BALASUBRAHMANYAN, J. - (1.)THIS reference under the Companies (Profits) Surtax Act, 1964, raises a point about the computation of capital under the Second Schedule to that Act. Under the scheme of this Act, a company is liable to surtax on the excess of its chargeable profits over the statutory deductions. The statutory deduction itself is 10 per cent. of the capital of the company. The capital of a company, for the purpose of calculating the statutory deduction must be computed in accordance with the rules set out in the Second Schedule. Rule I of the Second Schedule lays down that the capital of a company shall be the aggregate of the amounts mentioned in cls. (i) to (v) mentioned therein. Clause (i) refers to the paid up share capital. Clause (ii) refers to the general reserves. Clause (iii) refers to the other reserves. Clause (iv) refers to the debentures, and, cl. (v) refers to moneys borrowed from Government concerns. It is the sum total of the paid up share capital, the reserves, debentures and the moneys borrowed, which makes up the capital for the purposes of the statutory deduction. Rule 3 to the Second Schedule is by way of an addition to the figure of capital computed in accordance with r. 1. It may be observed that under the scheme of the Second Schedule, the capital will have to be computed as on the first day of the previous year relevant to the assessment year in question. Rule 3, in that context, provides that where after the first day of the previous year, the capital of a company as computed in accordance with r. 1 (and other relevant rules) of the Second Schedule is "increased" by any amount during that previous year on account of increase in paid -up share capital or the issue of debentures, etc., then the capital as computed under r.1 shall be increased by a sum worked out both on the time basis and the quantum basis. The reference in the present case has arisen because of a controversy between the assessee on the one hand, and the Department on the other, as to whether r. 3 of the Second Schedule can be invoked by the assessee in the events that happened which are as follows. The assessment year in question is 1971 -72. The relevant previous year is the year beginning from August 1, 1969 and ending July 31, 1970. For the purpose of ascertaining the statutory deduction, in this case, the capital will have to be computed as on August 1, 1969, as provided for in r. 1 of the Second Schedule. There is no doubt as to the amount of capital as on August 1, 1969, which was computed in the sum of Rs. 1, 43, 39, 462. There is also no doubt that this figure of computation of capital included, among other things, the cornpany's paid up share capital and its reserves. On February 23, 1970, during the middle of the account year in question, the assessee issued 20, 400 bonus shares of the face value of Rs. 100 each. This bonus issue was brought about by capitalising part of the company's general reserves. In other words, a sum of Rs. 20, 40, 000 was transferred from the general reserves and converted into bonus shares. The assessee claimed that this amount of Rs. 20, 40, 000, which represented the bonus issue as on February 23, 1970, must be the basis for an increase in the capital as already determined at Rs. 1, 43, 39, 462 as on the first day of the previous year, viz., September 1, 1969. It was claimed that the bonus shares really constituted an addition to the paid up capital of the company. Since any "increase" in the paid up capital was to be properly reckoned for the purpose of computation of capital under r. 3 of the Second Schedule to the Act, it was claimed that a proportionate amount worked out on a time basis, viz., Rs. 8, 84, 237 must be added to the capital as on August 1, 1969 for the purpose of capital computation The ITO rejected this contention, but the Tribunal in appeal accepted the assessee's case. The correctness of the decision of the Tribunal is challenged by the Department in the following question of law which has been referred to us by the Tribunal
"Whether, on the facts and in the circumstances of the case, and having regard to rule 3 of the Second Schedule to the companies (Profits) Surtax Act, 1964, the share capital of the company should be increased proportionately on account of issue of bonus shares for the purpose of computation of capital under the Companies (Profits) Surtax Act, 1964?"

(2.)THE answer to the question bears on a proper understanding of what happens when a part of the company's reserves is capitalised and bonus shares are issued. It is clear enough to see that this process of issuing bonus shares would increase the paid up capital of the company., But, so far as the liabilities column of the balance -sheet of the company is concerned, what happens is that a sum equivalent to the value of the bonus shares is caried out from the amount of reserves and placed in the earlier column of paid up capital of the company, on the very liabilities side of the balance -sheet. The process of conversion of reserves into bonus shares does not reduce the overall capital of the company, nor increase it. The overall capital just remains as it was as at the beginning of the year. The capital of the company, which includes the paid up capital and reserves does not undergo any change merely because a part of the reserves is capitalised into bonus shares. What r. 3 of the Second Schedule to the Act contemplates is that quite apart from the figure of capital as on the first day of the previous year (which includes in its computation both the paid up capital as on the first day as well as the general reserve of the company as on the same day) the capital must, subsequent thereto, during the previous year, get increased by way of an addition to any part of the capital so computed, whether the increase be to the paid up capital or whether it be to the reserves or to any other item figuring on the liabilities side of the balance -sheet. In other words, there must be a fresh influx of capital into the company in order to attract r. 3 of the Second Schedule to the Companies (Profits) Surtax Act, 1964In the present case, it cannot be denied that the mere act of capitalising part of the reserves and issuing bonus shares does not mean that there is any influx of additional capital into the company, over and above what figured as the opening capital in the liabilities side of the balancesheet consisting of the paid up capital and the reserves, among other things. We are, therefore, satisfied that on a common sense understanding of the rules in the Second Schedule to the Surtax Act and on a proper reading of the various entries in the company's, balance -sheet, the contention put forward by the assessee must be rejected as untenable A question of this kind was considered by the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd. The learned judges of the Bombay High Court posed the question, and gave the answer, in the following passage (p. 14)
"The question is whether merely because during the previous year there was an increase of paid -up share capital, the provisions of rule 3 will be automatically attracted. Mr. Mehta, on behalf of the assessee, has submitted that when after the first day of the previous year the paid up capital is increased in any manner whatsoever, whether by issue of bonus shares or by issue of right shares upon payment of cash, provisions of rule 3 are attracted. In our opinion, mere increase of paid up capital is not sufficient to attract the provisions of rule 3. The provisions of rule 3 will be attracted on account of increase of paid -up capital only if by reason thereof the capital of a company as computed in accordance with rules I and 2 of the Second Schedule of the Act is increased by any amount."

Proceeding to discuss what happens when reserves are capitalised by the issue of fully paid bonus shares, the learned judges observed as follows (p. 15)What has been done in such a case is that a part of the sum standing to the credit of one of the sub -items to be included in the computation of capital is during the previous year transferred to another item to be included in computation of capital under rule 1. When such a thing is done the capital of a company computed in accordance with rule I is not increased by any amount whatsoever. It is merely a transfer of a particular sum included in one item into another item, but as a result of such alteration or transfer the capital to be computed in accordance with rule, I will not be increased by any amount whatsoever

(3.)A decision rendered by the Delhi High Court in Addl. Commissioner of Surtax v. Food Specialities Ltd. is to the same effect. Indeed, the decision of the Delhi High Court cites in -support the decision of the Bombay High Court already referred to by us Reference, however, was made in the course of arguments to a decision rendered by the Himachal Pradesh High Court, CIT v. Mohan Meakin Breweries Ltd. In that decision it was held that an increase in paid -up capital by the simple process of capitalising a part of the existing reserves, would entitle the assessee to an increase in the computation of its capital under r. 3 of the Second Schedule to the S.P.T. Act, 1963. With respect, we do not accept this view as correct, both on a construction of the provisions of r. 3 and on a proper understanding of what happens when there is a corporate exercise of discretion to effect conversion of reserves and capitalisation thereof into fully paid bonus shares. Besides, this decision was rendered as a matter of construction and application of r. 2 of the Second Schedule to a different statute, namely, the Super Profits Tax Act, 1963. There is a slight difference between the language of r. 2 of the S.P.T. Act, 1963, and r. 3 of the C. (P.) S.T. Act, which is the provision under consideration in the present reference.