Navnitlal C. Javeri Vs. K. K. Sen,
Assistant Commissioner of income-Tax  INSC 241 (28 October 1964)
28/10/1964 GAJENDRAGADKAR, P.B. (CJ)
GAJENDRAGADKAR, P.B. (CJ) WANCHOO, K.N.
DAYAL, RAGHUBAR MUDHOLKAR, J.R.
CITATION: 1965 AIR 1375 1965 SCR (1) 909
CITATOR INFO :
R 1965 SC1387 (18) RF 1965 SC1862 (10) F 1972
SC 524 (18) RF 1973 SC1461 (218) RF 1977 SC1802 (29) RF 1981 SC1922 (9) R 1984
SC 420 (45) D 1985 SC1698 (31) C 1990 SC 781 (72) R 1990 SC1637 (38) D 1990
SC1664 (6) RF 1992 SC 803 (41,44) RF 1992 SC1360 (9)
Constitution of India, 1950, List 1, VII
Schedule, Entry 82Income--Income-tax Act (11 of 1922), ss. 2(6A) (e) and 12
(1B)-Legislative competence and constitutional validity.
The assessee was a share holder in a private
limited company whose ordinary business was not money-lending business. He took
a loan amounting to over Rs. 4 lakhs from a company.
The Income-tax Officer computed the
assessee's income at Rs. 3 lakhs and odd, under s. 12(1B) read with s. 2 (6A)
(e) of the Income-tax Act, 1922. That amount included a sum of over Rs. 2 lakhs
representing the accumulated profits of the company. The assessee's share in
the accumulated profits, if distributed as dividend, would be an amount
proportionate to the number of shares held by him. He therefore contended, that
the balance of the accumulated profits was not his income and that the
Legislature was not competent to enact the two sections according to which that
amount was also treated as his income. His writ petition in the High Court
challenging. the constitutional validity of the two sections was dismissed. He
appealed to the Supreme Court.
HELD (Per Gajendragadkar, C. J., Wanchoo,
Hidayatullah and Mudholkar JJ.) : (i) The sections are not beyond the
legislative competence of Parliament.
The companies to which s. 12(1B) applies arecompanies
in which at least 75% of the voting power lies in the hands of persons other
than the public. They are controlled by a group of persons allied together and
having the same interest. The controlling group can determine whether the
profits made by the company should be distributed as dividends or not. When
they deliberately refused to distribute the accumulated profits as dividends
but adopted the device of advancing the profits by way of loan to one of the
shareholders, it was with the object of evading the payment of tax by the
company on the accumulated profits.
Section 12(1B) provides that if a controlled
company adopts the device of making a loan to one of its shareholders, he will
be deemed to have received the amount out of the accumulated profits as
dividend and would be liable to pay tax on his income. The word
"income" in Entry 82 in List I of the 7th Schedule to the
Constitution must receive a wide interpretation depending on the facts of each
case. Having regard to the fact that the Legislature was aware of the devices
to evade tax, it would be within its competence to devise a fiction for
treating an ostensible loan as the receipt of the dividend. [919 A-H. 920 H;
921 C-D] (ii) The absence of a provision enabling the income-tax officer to
consider in each case whether the loan was genuine or the result of a device
does not make the section go beyond the competence of the Legislature. [921
D-E] If the Legislature thought that in almost every case the advances or loans
were the result of a device to evade tax, it would be competent to 910 it to
prescribe a fiction and hold that in cases of such advances or loans, tax
should be recovered from the shareholder on the basis that he had received a
[921 G-H] (iii) Section 12(lB) does not
impose an unreasonable restriction on the appellant's fundamental rights under
19(1) (f) and (g) of the Constitution. [922
A] The section does not affect the appellant's right to borrow money. There is
no element of unfairness, because the other shareholders have deliberately
agreed to make the loan or the advance and the shareholder to whom the loan is
advanced deliberately takes it with a view to assist the company to evade the
payment of tax and to have the benefit of the use of the amount subject to the
payment of interest. The company receives interest, the shareholder enjoys the
use of the money and in the process the payment of tax is evaded.
Further, past transactions were excluded from
the operation of the sections by the issue of a circular by the Central Board
of Revenue. [922 B-F] Per Raghubar Dayal J. (dissenting) : (i) Sections 2(6A)
(e) and 12(lB) of the Income-tax Act, 1922 as they stood in 1955 are void. [923
B] It is not open 'to the Legislature to describe any payment of money by a
company to a shareholder by the word "dividend" and then provide that
such payment will come within the expression "income" in item 82,
List I of Schedule 7. The definition of dividend must have a rational
connection with concept of dividend in the context of the profits of the
company and its distribution amongst the shareholders. The essence of an amount
paid as dividend is that it has to represent the proportionate amount a
particular shareholder is to get on the basis of the shares held by him out of
the profits of the company set apart for payment of dividend to shareholders.
Any ad hoc payment of money to a shareholder as advance or loan unrelated
to-his share in the accumulated profits cannot rationally come within the
expression dividend. [926 E-H] (ii) The provisions of the impugned sections
impose unreasonable restrictions on the fundamental right to hold property
under Art. 19(1)(f) of the Constitution. [928 E] If any enactment provides that
certain profits of the company, though not distributed as dividend, be treated
as used for the payment of dividends it should necessarily follow that a
particular shareholder be deemed to have received a proportionate amount of
such profits. It would be unreasonable to provide that a particular shareholder
should be deemed to have received an amount in excess of his proportionate
share as dividend. It is unreasonable that a particular shareholder who
receives a loan or advance from a company be deemed to have received that
entire amount as dividend when his proportionate share would be much less.
[928 B-E] Navinchandra Mafatlal v.
Commissioner of Income-tax, Bombay City,  1 S.C.R. 829, Sardar Baldev
Singh v. Commissioner of Income-tar, Delhi and Agra  1 S.C.R.
482 and Balaji v. Income-tax Officer, Special
Investigation Circle,  2 S.C.R. 983, referred to.
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 45 of1964.
Appeal from the judgment and order dated July
30, 1962, of the Bombay High Court in Special Civil Application No. 69 of 1962.
G.S. Pathak, M. M. Gharekhan and 1. N.
Shroff, for the appellant.
911 C.K. Daphtary, Attorney-General, R.
Ganapathy Iyer, Gopal Singh and R. N. Sachthey, for the respondent.
The Judgments of P. B. GAJENDRAGADKAR C.J.,
K. N. WANCHOO, M. HIDAYATULLAH and J. R. MUDHOLKAR JJ. was delivered by
GAJENDRAGADKAR C.J. RAGHUBAR DAYAL J. delivered a dissenting Opinion.
Gajendragadkar C.J. This appeal arises from a
writ petition filed by the appellant Navnit Lal C. Javeri in the Bombay High
Court in which he challenged the validity of section 12(1B) read with s. 2 (6A)
(e) of the Indian Income-tax Act, 1922 (No. 11 of 1922) (hereinafter called the
Act) as it stood in 1955. The High Court has rejected the appellant's
contention that the said section is invalid, and the appellant has come to this
Court with a certificate granted by the High Court.
The appellant holds 11 out of 845 shares in a
private limited company named the Malegaon Electricity Co., (Private) Ltd.
(hereinafter referred to as the company).
The value of each share is Rs. 100. The
business of the company is to supply electricity to the residents of Malegaon. Sometime
during 1955, the appellant took a loan amounting to over Rs. 4 lakhs from the
company. A notice was issued to the appellant by the 8th, Income-Tax Officer
under s. 22(2) of the Act calling, upon him to make his return for the
assessment year 1956-57. The Income-tax Officer computed his income at Rs.
3,58,460. This amount included a sum of Rs. 2,83,126 representing the
accumulated profits of the company. The Income-tax Officer took the view that
under s. 2 (6A) (e) the said amount must be deemed to be dividend received by
the appellant, and as such, must be included in the total income of the
appellant as income from other sources within the meaning of s. 12(1B) of the
Act. This order was challenged by the appellant by preferring an appeal before
the Appellate Assistant Commissioner. The appeal, however, failed and was
dismissed. The appellant then preferred a second appeal before the Income Tax
Appellate Tribunal. Whilst this appeal was pending, before the said Tribunal,
the appellant moved the High Court under Articles 226 and 227 of the
Constitution, and contended that the relevant section under which the
department had purported to levy assessment against him on the sum of Rs.
2,83,126, was ultra vires.
That is how the only question which the High
Court had to decide in the present writ proceedings was whether s. 12 (1B) read
with s. 2 (6A) (e) was constitutionally valid.
912 in order to deal with this point, it is
necessary to read the two relevant provisions of the Act. Section 2(6C) defines
"income" as including dividend. Section 2 (6A) defines
"dividend" in an inclusive manner. Section 2 (6A) (e) provides
"Dividend" includes(e) any payment by a company, not being a company
in which the public are substantially interested within the meaning of s. 23A,
of any sum (whether as representing a part of the assets of the company or
otherwise) by way of advance or loan to a shareholder or any payment by any
such company on behalf or for the individual benefit of a shareholder, to the
extent to which the company in either case, possesses accumulated profits; but
dividend does not include(i) (ii) any advance or loan made to a shareholder by
a company in the ordinary course of its business where the lending of money is
a substantial part of the business ,of the company;
(iii) any dividend paid by a company which is
set off by the company against the whole or any part of any sum previously paid
by it and treated as a dividend within the meaning of sub-clause (e), to the
extent to which it is so set off." Thus, the inclusive definition of
"dividend" takes in the payments to which clause (e) of s. 2(6A)
refers and makes them dividend for the purpose of the Act.
Section 12(1) provides that the tax shall be
payable by an assessee under the head "Income from other sources" in
respect of income, profits and gains of every kind which may be included in his
total income (if not included under any of the preceding heads). Section 12(lB)
provides :"any payment by a company to a shareholder by way of advance or
loan which would have been treated as a dividend within the meaning of clause
(e) of subsection (6A) of s. 2 in any previous year relevant to any assessment
year prior to the assessment year ending on the 31st day of March, 1956, had
that clause been in force in that year, shall be treated as a dividend received
by him in the previous year relevant to the 913 assessment year ending on the
31st day of March, 1956, if such loan or advance remained outstanding on the
first day of such previous year".
Both these provisions viz., s. 2(6A)(e) and
s. 12(lB) were introduced in the Act by the Finance Act 15 of 1955 which came
into operation on the 1st of April, 1955.
It is thus clear that the combined effect of
these two provisions is that three kinds of payments made to the shareholder of
a company to which the said provisions apply, are treated as taxable dividend
to the extent of the accumulated profits held by the company. These three kinds
of payments are: (1) payments made to the shareholder by way of advance or
loan; (2) payments made on his behalf; and (3) payments made for his individual
benefit. There are five conditions which must be satisfied before s. 12(lB) can
be invoked against a shareholder. The first condition is that the company in
question must be one in which the public are not substantially interested
within the meaning of s. 23A as it stood in the year in which the loan was
advanced. The second condition is that the borrower must be a shareholder at
the date when the loan was advanced; it is immaterial what the extent of his
shareholding is. The third condition is that the loan advanced to a shareholder
by such a company can be deemed to be dividend only to the extent to which it
is shown that the company possessed accumulated profit at the date of the loan.
This is an important limit prescribed by the relevant section. The fourth
condition is that the loan must not have been advanced by the company in the
ordinary course of its business. In other words, this provision would not apply
to cases where the company which advances a loan to its shareholder carries on
the business of money-lending itself ; and the last condition is that the loan
must have remained outstanding at the commencement of the shareholder's
previous year in relation to the assessment year 1955-56. In dealing with the
question about the constitutionality of the impugned provisions, it is
necessary to bear in mind these respective conditions which govern the
application of the said provisions.
There is another material circumstance which
cannot be ignored. It appears that when these amendments were introduced in
Parliament, the Hon'ble Minister for Revenue & Civil Expenditure save an
assurance that outstanding loans and advances which are otherwise liable to be
taxed as dividends in the assessment year 1955-56 will not be subjected to tax
if it is shown that they had been genuinely refunded to the respective
companies before the 30th June, 1955. It was realized by the Government 914
that unless such a step was taken, the operation of s.
12(1B) would lead to extreme hardship,
because it would have covered the aggregate of all outstanding loans of past
years and that may have imposed an unreasonably high liability on the
respective shareholders to whom the loans might have been advanced. In order
that the assurance given by the Minister in Parliament should be carried out, a
circular [No. 20(XXI-6)/55] was issued by the Central Board of Revenue on the
10th May, 1955. It is clear that a circular of the kind which was issued by the
Board would be binding on all officers and persons employed in the execution of
the Act under s. 5(8) of the Act. This circular pointed out to all the officers
that it was likely that some of the companies might have advanced loans to
their shareholders as a result of genuine transactions of loans, and the idea
was not to affect such transactions and not to bring them within the mischief
of the new provision. The officers were, therefore, asked to intimate to all
the companies that if the loans were repaid before the 30th June, 1955 in a
genuine manner, they would not be taken into account in determining the tax
liability of the shareholders to whom they may have been advanced. In other
words, past transactions which would normally have attracted the stringent
provisions of s. 12(lB) as it was introduced in 1955, were substantially
granted exemption from the operation of the said provisions by making it clear
to all the companies and their shareholders that if the past loans were
genuinely refunded to the companies, they would not be taken into account under
s. 12(lB). Section 12(1B) would, therefore, normally Apply to loans granted by
the companies to their respective shareholders with full notice of the
provisions prescribed by it.
Mr. Pathak for the appellant contends that
the impugned provision is constitutionally invalid, because it is beyond the
legislative competence of Parliament. He argues that Entry 82 in List I of the
Seventh Schedule which deals with "taxes on income other than agricultural
income" cannot justify the impugned provision, because a loan advanced to
a shareholder by the company cannot, in any legitimate sense, be treated as his
income; and so, the artificial manner in which such dividend is ordered to be
treated as income by the impugned provision is not justified by the said Entry.
He also contends that the said provision
offends Art. 19(1) (f) & (g) and cannot be said to be justified by clause
(5) or (6) of the said article. There is no doubt that if the impugned
provision is beyond the legislative powers of Parliament, it would be bad.
Similarly, it is now wellsettled that even tax 915 legislation must stand the
scrutiny of the fundamental rights guaranteed by the Constitution, and so,
there can be no doubt that if the impugned provision invades the fundamental
rights of the appellant and the invasion is not constitutionally justified, it
would be invalid.
In dealing with this point, it is necessary
to consider what exactly is the denotation of the word "income" used
in the relevant Entry. It is hardly necessary to emphasis that the entries in
the Lists cannot be read in a narrow or restricted sense, and as observed by
Gwyer C.J. in the United Provinces v. Atiqa Begum(1). " each general word
should be held to extend to all ancillary or subsidiary matters which can
fairly and reasonably be said to be comprehended in it." What the entries
in the List purport to do is to confer legislative powers on the respective
Legislatures in respect of areas or fields covered by the said entries-. and it
is an elementary rule of construction that the widest possible construction
must be put upon their words. This doctrine does not, however, mean that
Parliament can choose to tax as income an item which in no rational sense can
be regarded as a citizen's income. The item taxed should rationally be capable
of being considered as the income of a citizen. But in considering the question
as to whether a particular item in the hands of a citizen can be regarded as
his income or not, it would be inappropriate to apply the tests traditionally
prescribed by the Income-tax Act as such.
In Navinchandra Mafatlal v. The Commissioner
of Income-tax, Bombay City(1), this Court had occasion to consider the question
as to whether capital gains could be treated as income within the meaning of
item 54 of List I of the Seventh Schedule to the Government of India Act, 1935.
Section 12-B of the Indian Income-tax Act,
1922 which had been inserted in the said Act by Act XXII of 1947, had imposed
tax on 'capital gains'. The validity of this provision was challenged on the
ground that capital gains cannot be treated as income within the meaning of
This plea was rejected by this Court on the
ground that the words used in a constitutional enactment conferring legislative
powers ought to be construed most liberally and in their widest amplitude.
Adopting this approach Das J. as he then was, speaking for the Court, observed
that the word "income" used in the said entry must be given its
ordinary, natural and grammatical meaning and that was, income is a thing that
comes in. On this view, the Court found no difficulty in coming to the
conclusion that income would include capital gains. If the traditional (1)
 F.C.R. 110. (2) 1 S.C.R. 829.
Sup./65916 sense of income had been accepted,
then, of course, capital gains could not be treated as income. That, in fact,
was the argument which was pressed by Mr. Kolah who appeared for the appellant.
"If we hold", observed the learned Judge, "as we are asked to
do, that the meaning of the word 'income' has become rigidly crystallised by
reason of the judicial interpretation of that word appearing in the Income-tax
Act, then logically no enlargement of the scope of the Income-tax Act, by
amendment or otherwise, will be permissible in future." And he has
significantly added that a conclusion so extravagant and astounding can
scarcely be contemplated or countenanced. This decision, therefore shows that
the word "income" used in entry 54 which corresponds to the present
entry 82 in List I of the 7th Schedule to our Constitution, was liberally
construed, and capital gains were deemed to be included within its scope.
This aspect of the matter has also been
clearly enunciated by Gwyer C.J. in re: The Central Provinces and Berar Sales
of Motor Spirit and Lubricants Taxation Act, 1938 (No.
14 of 1938) (1). "I conceive", said
the learned Chief Justice, "that a broad and liberal spirit should inspire
those whose duty it is to interpret it (the Constitution);
but I do not imply by this that they are free
to stretch or pervert the language of the enactment in the interests of any
legal or constitutional theory, or even for the purpose of supplying omissions
or of correcting supposed errors".
The next decision to which we ought to refer
deals with s. 23A of the Act. In Sardar Baldev Singh v. Commissioner of
Income-tax, Delhi & Ajmer(1) the validity of the said section was
challenged. Section 23A(1) provides, inter alia, that subject to the provisions
of sub-sections (3) and (4), where the Income-tax Officer is satisfied that in
respect of any previous year the profits and gains distributed as dividends by
any company within the twelve months immediately following the expiry of that
previous year are less than sixty per cent of the total income of the company
of that previous year as reduced by the amounts specified in clauses (a), (b)
& (c) of the said sub-section, the Income-tax Officer shall, unless he is
satisfied that having regard to losses incurred by the company in earlier years
or to the smallness of the profits made in the previous year, the payment of a
dividend or a larger dividend than that declared would be unreasonable, make an
order in writing that the company shall, apart from the sum (1)  F.C.R.
18 at p. 37.
(2)  1 S.C.R. 482.
917 determined as payable by it on the basis
of the assessment under s. 23, be liable to pay super-tax at the rate specified
by the said sub-section. The object of this section is to prevent avoidance of
super-tax by shareholders of a company in which the public are not
substantially interested. As is well-known, the rates of super-tax applicable
to companies are much lower than the rates applicable to individual assessees.
The legislature thought that individuals tried to avoid the payment of
super-tax at a higher rate by transferring to a private limited company it).
return for shares the sources of their income, and then the profits made by the
company were allowed to accumulate in the hands of the company, dividends not
being declared, and the said profits would ultimately be distributed in a
capital form by one device or another. The object of s. 23A was to defeat such
attempts. The main effect of the provisions of s. 23A appears to be that a
company should not accumulate more than 40 per cent of its net profits to build
up reserves or to provide for capital expenditure It will be recalled that s.
2(6A) has taken within the definition of 'dividend" the accumulated
profits of such companies, and so s. 23A attempts to reach such accumulated
profits for the purpose of taxation.
The argument which was urged before this
Court in the cast of Sardar Baldev Singh(1) was that a company and its share,
holders are different persons, and so, s. 23A was ultra vires inasmuch as it
purported to tax the shareholders on the income of the company in which they
hold shares. If the accumulated profits are distributed amongst the
shareholders by way of dividends, the shareholders could legitimately be taxed
in respect of the dividends received by them; but when s. 23A attempts to tax
the shareholders for accumulated profits even though they are not distributed
as dividends, what, the section purports to do is to tax the share-holders for
the profits made by the company; and that, according to the appellant, made s.
23A invalid. This argument was repelled by this Court on the ground that the
obvious intention of s. 23A was to prevent evasion of tax, and it was held that
entry 54 should be read not only as authorising the imposition of a tax, but
also as authorising an enactment which prevents the tax imposed being evaded;
otherwise the power to tax a person on his
income might often be made in fructuous by ingenious contrivances. It would be
noticed that s. 23A wanted to deal with a situation where shareholders did not
deliberately distribute the accumulated profits as dividends amongst
Section (1)  1 S.C.R. 482.
918 23A, therefore, provides that these
accumulated profits will be deemed to have been distributed to the shareholders
and tax levied against them on that basis. It is likely that in such a case,
hardship may be caused in some honest cases; but this Court made it perfectly
clear that considerations of hardship are irrelevant for determining questions
of legislative competence. It is thus clear that the result of the decision of
this Court in Sardar Baldev Singh(1) is that the income which technically
belonged to the 'company, was treated, as income belonging to the shareholders
in proportion to the shares they held in the company, and on that footing tax
was levied on them; and yet the said tax was held to be constitutionally valid.
There is yet another case in which a similar
question was considered. In Balaji v. Income-tax Officer, Special Investigation
Circle, (2) a person and his wife started business in partnership and admitted
their three minor sons to it. In computing the total income of the said person
for the purpose of assessment, the Income-tax Officer included the share of the
income of his wife and three minor sons under S. 16 (3) (a) (i) & (ii) of
the Act. The validity of this provision was challenged on the ground that the
impugned section purported to tax a person for the income of other persons,
namely, his wife and minor sons. In rejecting the contention raised against the
validity of the impugned section, this Court held that the Entries in the
Legislative Lists are not powers but fields of legislation and the widest
import and significance should be attached to them. On this view, the
conclusion reached by this Court was that Entry 54 of the Federal Legislative
List covered legislation like s. 16 (3) (a) (i) & (ii), because it was
intended to prevent evasion of tax. It appears from the judgment that the
validity of the said section was also challenged on the ground that it
contravened Articles 14 and 19(1) (f) & (g) of the Constitution. This plea
was also rejected. One of the considerations which weighed with the Court in
repelling the said plea was that the additional payment of tax made on the
income of the wife or the minor children would ultimately be home by them in
the final accounting between them. Having regard to this consideration and
bearing in mind the fact that the mode of taxation authorised by the impugned
section, though harsh, was thought to be necessary to prevent evasion of
payment of tax, this Court held that the said section was valid. It is in the
light of these decisions that we must proceed to consider Mr. Pathak's argument
that s. 12(1B) of the Act is ultra wires.
(1)  1 S.C.R. 482. (2)  2 S.C.R.
In dealing with Mr. Pathak's argument in the
present case, let us recall the relevant facts. The companies to which the
impugned section applies are companies in which at least 75 per cent of the
voting power lies in the hands of persons other than the public, and that means
that the companies are controlled by a group of persons allied together and
having the same interest. In the case of such companies, the controlling group
can do what it likes with the management of the company, its affairs and its
profit within the limits of the Companies Act. It is for this group to
determine whether the profits made by the company should be distributed as
dividends or not. The declaration of dividend is entirely within the discretion
of this group.
When the legislature realized that though
money was reasonably available with the company in the form of profits, those
in charge of the company deliberately refused to distribute it as dividends to
the shareholders, but adopted the device of advancing the said accumulated
profits by way of loan or advance to one of its shareholders, it was plain that
the object of such a loan or advance was to evade the payment of tax on
accumulated profits under s. 23A. It will be remembered that an advance or loan
which falls within the mischief of the 'impugned section is advance or loan
made company which does not normally deal in money lending is made with full
knowledge of the provisions contained impugned section. The object of keeping
accumulated without distributing them obviously is to take the benefit lower
rate of super-tax prescribed for companies. This was defeated by s. 23A which
provides that in the case distributed profits, tax would be levied on the
shareholders on the basis that the accumulated profits will be deemed to have
been distributed amongst them. Similarly, s. 12(1B) provides that if a
controlled company adopts the device of making a loan or advance to one of its
shareholders, such shareholder will be deemed to have received the said amount
out of the accumulated profits and would be liable to pay tax on the basis that
he has received the said loan by way of dividend. It is clear that when such a
device is adopted by a controlled company, the controlling group consisting of
shareholders have deliberately decided to adopt the device of making a loan or
advance. Such an arrangement is intended to evade the application of a. 23A.
The loan may carry interest and the said interest may be received by the
company; but the main object underlying the loan is to avoid payment of tax. It
may ultimately be repaid to the company and when it is so repaid, it may or may
not be treated as part of 920 accumulated profits. It is this kind of a
well-planned device which s. 12(1B) intends to reach for the purpose of
It appears that such a device is adopted by
private companies in many countries. Simon has referred to this device in these
words :"Generally speaking, surtax is charged only on individuals, not on
companies or other bodies corporate. Various devices have been adopted from
time to time to enable the individual to avoid surtax on his real total income
or on a portion of it, and one method involved the formation of what is
popularly called a 'one man company'. He individual transferred his assets, in
exchange for shares, to a limited company, specially registered for the
purpose, which thereafter received the income from the assets concerned. The
individual's total income for tax purposes was then limited to the amount of
the dividends distributed to him as practically the only shareholder, which
distribution was in his own control. The balance of the income, which was not
so distributed, remained with the company to form, in effect, a fund of savings
accumulated from income which had not immediately attracted surtax. Should the
individual wish to avail himself of the use of any part of these savings he
could effect this by borrowing from the company, any interest payable by him
going to swell the savings fund; and at any time the individual could acquire
the whole balance of the fund in the character of capital by putting the
company into liquidation."(1) What Simon says about one-man company can be
equally true about the controlled company whose affairs are controlled by a
group of persons closely knit and having the same interest.
The question which now arises is, if the
impugned section treats the loan received by a shareholder as a dividend paid
to him by the company, has the legislature in enacting the section exceeded the
limits of the legislative field prescribed by the present Entry 82 in List I.
As we have already noticed, the word "income" in the context must
receive a wide interpretation; how wide it should be it is unnecessary to
consider, because such an enquiry would be hypothetical. The question must be
decided (1) Simon's Income-tax, 2nd Ed. Vol. 3, para 592, p. 341.
921 on the facts of each case. There must no
doubt be some rational connection between the item taxed and the concept of
income liberally construed. If the legislature realises that the private
controlled companies generally adopt the device of making advances or giving
loans to their shareholders with the object of evading the payment of tax, it
can step in to meet this mischief, and in that connection, it has created a
fiction by which the amount Ostensibly and nominally advanced to a shareholder
as a loan is treated in reality for tax purposes as the payment of dividend to
him. We have already explained how a small number of shareholders controlling a
private company adopt this device. Having regard to the fact that the
legislature was aware of such devices, would it not, be competent to the
legislature to device a fiction for treating the ostensible loan as the receipt
of dividend? In our opinion, it would be difficult to hold that in making the
fiction, the legislature has traveled beyond the legislative field assigned to
it by entry 82 in List 1.
It is, however, urged by Mr. Pathak that
while providing for such a fiction, the legislature should have required the
Income-tax Officer to consider in each case whether the loan was genuine, or
was the result of a device; and he argues that since no such provision has been
made and a uniform presumption by fiction is, sought to be raised, the
legislature has gone beyond its legislative competence. In support of this
argument, Mr. Pathak has referred to the fact that under s.108(1) of the
Commonwealth Income-tax Act it is provided that the amount paid to the
shareholder by way of advance or loan can be taxed if in the opinion of the
Commissioner it represents distributions of income, Such a provision would have
made the impugned section valid, Mr. Pathak argues that omission of Parliament
to exclude from the operation of s. 12(lB) genuine loans or advances, and its
failure to distinguish between such loans and advances and loans and advances made
as a device shows, that it has acted blindly and must, therefore, be held to
have exceeded its legislative power. We are not inclined to accept this
argument. If the legislature thinks that the advances or loans are in almost
every case the result of a device, it would be competent to it to prescribe a
fiction and hold that in cases of such advances or loans, tax should be
recovered from the shareholder an the basis that he has received the dividend.
Therefore, we are satisfied that the High Court was right in coming to the
conclusion that the impugned section is not beyond the legislative competence
of the legislature.
922 Then it is argued by Mr. Pathak that the
impugned provision contravenes the appellant's fundamental rights under Art.
19(1) (f) & (g) and is not saved by
clauses (5) & (6) of the said article. It is not easy to appreciate this
Art. 19(1) (f) recognises the right of a
citizen to acquire, hold and dispose of property and Art. 19(1)(g) recognises
the right to practice any profession, or to carry on any occupation, trade or
business. The impugned provision does not contravene either of these rights.
The shareholder's right to borrow money from his own company cannot be said to
be a fundamental right; besides all that the impugned section does is to
provide that if a loan is borrowed by a shareholder from a company to which they
said provision applies, it will be deemed to be a receipt by him of the
dividend. This provision does not affect the appellant's right to borrow money
from any other source; and his company from which he borrows does not
ordinarily do money-lending business. That is why the restriction imposed by
the section cannot be said to be unreasonable at all. In dealing with the
question about the reasonableness of this provision, we cannot also overlook
the fact that past transactions were excluded from its operation by the issue
of a circular to which we have already referred. There is no element of
unfairness in the fiction, because the other shareholders have deliberately
agreed to make the loan or the advance and the shareholder to whom the loan is
advanced deliberately takes it with a view to assist the company to evade the
payment of tax and to have the benefit of the use of, the amount subject to the
payment of interest. The company receives interest, the shareholder enjoys the
use of the money, and in the process the payment of due tax is evaded. That is
the assumption made by the legislature in making this provision. How can it be
urged that either the shareholder who is taxed, or the other shareholders who
deliberately make the advance to a colleague of theirs, are unfairly dealt with
by the impugned provision. In our opinion, there is no scope for arguing that
the fundamental rights of the shareholder under Art. 19 (1) (f ) & (g) have
been contravened by the impugned provision. Therefore, we must reject Mr.
Pathak's argument that the impugned provision is invalid on the ground that it
19(1)(f) & (g). There is obviously no
scope for suggesting that the impugned provision contravenes Art. 14; and in
fact Mr. Pathak has not raised this point before us. In that connection, he
himself fairly invited our attention to the decision of the Madras High Court
in K. M. S. Lakshmana Aiyar v. Additional Income-tax Officer, Special 923
Circle, Madras, (1) where the challenge to the validity of the impugned section
on the ground that it contravened Art.
14 has been repelled.
The result is, the appeal fails and is
dismissed with costs.
Raghubar Dayal J. I am of opinion that the
appeal should be allowed as ss. 12 (1B) and 2 (6A) (e), of the Indian
Income-tax Act, 1922, hereinafter called the Act, as they stood in 1955, are
The two provisions were enacted by Parliament
in view of Entry 82, List 1, Seventh Schedule of the Constitution which reads :
"Taxes on income other than agricultural income".
It is not disputed that whatever wide
connotation the word 'income' in this Entry may have, the item taxed should
really be capable of being considered as income, that there be some rational
connection between the item taxed and the concept of "income" and
that it is not open to Parliament to choose to tax, as income, an item which in
no rational sense can be regarded as income. It is also not disputed that Parliament
can enact a law dealing with the evasion of payment of income-tax.
In Navinchandra Mafatlal v. The Commissioner
of Income-tax, Bombay City(1) this Court had to consider the content of the
word "income" as used in Entry 54, List 1, Seventh Schedule to the
Government of India Act, 1935 (which is identical with Entry 82. List 1,
Seventh Schedule to the Constitution), in determining whether the imposition of
a tax under the head "capital gains" by the Central Legislature, was
Section 12-B inserted in the Income-tax Act
by the Indian Income-tax and Excess Profits Tax (Amendment) Act, 1947 (Act XXII
of 1947) provided for the imposition of a tax on capital gains arising from
certain transactions mentioned in the section. This Court said that "income",
according to the dictionary, means "a thing that comes in" and that
in the United States of America and Australia, the word "income" was
used in a wide sense so as to include "capital gains". It referred to
certain cases of those countries in which a very wide meaning was ascribed to
the word "income" as its natural meaning and held that "its
natural meaning embraces any profit or gain which is actually received".
In the United States, the word
"income" was first defined in Stratton's Independence v. Howhert(3)
decided on December 1, 1913, as "gain derived from capital, from labour,
or from both (1) (1960) 40 I.T.R. 469.
(2)  1 S.C.R. 829.
(3) 231 U.S. 399-59 L. Ed. 285.
924 combined". The court had to construe
the word "income" as used in S. 38 of the Corporation Excise Tax Act
of August 5, 1909, which imposed an excise tax "equivalent to one per
centum upon the entire net income .... received by it from all sources during
In Eisner v. Macomber(1) referred to by this
Court in Mafatlal's case(1), the court had to construe the word
"income" as used in the XVI Amendment of the Constitution of the
United States, which is :
"The Congress shall have power to lay
and collect taxes on incomes, from whatever source derived, without apportionment
among the several States, and without regard to any census or
enumeration." and observed, at p.
" Congress cannot by any definition it
may adopt conclude the matter, since it cannot by legislation alter the
Constitution, from which alone it derives its power to legislate, and within
whose limitations alone that power can be lawfully exercised.
.... For the present purpose we require only
a clear definition of the term 'income,' as used in common speech, in order to
determine its meaning in the Amendment; and, having formed also a correct
judgment as to the nature of a stock dividend, we shall find it easy to decide
the matter at issue.
After examining dictionaries in common use we
find little to add to the succinct definition adopted in two cases arising
under the Corporation Tax Act of August 5, 1909. 'Income may be defined as the
gain derived from capital, from labour, or from both combined,' provided it be
understood to include profit gained through a sale or conversion of capital
assets. to which it was applied in the Doyle case Brief as it is, it indicates
the characteristic and distinguishing attribute of income, essential for a
correct solution of the present controversy." The definition of
"income" given in this case has been followed in the other two cases
referred to in Mafatlal's case(2) ViZ., Merchants' Loan & Trust Co. v.
Smietanka(3) and United States (1)252 U.S. 189=64 L. Ed. 521.
(2) [19551 1 S.C.R. 829.
(3) 255 U.S. 509=65 L. Ed. 751.
925 v. Stewart(1), cases which dealt with the
taxation of gains from the sale of capital assets.
The question in the Australian case viz.,
Resch v. The Federal Commissioner of Taxation(1) was about the validity of the
provinces in the income-tax legislation to the effect that distribution of profits
in the course of winding-up of a company would be treated on the same footing
as the distribution by the company as a going concern. The provision was held
valid as Parliament possessed power to bring to charge in an income-tax Act all
profits and gains accruing to a tax-payer, without distinguishing whether the
profit or gain should be regarded as a receipt on capital or on income or
The word "income" has been
interpreted in a natural sense in these cases and the definition given in
Eisner's case($) is much narrower and limited in content than the widest
meaning which is now sought to be given to it by the respondent. In Mafatlal's
case (4) too, this Court has not given such a wide meaning to the word
"income" as to include "anything which comes in" and
therefore to include the amount of a loan which may be said to come in the
hands of the borrower. Loans borrowed by a shareholder from the company do not,
as such, come within the above general definition of "income". They
do not represent gains from his labour or capital or profits gained through
sale of capital assets. The borrower has to repay them. If a shareholder is
really paid his share of the profits ostensibly as a loan, such a nominal loan
but really a share of profits-can be taxed as "income" under an
We may now consider the nature of what had
been taxed in this case and to which objection has been taken on the ground
that ss. 2 (6A) (e) and 12 ( 1 B) are invalid.
The appellant holds 11 out of 845 shares in a
private limited company. The value of each share is Rs. 100. In 1955 he took a
loan of over Rs. 4,00,000 from the company.
Rs. 2,83,126, the amount of accumulated
profits the company had then, have been added to the appellant's total income
for the relevant assessment year, in view of ss. 2(6A)(e) and 12(1B) of the
Act. He appellant's share in the accumulated profits, if distributed as
dividend would be 11/845the of Rs. 2,83,126 i.e., Rs. 3,686. Rs. 2,79,440, the
balance, would then be the dividend payable to the other co-sharers. The
appellant contends that Rs. 2,79,440 (1) 311 U S 60 = 85 Ed 40 (3) 252 U.S.
189=64 L. Ed. 521.
(2) 66 C.L.R. 198.
(4)  1 S.C.R. 829.
926 is not his income and that Parliament was
not competent to enact ss. 2 (6A) (e) and 12 ( 1B) which treat it as his
"income" from dividend.
Before dealing with the contention, reference
may be made to what the impugned sections provide. Section 2 (6A) (e) defines
"dividend", in the circumstances mentioned in that clause, to include
any payment by a company of any sum by way of advance or loan to a shareholder,
or any payment by any Such company on behalf of or for the individual benefit
of a shareholder to the extent to which the company in either case possesses
accumulated profits. Section 12(1B) provides that any such payment to a
shareholder made by way of advance or loan in certain circumstances would be
treated as dividend received by him in the previous year relevant to the
assessment year ending March 31, 1956, if such loan or advance remained
outstanding on the first day of such previous year. Now, the contention for the
appellant is that though Parliament can enact a law dealing with evasion of
payment of income-tax, it cannot tax what is not "income", that the
amount in excess of his proportionate share in Rs. 2,83,126, if it had been
actually distributed as profits by the company, could not have been his income
from dividend, that he could not have evaded payment of income-tax on this
amount from its being not distributed as dividend and that therefore Parliament
could not enact that such excess amount be treated as dividend paid to him and,
consequently, as his "income".
The contention has force. The essence of an
amount paid as dividend is that it has to represent the proportionate amount a
particular shareholder is to get on the basis of the shares held by him out of
the profits of the company set apart for payment of dividend to shareholders.
Any ad hoc payment of money to a shareholder as advance or loan unrelated to
his share in the accumulated profits cannot rationally come within the
expression "dividend". I am therefore of opinion that it is not open
to the legislature to describe any payment of money by a company to a
shareholder by the word "dividend" and then provide that such payment
(called dividend) will come within the expression "income" for the
purposes of any law enacted by virtue of Entry 82, List 1, Seventh Schedule to
the Constitution. The definition of "dividend" must have rational
connection with the concept of "dividend" in the context of the
profits of a company and its distribution amongst shareholders at any time
after the profits have been earned. Clauses (a) to (d) of S. 2 (6A) may be said
to have such a connection.
927 It is conceivable, and not disputed for
the appellant, I that attempts are made by persons to evade payment of
income-tax and that one mode of such attempts is that companies accumulate
profits, do not use them for payment of dividends and later pay the amount to
shareholders by way of profits but in the form of advance of moneys or loans to
some shareholders who pass on the ratable share of the remaining shareholders
and the shareholders thus escape payment of super-tax at a higher rate as their
receiving such amounts could not be treated as "dividends" and so
could not be added to their "income'. At the same time, it is not disputed
for the respondent that there can be genuine cases of loans taken by
shareholders from a company when the company was in a position to lend money out
of its funds.
In fact, after the enactment of s. 2(6A)(e),
the Central Board of Revenue issued a Circular directing its officers to
intimate to all companies that if loans advanced by them were repaid before
June 30, 1955, in a genuine manner, they would not be taken into account in
determining the tax liability of the shareholders to whom they had been
advanced as it was likely that some companies might have advanced loans to
their shareholders as a result of genuine transactions of loans and the idea was
not to affect such transactions and not to bring them within the mischief of
the new provision. The provisions of s. 2 (6A) (e) take into account all cases
of advances or loans made by companies to their shareholders, be they bona fide
or be they for the purpose of evading payment of super tax, and make the
borrower liable for the tax on even such amount of the loan as be in excess of
his proportionate share in the accumulated profits up to the amount of the
Reference may be made to the fact that in
other countries too, notice has been taken of attempts to evade payment of
income-tax by similar devices, and that enactments to defeat the devices have
been made by the legislatures of those countries. We have been referred to s.
108 of the Income Tax and Social Services Contribution Assessment Act 1936-53
(of the Commonwealth of Australia) which deals with loans to shareholders. Its
provisions materially differ in one respect from those of the impugned
sections. Only so much of the advances or loans are deemed to be dividends paid
by the company as in the opinion of the Commissioner represents distributions
of income. The entire amount of advance of loan is not treated as dividend
received by the borrower shareholder.
Imposition of a tax is a restriction on the,
right of an assessee 928 to hold property and a particular tax can be justified
only as a reasonable restriction on the exercise of that right in the interests
of the general public. The shareholder who takes a loan or advance from a
company which possesses accumulated profits is, under the impugned provisions,
treated to have received the amount of the loan or advance to the extent of the
accumulated profits, as dividend. As already stated, the amount of profits set
apart for dividends is to be proportionately distributed among the various
shareholders. If any enactment provides that certain profits of the company,
though not distributed as dividend, be treated as used for the payment of
dividends, it should necessarily follow that a particular shareholder be deemed
to have received a proportionate amout of such profits as dividend. It would be
unreasonable to provide that a particular shareholder should be deemed to have
received an amount in excess of his proportionate share as dividend. The other
shareholders should, in the circumstances, be deemed to have received their
proportionate shares of the profits deemed to have been distributed as
dividends. A reasonable law may provide for their assessment as wan on the
amount of dividends deemed to have been distributed to them. It appears to me
unreasonable that a particular shareholder who receives a loan or advance from
a company be deemed to have received that entire amount as dividend when his
proportionate share be much less. I would, for this reason also, consider the
provisions of the impugned sections to amount to imposing unreasonable
restrictions on the fundamental right to hold property under Art. 19(1)(f).
I would now refer to certain cases on which
reliance is placed for the proposition that this Court has held valid laws made
to cover attempts for evasion of income-tax and that therefore the impugned
provisions enacted with the same object to cover attempts to evade payment of
super-tax should be held valid. These case are : Mafatlal's case(1), already
referred to; Sardar Baldev Singh v. Commissioner of Income-tax, Delhi &
Ajmer (2) ; and Balaji v. Income-tax Officer, Special Investigation Circle(a).
Mafatlal's case(1) dealt with the validity of
the tax on capital gains under S. 12B of the Act. In that case what was taxed
was what had been gained by the assessee as a result of some dealing in capital
assets. The capital gain was to be computed after making certain deductions
including the actual cost to the assessee of (1) 1 S.C.R. 829. (3) 
2 S.C.R. 983.
(2)  1 S.C.R. 482.
929 The capital assets, and did not represent
the entire amount that came in as a result of the transaction. This case is
therefore an authority for the simple proposition that the word
"income" in Entry 82, List 1, Seventh Schedule 'to the Constitution,
has wide connotation and is not to be restricted to have the same content as
judicial decisions had given to that word as used in the Act.
"Income", in the Act, has been construed in the context of the scheme
of the Act and has been considered to mean generally what one earns mostly in a
recurring form from some existing sources. The profits that one earns from the
transfer of a capital asset could be rationally considered, as held by this
Court, to be income, as it represented the amount in excess of what the
transferor-assessee had spent in acquiring that asset.
Baldev Singh's case(1) was concerned about
the validity of the provisions of s. 23A of the Act which authorised the
Income-tax Officer to order in writing that the undistributed portion of the
ostensible income of a company calculated as profit therein shall be deemed to
have been distributed as dividends amongst the shareholders as at the date of
the general meeting aforesaid and that thereupon the proportionate share
thereof of each shareholder shall be included in the total income of such
shareholder for the purpose of assessing his total income. The Income-tax
Officer was to make such an order only when he was satisfied that the profits
and gains distributed as dividends by any company up to the end of the sixth
month after its accounts for the previous year are laid before the company in
general meeting, were less than 60% of the assessable income of the company and
that payment of a larger dividend would not be unreasonable keeping in view the
losses incurred by the company in the earlier years and of the smallness of the
It will be noticed that the order of the
Income-tax Officer could not be to the effect that the undistributed profits
would be deemed to be the dividend paid to any particular shareholder or
shareholders but could be to the effect that they were distributed as dividends
amongst all the shareholders. The validity of this provision was not questioned
in the case. What was questioned in the case was that the proportionate share
of Baldev Singh, assessee, in such undistributed profits, could not be added to
his total income of the particular year to which it was added. It was held that
in view of the deeming provision with respect to the distribution of profits as
dividends amongst shareholders, the proportionate share of the dividends would
be deemed to be (1) 1 S.C.R. 482.
930 income of the assessee and that
therefore, when it was not taxed, would be deemed to have escaped assessment
for the purposes of s. 34 of the Act. The case is distinguishable on several
grounds. One is that the Income-tax Officer is to make the order when he is
satisfied that a larger dividend could have been justifiably distributed, a
view necessarily leading to the inference that a lower dividend was distributed
in order to escape payment of super tax by shareholders liable to pay such tax.
The other is that the Income-tax Officer was given power to make the order only
when profits less than 60% of the assessable income were distributed as
dividend. This indicates that the company could accumulate profits up to 40% of
the assessable income for reasons which would be deemed to be genuine. This
should lead to the inference that the accumulation of profits with respect to
which no action has been taken under s. 23A was justified and that therefore if
in case a company could spare the money to advance to a shareholder for his
needs, that alone should not lead to the inference that the advance was made to
evade the payment of super-tax by the shareholder. The third point of
distinction, and of significance, is that no individual shareholder is made
liable for tax on an amount of the undistributed profits in excess of his
proportionate share in those profits. The shareholder is not thereby
prejudiced. His income is increased by an amount which he could have
legitimately got from the company if the persons in control had acted
reasonably and had retained such profits undistributed as were necessary for
the purposes of the company.
Another objection taken in Baldev Singh's
case(1) was about the constitutionality of s. 23A on the ground that it
purports to tax the shareholders on the income of the company in which they
held shares, especially when it does not give a right to the shareholders to
realise from the company the dividend which by the order is deemed to have been
paid to them. The section was held to be constitutionally valid as it was
enacted for preventing evasion of tax in view of the conditions of its
applicability. In the circumstances of the cases covered by S. 23A, there was a
reasonable connection between the amount deemed to be distributed as dividend
and the possible attempt for evading payment of super tax. The assessee could
not have been prejudiced if the persons in control of the management of the
company had acted reasonably or actually distributed that amount as profits
subsequent to the order of the Income-tax-Officer.
(1)  1 S.C.R. 482.
931 In Balaji's case(1), the validity of s.
16(3) (a), clauses (i) and (ii), came up for consideration. These clauses
provide that in computing the total income of any individual for the purpose of
assessment there shall be included so much of the income of his wife or minor child
as arises directly or indirectly from the membership of the wife in a firm of
which her husband is a partner or from the admission of the minor to the
benefits of partnership in a firm of which such individual is partner. These
provisions were held valid. The Court left open the question whether A could be
taxed on the income of B and formulated the question for decision as whether s.
16(3) (a), clauses (i) and (ii), is a provision made by the Legislature to
prevent evasion of tax and answered it in the affirmative, as the husband or
the father could nominally take his wife or minor child, in partnership with
him, so that the tax burden may be lightened and as this device enabled the
assessee to secure the entire income of the business and yet evade income-tax
which he would otherwise have been liable to pay.
It was said at p. 999:
"The scope of the provisions is limited
only to a few of the intimate members of a family who ordinarily are under the
protection of the assessee and are defendants of him. The persona selected by
the provisions, namely, wife and minor children, cannot also be ordinarily
expected to carry on their business independently with their own funds when the
husband or the father is alive and when they are under his protection." It
is therefore clear that the basis for holding s. 16(3) (a), clauses (i) and
(ii), valid was that in effect the husband or the father was the real person
who ran the firm and that the others were made partners nominally and therefore
the partnership was not genuine. In this view, there could be no question of
the provisions affecting the husband or the father prejudicially or including
in his income amounts which were not his income. This, however, cannot be said
in the present case or in cases which come within the purview of the impugned
In dealing with the contention that the
provisions of s. 16 (3) (a), clauses (i) and (ii), contravened Art. 14 of the
Constitution, it was said at p. 991 :
"We have held that the object of the
legislation was to prevent evasion of tax. A similar device would not
ordinarily be resorted to by individuals by entering (1) [1962) 2 S.C.R. 983.
Supp. 1/65932 into partnership with persons
other than those mentioned in the sub-section, as it would involve a risk of the
third-party turning round and asserting his own rights. The Legislature,
therefore, selected for the purpose of classification only that group of
persons who in fact are used as a cloak to perpetrate fraud on taxation."
Such a risk is always involved in a company making payments as advances or
loans to a shareholder when it possesses accumulated profits as the other
shareholders run the risk of not getting their proportionate share of profits
which they would have got if they had been really distributed as dividends.
This consideration, again, points to the conclusion that the probability of
such an advance or loan being genuine would be dependent not so much on the
existence of accumulated profits but on the number of shareholders in the
company and the proportion of the number of shares the borrower has to the
total number of shares held by the shareholders of the company. The lesser the
proportion, the greater is the chance of the advance or loan being genuine, as
there would in that case be greater risk of the other shareholders losing their
share in the profits deemed to be distributed as dividends.
I am therefore of opinion that the impugned
sections viz., ss. 2(6A) (e) and 12(1B) of the Act are void and that this
appeal should be allowed.