Emerald and Co. Ltd. vs Commissioner Of Income-Tax, Bombay

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 26 March, 1959

Coram: B.P. Sinha, J.L. Kapur, M. Hidayatullah

In this matter, the parties were Emerald and Co. Ltd., the assessee company, and the Commissioner of Income‑Tax, Bombay. The appeal was filed by the assessee company on 26 March 1959, seeking special leave to be heard before the Supreme Court of India. The bench that heard the case consisted of Justices B. P. Sinha, J. L. Kapur and M. Hidayatullah, and the judgment was written by Justice Hidayatullah. The appeal challenged the decision of the High Court of Judicature at Bombay dated 27 September 1955, which had been rendered in Income‑tax Reference No. 23 of 1955. The specific question before the High Court was whether the loss of Rs 35,801 computed by the assessee company was correct according to law, or whether the loss calculated by the Income‑Tax Officer and the Tribunal was the proper figure.

The High Court, comprising Chief Justice Chagla and Justice Tendolkar, held that the loss computed by the Income‑Tax Officer was in accordance with the law. The factual backdrop to the appeal was as follows: The assessee company was engaged in the trade of shares and valued its closing stock of shares at cost price. During the financial year 1950‑1951, the company bought fifty shares of Bombay Dyeing and Manufacturing Co. Ltd. on 11 November 1950 for Rs 49,101. On 9 January 1951 the issuer of those shares declared one bonus share of Rs 250 face value for each share held. Consequently, the assessee company received fifty bonus shares, each with a face value of Rs 250. The company then sold the original fifty shares on 12 January 1951 for Rs 26,125. Subsequently, on 5 March 1951 the company purchased one hundred additional shares of the same company for Rs 48,359. In its books, the company recorded the face value of the bonus shares, amounting to Rs 12,500, as a debit to its share account. For the assessment year 1951‑1952, the Income‑Tax Officer, following the Bombay High Court’s earlier decision in Manecklal Chunilal & Sons Ltd. (Income‑tax Reference No. 16 of 1948), determined that the company’s profit was Rs 1,760. The assessee company, however, claimed a loss of Rs 1,365 for that year, contending that the Department had valued the bonus shares at nil. The company did not lodge an appeal against that assessment.

In the following accounting year, 1951‑1952, the assessee company held a total of one hundred and fifty shares of Bombay Dyeing, which included the one hundred shares purchased on 5 March 1951. The company later bought two lots comprising two hundred shares for a total price of Rs 99,939. It subsequently sold three hundred shares in two separate lots, receiving a combined amount of Rs 1,20,550. At the close of that accounting year, the bonus shares remained in the company’s possession. Applying the same accounting method as before, the company recorded the cost of the bonus shares at their face value of Rs 12,500 and declared a loss of Rs 35,801 for the assessment year 1952‑1953.

The records indicated a figure of Rs. 35,801 for the assessment year 1952‑1953. The Income‑Tax Officer, applying the same method that had been used in the preceding year, arrived at a computed loss of Rs. 27,766 for that year. The assessee company challenged this second assessment and the matter proceeded to the Appellate Tribunal at Bombay. The Tribunal, after its own calculation, found the loss to be Rs. 27,748, a difference of only eight rupees from the assessment officer’s figure. Because the discrepancy was negligible, the Tribunal chose not to disturb the officer’s order that set the loss at Rs. 27,766. Nonetheless, the Tribunal, on an application made by the assessee company, concluded that a point of law raised by the parties arose from the factual matrix of the case and therefore referred the question to the higher court for determination.

The Bombay High Court, following its earlier ruling in Maneuklal & Sons Ltd. (Income‑Tax Reference No. 16 of 1948) dated 23 March 1949, held that the Department’s computation of the loss incurred by the company was correct. In effect, the High Court rejected both the loss calculation prepared by the assessee company and the alternative calculation previously formulated by the Income‑Tax Appellate Tribunal. Before the Supreme Court, it was contended that the High Court erred in accepting the Income‑Tax Officer’s computation. The assessee company argued that its own method of calculating the loss was in accordance with law, whereas the Department, represented by the Solicitor‑General, maintained that the Tribunal’s computation was perfectly accurate, having taken into account the transactions and the accounting method employed by the company. Relying on precedents such as In re Eddystone Marine Insurance Company, Bouch v. Sproule, Swan Brewery Company Limited v. Rex and Inland Revenue Commissioners v. Greenwood, the company asserted that it should be treated as having paid for the fully paid bonus shares because it had forfeited an equivalent right in the company’s reserves, whether of profit or capital. Counsel for the company, Mr. Sachin Chowdhary, argued vigorously that the issuance of fully paid bonus shares was essentially a purchase by the shareholder, with consideration represented by the proportionate reduction of the shareholder’s interest in the reserves from which the bonus shares were drawn. The Solicitor‑General, in an equally forceful response, quoted Eisner v. Macomber and contended that the issue of bonus shares neither added to nor diminished the shareholders’ interests or the company’s property; the proportional interest of each shareholder remained unchanged, and only the evidentiary representation of that interest was altered, the new bonus shares together with the original holdings reflecting the same proportional stake that existed before the bonus issue.

The learned Solicitor‑General observed that the bonus shares remained in the possession of the assessee company, and therefore the profit‑and‑loss account could be computed solely on the basis of the cost of the ordinary shares that were actually bought and sold and their respective sale prices. He argued that the valuation of the bonus shares—whether taken at face value, market value, nil or any notional amount—did not enter into the computation of the loss on the transactions involving the ordinary shares. Accordingly, he urged the Court to defer the question of whether the issuance of fully paid bonus shares represented an expenditure by the assessee company until such bonus shares were actually sold. He further submitted that until the time of sale, the valuation of the bonus shares in the company's books would be reflected by equal debit entries on the stock side, whatever the amount of such entries might be.

Mr. Sachin Chowdhary, counsel for the appellant, pressed the Court very earnestly to answer the same question, which the High Court had previously considered and decided against the assessee company. While acknowledging that the question was an important one and might require determination in a future proceeding, the Court held that for the purpose of assessing the loss for the assessment year in dispute it was unnecessary to resolve the issue. The matter could be disposed of in the same manner as the Income‑Tax Tribunal had handled it. To illustrate its approach, the Court set out three separate calculations that had been made, respectively by the assessee company, by the Income‑Tax Officer, and by the Tribunal, to compute the loss incurred by the company. The Court noted that, although the figures for both assessment years were reproduced, it agreed with the Solicitor‑General that the assessment for the first year could not be reopened and that the valuation of the stock as determined by the Income‑Tax Officer at the close of the first accounting year must be treated as final. Nonetheless, for the sake of completeness the Court presented the figures relating to all the share transactions of the Bombay Dyeing Company that were used in each of the three methods of computation.

In the calculation presented by the assessee company for the accounting year 1950‑51 (assessment year 1951‑52), the company recorded purchases of fifty ordinary shares at a total cost of Rs 49,10,00. It reported sales of fifty ordinary shares amounting to Rs 26,125. The company also recorded purchases of an additional one hundred ordinary shares at Rs 48,359. The closing stock consisted of one hundred and fifty shares valued at Rs 82,470, together with fifty bonus shares valued at Rs 12,500. The total cost of purchases and opening stock summed to Rs 1,09,960, while the total proceeds from sales and closing stock amounted to Rs 1,08,595, resulting in a loss of Rs 1,365 for that year. For the subsequent accounting year 1951‑52 (assessment year 1952‑53), the company opened stock with one hundred ordinary shares plus fifty bonus shares valued at Rs 82,471. It recorded sales of three hundred ordinary shares and purchases of two hundred ordinary shares at a total cost of Rs 120,550. The closing stock comprised fifty ordinary shares valued at Rs 26,059. The total cost of purchases and opening stock for this year was Rs 1,82,410, whereas the total realized from sales and closing stock was Rs 1,46,609, giving a loss of Rs 35,801.

The Income‑Tax Officer’s method for the same periods was also set out. For the accounting year 1950‑51 (assessment year 1951‑52), the Officer recorded a purchase of fifty ordinary shares at Rs 49,101, a sale of fifty ordinary shares at Rs 26,125, a purchase of one hundred ordinary shares at Rs 48,359, and a closing stock of one hundred and fifty shares valued at Rs 73,095. The Officer’s figures also included the valuation of fifty bonus shares at Nil. The total cost of purchases and opening stock was Rs 97,460, while the total proceeds from sales and closing stock were Rs 99,220, producing a profit of Rs 1,760. For the accounting year 1951‑52 (assessment year 1952‑53), the Officer opened stock with one hundred ordinary shares plus fifty bonus shares valued at Rs 73,096, recorded sales of three hundred ordinary shares, purchases of two hundred ordinary shares at Rs 120,550, and a closing stock of fifty ordinary shares valued at Rs 99,939. The Officer’s computation yielded a total cost of Rs 1,73,035 and total proceeds of Rs 1,45,269, resulting in a loss of Rs 27,766. Finally, the Income‑Tax Appellate Tribunal’s calculation for the same period was presented: it recorded purchases of one hundred ordinary shares at Rs 48,359 and two hundred ordinary shares at Rs 99,939, totalling Rs 1,48,298; sales of three hundred ordinary shares generated Rs 1,20,550; consequently, the Tribunal found a loss of Rs 27,748, with a balance of fifty bonus shares remaining. The Court concluded that the Tribunal’s calculation was in accordance with law and correct, and that the cost of the bonus shares was not the issue to be decided at this stage. The Tribunal’s view allowed for the possibility that the bonus shares might have cost Rs 12,500 as claimed by the assessee company, or nothing as the Income‑Tax Officer had asserted. The passage ends with the statement “Purchase 50 ordy. Rs.”

The Income‑tax Officer’s arithmetic showed that, for the assessment year 1951‑52, the company had purchased fifty ordinary shares at a cost of Rs 49,101 and sold fifty ordinary shares for Rs 26,125. The purchase of one hundred ordinary shares was recorded at Rs 48,359, and the closing stock consisted of one hundred fifty shares valued at Rs 73,095. The officer’s table listed a total of Rs 97,460 as the aggregate of purchases and a total of Rs 99,220 as the aggregate of sales, noting that the fifty bonus shares were recorded at nil value. After deducting the total sales from the total purchases, the officer arrived at a profit of Rs 1,760 for that assessment year. For the subsequent assessment year 1952‑53, the officer’s computation began with an opening stock of one hundred ordinary shares together with fifty bonus shares, valued at Rs 73,096. During the year the company purchased two hundred ordinary shares at a cost of Rs 1,20,550 and sold three hundred ordinary shares, while the closing stock comprised fifty shares valued at Rs 99,939. The officer’s statement showed a total purchase amount of Rs 1,73,035 and a total sales amount of Rs 1,45,269, which produced a loss of Rs 27,766 for the second assessment year.

The Income‑tax Appellate Tribunal, however, adopted a different method of calculation. It recorded the purchase of one hundred ordinary shares at Rs 48,359 and the purchase of two hundred ordinary shares at Rs 99,939, giving a combined purchase total of Rs 1,48,298. The tribunal then recorded the sale of three hundred ordinary shares for Rs 1,20,550. Subtracting the sales figure from the purchase total yielded a loss of Rs 27,748. The tribunal also noted that fifty bonus shares remained unsold and therefore were not assigned any cost in the computation. The Court observed that the tribunal’s calculation complied with the law and was therefore correct. It held that the question of the cost of the bonus shares was not material at this stage because the bonus shares had not been sold; their cost could be Rs 12,500 as claimed by the assessee, nil as asserted by the Income‑tax Officer, or any other amount under a different principle, but the pending sale would determine the appropriate valuation. The Court further noted that the books of the assessee included the closing stock at cost price, and that the tribunal’s profit‑and‑loss computation adhered to this accounting treatment. All ordinary shares that had been purchased were shown to have been sold, with both purchase and sale prices known. Consequently, the trading loss for the second assessment year, calculated on the basis of the three hundred shares bought and sold, was Rs 27,748, which the Court affirmed as a lawful determination. Finally, the Court answered the reference by confirming that the loss as computed by the Tribunal was correct and legal, and it ordered that no costs be awarded in the circumstances of the case.