COMMISSIONER OF INLAND REVENUE v. TONG KWAN-CHE

bjbj HCIA000001/1976 IN THE SUPREME COURT OF HONG KONG (APPELLATE JURISDICTION) INLAND REVENUE APPEAL NO.1 OF 1976 ----------------- BETWEEN COMMISSIONER OF INLAND REVENUE Appellant TONG KWAN-CHE Respondent ----------------- Coram: Li, J. Date of Judgment: ----------------- JUDGMENT ----------------- This is an appeal by the Commissioner of Inland Revenue by way of case stated from a decision of a Board of Review on an appeal against the confirmation by the Commissioner of an assessment of profits tax. The facts, in so far as they affect the principle of assessment, are not in dispute and are set out in the case stated. At the hearing of this appeal, counsel for the Commissioner asked for leave to put before me 3 documents showing the difference in method of computing profits by the Commissioner and that by the Taxpayer. These documents contained the actual figures put before the Board of Review. However Counsel was unable to obtain the consent of the Taxpayer who earlier indicated that he would not appear at the hearing of this appeal and had left the Colony. I accepted the 3 documents as they do not affect the principle in issue. On the contrary they serve to give a clearer background of the facts. The Taxpayer was trading in stock and shares in the year of assessment 1973/74. Apparently sometime prior to that he acquired 40 Hongkong & Shanghai Bank shares for the sum of $27,135. After such acquisition the Hongkong & Shanghai Bank made a bonus issue of 1 for 5. Thus the Taxpayer was allotted 8 shares without being obliged to pay for them. At that time the Hongkong & Shanghai Bank shares were issued at the par value of $25 each. In the year of assessment 1973/74 they split from 1 to 10 shares at the par value of $2,50 each. Similarly the Taxpayer acquired 200 Jardines shares for the sum of $45,113. The Jardines gave a bonus issue of 1 for 1 share. In the year of assessment the Jardines made a further bonus issue of 2 for 5 shares. The par value of the Jardines shares was at all material times $6.00 each. Based on the aforesaid data the Taxpayer filed his profit tax return for the year 1973/74 regarding his holdings of the Hongkong & Shanghai Bank shares as having the opening stock of 48 shares at the cost of $27,135 plus $200. After the split his accounts in this respect showed an opening stock of 400 shares at the cost of $27,135 plus 80 shares at $200. For the same reason his profit tax return showed an opening stock of the Jardines shares of 200 shares at the cost of $45,113 plus 200 shares at $1,200, plus the bonus issued of 160 at $960. It will be observed that the $200 and $1,200 were put in as part of the costs of his opening stock for the 80 Hongkong & Shanghai Bank shares and the 200 Jardines shares respectively allotted to him at their par value. The $960 were put in as the par value of the 160 Jardines shares allotted to him within the year 1973/74. Subsequently the Taxpayer sold all the 480 Hongkong & Shanghai Bank shares for the total sum of $15,548 showing a loss of $11,787. He sold also 400 of his Jardines shares for the total sum of $9,740 leaving as closing stock 160 shares the costs for which he computed as 160/560 * $47,273 = $13,506. This showed a trading loss in respect of the Jardines shares of $47,273 - ($9,740 + $13,506) = $24,027. The assessor made an assessment which was confirmed by the Commissioner on the basis that the Taxpayer could not assign any cost even at par value to the bonus shares issued and allotted to the Taxpayer who paid nothing for them. In the view of the Assessor and the Commissioner the costs for the 480 Hongkong & Shanghai Bank shares remained at $27,135 and those for 560 Jardines shares at $45,113. Before the Board of Review the Taxpayer contended that:- a bonus share was a dividend in specie in lieu of cash for which there had been taxation at source prior to distribution; and a value must be put on the bonus shares with the result that the measure of profit was the difference between their par value and the price for which they were sold. The Board of Review found against the Taxpayer on his contention in (a) from which ruling there is no appeal. However by majority the decision by Board allowed the appeal based on the Taxpayer's contention in (b). It is from this decision that the Commissioner appeals. The questions of law for the opinion of the Court are: Was the Board correct in holding that, for the purposes of computing the assessable profits for the year of assessment 1973/74, the taxpayer is entitled to regard the bonus shares as having cost him the par value for those shares? (ii) If the answer to (i) is 'no', what cost, if any, is the taxpayer entitled to impute to the bonus shares allotted to him? In the majority decision the Board found that: " .....it would appear odd to attach no value to an asset of value because pushed to its logical conclusion it means that no comparison has been taken between the cost of the asset and that for which it was sold to determine whether a profit or loss was made. Byan's Manual of the Law of Income Tax in Australia, 2nd edition at page 160 has this to say: Where a taxpayer sells the bonus shares, the assessable profit or loss will be restricted to the balance between the sale price and the paid-up value of the shares..... In the case of a dealer of shares, the excess of a sale price over the paid-up value of the shares constitutes proceeds of business carried on by him and would be assessable. Vice versa the excess of the paid-up value over the sale price would be allowable as a business loss.' This passage supports the taxpayer's mode of computation and in our view it represents the correct formula to be used in ascertaining the gain or loss in the sale of bonus shares." In their case stated they said: "The expression 'bonus shares' mistakenly gives the impression that the shares are 'free'. This is not so. The company makes no gift. If they were a gift they would not be paid up at all. The bonus shares are paid for in full by the capitalized profits or reserves which would otherwise be distributed to shareholders as a cash dividend. The position is created as if the shareholder received cash and immediately handed the amount back to the company in payment for new shares. Actually, this is the form which the transactions take in the accounts of a company It cannot sell its shares for less than face value; it must be able to point to a receipt of payment from the shareholders. The payment is represented by what is notionally received by the shareholder in cash but credited to the shareholder against the liability to pay the amount for the bonus shares. That amount is the par value for the shares. Viewed in that light, it may be said that the cost of the bonus shares to the taxpayer is the par value of those shares. In our opinion, for accounting purposes it would be proper and the taxpayer is entitled to regard the bonus shares as having cost him the par value for those shares. The assessment is, therefore, reduced accordingly. We would add that we find support for our decision in the Full Court judgment of Curran v. F.C.T. (1947) 4 Australian Law Reports, page 504." Learned Counsel for the Commissioner in his argument against the Board's decision adopted two ways of approach in that he treated the 160 Jardines bonus shares issued within the year of 1973/74 on a different basis from the other bonus shares issued before the 1st April 1973. His first contention was that the 160 shares were acquired in 1973 without cost. As such the Taxpayer was not in a position to show any permitted deductions within the meaning of Section 16 of the Inland Revenue Ordinance. There was no outgoings or expenses for the 160 shares. As regards the bonus shares issued prior to 1st April 1973 and thus regarded as the opening stock of the Taxpayer for the year of assessment 1973/74 he contended that the method adopted to calculate the value of the stock in trade must be one which gave a substantially reflexion of the true position. As such there was no reason to calculate the value of the shares on the basis of the buying value of the costs of the original shares plus the par value of the bonus shares. In view of the Board's decision, however, I am of the opinion that both the bonus issues allotted prior to and those allotted during the year of assessment to the Taxpayer may be considered on the same light. The decision of the Board was founded on the basis that there had been a notional payment by or on behalf of the Taxpayer for the bonus shares allotted to him. If that was correct then such notional payments might be construed as outgoings incurred during the year of assessment. In its decision the Board relied on the fact that the Company capitalized its profits and reserves to apply in payment in full for the bonus shares distributed to the Taxpayer in proportion to his shareholdings. Such a proposition finds support in Ryan's Manual of the Law of Income Tax in Australia, 3rd edition at page 174, as well as the majority decision of the Full Court in the Australian case of Curran v. Federal Commissioner of Taxation (1974) Australian Law Reports 504. In that case it was held that the taxpayer received a distribution in the form of the capitalized profits and should be considered to have paid this amount to acquire the shares. On the face of it the principle involved in the present case appears to be on all fours with the Curran's case. It appears, however, that the Australian case was decided on the provision of the Australian Income Tax Assessment Act 1936-1969. Section 6 of the said Act defined "dividend" as including "the paid up value of shares issued by a Company to any of its shareholders to the extent to which the paid up value represents a capitalisation of profits". In his judgment Barwick C.J. said at page 509: "Thus, in more than a formal sense, the shareholder who has been credited actually or notionally with an amount of distributable profits pursuant to a resolution to capitalize them and to issue bonus shares to a total paid up value equal to or less than the amount of such profits, by accepting the bonus shares in terms of the resolution to issue them has paid for the shares. By accepting them he has agreed to the application to the capital of the company of the amount of the distributable profits so credited to him, thus effecting payment for the shares. For the purpose of income tax under the Act, the amount of the distributable profits thus credited to the shareholder constitutes income. This is so whether or not the company first purports to capitalize such profits before effecting any distribution of them. Having regard to Inland Revenue Commissioners v. Blott (1921) 2 A.C. 171; (1921) All E.P Rep. Ext. 810, it may properly be said that the receipt of the bonus share, representing an interest in the capital of the company, is not income: but the crediting of the sum of profits used to effect payment for that share is income: see James v. Federal Commissioner of Taxation (1924) 34 C.L.R. 404; 30 A.L.R. 293; Commissioner of Taxes (Vic) v. Nicholas (1938) 59 C.L.R. 230 (particularly the judgment of Sir George Rich at 240-5); (1938) A.L.R. 192; and Nicholas v. Commissioner of Taxes (Vic) (1940) A.C. 744 (per Lord Thankerton at 759); (1940) 3 All E.R. 91. Thus, where a company having distributable profits impliedly effects their distribution by the issue against them of bonus shares fully or partly paid up, the recipient of the shares, having regard to the definition of 'dividend' in s.6 of the Act, must treat himself as having received income to the amount of the profits of the company applied to pay for the bonus shares and, in my opinion, will be entitled to regard those shares as having cost him that amount of money, even though the resolutions of the company do not provide for payment to him of that sum of money. Whether or not the recipient of the bonus shares must pay income tax in respect of the amount credited to him by the company in connection with the issue of the bonus shares depends on the provisions of the Act. But, in my opinion, whether or not he pays income tax on the amount so credited can have no relevance to the question whether he is entitled to treat himself as having paid the amount credited to him by the company as the cost of the bonus shares." Later he said at page 510: " .....The appellant is bound to treat the amount of $191,000 credited by the company as income received by him, though by reason of s.44 (2)(b)(iii) it is not assessable income. In my opinion, he is also entitled to treat himself as having paid for the bonus shares the amount credited to him by the company in connection with the issue of those shares. He paid for them by means of the credit given him by the company of his aliquot share of the distributable profits of the company derived from the realization of assets not acquired for resale at a profit. The resolutions of the extraordinary general meeting of Stewart Bacon went to unnecessary lengths in purporting to allot aliquot portions of the capitalized profits of the company to the shareholders before resolving to issue the bonus shares. But it was the resolution described in the side note as a 'Special Effecting Bonus Issue of Shares from Capital Profits Reserve', which included the resolution to apply a capitalized sum in paying in full the bonus shares, which was effective to warrant the appellant in treating the amount credited to him as his share of the capitalized profits, as having been paid by him for the bonus shares issued to him." Menzies J. said at page 511: "In my opinion, although the resolutions of the company relating to the bonus issue disclose some confusion resulting in some inconsistency, it ought to be concluded that they did result in the declaration of a dividend and its application to pay up in full the shares to be issued as bonus shares. By reason of this, and the appellant's acceptance of the bonus shares, a payment was made for those shares out of a credit created in favour of the appellant by the declaration of the dividend. It matters not that the dividend had to be so applied and was not payable in cash. The significance of this is simply that the dividend was one within s.44(2)(b)(iii) of the Act." Gibbs J. said at page 514: "In fact no dividend, as that word is ordinarily understood, was declared by Steward Bacon. The appellant was never entitled to receive in cash his proportion of the capitalized profits. Nevertheless, the effect of the special resolution was that capitalized profits to the extent of $191,000 were credited to the appellant and applied on his behalf in paying up the shares: James v. Federal Commissioner of Taxation (1924) 34 C.L.R. 404 at 416; 30 A.L.R. 293; Commissioner of Taxes (Vic) v. Nicholas (1938) 59 C.L.R. 230 at 244; (1938) A.L.R. 192; Nicholas v. Commissioner of Taxes (Vic) (1940) A.C. 744 at 757-9; (1940) 3 All E.R. 91. In a sense, therefore, it may be said that the shares cost the appellant $191,000 and that it was appropriate to treat their acquisition as a purchase for that amount. However, I do not need to base my decision on that ground. In my opinion it was not possible to arrive at the appellant's true income without taking the bonus shares into account as trading stock acquired, whether or not those shares could properly be regarded as having been purchased. The appellant's trading account would not reveal the real situation if it brought in at no value shares which were in fact valuable, because the amount which it would then show as income would include the value which the shares possessed when they were first brought into stock. The case may be compared with that of a trader who takes into his trading stock articles which he received by way of gift or under a bequest. Cases of that kind not falling within s.36 of the Act may be rare, but they can be envisaged. In such a case an account will not reveal the true result of the trading unless those articles are brought in at an appropriate value, e.g. market selling value. If the account showed that the articles cost nothing, the result would be to increase the amount of the trader's profit or decrease the amount of his loss by the value of the gift or bequest and in effect to make the trader pay income tax on the gift or bequest. The only practicable way of reaching a true result in a case of that kind would be to bring the articles into the account at an appropriate value as though they had been purchased, and there is no provision in the Act that would require any different approach. To arrive at a true estimate of the appellant's income it seems to me necessary to bring the shares into the trading account at an appropriate value, which in the circumstances of the case must be their par value. However, it may be said that if this were done it would ignore the fact that the shares came to the appellant as the result of a bonus issue made by a company whose shares formed part of the appellant's trading stock and that in fact the transactions proved to be profitable. It must, however, be remembered that the transactions had two distinct aspects - first the acquisition of the shares and then the not of treating them as part of the trading stock and selling them. That which made the transactions profitable was the receipt of the shares as a bonus. If it were not for s.44(2)(b)(iii), it would have been necessary to show the value of those shares on the income side of the trading account when they were allotted. It is true that it was held in Gibb v. Federal Commissioner of Taxation (1966) 118 C.L.R. 628; (1967) A.L.R. 527, that the value of bonus shares issued to a taxpayer does not constitute income in the ordinary sense, but that case was not dealing with the position of a porson who traded in shares; if there were no such provision as s.44(2)(b)(iii) the account of a share trader who received bonus shares in the circumstances of the present case would be misleading if it did not reflect in the account the benefit received. Thereafter the shares, at their par value, would have had to be included in the account together with the purchases, to enable the necessary comparison to be made between stock held at the beginning of the period together with stock acquired, on the one hand, and stock held at the end of the period together with proceeds of sales, on the other. The ultimate result of accounts prepared in this way would have been to show that a profit of $2,782.64 resulted from the transactions relating to the Stewart Bacon shares considered as a whole. However, s.44(2)(b)(iii) has the effect that the value of the bonus shares cannot be included in the assessable income - it is that circumstance that leads to a result which appears to be distorted. That, however, is no reason for falsely showing the shares to have Lad no value when brought into the account as trading stock, and an account prepared on such a false basis would lead indirectly to the taxation of the 'dividend' which s.44(2)(b)(iii) declares shall not be included in the assessable income. In short, it was, in my opinion, right to bring the bonus shares into the trading account at par value and the reason why this leads to the result, at first sight surprising, that the transactions show a loss of $188,217.36, is that s.44(2)(b)(iii) had the effect that the value of the bonus shares never became part of the appellant's assessable income." In his dissenting judgment Stephen J. having analysed the effect of the Australian Tax Act on the resolution by the Company to issue bonus shares said at page 518: "Thus, neither pursuant to any provision of the Income Tax Assessment Act nor according to ordinary concepts will the transaction resulting in the issue of these bonus shares be productive of any income for the taxpayer. This court described the true consequence of such a transaction when it said, in McRae v. Federal Commissioner of Taxation (1969) 121 C.L.R. 266 at 271: '..... the entire transaction consisting of the declaration dividend plus the crediting of the bonus shares as fully paid had no other effect than that of a transfer of part of the value of the original shares to the bonus shares. The same property which had been the asset backing for 35,000 shares be came the asset backing for 60,000 shares.' If for '35,000 shares' and '60,000 shares' there be substituted '200 shares' and '191,200 shares' this passage precisely describes what here occurred. In Federal Commissioner of Taxation v. W.E. Fuller Pty Ltd (1959) A.L.R. 1233; 101 C.L.R. 403, Dixon C.J. said, at 407-8, of bonus shares which had there been paid up out of the revaluation of capital assets: 'It appears to me that the allotment of shares and the distribution of the share certificates cannot involve a receipt or derivation of income except under some artificial statutory definition of that word and that the appropriation of the aliquot part of the profit fund to the payment up of the shares does not involve the shareholder in a receipt or derivation of income. The objection to considering the allotment of the shares and distribution of the certificates to be income is that it is settled law that they are distributed and received as capital.' In the absence of any 'artificial statutory definition' the transaction must be regarded as having no effect beyond what it in fact does, that is, its effect of transferring almost all of the value of the original 200 shares to the bonus shares." With reference to the accounting practice he said at page 520: "When shares are acquired as part of a trader's stock in trade in the course of a year's trading it is their cost, not their value, which must initially be shown in a trading account if that account is to fulfil its purpose of disclosing the trader's financial results for the year. Value will be relevant only if, at the close of the year, those shares remain in stock and it is desired, by a departure from original cost, to reflect in the profits or losses of that year the unrealized profit or loss which has resulted from some change in value since date of acquisition. Section 29 and 31 permit of this, the latter providing for a choice between two bases of valuation as alternatives to adherence to original cost. The Income Tax Assessment Act contains no prescription concerning the figure at which acquired stock is to be first entered in a trader's account, just as it is silent concerning the correct figure to ascribe to ascribe to sales. In Ballarat Brewing Co. Ltd. v. Federal Commissioner of Taxation (1951) A.L.R. 603; 82 C.L.R. 364 at 368, Fullagar J. referred to this silence saying that the consequence was that: 'The question does not depend upon any express provision to be found in the Act. It depends upon 'the conceptions of business and the principles and practices of commercial accountancy' (per Dixon J. in Commissioner of Taxes (S.A.) v. Executor Trustee v. Agency Co. of South Australia Ltd. (Carden's Case) (1939) A.L.R.81; 63 C.L.R.108 at 153).' But the matter cannot, I think, be in doubt; what must be done is to adopt that method of accounting which is 'calculated to give a substantially correct reflex of the taxpayer's true income' - per Dixon J. in Carden's Case (63 C.L.R. at 154), due regard being had to the principles recognized or followed in business and commerce in the absence of any statutory provision to the contrary - and see generally Arthur Murray (N.S.W.) Pty Ltd. v. Federal Commissioner of Taxation (1965) 114 C.L.R. 314. In all but exceptional cases only by entering stock in trade at cost will a correct reflex of true income emerge from the trading account of the year of acquisition of that stock. Although not expressly adverted to, this approach appears to me to be consistent with the way in which this court has in the past discussed the proper composition of such accounts." It is observed that in the Curran's case the majority decision relied substantially on the effect of Section 6 of the Australian Tax Assessment Act ...(illegible) there had been a notional payment of dividend. This was supported by the resolution of the share issuing company that: "The sum of $205,325 forming part of the capital profits reserve account be 'capitalized' and distributed amongst those who were members in respect of ordinary shares on 29 April 1969 'on the footing that they become entitled thereto as capital in pursuance of Article 96A' and in proportion to their ordinary shareholding. The capitalized sum of $205,325 be applied in paying up in full 205,325 of the unissued ordinary shares of $1 each in the capital of the company and that the same be distributed amongst the members aforesaid in fully paid ordinary shares of $1 each in satisfaction of the said capital sum and in proportion to the number of shares then held by them respectively." (See Judgment of Barwick C.J. in Curran's Case at page 508). That part of the judgment of Gibbs J. equating the situation where the taxpayer received a gift was adequately explained by Stephens J. in the following terms at page 521: "An exceptional case will arise should a trader receive stock in trade by way of gift. Such a situation was considered by Lord Greene M.R. in Craddock v. Zevo Finance Co. Ltd. (1944) 27 T.C. 267 at 279; (1946) 1 All E.R. 523 (n). That rather special circumstance will require special treatment, the acquisition will not have formed part of normal trading activities and the stock thus acquired will have to have a value placed upon it, otherwise its value will be reflected in any profit for the year whereas it truly represents not any profit from trading but, rather, the monetary measure of the donor's benevolence. However, with this situation we are not here concerned, the present case involves no gift; the taxpayer, when he purchased the 200 shares, paid a price reflecting the value of an aliquot share of the assets of the company, he gained the opportunity of creating the additional bonus shares which when issued to him still, together with his original share, only reflected the value of that same aliquot share. In a very real sense he paid for the bonus shares when he purchased the original 200 shares. There was no change in the 'wealth' of the taxpayer before and after the issue of the bonus shares; all that had occurred was 'a transfer of part of the value of the original shares to the bonus shares' (McRae's Case, supra)." The Inland Revenue Ordinance in Hong Kong contains no provision whereby bonus shares may be treated as dividends paid to shareholders. The resolution passed by the Hongkong & Shanghai Banking Corporation as exhibited in the case stated made no reference to distribution of the capitalized profit to shareholders to be applied in paying for the bonus shares. This alone is sufficient to distinguish the present case from the Curran's case. However, in principle I am inclined to follow the analysis and the reasoning in the dissenting judgment of Stephen J. The Taxpayer in the present case received no cash, notional or otherwise from the companies and he paid nothing for the bonus shares. To hold that there had been a notional payment on behalf of the Taxpayer is, in fact, contradictory to the Board's own ruling that the bonus shares were not dividends in specie. Once the Taxpayer was deemed to have paid for the bonus shares the only argument in support of such a proposition could only be that he received taxed profit of the companies to effect payment. The companies capitalized their profits reserve to apply in payment of the bonus shares not on behalf of any particular shareholder. This was a step to convert a portion of the existing assets of the companies into a greater number of shares. The Taxpayer was only allotted a portion of the increased number of shares which represented the assets of the companies which were already existing when he acquired the original number of shares. Originally the Taxpayer acquired 40 (or 400) of the Hongkong & Shanghai Bank shares for the sum of $27,135. Such a high price was paid because of the pregnant assets within the Bank at the time of purchase. When the 8 (or 80) bonus shares were allotted to him no further assets were injected into the Bank. Immediately after the 80 bonus shares were allotted the value of the 400 shares could only be valued as 400/480 x 27,135 and that of the 80 bonus shares as 80/480 x $27,135. That is another way of saying that the cost value of the 480 was $27,135 treating the 80 bonus shares as having nil value. The aforesaid analysis is applicable mutadis mutandis to his Jardines shareholdings. To allow the Taxpayer to take into account the par value of the bonus shares as his costs of acquisition amounts to permitting him to count his costs of purchase twice over - once the costs of acquiring the original shares with pregnant assets of the Company and again the costs for the capitalization of the same assets. Thus in Spicer and Pegler's Book Keeping and Accounts (17th edition) the author wrote at page 271: "A bonus issue of shares adds nothing to the net assets of the company; it divides the capital employed in the business into a larger number of shares. This can be explained by an illustration. Illustration (1) A company's summarized Banlance Sheet is as follows: Share Capital in 1 Shares 100,000 Sundry Assets, less Creditors 150,000 Reserves .. .. .. .. 50,000 ======== ======== If the assets and goodwill are fully valued, each 1 share is worth 1.50 cum dividend. On the profits being capitalized, if the bonus shares are issued at par, the share capital becomes 150,000 in 1 shares. Each share is now worth 1, but each shareholders has 50 per cent more shares. The shareholders are no better off." and later at page 627: " ..... It will be appreciated that the assets underlying the share capital are not in any way changed by a bonus issue and, therefore, in theory, the increased number of shares subsequently held by a shareholder is of the same value as his original holding ..... From the viewpoint of the recipient of bonus shares, however, they have been acquired without payment and therefore no value should be placed upon them in the books, the only amendment required in the Investment Account being an addition to the number of shares held. If, however, the shareholder sells the bonus shares he receives, it would be permissible to take credit for the profit on the sale, as the price obtained contains some element of the profit which existed on the original holding before the allotment of the bonus shares. Illustration (3) J. Brown purchased 1,000 ordinary shares of 1 each in Wyezed Company Limited for 1,250, inclusive of brokerage and stamp duty. Some years later the company resolved to capitalize profits and to issue to the holders of ordinary shares one new ordinary share for every share held by them. Prior to the capitalization, the shares of Wyezed Company Limited stood in the market at 1.75 per share. After the capitalization the company's shares were dealt in on the market at 93p per share. J. Brown decided to sell the bonus shares he received and the sale was effected at 90p per share net. WYEZED CO. LTD. 1 ORDINARY SHARES Date Nominal Date Nominal Cash 1,000 1,250 Cash-Sale at 90p 1,000 Bonus 1,000 Balance c/d 1,000 Profit transferred ----------------- ----------------- ----------------- ----------------- 2,000 1,525 2,000 1,525 ============ =========== =========== ====== Balance b/d 1,000 Notes: As no value is placed on the bonus shares when received the book value of the total holding is reduced from 1.25 to 0.625 per share. (ii) The shares held after the sale are carried down at cost, viz. 1,000/2,000 x 1,250 = 625." In Gower's Modern Company Law (3rd edition) the author wrote at page 110: " By this means the reserves or share premium account, or some part of them, are capitalized or converted into share capital. The only result, from the shareholder's point of view is that his proportion of the capital of the business is now represented by a greater number of shares, each of which is therefore worth less and this may make them more readily marketable. From the point of view of the company, the capitalization of free, i.e., voluntary, reserves merely means that undistributed profits have been permanently "ploughed back" and converted into share capital which, as we shall see, cannot be returned to the members by way of dividend. Essentially a bonus issue is nothing more sinister or subtle than a formal means of restoring share capital and net book value of the undertaking to something approaching equilibrium." In Pennington's Company Law it is said at page 361: " ..... a bonus issue increases the total market value of a shareholder's holding only marginally; he merely has more shares of a correspondingly lower value each (h)." It will be observed that in all instances the authors have imputed no cost for the acquisition of the bonus shares and value the bonus shares together with the original holdings on the average of the costs for the acquisition of the original holdings. For the aforesaid reasons my answer to the first question is that for the purposes of computing the assessable profits for the year of assessment 1973/74 it is not correct to hold that the Taxpayer is entitled to regard the bonus shares as having cost him the par value of those shares. My answer to the 2nd question is that the cost is "nil". Representation: PAGE - PAGE \* MERGEFORMAT - &`#$ HCIA000001/1976 COMMISSIONER OF INLAND REVENUE v. TONG KWAN-CHE Normal Kodak Microsoft Word 9.0 Judiciary Hong Kong SAR Judiciary Hong Kong SAR HCIA000001/1976 COMMISSIONER OF INLAND REVENUE v. TONG KWAN-CHE Title Microsoft Word Document MSWordDoc Word.Document.8 HCIA000001/1976 COMMISSIONER OF INLAND REVENUE v. TONG KWAN-CHE Normal Kodak Microsoft Word 9.0 Judiciary Hong Kong SAR Judiciary Hong Kong SAR HCIA000001/1976 COMMISSIONER OF INLAND REVENUE v. TONG KWAN-CHE Title