the appellant did not con_stitute
'transfer' as it did not involve any existing property at the
time of such allotment, thus there was no element of .gift
u/s. 4(1)(a) of the 1958 Act; and that the seven-investment·
companies made payment towards the face value of the
F shares, thus, the contract was not without consideration.
Aggrieved, respondent-Department filed appeal which
was disposed of in its favour. Hence the present appeal.

Allowing the appeal, the Court
G HELD: 1.1 There is a vital difference between
'creation' and 'transfer' of shares. The words 'allotment
of shares' have been used to indicate the creation of
shares by appropriation out of the unappropriated share
capital to a particular person. A share is a chose in action.
H
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1135
INCOME TAX AND ANR

A chose in action implies existence of some person A
entitled to the rights in action incontradistinction from
rights in possession. There is a difference between issue
of a share to a subscriber and the purchase of a share
from an existing shareholder. The first case is that of
creation whereas the second case is that of transfer of B
chose in action. In the instant case, when twenty
shareholders did not subscribe to the rights issu.e, the
appellant allotted them to the seven investment
companies, such allotment was not transfer. In the
circumstances, s. 4(1)(a) of the Gift-Tax Act, 1958 was not · c
applicable as held by the tribunal. [Para 8] [1142-C-E]
1.2. There is a difference between "renunciation" and
"allotment". In the instant case, the Department did not
keep in mind the difference between the two concepts
and confused the same. It sought to tax the appellant- D
company as a donor under the 1958 Act for making
allotment of right shares. The Department has not taxed
the renouncer shareholders despite the decision of
CIT(A). Allotment is not a transfer. Moreover, there is no
element of existing right in the case of allotment as E ·
required under s. 2(xii) of the 1958 Act. In the case of
renunciation for inadequate consideration in a given
case s. 4(1 )(a) could stand attracted. However, in such a
case, the Department has to proceed against the
renouncer (shareholder). [Para 10) [1143-F-H; 1144-A] F
1.3. According to CIT(A), the right shares were
allotted to the seven investment companies because the
other existing shareholders did not subscribe for the
shares, and the gift tax proceedings ought to have been
initiated against the existing shareholders, who had G
renounced their rights. It is surprising that despite the
orders passed by CIT(A), the Department did not initiate
proceedings under the 1958 Act against the shareholders
who had renounced their rights, particularly when the
CIT(A) has specifically said so in her order. The word H
1136 SUPREME COURT REPORTS [2008) 15 S.C.R.

A "allotment" indicates creation of shares.by appropriation
out of the unappropriated share capital to a particular
person and that such creation did not amount to transfer.
That, in any (!Vent, liability to pay gift tax would be on the
donor (shareholder) who ex.~rcises the option to
B renounce and noton the appeltant-company. Thus, no
'gift' arose in terms of s·. 2(xii) of the 1958 Act on the
allotment of rights issue by appellant company to its
shareholders vide Board's ~esolution. [Para 11] [1144-8-
E]
c Sri Gopa/ Jalan & Company v. Calcutta Stock Exchange
Association Ltd. 1964 (3) SCR 698, Held applicable.

S.R. Chockalingam Chettiar v. Commissioner of Gift-Tax
(1968) 70 ITR 397, Held inapplicable.
D
· Sangramsinh P. Gaekwad and Ors. V. Shantadevi P.
Gaekwad (Dead) through LRs. and Ors. (2005) 11 SCC 314,.
referred to. ·
. . . .

· . 2.1"' When 'a c'ompany is prosperous and ·
E accumulates:a large surplus, it converts this surplus int6
capital and divides the capital amongst the members in
proportion to their rights. This is done by issuing fully
paid shares representing the increased capital. The
· s·hareholders to whom the shares are allotted have .to pay
F nothing. The purpose is to capitalize profits which may.
be available for division. Bonus shares go by the modern
name of "capitalization shares". If the Articles of a
company empowers the company, it can capitalize
profits or reserves and issue fully paid shares of nominal
G value, equal to the amount capitalized, to its
shareholders. The idea behind the issue of bonus shares
is to bring the nominal share capital into line with the 'f ·' -

excess of assets over.liabilities. A company would like to
have more working capital but it need not go into the
H market for obtaining fresh capital by issuing fresh shares.
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1137
INCOME TAX AND ANR.
'-.
The necessary money is available with it and this money A
is converted into shares which really means that the
undistributed profits have been ploughed back into the
business and converted into share capital Therefore,
fully paid bonus shares are merely adistribution of
capitalized undivided profit. It would be a misnomer to · B
call the recipients of bonus shares a$ donees of shares
from the company. [Para 13] [1144-H; 1145-A-D]

Hunsur Plywood Works Ltd. v. Commissioner of Income-
Tax (1998) 229 ITR 112, referred to.
c
2.2. It is not known why the Department had not
proceeded under the Income-Tax Act, 1961 if, according
to the Department, the case was of tax evasion.
According to the CIT(A), ~he appellant had undertaken an
.... exercise to avoid wealth tax whereas according to the D
Assessing Officer the exercise undertaken by the
appellant was to evade Gift Tax and in the same breadth
the A.O. states that the entire exercise was to evade tax
by allotting shares to the Directors which attracted the
deeming provisions of Section 2(22) of the 1961 Act . E
There is utter confusion on this aspect. Therefore, on the
question of evasion of tax, the submission of the
Department is conflicting. In fact, it messed up the entire
case. None of the said aspects have been dealt with. by
the High Court in its impugned judgement. [Paras 16 and F.
17] [1150-C-G]
·Case Law Reference:
2oos (11) sec 314 Referred to. Para 5
1964 (3) SCR 698 Held applicable. Para 8 G
'>,· 1968 (70) ITR 397 Held inapplicable. Para 9, 10
1998 (229) ITR 112 Referred to. Para 14
H
1138 SUPREME COURT REPORTS [2008] 15 S.(\.R.
'
A CIVIL APPELLATE JURISDICTION : Civil Appeal· No.
6654 of 2008.

From the final Judgment and Order dated 1.8:2007 of the
. High Court of Karnataka at Bangalore in Gift Tax Appeal No. 2
of:2002.
B
Priteesh Kapur,Yashraj Singh Deora, A.A. Kulkarni and
Dhruv Mehta (for.Mis. K.L. Mehta & Co.) for the Appellant.

Mohan Parasaran, ASG., V. Shekhar, Sr. Advs., D.L.
c Chidananda, Vikash Sharma, Gaurav Dhingra, Sanjeev K.
Bharadwaj and s:v. Balaram Das for the Respondents~

The Judgment of the Court was delivered by

S.H. KAPADIA, J. 1. Leave granted.
D
2. This civil appeal filed by the assessee seeks to
challenge judgme.nt and order passed by the Karnataka High
Court dated 1.8.2007 in Gift Tax Appeal No. 2/02. In this civil
appeal we are· concerned with· the assessment
.
year 1987-88.c
E
3. Two questions arise for determination in t~is civil appeal,
which are as follows: '-

(i) Whether any "gift" arose in terms of Section 2(xii)
. of the Gift-tax Act, 1958 ("1958 Act") on the
F allotment of rights issue by the appellant company
to its shareholders vide Board's Resolution dated
29.1.1986?

(ii) · Whether there was any element of "gift"· as defined ·
under Section 2(xii) in the appellant issuing Bonus
G
shares in the ratio of 1:23 in April/May 1986?
I ·

Answer to Question No. 1 :

4. On 29.1.1986. the appellant company, on the other
H . shareholders not exercising the option given to them to take
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1139
INCOME TAX AND ANR. [S.H. KAPADIA, J.]
,.._
up the right shares issued by the appellant, allotted them to the A
"' seven investment companies, who were the shareholders in the
appellant's company. At this stage, it may~ stated, that in ·all
there were twenty-seven shareholders. Twen shareholders did
not subscribe to the rights issue and consequently the appellant-
company allotted them to the remaining existing shareholders. B
The A.O. held that the said allotment by way of rights issue was
without adequate consideration within the meaning of Section
4(1)(a) of the 1958 Act. He further held that the modus operandi
was an attempt to evade taxes; that it was a colourable
transaction and since the shares allotted were without adequate c
consideration, there was a deemed gift under Section 4(1) of
the 1958 Act. Accordingly, the difference between the value of
the shares on yield basis and the face value of Rs. 10/- at which
the shares were allotted was sought to be brought to tax under
the said section. Aggrieved by the decision of the A.O., the
appellant carried the matter in appeal to CIT(A). It was held that D
the entire exercise undertaken by the appellant was to evade
payment of wealth tax by the individual. shareholders of the
appellant-company. This finding was given by the CIT(A) on the
ground that right shares were allotted because 20 existing
shareholders out of 27 shareholders of the company did not E
subscribe for the rights. However, according tot.he CIT(A), gift
tax proceedings had to be initiated by the Department not
against the appellant company but it ought to have initiated gift
~·
tax proceedings against the existing shareholders wno had
renounced their rights. Having so held, the CIT(A) came to be F
conclusion that the entire exerdse undertaken by the appellant
was to avoid payment of wealth tax and, therefore, it was held
that the company was liable to pay gift tax for transfer of the
said shares to the seven investment companies. This decision
of the CIT(A) stood reversed by the Tribunal which decided the G
appeal filed by the company against the Department. The
Tribunal came to the conclusion that the allotment of rights by
the appellant did not constitute "transfer" as it did not involve
any existing property at the time of such allotment According
to the Tribunal, the seven investment companies made H
1140 SUPREME COURT REPORTS [2008] 15 S.C.R.

' ......
A payment towards the face value· of the sh.ares and,
'consequently, it cannot be said that the contract was without
consideration. It was further held that'in this case there was no
element of gift under Section 4(1)(a) as there was no transfer
of property as· defined under Section 2(xxiv) of the 1958 Act.
8 Aggrieved by· the decision of the Tribunal, the· Department
preferred Gift Tax Appeal No. 2/02, which, vide the impugned
judgment, stood disposed of in favour of the Department,
hence, this civil appeal.

5. Shri Soli J. Sorabjee, learned senior counsel appearing
C on behalf of the appellant, submitted that gift tax is not attracted
on.initial allotment ofshares because there is no transfer of any
existing movable property, namely; the shares. According to the
learned counsel, till allotment is made, shares did not exist. It
is only on allotment that shares cpme into existence, In this
D connection, learned counsel placed reliance on the judgment
of this Court in the case of Sri Gopal Ja/an & Company v. ·
Calcutta Stock Exchange AssoCiation Ltd. reported in 1964
(3) SCR 698. He also relied.upon the judgment of this Court in
the case of Sangramsinh P. Gaekwad:and ors~ V. Shantadevi
E P, Gaekwad (Dead) through LRs~ and ors. reported· in (2005)
11 SCC 314. Learned counsel further submitted that there is a
·vital difference between tax planning and tax evasion.
According to the learned counsel, it is perfectly legitimate and
permissible for an assessee to so arrange his affairs with a
F · view to reduce its tax liability and such.tax planning cannot be
· equated with tax evasion. lnthis connection, learned counsel
submitted that the transaction in question was not sham or
fictitious but real and it was given effect to: Moreover, it was
contended that the stand taken by the Department, in this case,
G was conflicting inasmuch as according to the A.O. what was
intended to be evaded was income-tax by the Directors of the
appellant-company whereas, according to the CIT(A), the I
exercise undertaken by the appellant-company was to evade
wealth tax. Learned counsel submitted in the alternative that/
H even assuming whilst denying that there was an intention to

,,.•"'
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1141
INCOME TAX ANDANR. [S.H. KAPADIA, J.]

evade income tax or wealth tax, the correct course open to the A
Department was to include the income or wealth in the income
tax or wealth tax assessment of the concerned assessee. For
the aforestated reasons, learr.ed counsel submitted that the
High Court should not have interfered with the decision of the
Tribunal. B

6. Shri Mohan Parasaran, learned Additional Solicitor
General, appearing on behalf of the Department submitted that
allotment of shares on rights basis under Section 81 of the
Companies Act, 1956 would come under the concept of
"deemed gift" under Section 4(1 )(a) of the Gift-tax Act. C
According to the learned counsel, no sooner a declaration is
made by the Board of Directors announcing issue of rights, a
right accrues to the existing shareholders either to opt for rights
or to renounce it in favour of existing shareholders. In this
connection, learned counsel submitted that no sooner the D:
Board of Directors decide to issue rights, the existing
shareholders who are offered rights get a tangible right to opt
for allotment or they could renounce it in favour of existing
shareho1ders and as and when said option is exercised, the
right gets crystallized and, therefore, in such cases where E
renouncement takes place on exercise of the option in favour
of the existing shareholder(s) there would be a transfer of an
existing interest, which transfer would attract Section 4(1)(a) of
the Gift-tax Act. In this connection, learned counsel placed
heavy reliance on the judgment of the Madras High Court in the F
case of S.R. Chocka/ingam Chettiar v. Commissioner of Gift-
Tax reported in (1968) 70 ITR 397.

7.At the outset, we may state that none of the above
arguments have been considered by the High Court in its c_S
impugned judgment. In the case of Sri Gopal Jalan & Company
(supra) a question arose as to the meaning of the word
"allotment". It was held that in Company Law the word
"allotment" means appropriation out of previously
unappropriated capital of a company, of a certain number of
H
1142 SUPREME COURT REPORTS [2008) 15 S.C.R.

A shares, to a person and till such allotment, the shares do not ,"'(

exist as such. It is only on allotment that the shares come into
existence and in every case the words "allotment of shares" ---
have been used to indicate the creation of shares by
appropriation out of the unappropriated share capital to a
B particular person.

8. In our view, the judgment of this Court iri Sri Gopal Jalan ...
& Company (supra) squarely applies to the present case. )_
There is a vital difference between "creation" and "transfer" of
shares. As stated hereinabove, the words "allotment of shares"
c have been used to indicate the creation of shares by
appropriation out of the unappropriated share capital to a
particular person. A share is a chqse in action. A chose in
action implies existence of some person entitled to the rights
in action incontradistinction from rights in possession. There is
D a differe.nce between issue of a share to a subscriber and the
)-
purchase of a share from an existing shareholder. The first case
is that of creation whereas the second case is that of transfer
of.chose in action. In this case, when twenty shareholders·did
not subscribe to the rights issue, the appellant allotted them to
E the seven investment companies, such allotment was not
transfer. In the circumstances, Section 4(1)(a) was not
. applicable as held by th~ Tribunal.

9. Since heavy reliance is placed by the learned Additional
F Solicitor General on the judgment of the Madras High Court in
the case of S.R. Chockalingam Chettiar (supra), we may state
that the said judgment has no application to the facts of the
present case. In that case, the facts were as follows. Appellant
was a shareholder of S.R.C.M. Ltd .. Appellant was an
assessee. Appellant was entitled to apply for 800 equity shares
G
in a fresh issue of capital by the company with a option to
renounce the same as provided for in Section 81 of the
Companies Act, 1956. On 15.6.1957, appellant renounced
these shares in favour of S, who applied for those shares on
the·strength of the renunciation. The Gift-tax Officer held that
H
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1143
INCOME TAX AND ANR. [S.H. KAPADIA, J.]
>--
~
the renouncement involved the gift of a valuable right and, A
evaluating the value of the gift as the difference between the
market value of the shares on the date of renunciation
(15.6.1957) and the value at which they were issued to the
existing shareholders, levied gift tax on the total amount. On
Reference to the High Court, it was held that the right to obtain B
...., a specified number of right shares under Section 81 of the
~ Companies Act in the fresh issue of capital is a tangible right
and is not an interest in future property but it is existing property ·
as defined in the Gift-tax Act and, therefore, Tribunal was right
in directing the Gift-tax Officer to levy gift tax on the market C1
quotations of the rights. This judgment has no application to the
facts of the present case. In the case of S.R. Chockalingam
Chettiar(supra), the assesseewas ·an individual shareholder,
who was held to be a donor. In that case, the company allotting
the shares was not treated as an assessee under the Gift-tax
D'
Act. The liability under the Gift-tax Act to pay the gift tax is on
the donor. In the present case, one fails to understand how the
appellant-company could be treated as donor. S.R.
Chock~lingam Chettiar was a shareholder of S.R.C.M. Ltd. and
he was sought to be assessed under the Gift-tax and not
S.R.C.M. Ltd .. Therefore, judgment in S.R. Chockalingam E
Chettiar has no application.

-4. .
10. There is a difference between "renunciation" arid
"allotment". In this case, the Department has confused the two
concepts. The judgment of the Madras High Court in the case F
of S.R. Chockalingam Chettiar (supra) dealt with the case of
renunciation in which case under certain circumstances the
renouncer could be· treated as a donor liable to be taxed under
Section 4(1 )(a) of the Gift-tax Act, 1958. That is not the situation
here. In the present case, the Department has sought to tax the G
appellant-company as a donor under the 1958 Act for making
allotment of right shares. The Department has not taxed the
renouncer shareholders despite the decision of CIT(A).
Allotment is not a transfer. Moreover, there is no elemert of
existing right in the case of allotment as required under Section H
1144 SUPREME 'COURT REPORTS [2008] 15 S.C.R. - .

...(

A 2(xii) of the 1958 Act. In the case of renunciation for inadequate '"",
consideration in a given case Section 4(1 )(a) could stand
attracted. However, in such a case, the Department has to
proceed against the renouncer (shareholder). For the above
reasons, the judgment of the Madras High Court in S.R.
B Chockalingam Chettiar case has no application.
..
~

11. One more aspect needs to be mentioned. As stated . ·.
l
above, in this case, even according to CIT(A), the right shares.
· were allotted to the seven investment companies because the
other existing shareholders did not subscribe for the shares.
c According to CIT(A), the gift' tax proceedings ought to have '

been initiated against the existing shareholders, who had
renounced their rights. We are surprised that despite the orders
passed by CIT(A), the Department did not initiate proceedings
under the Gift-tax Act against the shareholders who had
,,__
D renounced their rights, particularly when the CIT(A) has
specifically said so in her order. For the aforestated reasons,
we hold that.the word "allotment" indicates creation of shares
by appropriation out of the unappropriated share capital to a
particular person .and that such creation did not amount to ·
E -transfer. That, in any event, liability to pay gift tax would be on
the donor (shareholder) who exercises the option to renounce
and not on the appellant-company. Accordingly, question no. 1
is answered in favour of the ap.pell~nt . and against
.
the
Department.
F
Answer to Question No. 2:

12. The second issue to be decided is vyhether there is
element of "gift" in the appellant issuing bonus shares in the
ratio of 1:23 in April/May, 1986. In addition to the levy of gift
G tax on the allotment of right shares, the A.O. levied gift tax on
the bonus shares issued later by the appellant. I

13. When a company is prosperous and accumulates a
large surplus, it converts this surplus into capital and divides
H the capital amongst the members in proportion to their rights.
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1145
INCOME TAX AND ANR. [S.H. KAPADIA, J.]
,,.._
This is done by issuing fully paid shares representing the A
;;
increased capital. The shareholders to whom· the shares are
allotted have to pay nothing. The purpose is to capitalize profits
which may be available for division. Bonus shares go by the
modern name of "capitalization shares". If the Articles of a
company empowers the company, it can capitalize profits or B
reserves and issue fully paid shares of nominal value, equal to
"'" ,I.,
the amount capitalized, to its shareholders. The idea behind the
issue of bonus shares is to bring the nominal share capital into
line wit.h the excess of assets over liabilities. A company would
like to have· more working capital but it need not go into the c
market for obtaining fresh capital by issuing fresh shares. The
necessary money is available with it and this money is converted
into shares which really means that the undistributed profits
have been ploughed back into the business and converted into
~hare capital. Therefore, fully paid bonus shares are merely a
"( D
distribution of capitalized undivided profit. It would be a
misnomer to call the recipients of bonus shares as donees of
shares from the company.

14. Our aforesaid view, namely, that bonus shares go by
the modern name of "capitalization shares" finds support in the E
judgment of this Court in the case of Hunsur Plywood Worl<s
Ltd. v. Commissioner of Income-tax reported in (1998) 229 ITR
112. The relev~nt portion of which reads as under:
~

"... The issuance of bonus shares was nothing but F
mere capitalisation of the profits of the Company in
respect of which certificates are issued to the shareholders
entitling them to participate in the amount of the reserve
but only as part of the capital.

The mechanism and effect of issuance of bonus G
shares have been explained by the English courts in a
number of cases.

Lord Haldane in the case of /RC v. Blott (1921) 2
AC 171 (HL) held (page 184): H
1146 SUPREME COURT· REPORTS [2008] 15 S.C.R.

,...,
A "My Lords, for the reasons I have given I think it is,
as matter of principle; within the power of an ordinary joint
·~ stock company with articles such as those· in the case
before us to determine conclusively against the who.le
world whether it will withhold profits it has accumulated from
B distribution to its shareholders as iiicome, and as an · ·
alternative not distribute them at all, but apply them in
paying up the capital sums which shareholders electing to
,J.
take up unissued shares would otherwise have to
contribute. If this is done, the money so applied is capital ·
c and never becomes profits in the hands of .the shareholder.
at all. What the latter gets is no doubt a valuable thing. But
it is a thing in the nature of an extra share certificate in the
company."

In that case, Viscounts Haldane, Finlay and Cave
D held that an amount equal to the face value of t_he shares y

could not be regarded as received by the. shareholders.
A contrary view was taken by Lord Dunedin and ~ord
Sumner who held that th.e word "capitalisation" .was
somewhat hazy and the amount that was capitali.sed had
E to be treated as to have been paid to the shareholders.

In the case of Commissioners of Inland Revenue
v. Fisher's Executors (1926) AC 395 (HL) •. Viscount Cave
dealt with the case of a company which ·had large
·F undistributed profits. It decided to capitalise a part of these
profits and distribute it pro rata among the ordinary
shareholders as a bonus in the form of five per cent
debenture stock. The stock was duly issued, conditions
providing that the Company might redeem the stock after
a certain time and in certain events. The question that
G
came up for decision was whether the bonus paid in the
form of debenture stock was income in the hands of the (
shareholders and was, therefore, liable to super tax.
Viscount Cave held (page 404):

H "The whole transaction was 'bare machinery' for
KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1147

... ~
INCOME TAX AND ANR. [S.H. KAPADIA, J:]

capitalizing profits and involved no release of assets either A
as income or as capital.';

In coming to this conclusion, Viscount Cave relied
upon the following observation of Lord Finlay in Blott's case:

"The general scope and effect of these transactions B '

is beyond dispute. There was an increase in the capital
~
of the company .by the -retention of the amounts available
for dividends .... The use of' the sums which had been
available for dividend to increase capital would enable the
company to carry on a larger and more profitable business, c
which might be expected to yield larger dividends. The
dividends, however, were to be in the future. So far as the
present was concerned there was no dividend out of the
.accumulated profits; these were devoted to increasing the
"'(
~ . capital ,of the company. The company had power to do 0
what it pleased with any_ .profits which it might make. It
__, might spend the accumulated profits in the improvement
I
of .the company's works and buildings and machinery.
If These improvements might lead to a great accession of
b.usiness and increase of profits by which every E
shareholder would benefit, but of course it could not for a
moment be contended that such a benefit would render
., him liable to super tax in respect of it. The benefit would
not be in the nature of income, and super tax can be levied
only on income." F
~

In our view, the principle stated by Lord Finlay really
resolves the controversy raised in this case. The profits
made by the Company may be distributed as dividends
or retained by the Company as its reserve which may be
used for improvement of the Company's works, buildings G
) and machinery. That will enable the Company to make
larger profits. There cannot be any dispute that the
shareholders will benefit from the improvements brought
about in the profit-making apparatus of the Company.
Likewise, if the accumulated profits are capitalised and H
1148 SUPREME COURT REPORTS [2008] 15 S.C.R.
~
·i
1. ..
A capital base of the Company is enlarged, this may enable
the Company to do its business more profitably. The
.shareholders will also benefit if the share capital is
increased. They may benefit immediately by issue of
bonus shares. But neither in the case of improvement in
B the profit-making apparatus nor in the case of expansion
of the share capital of the Company, can it be said that
j.
the shareholders have. received any money from the
. Company. They may have benefited in both the cases. But
this benefit cannot be treated as distribution of the amount
c standing to the credit of any reserve fund of the Company
to its shareholders.

In fact, the transfer of the amounts standing to the
credit of development rebate reserve to the share capital
account, does not involve any disbursement
. . of money by ,.,...
D .the Company. Nothing_ comes out of the till of the Company
to the shareho_lder. The entireamount o(money shown as
development rebate reserve is retained by the Company
in another account. It cannot. be said that by the issue of
bonus shares, the Company had distributed its reserve
E fund to the shareholders even though it had retai!1ed the
entire amount with it in the share capital account.
..
It must also be noted that while dealing with the
question ofvaluation of bonus shares in the case of CIT
F v. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (SC),
Hidayatullah, J. (as His Lordship then was), after referring .
to Blott's case, preferred the view expressed by Viscounts
Haldane, Finlay and Cave to the dissenting view t?ken by
Lord Dunedin and Lord Sumner. Dealing with the effect of
issue of bonus shares, Hidayatullah, J. held that "the
G floating capital used in the Company which formerly
(
consisted of subscribed ~apital and the reserv~s now
becomes the subscribed capital" of the Company. The
certificates in the hands of the shareholders were property
from which income.will be derived in future.
H
. KHODAY DISTILLERIES LTD. v. COMMISSIONER OF 1149
INCOME TAX AND ANR. [S.H. KAPADIA, J.]

Hidayatullah J., in Dalmia case, also quoted with A
approval a passage from a decision of the Supreme Court
of the United States, Eisnerv. Macomber(1920) 252 U.S.
189:

"A stock dividend really takes nothing from the
B
property of the corporation, and adds nothing to the
interests of the shareholders. Its property is not diminished,
and their interests are not increased .... The proportional
interest of each shareholder remains the same. The only
change is in the evidence which represents that interest,
the new shares and the original shares together
c
representing the same proportional interest that the original
shares represented before the issue of the new ones ....
In short, the corporation is no poorer and the stockholder
is no richer than they were before .... If the plaintiff gained
any small advantage by the change, it certainly was not an D
advantage of£ 417,450 the sum upon which he was taxed .
... What has happened is that the plaintiff's old certificates
have been split up in effect and have diminished in value
to the extent of the value of the new."
E
When a shareholder gets a bonus share the value
of the original share held by him goes down. In effect, the
shareholder gets two shares instead of the one share held
.....
by him and the market value as well as the intrinsic value
of the two shares put together will be the same or nearly F
the same as the value of the original share before the
bonus issue.

It appears from the various decisions cited
hereinabove, that issuance of bonus shares does not
amount to distribution of accumulated profit of a company. G
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."

,15. One of the points raised on behalf of the Department H
-.! _J,..

1150 . SUPREME COURT RaPORTS [20081. ts: s-c. R

A was that the entire: exercise;· undertak~n, by, the" appellant
constituted" tax evasion. According to the Department; by, a
paltry: investment of-Rs. 1Q_. lacs. (approximately,); the· seven
investment companies: became.owners of;2~.,00;.168 shares.. of
M/s Khodey Distilleries Ltd. worth Rs. 2,40,01,(380. According
8 to the Department, .the market value ofthe said shares and the ..
yield from· the said: shares.were-totally;disproportiot\ate to :the
investments made by the. seven inyestment companies. .J.
,,r-
~-
Therefore, according to the Department, the modus operandi r
adopted by the appellantwas an exercise· in· tax evasion.
;
c 16. As stated above; we do not-know.the reason why the
Department had not proceeded·underthe Income-tax.Act, 1961
if, according to the Department, the case,was of tax evasion:
According to the CIT(A), the appellant had undertaken an
exercise to avoid wealth taxwhereas according to the AO. the
D exercise undertaken by the appellantwas to evade Gift Tax and
in the same breadth the AO: states thatthe entire exercise· was
to evade tax by allotting shares· to the Diredors which attracted
the deeming provisions of Section 2(22) of the 1961· Act (see
page 35 of the Paper Book). There is utter confusion on this
E aspect. Therefore, in our view, on the question of evasion of
tax, the contention of the Department is conflicting. In fact, as
stated above, the Department has messed up the entire case.
The Department has notkept in mindJhe difference between
"allotment" and "renunciation". The.Department has not invoked
F the provisions of the Gift-tax Act against the renouncer
shareholder despite the observation of the CIT(A) in that
regard. ·

17. None of the above aspects has· been dealt'with· by the
G High Court in its impugned judgment.
18. For the aforestated reasons, the impugned·:judgment ~
of the High Court is s·et aside.-and :the civil appeal filed\by the
assessee stands allowed with.no order as to costs. ''F
H N.J. Appeal allowed,