Supreme Court on ‘Allotment of Shares’ and ‘Issue of Bonus Shares’

In a recent judgment (Khoday Distilleries v. CIT, Civil Appeal 6654/2008, judgment of 14 November 2008), the Supreme Court explained some important corporate law concepts. The issues before the Supreme Court arose out of a matter under the Gift Tax Act, 1958; and the Supreme Court had to elaborate upon the nature of an allotment of rights issue.

In the facts of the case, twenty out of the twenty-seven shareholders of the appellant company did not take part in a rights issue, upon which the shares were allotted to the other seven shareholders. The contention raised by the Revenue was that this amounted to a ‘transfer’ in favour of the seven shareholders.

The Court explained that the term “allotment of shares” is 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. A chose in action implies existence of some person entitled to rights in action in contradistinction 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 chose in action. In this case, when twenty shareholders did not subscribe to the rights issue, the appellant allotted them to the seven investment companies, such allotment was not transfer.

The Court held that for a ‘transfer’ of shares to take place, it was essential that some right was transferred from one person to another. In an allotment of shares such as the one seen in the case, the shares were created for the first time – there was no transfer of any right but the creation of a right.

It is perhaps still open to the Department to contend that in certain situations, such a transaction may be treated as a device for evasion; and that the substance of the transaction is one of transfer. In that case, however, the transfer would not be from the company, but from the shareholders who did not take part in the rights issue. Thus, under no circumstances can the company be said to have transferred shares through an allotment.

The case also discussed the nature of an issue of bonus shares. The question in this connection was “Whether there is an element of ‘gift’ in the appellant issuing bonus shares in the ratio of 1:23?”

The Court explained, “The idea behind the issue of bonus shares is to bring the nominal share capital into line with the excess of assets over liabilities. A company would like to have more working capital but it need not go into the 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 share capital. Therefore, fully paid bonus shares are merely a distribution of capitalized undivided profit. It would be a misnomer to call the recipients of bonus shares as donees of shares from the company.

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Mihir Naniwadekar


  • Mihir, thanks for post. The situation might be somewhat different in a rights issue if renunciation was involved. In that case, it may perhaps be hard to argue that there is no “tranfser”. Although there may be no transfer of shares, there is a transfer of the right to be allotted shares.

  • Hello Sir, thank you for the comment. TheCourt briefly touched on ths aspect, here is what it said:

    “There is a difference between ‘renunciation’ and ‘allotment’… The judgment of the Madras High Court in S.R.Chockalingam Chettiar (1968) 70 ITR 397 dealt with the case of renunciation in which case under certain circumstances the renouncer could be treated as a donor…”

    The Courtwent on to state that even in such a case, the transferor would not be the company but the renouncer – the tax liability for the transfer if any would ave to be borne by the renouncing shareholders and not by the company.

  • Has any case ever dealt with the difference between issuance of shares and allotment of shares? How are these two different? Is it necessary to convene a board meeting for conversion of CCPS into equity shares when the same has been approved at the time of issuance of CCPS? Can the company convert the shares just passing a circular? Any inputs on this?

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