1. These cross appeals arise from the order dated 2-7-1999 of CIT(A)-Central V, Mumbai, and are disposed of by this common order as under :

2. The first ground of appeal in both the appeals pertains to determination of income under the head ‘Capital gains on sale of shares’. Ground No. 1 raised by the assessee is as under:

"On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the computation of average cost of post 1-4-1981 - shares of Premier Automobiles Ltd., made by the learned Assessing Officer while computing the long-term capital gains arising on sale thereof."

On the other hand, Ground No. 1 raised by the Department is as under :

"On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in directing the Assessing Officer to compute long-term capital gain on the indexed cost of the market value of shares as against the "average cost" taken by the Assessing Officer for computation of long-term capital gain on sale of shares of Premier Automobiles Ltd."

3. The relevant facts may be stated briefly. During the previous year relevant to the assessment year under appeal, the assessee-company sold the shares, including bonus shares, held by it in the following three companies :

(1)Premier Automobiles Ltd. (PAL)

(2)Walchandnagar Industries Ltd. (WIL)

(3)Bombay Cycle and Motor Agencies Ltd. (BCMA)

The assessee declared long-term capital gain on sale of these shares at Rs. 918.93 lakhs. As against this, the Assessing Officer determined the capital gain at Rs. 1,113.34 lakhs. Some of the shares were acquired by the assessee prior to 1-4-1981 whereas some shares were acquired by the assessee after the above date. Bonus shares were issued to the assessee after the statutory date of 1-4-1981. There is no dispute between the assessee and the revenue on the point that for determining the cost of acquisition, the original cost is to be averaged out between the original shares held by the assessee and the bonus shares issued on the basis of the existing shareholding. However, the bone of contention is the methodology adopted for the exercise of averaging out. Insofar as the shares acquired by the assessee prior to 1-4-1981, the assessee exercised option to adopt the cost of acquisition to be the Fair Market Value (FMV) prevailing as on 1-4-1981 or the original cost whichever is more, in terms of provisions of section 55(2) of the Income-tax Act. The assessee acquired shares of PAL post 1-4-1981 during the financial years 1981-82, 1982-83 and 1983-84. In the financial year 1986-87, the assessee was allotted bonus shares of PAL in the ratio of 1:1 and thus after issue of bonus shares the total shareholding of the assessee including bonus shares of PAL stood at 16,00,560 shares. Thereafter the assessee acquired further shares of PAL during the financial years 1987-88, 1988-89 and 1989-90. The total shareholding, therefore, during the assessment year under appeal stood at 33,83,976. We are not mentioning here the position of shareholding in the other two companies. With regard to 46,250 shares of PAL owned by the assessee prior to 1-4-1981, the assessee adopted the FMV as on 1-4-1981 to be the cost of acquisition for the purpose of computation of capital gains @ Rs. 16.3 per share. As mentioned above, on the basis of the shareholding, the assessee was allotted 8,00,280 bonus shares of PAL in the financial year 1986-87. The question arose as to how the cost of acquisition and the indexed cost of requisition of these shares should be determined. In respect of the original shares held by the assessee prior to 1-4-1981 the assessee adopted the indexed cost on the basis of FMV as on 1-4-1981. The next question was the method to be adopted for averaging out the cost of acquisition between the original holding of shares and the bonus shares. The assessee increased the cost of the shares held by it in the ratio of the index factor of the year of acquisition of the original shares and the index factor of the financial year 1986-87 when the bonus shares were issued. For example, the cost of acquisition in respect of pre 1-4-1981 which was Rs. 7.44 lakhs (No. of shares 46,00,250 multiplied by FMV on 1-4-1981 Rs. 16.3 per share), was increased to Rs. 10.56 lakhs. The increase in the ratio of index factor of 100 in the year 1981-82 and the index factor 140 in the financial year 1986-87. The cost of acquisition of the shares acquired by the assessee in the financial years 1981-82, 1982-83 and 1983-84 was also increased in similar manner. Such increased cost was adopted for the purpose of deriving the average cost per share. Such average cost of acquisition was further indexed by the assessee to the level of the financial year relevant to the assessment year under appeal. Capital gain was worked out on the above cases.

4. The Assessing Officer rejected the aforesaid method adopted by the assessee for determining the cost of acquisition. He held that for averaging the actual cost of pre 1-4-1981 shares should be adopted instead of FMV as on 1-4-1981. He also held that the assessee cannot get the benefit of double indexation of the cost of acquisition i.e., first up to the financial year 1986-87 when the bonus shares were allotted, and again up to the level of the financial year 1993-94 when the shares were sold. Assessing Officer, therefore, re-determined the cost of acquisition and worked out capital gain chargable to tax as per annexure to the assessment order.

5. When the matter came up before the learned CIT(A), he confirmed the Assessing Officer’s order with regard to the finding that indexation can be done only once. However, he held that the FMV as on 1-4-1981 is to be adopted for the purpose of indexation. The department as well as the assessee are aggrieved on account of the finding of the learned CIT(A).

6. The learned counsel appearing for the assessee argued before us submitted that in respect of pre 1-4-1981 shares the FMV adopted on 1-4-1981 is unalterable and this value has to be taken for the purpose of averaging as also for indexation up to the year of sale. He relied on the Supreme Court decision in the case of Shekhawati General Traders Ltd. v. ITO [1971] 82 ITR 788. [LQ/SC/1971/523] The learned counsel then submitted that the assessee must get the benefit of inflation which has taken place up to the year in which bonus shares have been issued and, therefore, it is reasonable and logical that the FMV as on 1-4-1981 in respect of pre 1-4-1981 shares, and the cost of acquisition of the shares subsequently acquired by the assessee up to the allotment of bonus shares, should be adjusted and increased up to the level of the index factor of the year in which bonus shares were issued. It is argued that this would be the proper method for determining the average cost of acquisition of the shareholding of the assessee including the bonus shares. It is argued that the question of double indexation does not arise because, once the average cost is determined, the further indexation up to the year of sale would be on the basis of the index factor prevailing in the financial year 1986-87, which would be the base year. The learned counsel for the assessee invited our attention to a note filed by him explaining the method of computation of long-term capital gains, as adopted by the assessee. This note may be reproduced below :

"1.While computing the long-term capital gains, the provisions of section 48 and the second proviso thereto are considered. Accordingly from the full value of consideration accruing as a result of sale of shares, the indexed cost of acquisition of shares has been deducted to arrive at the net capital gains.

2.Where bonus shares are sold along with the original shares, the indexed cost of the bonus shares is determined by adopting the principles of averaging the cost of acquisition of cash-paid shares by spreading it over the total No. of shares including both, bonus shares and cash-paid shares acquired prior to the issue of bonus shares. The principle of averaging the cost is as laid down by the Apex Court in following cases:

(a)CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 [LQ/SC/1964/83] ;

(b)CIT v. Gold Mohore Investment Co. Ltd. [1968] 68 ITR 213 [LQ/SC/1967/206] /[1969] 74 ITR 62 [LQ/SC/1969/156] ;

(c)CIT v Gold Co. Ltd. [1970] 78 ITR 16.

3.For the purpose of determining the average cost, the original cost of cash paid shares [in the case of pre-1-4-1981 shares, the cost is taken either at the actual cost or fair market value as on 1-4-1981 whichever is higher - as per section 55(2)(b)(i)] is indexed so as to bring it to the level of index of the year of issue of bonus shares. Such indexed cost is spread over the total No. of shares to arrive at the average cost, which I then applied to all the shares except pre 1-4-1981 shares where the fair market value as on 1-4-1981 is substituted in the place of cost of acquisition as provided under section 55(2)(b)(i). The aggregate of the average indexed cost as of the bonus year is then brought to the indexed level of the year of sale by taking the cost inflation index of the year of sale and that of the bonus year. The objective underlying this exercise is to reflect the true indexed cost while averaging the cost of shares. From the assessment year 1993-94 the deduction is allowed with reference to the indexed cost of acquisition as against the cost of acquisition. This scheme of indexation is aimed at reducing the impact of inflation on the profits. In other words, the capital gains which arise due to pure inflation over the period of holding is to be kept outside the tax net. In para 35 of the Circular No. 636, dated 31-8-1992 (1992) 198 ITR St. 1, the Board has explained the purpose of new provisions in the following words—

‘. . .As an additional measure to offset the effect of inflation, all appreciation before 1-4-1974 in the value of assets was excluded from taxation. A fair method of allowing relief for these factors is to link it to the period of holding. For this purpose, the cost of acquisition of and the cost of improvement to the asset are to be inflated to arrive at the indexed cost of acquisition and indexed cost of improvement and then deduct these amounts from the sale consideration to arrive at the long-term capital gains . . .’ [Emphasis supplied]

Thus, under the new scheme of indexation period of holding of the asset is very significant, based on which the cost of acquisition is suitably inflated. It is settled law that the bonus share’s cost is embedded in the cost of original shares which make the holder thereof entitled to the bonus. In other words, the right to receive bonus shares stems from the original shares held by a person. In fact, on this fundamental reasoning, the principle of averaging cost is based. The decisions of the Apex Court referred to above also confirms this position. Therefore, when the cost of bonus shares issued in a later year is to be determined by the process of averaging and if, to such derived average cost the index of bonus year is to be applied for determining the indexed cost, obviously, that will defeat the very purpose of indexation because the index of the later year (bonus year) (which is bound to be lower than the index of the year of acquisition of the original share) will be applied to a portion of the original cost though it is, in point of time incurred much earlier when the original shares were acquired. By this process the assessee will be denied the true benefit of indexation.

Therefore, in order to reflect the true indexed cost under the averaging principle, it was necessary to upgrade the original cost to the level of index of bonus year and then average it out. This method is intended to promote the object of the new scheme of indexation in its true spirit to keep off the inflationary profits from taxation.

4.In respect of other post-bonus shares, the actual cost of acquisition is suitably indexed having regard to the cost inflation index of the year of sale and that of the year of acquisition.

5.As explained earlier, the cost of acquisition of pre 1-4-1981 shares is taken at the fair market value as on 1-4-1981 or the original cost whichever is beneficial to the company since the company has option to do so under section 55(2)(b)(i). In this case even though by the averaging method, the original cost of pre 1-4-1981 shares gets reduced, since the fair market value as on 1-4-1981 being more than such reduced cost, the fair market value is substituted in the place of the average cost. This is in accordance with the provisions of section 55(2)(b)(i) and same is supported by the Supreme Court decision in the case of Shekhawati General Traders Ltd. v ITO [1971] 82 ITR 788. [LQ/SC/1971/523] Even the later Supreme Court decision in the case of Escort Ramgarh (Farm) Ltd., has not changed this position, but has impliedly reaffirmed the ratio laid down in Shekhawati’s case (supra).

6.In view of the above, we submit that the computation of long-term capital gains as per the return of income is in accordance with the provisions of sections 48 and 55 of the Income-tax Act, 1961. The cost of acquisition of bonus shares is determined on principles of averaging as laid down by the Apex Court and adjusted further for indexation keeping in view the true spirit and object of the new scheme of indexation. Therefore, in our respectful submissions, the long-term capital gains as per our computation should be accepted."

7. The learned counsel strongly defended the method adopted by the assessee for averaging and for adopting the indexed cost of acquisition. Alternatively, the learned counsel submitted that the entire lot of shares have been sold away by the assessee and, therefore, the cost of bonus shares need not be determined at all and the actual cost of acquisition of the original shares may be adopted for the purpose of computation of capital gains. In support of this contention, the learned counsel relied on the Madras High Court decision in the case of H.F. Craig Harvey v. CIT [2000] 244 ITR 5781. For the same proposition he also drew support from the earlier decision of the Madras High Court in the case of CIT v. T.V.S. & Sons Ltd. [1983] 143 ITR 6442. The learned counsel also pointed out that similar issue arose in the case of Walchand & Co. Ltd., for the assessment year 1994-95 in I.T.A. No. 4695/Mum./98 and decided by the Tribunal vide order dated 28-9-2004. The Tribunal observed that in view of the Madras High Court decision there was no necessity of averaging and it directed the CIT(A) to recompute the cost of acquisition of shares and capital gain keeping in view the ratio laid down by the Madras High Court in the above case. The learned counsel was intimated by us about theAT Pune Bench (TM) in the case of Kalyani Exports & Investments (P.) Ltd. v. Dy. CIT [2001] 78 ITD 95 [LQ/ITAT/2001/340 ;] , wherein these relevant issues were comprehensively dealt with and decided.

8. The learned DR relied on the Assessing Officer’s order and invited our attention to the discussion contained at page 15 of the Assessing Officer’s order and the annexure to the assessment order where the cost of acquisition has been determined. It was argued that the Assessing Officer’s order is in conformity with the provisions of law.

9. We have given our careful consideration to the rival submissions vis-a-vis the relevant facts and the legal position as emerging from the cases cited before us. First of all, we would like to refer to theAT Pune Bench (TM) decision in the case of Kalyani Exports & Investments (P.) Ltd. (supra). On a difference of opinion between the learned Judicial Member and the learned Accountant Member, the relevant issues were placed before the Third Member. The issues, therefore, stand decided by the majority. One of the questions dealt with by the Tribunal pertained to as to whether statutory cost of acquisition can be affected by issue of bonus shares subsequent to statutory date. The Tribunal observed that this issue came for consideration before the Supreme Court in the case of Shekhawati General Traders Ltd. (supra), where it was held that any event prior or subsequent to the statutory date is irrelevant and, therefore, statutory cost of acquisition remains unchanged.

10. The Tribunal also referred to the Supreme Court decision in the case of Escorts Farms (Ramgarh) Ltd. v. CIT [1996] 222 ITR 5093. The Tribunal also drew support from the Madras High Court decision in the case of CIT v. G.N. Venkatapathy [1997] 225 ITR 9524 and also the Madras High Court’s decision in the case of S. Ram v. CIT [1998] 230 ITR 3531. The Tribunal at para 60 reproduced the relevant observations of the Madras High Court in the case of S. Ram (supra) as under :

"In a case where the original shares were obtained before 1-1-1954, and the bonus shares were obtained after 1-1-1954, and where the assessee exercised his option as per the provisions of section 35(2) of the Income-tax Act, 1961, to adopt the fair market value as prevalent on 1-1-1954, while ascertaining the cost of acquisition of the bonus shares, it is not possible to adopt one value for the original shares, viz., the value as on 1-1-1954. Once the value of the original shares is determined in accordance with the statutory provisions, thereafter the said value is unalterable. The said value should be adopted for the purpose of dividing the same by bonus shares as well as the original shares. Any alteration to the above method would be hit by the provisions contained in section 55(2). While ascertaining the value of bonus shares the value of the shares as opted by the assessee as on 1-1-1954, as per the provisions of section 55(2) has to be taken into account and both the original shares and the bonus shares should be clubbed together and the average value of each share should be found by dividing the fair market value opted on 1-1-1954, by the total number of shares."

11. After considering the legal position as emerging from the cases mentioned above, the Tribunal held that wherever the actual cost of acquisition is substituted by FMV on the statutory date the said value is unalterable and the same should be adopted for the purpose of arriving at the average cost of acquisition of the original and the bonus shares. In other words, it is the statutory cost of acquisition which is to be spread over the original shares and the bonus shares for determining the cost of bonus shares.

12. Coming to the argument of the learned counsel for the assessee that the FMV as on 1-4-1981 in respect of the old shares and the cost of acquisition for the shares acquired by the assessee between 1-4-1981 and the date of issue of bonus shares should be inflated in the same ratio as the cost inflation factor for the financial year 1986-87 bears to the cost inflation factor of the relevant financial year in which the shares were acquired by the assessee, in our view, this submission cannot be accepted. There is no warrant for adopting this methodology under the provisions of Income-tax Act and no authority has been cited by the learned counsel for the assessee in support of this argument. The various judicial pronouncements including the Supreme Court’s decision available on this point, lay down the principle that either the FMV as on the statutory date or the actual cost of acquisition of the shares has to be spread over the original shares and the bonus shares. The benefit of cost inflation index will be available to the assessee as the base year has to be taken to be financial year wherein the statutory date falls or the relevant financial years in which further shares were acquired, as the case may be. Such statutory cost and the cost of acquisition will be inflated on the basis of the index factor of the base year and the index factor of the year in which the shares have been sold. Accordingly, we reject this argument raised before us on behalf of the assessee.

13. The alternative claim made before us by the learned counsel for the assessee is that when the shares have been sold in a single lot, there is no need to determine the cost acquisition of the bonus shares by resorting to the method of averaging. In other words, the actual cost of acquisition/FMV on statutory date should be adopted as the cost of acquisition of the original shares and the bonus shares taken together and capital gain shall be computed accordingly after adopting the indexed cost of acquisition. The learned counsel for this proposition has relied on ITAT’s order in the case of Walchand & Co. Ltd. (supra) (copy placed on record). We have gone through this case. The Tribunal relied on the Madras High Court in the case of H.F. Craig Harvey (supra) and remitted the CIT(A) with the following direction at para 26 of the order :

"It is pertinent to note that assessee has sold original as well bonus share in the previous year relevant to the assessment year under appeal. We, therefore, respectfully following the order of the Madras High Court in the case of H.F. Craig Harvey (supra), set aside the order of the CIT(A) and restore the issue back to the file of the CIT(A) and direct him to recompute the cost of acquisition of shares sold and capital gain keeping in view the ratio laid down by the Hon’ble Madras High Court (supra) after giving opportunity of being heard to both the sides."

14. The learned counsel for the assessee has also relied on the Madras High Court’s decision in the case of T.V.S. & Sons Ltd. (supra) for the same proposition. We have carefully gone through these two Madras High Court’s judgments. It would be appropriate to reproduce below the relevant discussion from the case of H.F. Craig Harvey (supra), from pages 587 and 588 of the report :

"Insofar as the question referred at the instance of the assessee is concerned, we are of the view that once the fair market value of the shares as on 1-1-1964, is determined, it remains an unalterable figure and any issue of bonus shares subsequent to that date is wholly extraneous and irrelevant and cannot be taken into consideration. This court in Mala Ramesh v. CIT [1995] 214 ITR 225 has taken the view that the value of the bonus shares is not to be separately ascertained when an entire block of shares including bonus shares held by the assessee were sold or transferred, and in such a situation, it is not necessary to ascertain the individual cost of each share. The position was reiterated by this court in S. Ram v. CIT [1988] 230 ITR 353, wherein this court held that in case where the original shares were obtained before 1-1-1954, and the bonus shares were obtained after 1-1-1954, and where the assessee has exercised his option adopting the fair market value as prevalent as on 1-1-1954, it is not possible to adopt one value for the original shares, namely the value as on 1-1-1954, and another value for the bonus shares which was prevalent after 1-1-1954. This court held that once the value of the original shares was determined in accordance with the statutory provisions, then the said value remains an unalterable figure and the said value should be adopted for the purpose of dividing the same by bonus shares as well as the original shares and any alteration to the above method would be hit by the provisions of section 55(2) of the. This court held that once the value has been determined under section 55(2) of the Act, that value should be taken into account and both the original shares and bonus shares should be clubbed together and the average value should be found by dividing the fair market value opted on 1-1-1954, by the total number of shares. The same view was taken in CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC); Shekhawati General Traders Ltd. v. ITO [1971] 82 ITR 788 (SC); CIT v. Prema Ramanujam [1991] 192 ITR 692 (Mad.); CIT v. G.N. Venkatapathy [1997] 225 ITR 952 (Mad.) and CIT v. T.V.S. & Sons Ltd. [1985] 143 ITR 644 (Mad.).

The Supreme Court in Escorts Farms (Ramgarh) Ltd. v. CIT [1996] 222 ITR 509 [LQ/SC/1996/1594] has also accepted the principle that the subsequent issue of bonus shares does not have the effect of altering the original cost of acquisition of shares. The same view is reiterated by a decision of this court in Naresh (R) v. CIT [1998] 145 CTR 327. Therefore, when all the shares including bonus shares were sold and transferred, it is not necessary to ascertain the value of bonus shares separately and the cost of all shares being a known figure, it would be deducted to compute the capital gains. The view arrived at by the Tribunal is in consonance with various decisions, cited supra. Accordingly, we find no infirmity in the order of the Appellate Tribunal in holding that the assessee is not entitled to deduct the sum of Rs. 1,53,128 as cost of bonus shares in addition to the cost of acquisition of original shares in the two amalgamated companies."

15. From the above it may be seen that even the Madras High Court in this case upheld the method of determining the cost of acquisition of original and bonus shares by spreading the cost of the original shares over both original and bonus shares. However, it was observed that where the shares are sold in a single lot in toto including the original as well as the bonus shares it is not at all necessary to determine the cost of the bonus shares. Similar view was adopted by the Madras High Court in the earlier case of T.V.S. & Sons Ltd. (supra). The relevant observations from this case may be reproduced below from pages 649 and 650 of the report :

"The valuation of bonus shares on the averaging method is not intended to distort the total outlay on shares in the purchase account. The theory of averaging is a mere principle of costing. It is resorted to whenever it I found necessary to get to know the average cost of bonus shares with a view to reckoning the results of any separate transaction in which the bonus shares alone figured to the entire exclusion of the original shares. But where the entire block of shares held by a shareholder is sold or otherwise disposed of and in that sale also figure all the bonus shares held by that shareholder, there can be no occasion for entering into the exercise of costing of bonus shares. That is because the whole cost of shares including bonus shares is already a known figure, and it would be an unnecessary refinement to get to know the individual cost of each share. It is enough that we know the actual cost of all the original shares held by the assessee and since the whole block is sold, the actual cost of acquisition of the original shares alone will have to be taken. If, however, you follow a fastidious or an over sophisticated method of calculation taking note of only the average cost of the bonus shares, then you must also take into account the average cost of the original shares, in which even also there cannot be a separate addition to the actual cost, the average or notional cost of bonus shares."

16. It is notable that no question arose before the Madras High Court in the above two cases with regard to indexing the FMV on statutory date or the cost of acquisition as the case may be. Therefore, the Madras High Court adopted a logical view that where the original shares as well as the bonus shares are entirely sold away, spreading of cost between the original and the bonus shares would only be an exercise in futility, because in either case the total cost of acquisition would remain the same. In the case before us, the indexed cost of acquisition is required to be adopted. To make such indexation possible and workable it is essential to determine the base year and the cost of acquisition of the original shares which have been purchased during the base year. This would be possible only when some cost is attributed to the bonus shares. The principle of averaging the cost of the original shares between the original shares and bonus shares has been settled by the Supreme Court decision in the case of Escorts Farms (Ramgarh) Ltd. (supra). It may suffice to reproduce below the ratio of the Supreme Court decision from the head-note of the report as under :

"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 gets automatically reduced, notwithstanding the fact that the total holding of the shareholder may be larger. Where bonus shares are issued in respect of ordinary shares held in a company by an assessee who is a dealer in shares, their real 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 bear (if there is no other circumstance to differentiate them) or on equitable considerations based on the market price before and after issue. There is no "dichotomy", as to whether the shares are held by an "investor" or "dealer" in shares. In both the cases, it is the surplus receipt that is brought to tax, either as "capital gains" or "profit or loss", as the case may be, and in accordance with the relevant statutory provisions.

In Shekhawati General Traders Ltd. v. ITO [1971] 82 ITR 788 (SC), the court laid stress on the fact that the assessee had opted to take the cost of acquisition as provided by the relevant statute, i.e., the statutory cost of acquisition and thus substituting the market value as on 1-1-1954, in place of the actual cost of acquisition, and only in such a case, the subsequent issue of bonus shares cannot affect the issue. It is implicit from the above decision that the principle of averaging by spreading the cost over the old shares and the new bonus shares as enunciated by the Supreme Court in Dalmia Investment Co.’s case [1964] 52 ITR 567 [LQ/SC/1964/83] , 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 fictional figure - mostly inflated - having no connection with the original or actual cost. 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, that the Supreme Court in Dalmia Investment Co.’s case [1964] 52 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 general application."

17. In the present case, we have a situation where in respect of some of the original shares the cost of acquisition has been substituted by FMV on the statutory date. Further shares have been acquired by the assessee after the specified date. As per the principles laid down by the Supreme Court, the cost of acquisition of the bonus shares must be determined by the method of averaging out. It may not be out of place to mention here that the Supreme Court approved the Bombay High Court’s decision in the case of W. H. Brady & Co. Ltd. v. CIT [1979] 119 ITR 3591. The facts in that case are similar to the facts in the case of the assessee, which would be clear from the head-note of the report which is reproduced below :

"Between 1922 and 1941, the assessee had bought 670 shares of a company at a cost of Rs. 1,33,146. In May, 1942, the assessee acquired further 670 shares as bonus shares by virtue of its possession of 670 shares. Between April 16, 1942, and April 30, 1946, the assessee bought further 765 shares of the company for the aggregate price of Rs. 3,22,252 and thus the company had a total holding of 2,105 shares of the company. On April 30, 1946, the assessee received another lot of 2,105 bonus shares. Between April, 1946, and February, 1960, the assessee acquired further 4,623 shares for the aggregate of Rs. 8,55,122. In the accounting year ending December 31, 1961, the assessee sold all the shares at the rate of Rs. 275 per share and realised Rs. 24,29,075. The assessee incurred an expenditure of Rs. 51,843 in connection with the sale of the shares.

For the assessment year 1962-63, the assessee claimed that his capital gains by the sale of the shares were only Rs. 5,99,899 as under :

Rs.

Rs.

Sale proceeds of 8,833 shares

24,29,075

Less: Actual cost of 6,058 shares

13,12,520

Value of 2,775 bonus shares at Rs. 167.50, being the market value as on 1-4-1954

4,64,813

Expenditure incurred for sale

51,843

18,29,176

5,99,899

In effect, the assessee treated the cost of acquisition of the bonus shares as nil and sought to exercise the option of substituting the market value of the asset as on January 1, 1954, under section 48 and section 55(2)(i) of the Income-tax Act, 1961, in respect of these shares in place of their cost of acquisition.

The ITO spread the cost of the original shares over the whole lot of 2,680 shares which included 670 original shares and 2,010 bonus shares. Since the average cost according to this formula was much less than the market price of the shares as prevailing on 1-1-1954, he gave the assessee the benefit of the option of the market price as on 1-1-1954, in respect of this lot of 2,680 shares. In regard to the second lot of 765 shares bought between 1942 and 1946 and 765 bonus shares issued to the assessee in April, 1946, the average cost came to Rs. 210 per share. It was much higher than the market price of the shares as on 1-1-1954. The ITO, therefore, did not substitute the market price as on 1-1-1954, in place of the original cost in respect of the second lot. In respect of the third lot also the position was the same as in the case of the second lot, except that in the third lot there were no bonus shares. No substitution was, therefore, necessary in the case of the third lot. The ITO thus determined the capital gains at Rs. 7,50,958 as under :

Rs.

Rs.

Sale proceeds of 8,833 shares

24,29,075

Less: Market price as on 1-1-1954 of shares acquired before May, 1946

4,48,900

Actual cost of the remaining shares

11,77,374

Expenses in connection with sale

51,843

16,78,117

7,50,958

In appeal, the AAC agreed with the assessee, but on further appeal the Appellate Tribunal restored the order of theO. On a reference:

Held, that in the case of CIT v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC), the Supreme Court has held that where the existing shares and the bonus shares rank pari passu, the proper method of valuation of the bonus shares is to take the amount spent by the shareholder in acquiring his original shares and to spread it over the old and new shares treating the new as accretions to the old and to treat the cost of the original shares as the cost price of the old shares and bonus shares taken together. This was the method rightly followed by theO. The decision in the case of Dalmia Investment Co. has also been affirmed by the Supreme Court in the case of CIT v. Gold Mohore Investment Co. Ltd. [1969] 74 ITR 62."

18. From the above, there remains no doubt that in the present case the cost of the bonus shares has to be determined by adopting the method of averaging. The Madras High Court decisions were rendered in a different context and even the Madras High Court upheld the principle of averaging for determining the cost of bonus shares. In any case, the principles laid down by the Supreme Court and the Bombay High Court are binding on us. We, therefore, reject the alternative claim made by the learned counsel for the assessee that there is no necessity to determine the cost of the bonus shares by resorting to the method of averaging. To summarise, the capital gains in the present case have to be determined on the basis of the following principles :

(a)The cost of acquisition of pre-1-4-1981 shares has to be adopted as FMV as on that date or the original cost of acquisition, as opted by the assessee.

(b)The FMV adopted as on 1-4-1981 is unalterable and cannot be changed.

(c)The cost of the bonus shares is to be worked out on the basis of the statutory cost as adopted on 1-4-1981 and the actual cost of acquisition of shares acquired by the assessee post 1-4-1981.

(d)The base year in respect of bonus shares shall be the financial year in which bonus shares are allotted.

(e)The base year in respect of pre 1-4-1981 shares shall be the financial year 1981-82.

(f)The base year in respect of shares acquired post 1-4-1981 shall be the relevant financial year.

(g)On the above basis, the indexed cost of acquisition shall be adopted by the Assessing Officer and the income under the head capital gains shall be determined accordingly.

19. We direct the Assessing Officer to recompute the income under the head ‘Capital gains’ on the basis of the discussion given above.

20. Ground No. 2 of the assessee’s appeal as also of the Department’s appeal pertains to the additions made by the Assessing Officer by disallow-ing the assessee’s claim for bad debts, in respect of which part relief has been allowed by the learned CIT(A). Both the parties are aggrieved on account of the order of the learned CIT(A) on this issue. The assessee is disputing the confirmation of addition to the extent of Rs. 11,45,000. The Department is in appeal against the relief allowed by the learned CIT(A) of Rs. 18,59,000. We have heard both the sides. The learned counsel for the assessee has submitted that the issue is covered in assessee’s favour by Tribunals order in assessee’s own case for the assessment year 1992-93 as per order dated 17-10-2006 in I.T.A. No. 6467/Mum./96. We find that the issue before the Tribunal for the assessment year 1992-93 pertained to disallowance of a sum of Rs. 18,12,000 being bad debts in the name of Meher Pharma Ltd. The Tribunal decided the issue in assessee’s favour following theAT Mumbai Special Bench decision in the case of Dy. CIT v. Oman International Bank,SAOG [2006] 100 ITD 285. [LQ/ITAT/2006/384] The learned DR relied on the Madras High Court decision in the case of South India Surgical Co. Ltd. v. Asstt. CIT [2006] 287 ITR 621.

21. It may be appropriate to consider the factual position in the light of the submissions made before us by both the sides. The assessee has written off as bad debts a sum of Rs. 11,45,000 due from Taparia Steels Ltd. The assessee claimed that moneys were lent to the aforesaid party during the ordinary course of carrying on hire purchase business which is akin to money lending business. The assessee could not recover the amount and the aforesaid party was not responding to any correspondence from the assessee. The learned CIT(A) has observed that deduction cannot be allowed to the assessee merely because the debt has been written off by the assessee. He held that the aforesaid amount of Rs. 11,45,000 represented the cost of items given on hire purchase and it cannot be said that assessee was carrying on any banking or money lending business. In our view the assessee must succeed on this point. The debt has arisen during the course of carrying on the hire purchase business by the assessee. Disallowance has been sustained by the learned CIT(A) on the ground that the amount was not taken into account while computing the total income for any earlier assessment years and, therefore, conditions of section 36(2) are not fulfilled. In our view, even if it is assumed that, strictly speaking, the assessee was not carrying on money lending business, there is no dispute that the debt has arisen in the normal course of carrying on the business activity and, therefore, if such debt cannot be recovered by the assessee and has written off in the books of account, it would constitute a legitimate business loss deductible under section 37. We have considered the Madras High Court decision in the case of South India Surgical Co. Ltd. (supra). The Madras High Court was concerned with debts recoverable from Government hospitals and institutions and the High Court observed that such debts cannot be said to have become irrecoverable or bad. The ITAT Mumbai Special Bench in the case of Oman International Bank, SAOG (supra) has held that writing off a bad debt in the books of account constitutes evidence of its having become bad and irrecoverable. The only condition is that such writing off should be bona fide and not fraudulent. It may be mentioned that the Gujarat High Court in the case of CIT v. Girish Bhagwat Prasad [2002] 256 ITR 772 has taken the view that after the amendment the onus is not on the assessee to establish that the debt written off, has become irrecoverable during the relevant year. Similar view has been adopted by the Delhi High Court in the following recent judgments :

(1) CIT v. Morgan Securities Credits, order dated 7-12-2006 in ITA No. 1442 of 2006.

(2)CIT v. DCM Ltd., dated 10-1-2007 in ITA No. 1307 of 2006.

22. Considering the entire facts and circumstances and the legal position as enunciated above, we delete the addition of Rs. 11,45,000 sustained by the learned CIT(A).

23. Coming to the ground raised by the Department on the same issue, the learned CIT(A) has allowed relief of Rs. 18.59 lakhs, which comprises of the following :

Sl. No.

Particulars

Amount (Rs. in lakhs)

(a)

M/s. Mansinghka Industries Ltd.

9.87

(b)

Penal charges recoverable from the above party

3.78

(c)

Debt in the name of M/s. Prabhat General Agency

2.95

(d)

M/s. Aries Agrovet Industries

1.99

24. The arguments raised before us are similar as already discussed above. The sum of Rs. 9.87 lakhs recoverable from Mansinghka Industries represent lease rentals and Rs. 3.78 lakhs due from the same party is on account of penal charges. The learned CIT(A) recorded a finding that these amounts were already assessed in earlier years and have been rightly written off as irrecoverable during this year as the assessee could not recover any amount. Necessary resolution was passed by the board of directors. Regarding Rs. 2.95 lakhs in the name of Prabhat General Agency and Rs. 1.99 lakhs recoverable from Aries Agrovet Industries, the learned CIT(A) has recorded similar finding. For the reasons already stated by us above, we hold that the disallowance to the extent of Rs. 18.59 lakhs has been rightly deleted by the learned CIT(A) and, therefore, on this issue we confirm his order.

25. We now take up the remaining grounds in assessee’s appeal.

26. Ground No. 3 is as under :

"On the facts and in the circumstances of the case, the learned CIT(A) erred in confirming the addition of Rs. 10,06,567 made by the Assessing Officer on account of accrued income. The learned CIT(A) failed to appreciate that out of this sum, Rs. 7,75,722 pertained to those parties whose accounts were written off by the appellant as bad debts."

27. Both the sides agreed that this issue is covered by the Tribunal’s order dated 15-12-2006 in ITA No. 7095/Mum./98 and 3497/Mum./01. We find that this issue has been considered and decided at paras 4 and 5 of the above order which are reproduced below:

"4. The next issue which is also common for the two assessment years under appeal pertains to confirmation of additions made by the Assessing Officer for lease rentals and hire charges on accrual basis. Similar issue has been dealt with by the Tribunal for the assessment years 1989-90 and 1991-92 in the order referred to above. The Tribunal considered this issue at paras 14 and 15 of the order and the matter was restored to the Assessing Officer for re-adjudication with the following observations at para 15 of the order:

‘We have gone through the aforesaid order of the Tribunal and find that the Tribunal, vide order dated 17-10-2006, has deleted similar addition in respect of 1992-93 and 1993-94 on the ground that addition has been offered on cash basis. Impliedly, the Tribunal has accepted the mixed system of accounting followed by the assessee. This issue had also arisen in assessment year 1985-86, which has been quoted extensively in the order dated 30-6-2005 pertaining to assessment years 1989-90 to 1991-92 and 1995-96. Considering the fact that the Tribunal has accepted the cash system of accounting in respect of interest, we also hold that lease rent and interest income should be assessed on receipt basis. The additional ground raised by the assessee is admitted and the matter is restored to the file of Assessing Officer for fresh adjudication after verifying the fact whether income has been assessed in subsequent years on cash basis or not.’

5. The learned counsel appearing for the assessee was fair enough to point out that insofar as the assessment year 1995-96 is concerned, the issue would be covered by the above mentioned finding of the Tribunal. However, for the assessment year 1997-98 the income will have to be assessed on accrual basis as amended section 145 would be applicable to the assessment year 1997-98. Accordingly we hold that for the assessment year 1995-96 the issue is covered and, therefore, the matter is restored to the Assessing Officer for fresh adjudication in the light of the observations made by the Tribunal as reproduced above. For the assessment year 1997-98 mixed system of accounting is no more permissible in view of the amended provisions of section 145 which mandates that the income chargeable under the head ‘Profits and gains of business or profession’ shall be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Admittedly, the assessee is following mercantile system of accounting and, therefore, the lease rental income/hire charges have to be assessed on accrual basis. Accordingly on this issue the finding of the learned CIT(A) is confirmed for the assessment year 1997-98."

28. From the above it may be seen that the Tribunal followed its order dated 12-12-2006 for the assessment years 1989-90 and 1991-92 in ITA Nos. 5804/Mum./98 and 1193/Mum./99. Respectfully following the pre-cedents, we confirm the order of the learned CIT(A) on this issue.

29. Ground No. 4 is as under :

"On the facts and in the circumstances of the case, the learned CIT(A) erred in confirming the disallowance of depreciation of Rs. 23,25,686 in respect of the assets leased back to Pertech Computers Ltd. and Indian Hume Pipe Co. Ltd. in the earlier years."

30. This issue is also covered by the Tribunal’s order for the assessment years 1995-96 and 1997-98 referred to above. The issue was restored to the Assessing Officer with the following observations at para 3 of the order :

"3. The first issue which is common for both the assessment years pertains to disallowance of depreciation in respect of computers leased by the assessee to PCL. Similar issue has been dealt with by the Tribunal in the order referred to above at paras 6 and 7. At para 7 the Tribunal observed that similar issue arose in the assessment year 1992-93 and vide order dated 17-10-2006 it was restored to the Assessing Officer for fresh adjudication. Therefore, for the assessment years 1989-90 and 1991-92 also this issue was restored to the Assessing Officer for re-consideration in accordance with the order of the Tribunal for the assessment year 1992-93. The facts and circumstances are admitted to be similar in the two assessment years which are under appeal and, therefore, respectfully following the precedents, we restore this issue for both the years to the Assessing Officer for re-adjudication in consonance with the Tribunal’s order for the assessment year 1992-93 referred to above."

31. Accordingly for the present assessment year also we restore this issue to the Assessing Officer for revenue expenditure - adjudication in consonance with the Tribunal’s order for the assessment year 1992-93.

32. The last ground of appeal pertains to rental income and service charges assessed by the revenue authorities as income from house property or income from other sources as against the assessee’s claim that the same should be assessed as business income. Similar issue arose before the Tribunal for the assessment years 1989-90 and 1991-92 as also assessment years 1995-96 and 1997-98 and was dealt with in the orders referred to supra. It was observed by the Tribunal that this issue is covered against the assessee by the decision of the Tribunal in assessee’s own case for the assessment year 1992-93 wherein it was held that the relevant income is to be assessed as income from house property. Respectfully following the precedents, we confirm the order of the learned CIT(A) on this issue.

33. Reverting back to the Department’s appeal, Ground No. 3 is as under :

"On the facts and circumstances of the case and in law, the learned CIT(A) has erred in deleting the addition of Rs. 16,69,700 on account of interest accrued on loan advances to M/s. Vikhroli Metal Fabrication Ltd."

34. Both the sides agreed that similar issue has been dealt with and has been decided in assessee’s favour by the Tribunal for the assessment years 1989-90 and 1991-92 vide order referred to supra. We find that similar issue has been dealt with at paras 8 to 11 of the order. The finding is at para 11 which is reproduced below :

"The learned counsel for the assessee, Mr. B.K. Khare, has contended before us that the assessee, from inception, had been following the mixed method of accounting. According to him, the accounts were mainly maintained on mercantile system but with respect to interest on loans, the assessee was offering income on cash basis. Though the parties’ accounts were debited with the amount of interest, the income was credited to suspense account instead of Profit and Loss Account and as and when the interest was received, the same was being credited to Profit and Loss Account and to that extent, the entry in suspense account was reversed. It was further submitted that this very issue arose before the Tribunal in assessee’s own case pertaining to assessment years 1989-90 to 1991-92 and the Tribunal had noted that income was offered on receipt basis. Since amount of interest was offered in the year of receipts, the Tribunal accepted the stand of the assessee vide order dated 30-6-2005. It appears that the Tribunal accepted the appeal of the assessee in order to avoid the double taxation. Therefore, following the same, the addition confirmed by the learned CIT(A) is hereby deleted. The Assessing Officer is directed to assessee the interest income on receipt basis in the years in which it is received."

35. Respectfully following the precedent, we confirm the order of the learned CIT(A) on this issue.

36. Ground No. 4, which is the last ground of appeal raised by the Department, is as under:

"On the facts and circumstances of the case and in law, the learned CIT(A) has erred, in deleting the disallowance of finance charges of Rs. 15,15,000 paid to M/s. Infrastructure Leasing and Finance Ltd."

37. This issue is admitted to be covered by the Tribunal’s order dated 17-10-2006 for the assessment year 1992-93 in ITA No. 6467/Mum./96. We find that on similar issue the Revenue was in Appeal and the Tribunal at para 12 of its order confirmed the order of the learned CIT(A). Respectfully following the precedent, we confirm the order of the learned CIT(A) on this issue.

38. In the result, both the appeals are partly allowed.