Supreme Court · 1967
(1967) 63 ITR 651 (SC)
Decided under Sections 48 & 55 of the 1961 Act; now Sections 72 & 90 of the 2025 Act.
Mode of computation; meaning of cost of acquisition and improvement
Yes. The rights entitlement comes into existence at the cost of a depreciation in the value of the original holding, and that diminution is the real cost the shareholder incurred to acquire it.
On sale of a rights entitlement, may the shareholder deduct the fall in value of the original shares caused by the rights issue in computing the gain?
The assessee held shares in a company which made a rights issue. She did not subscribe but sold her rights entitlement in the market and realised a sum. Because the rights issue diluted the company's shares, the market value of her original holding fell appreciably once the shares went ex-rights. The Revenue assessed the whole of the sale proceeds of the rights entitlement as a capital gain, on the footing that the entitlement had cost her nothing. She contended that it had cost her the fall in value of the shares she already held.
The assessment was upheld through the appellate stages and the High Court answered the reference against her. She appealed to the Supreme Court.
For the assessee
The rights entitlement did not arrive free. It came into being by diminishing the value of the existing holding, the total value of the holding plus the entitlement immediately after the issue being no more than the value of the holding before it. The depreciation in the original shares is therefore the price paid for the entitlement and must be brought into the computation.
For the Revenue
The assessee paid nothing for the entitlement, which accrued to her by virtue of her existing shareholding. A notional fall in the market value of shares she continued to hold is not expenditure and cannot be deducted; she may realise that value if and when she sells those shares.
The Court approached the question by asking what the shareholder had actually given up in order to obtain the thing she sold. It observed that immediately before the rights issue her holding had a certain market value, and immediately afterwards the shares stood at a lower quotation precisely because of the dilution the issue caused. The entitlement she was able to sell was carved out of the value that had previously resided in her shares. In a commercial sense, therefore, she acquired the entitlement at the cost of that depreciation, and the computation must reflect it if the exercise is to capture her real gain rather than an inflated figure. The Court held that the diminution in the value of the original shares, measured by the difference in quotation before and after the shares went ex-rights, is to be deducted in computing the gain on the sale of the rights entitlement. Any other approach would tax as profit an amount that was matched by a real fall in the value of what she continued to hold.
Cost of acquisition is dealt with in Section 90 of the IT Act 2025, which prescribes specific rules for rights entitlements and bonus shares. Those provisions now largely govern the computation, so the outcome should be checked against them. The reasoning retains value wherever a new asset is carved out of an existing holding and the statute leaves the cost to be determined on general principles.
Keywords: rights entitlement, renunciation, cost of acquisition, ex-rights, dilution, real gain, bonus shares
Note: This is a summary prepared for study and reference. The citation is given so the full text of the judgment can be consulted, and it should be, before the case is relied on. Corresponding Income Tax Act 2025 sections are drawn from the section mapping used across this site; where a provision has been recast rather than renumbered, the note above explains how far the principle still applies. This page is not a substitute for professional advice.