The Commissioner of Income-Tax, Madras
Vs. Sri Meenakshi Mills Ltd. & Ors [1966] INSC 227 (25 October 1966)
25/10/1966 RAMASWAMI, V.
RAMASWAMI, V.
SHAH, J.C.
BHARGAVA, VISHISHTHA
CITATION: 1967 AIR 819 1967 SCR (1) 934
CITATOR INFO:
E 1969 SC1160 (5) R 1986 SC 1 (4) RF 1986
SC1370 (90) R 1986 SC1483 (4)
ACT:
Indian Income-tax Act (11 of 1922), s.
42-Scope--Finding of fact by Tribunal-Interference by High Court, validity,Corporate
entity, if Court can lift veil-
HEADNOTE:
The assessee-companies, carried on business
in Madurai and each had a branch at Pudukottai, a former native State.
They hold majority share in a Bank which,
too, had its head office at Madurai and branch at Pudukottai. T, who was a
shareholder of the Bank, was the moving figure in the assessee-companies. The
assessees borrowed moneys from the Madurai head office of the Bank on the
security of fixed deposits made by the assessees' branches with the Pudukottai
branch of the Bank. The loans were far in excess of the available profits at
Pudukottai. The Income-tax Officer held that the borrowings in British India on
the security of the fixed deposits made at Pudukottai amounted to constructive
remittance of the profits by the branches of the assessee-companies to their
Head Office in India within the meaning of s. 4 of the Income-tax Act, and this
view the Appellate Assistant Commissioner upheld. The assessees appealed to the
Trbunal which took note that the branch whether of the assessee of the Bank
constituted only one unit, and the establishment of the branch of the Bank at
Pudukottai was intended to help the financial operations of T in the concerns
in which he was interested., and the Pudukottai branch of the Bank had
transmitted funds deposited by the assessees for enabling the Madurai branch to
advance loans at interest to the assessees and the transmission of the funds
was made with the knowledge of assessees. The Tribunal held that the assessees
were rightly assessed. In reference the High Court answered the question in
favour of the assessees holding it was not established that there was any
arrangement between the assessees and the Bank whether at Pudukottai or at
Madurai for transference of moneys from Pudukottai branch to Madurai and the
facts on record did not establish that there was any transfer of funds between
Pudukottai and Madurai for the purpose of advancing moneys to the assessees,
and the transactions represented ordinary banking transactions and there was
nothing to show that the amounts placed in fixed deposits in the branch were
intended to and were in fact transferred to head office for the purpose of
lending them out to the depositor himself. In appeals by the Commissioner, this
Court,
HELD: The appeals must be allowed The High
Court erred in law in interfering with the findings of the appellate Tribunal.
In a reference the High Court must accept the findings of fact reached by the
appellate Tribunal and it is for the party who applied for a reference to
challenge those findings of fact first by an application under s. 66(1). If the
party failed to file an application, under s. 66(1) expressly raising the
question about the validity of the findings of fact, he is not entitled to urge
before the High Court that the findings are vitiated for any reason. [938 H-939
B] India Cements Ltd. v. Commissioner of Income-tax, Madras, 60, I.T.R. 52,
relied on.
935 In the context of the facts as found by
the Tribunal, the entire transactions formed part of a basic arrangement or
scheme between the creditor and the debtor that the money should be brought
into British India after it was taken by the borrower outside the taxable
territory. [940 B-C] Section 42 requires, in the first place, that money should
have been lent at interest outside the taxable territory, in the second place,
income, profits or gains should accrue or arise directly or indirectly from
such money so lent at interest, and in the third place, that the money should
be brought into the taxable territories in cash or in kind. If all these
conditions are fulfilled, then the section lays down that the interest shall be
deemed to be interest accruing or arising within the taxable territories. [939
D] The provision in s. 42(1), which brings within the scope of the charging
section interest earned out of money lent outside, but brought into British
India, was not ultra vires the Indian Legislature on the ground that it was
extraterritorial in operation. [939 F] The section contemplates the bringing of
money into British India with the knowledge of the lender and borrower and this
gives rise to a real territorial connection. This knowledge must be an integral
part of the transaction. [940 A] A. H. Wadia v. Commissioner of Income-tax,
Bombay 17 I.T.R. 63, approved.
In certain exceptional cases the Court is
entitled to lift the veil of corporate entity and pay regard to the economic
realities behind the legal facade. For example, the Court has power to
disregard the corporate entity if it is used for tax evasion or to circumvent
tax obligation. [941 E] Devid Payne & Co. Ltd. in re, Young v. David Payne
& Co., Ltd. [1904] 2 Ch. D. 608. distinguished.
Case law referred to.
CIVIL APPELLATE JURISDICTION : Civil Appeals
Nos. 1084 to 1097 of 1965.
Appeals by special leave from the judgment
and order dated January 8, 1963 of the Madras High Court in Tax Case No. 108 of
1960.
B. Sen, A. N. Kirpal, S. P. Nayyar and R. N.
Sachthey, for the appellant (in all the appeals).
R. Venkataraman and R. Ganapathy Iyer, for
the respondent (in all the appeals).
The Judgment of the Court was delivered by
Ramaswami, J. These appeals are brought, by special leave, from the judgment of
the High Court of Madras dated January 8, 1963 in Tax Case No. 108 of 1960.
All the three respondents (hereinafter called
the assessee companies') are public limited companies engaged in the
manufacture and sale of yam at Madurai. Each of the assessee-companies had a
branch at Pudukottai engaged in the production and 936 sale of cotton yarn. The
sale-proceeds of the branches were periodically deposited in the branch of
Madurai Bank Ltd.
(hereinafter referred to as the 'Bank') at
Pudukottai a former native State either in the current accounts or fixed
deposits which earned interest for the various assessment years as follows:
Assessment years MeenakshiRajendra Saroja
Mills millsmills Rs. Rs. Rs.
---------------------------------------------------1946-47
1,08,902 25,511 1947-48 1,18,791 24,953 30,620 1948-49 1,50,017 33,632 36,890
1949-50 42,36941,393 195-0-51 1,27,314 41,957 42,092 The Bank aforesaid was incorporated
on February 8, 1943 with Thyagaraja Chettiar as founder Director, the Head
Office being at Madurai. Out of 15,000 shares of this bank issued 14,766 were
held by Thyagaraja Chettiar, his two sons and the three assessee-companies as
shown below:
Share holding
1. Thyagaraja Chettiar 1,008
2. Manickavasagam 250
3. Sundaram 250
4. Meenakshi Mills 5,972
5. Rajendra Mills 3,009
6. Saroja Mills 4,177 All the three assessee
companies borrowed moneys from the Madurai branch of the bank and on the security
of the fixed deposits made by their branches with the Pudukottai branch of the
Bank. It is the admitted case that the loans granted to the assessee-companies
were far in excess of the available profits at Pudukottai. In the assessment
proceedings of the assessee-companies for the various years under dispute, the
Income-tax Officer was of the view that the borrowings in British India on the
security of the fixed deposits made at Pudukottai amounted to constructive
remittances of the profits by the branches of the assesseecompanies to their
Head Offices in India within the meaning of s. 4 of the Indian Income-tax Act,
1922 (hereinafter called the 'Act'). Accordingly he included the entire profits
of the assessee-companies including the interest receipts from the Pudukottai
branches in the assessment of the assessee-companies, since the overdrafts
availed of by the assessee-companies in British India far exceeded the
available profits. The assessee-companies appealed to the Appellate Assistant
Commissioner of Income-tax. After examining the constitu937 tion of the
assessee-companies and the Bank and the figures of deposits and overdrafts, the
Appellate Assistant Commissioner found that the deposits made by the assessee companies
and other companies closely allied to them formed a substantial part of the
total deposits received by the Bank. He was also of the view that the
Pudukottai branch of the Bank had transmitted the funds so deposited for
enabling the Madurai branch to advance loans at interest to the
assessee-companies and that the transmissions of the funds were made with the
knowledge of the assessee-companies who were major shareholders of the Bank.
The Appellate Assistant Commissioner also considered that the Pudukottai branch
of the Bank had no other appreciable transactions except the collection of
funds and on the facts found S. 42(1) of the Act applied to the case. The
assessee companies took the matter in appeal to the appellate Tribunal -which
took note of the position that the head office and the branch-whether of the
assessee-companies or of the Bank-constituted only one unit and that Thyagraja
Chettiar occupied a special position in both the concerns and the establishment
of the branch of the Bank at Pudukottai was intended to help the financial
operations of Thyagaraja Chettiar in the concerns in which he was interested.
After detailed consideration of the deposits and overdrafts and the
inter-branch transactions of the Bank the appellate Tribunal held that s. 42(1)
of the Act was applicable to the facts of the case and that the assessee companies
must be attributed with the knowledge of the activity of their branches at
Pudukottai and of the remittances made by the Pudukottai branch of the Bank to
Madurai head office, and that the entire transactions formed part of an
arrangement or scheme.
In the course of its judgment, the appellate
Tribunal observed as follows:
"Even so, it seems to us, we cannot
escape the fact that Thyagaraja Chettiar, his two sons and the three Mills had
a preponderant, if not the whole, voice in the creation, running and management
of the Bank. We cannot also forget that Pudukottai is neither a cotton
producing area nor has a market for cotton; except that it was a non-taxable
territory, there was nothing else to recommend the carrying on of the business
in cotton spinning or weaving there. There is yet another aspect to which our
attention was drawn by the learned counsel for the assessee. That being, a
non-taxable area, there were many very rich men there with an influx of funds
to invest in banks and industries. By the same token, it appears to us it was
not necessary for the Madurai Bank which was after all a creation of certain
people which started with a small capital of Rs. 32,800 to have gone to Pudukottai
for opening a branch. If there was an influx of money in Pudukottai
Sup.C.I./66-14 938 because of the finances, nobody would have agreed to borrow
money from it. At any rate, it is clear it would have had no field for
investment in Pudukottai the only source of investment being outside
Pudukottai." The appellate Tribunal further stated:
"But having regard to the special
position of Thyagaraja Chettiar and the balance sheets of the bank referred to
above and the lack of investments in Pudukottai itself of' the moneys borrowed
there, it seems more reasonable to conclude that the bank itself was started at
Madurai and a branch of it was opened at Pudukottai only with a view to help
the financial operations of Thyagaraja Chettiar and the mills in which he was
vitally interested." At the instance of the assessee-companies the
appellate Tribunal referred the following question of law for the determination
of the High Court:
"Whether on the facts and in the
circumstances of the case, the taxing of the entire interest earned on the
fixed deposits made out of the profits earned in Pudukottai by the assessee's
branches in the Pudukottai branch of the Bank of Madurai is correct?" The
High Court answered the question in favour of the assessee-companies holding
that it was not established that there was any arrangement between the
assessee-companies and the Bank whether at Pudukottai or at Madurai for
transference of moneys from Pudukottai branch to Madurai and the facts on
record did not establish that there was any transfer of funds between
Pudukottai and Madurai for the purpose of advancing moneys to the
assessee-companies.
The High Court further took the view that the
transactions represented ordinary banking transactions and there was nothing to
show that the amounts placed in fixed deposits in the branch were intended to,
and were in fact transferred to head office for the purpose of lending them out
to the depositor himself.
On behalf of the appellant Mr. Sen submitted
at the outset that the High Court was not legally justified in interfering with
the findings of fact reached by the appellate Tribunal and in concluding that
there was no arrangement or scheme between the lender and the borrower for the
transference of funds from Pudukottai to Madurai. In our opinion, there is
justification for the argument put forward on behalf of the appellant and the
High Court erred in law in interfering with the findings of the appellate
Tribunal in this case. In India Cements Ltd., v. Commissioner 939 of
Income-tax, Madras(1) it was pointed out by this Court that in a reference the
High Court must accept the findings of fact reached by the appellate Tribunal
and it is for the party who. applied for a reference to challenge those
findings of fact first by an application under s. 66(1). If the party concerned
has failed to file an application under s. 66(1) expressly raising the question
about the validity of the findings of fact, he is not entitled to urge before
the High Court that the findings are vitiated for any reason. We therefore
proceed to decide the question of law raised in these appeals upon the findings
of fact reached by the appellate Tribunal.
Section 42 of the Act states as follows:
"All income, profits or gains accruing
or arising whether directly or indirectly through or from any money lent at
interest and brought into the taxable territories in cash or in kind shall be
deemed to be income accruing or arising within the taxable territories This
section accordingly requires, in the first place, that any money should have
been lent at interest outside the taxable territory. In the second place,
income, profits or gains should accrue or arise directly or indirectly from
such money so lent at interest, and, in the third place, that the money should
be brought into the taxable territories in cash or in kind. If all these
conditions are fulfilled, then the section lays it down that the interest shall
be deemed to be income accruing or arising within the taxable territories. This
section was the subject-matter of interpretation by the Federal Court in A. H.
Wadia v. Commissioner of Income-tax, Bombay(2) It was held by the majority of
the Judges in that case that the provision in s. 42(1) of the Act, which brings
within the scope of the charging section interest earned out of money lent
outside, but brought into, British India was not ultra vires the Indian
Legislature on the ground that it was extraterritorial in operation. It was
pointed out that the section contemplated the bringing of money into British
India with the knowledge of the lender and borrower and this gave rise to a
real territorial connection. The learned Chief Justice took the view that the
nexus was the knowledge to be attributed to the lender that the borrower had
borrowed money for the purpose of taking it into British India and earning
income on that money. Mukherjea and Mahajan, JJ. took a somewhat different
view. Mahajan, J.
considered that there must be an arrangement
between the lender and the borrower to bring the loan into British India, and Mukherjea,
J. further emphasised the point by stating that it must be the basic
arrangement underlying the transaction that the money should be brought into
British India after it is taken by the borrower outside his territory. But all
(1) 60 I.T.R. 52.
(2) 17 I.T.R. 63.
940 the learned Judges agreed that the
knowledge of the lender and the borrower that the money is to be taken into
British India must be an integral part of the transaction. That is the ratio of
the decision of the Federal Court with regard to the construction of s. 42(1)
of the Act.
Having examined the findings of the appellate
Tribunal in the present case we are satisfied that the test prescribed by the
Federal Court in Wadia's case(1) is fulfilled and the appellate Tribunal was
right in its conclusion that there was a basic arrangement or scheme between
the assesseecompanies and the Bank that the money should be brought into
British India after it was taken by the borrower outside the taxable territory.
The appellate Tribunal has pointed out that the assessee-companies had a
preponderant, if not the whole, voice in the creation, running and management
of the Bank and that Pudukottai was neither a cotton producing area nor had it
a market for cotton and except that it was a nontaxable territory there was
nothing else to recommend the carrying on of the cotton spinning or weaving
business there. The Tribunal further remarked that having regard to the special
position of Thyagaraja Chettiar and the balance sheets of the Bank and lack of
investments in Pudukottai, it was reasonable to conclude that the Bank itself
was started at Madurai and a branch was opened at Pudukottai only with a view
to helping the financial operations of Thyagaraja Chettiar and the mills in
which he was vitally interested.
The Tribunal found that Pudukottai branch of
the Bank had transmitted funds deposited by the assessee-companies for enabling
the Madurai branch to advance loans at interest to the assessee,companies and
the transmission of the funds was made with the knowledge of the
assessee-companies who were the major shareholders of the Bank. In the context
of these facts it must be held that the entire transactions formed part of a
basic arrangement or scheme between the creditor and the debtor that the money should
be brought into British India after it was taken by the borrower outside the
taxable territory. We are accordingly of the opinion that the principle laid
down in Wadia's(1) case is satisfied in this case and that the Income-tax
authorities were right in holding that the entire interest earned on fixed
deposits was taxable.
In the course of argument Mr. Venkataraman
contended that even if Thyagaraja Chettiar, a Director of the assesseecompanies,
knew in his capacity as Director of the Madurai Bank that money placed in fixed
deposit by the assesseecompanies would be transferred to the taxable territory,
that knowledge cannot be imputed to the assessee-companies and so it cannot be
said that the transfer was part of an integral arrangement of the loan
transaction. In support of this argument learned Counsel referred to the
decision. of the Court of Appeal in David Payne & Co. Ltd., In re. Young v.
(1) 17 I.T.R. 63.
941 David Payne & Co. Ltd.,(1) We are
unable to accept the argument of the respondents as correct. The decision in
David Payne & Co's (1) case, has no bearing on the question presented for
determination in the present case. In David Payne & Co's (1) case, supra,
the question at issue related to the powers and duties of Directors and it was
held that because the same person is a common director of two companies, the
one company has not necessarily notice of everything that is within the
knowledge of the common director, which knowledge he has acquired as director
of the other company. In the present case the question at issue is entirely
different. The appellate Tribunal has, upon examination of the evidence, found
that the transference of funds from Pudukottai to Madurai was made as part of
the basic arrangement between the Bank and the assesseecompanies and that
Thyagaraja Chettiar who was the moving figure both in the Bank and in each of
the assessee companies had knowledge of this arrangement. It is well
established that in a matter of this description the Incometax authorities are
entitled to pierce the veil of corporate entity and to look at the reality of
the transaction. It is true that from the juristic point of view the company is
a legal personality entirely distinct from its members and the company is
capable of enjoying rights and being subjected to duties which are not the same
as those enjoyed or borne by its members. But in certain exceptional cases the
Court is entitled to lift the veil of corporate entity and to pay regard to the
economic realities behind the legal facade.
For example, the Court has power to disregard
the corporate entity if it is used for tax evasion or to circumvent tax
obligation. For instance, in Apthorpe v. Peter Schoenhofen Brewing Co.(2) the
Income Tax Commissioners had found as a fact that all the property of the New
York company, except its land, had been transferred to an English company, and
that the New York company had only been kept in being to hold the land, since
aliens were not allowed to do so under New York law. All but three of the New York
company's shares were held by the English company, and as the Commissioners
also found, if the business was technically that of the New York company, the
latter was merely the agent of the English company. In the light of these
findings the Court of Appeal, despite the argument based on Salomon'S(3) case,
held that the New York business was that of the English company which was
liable for English income tax accordingly. In another case-Firestone Tyre and
Rubber Co. v. Llewellin(4)--an American company had an arrangement with its
distributors on the Continent of Europe -whereby they obtained supplies from
the English manufacturers, its wholly owned subsidiary. The English company
credited the American with the price received after deducting the costs plus 5
(1) [1904] 2 Ch. D. 608.
(3) [1897] A.C. 22.
(2) 4 T.C. 41.
(4) [1957] 1 W.L.R. 464.
942 per cent. It was conceded that the
subsidiary was a separate legal entity and not a mere emanation of the American
parent, and that it was selling its own goods as principal and not its parent's
goods as agent.
Nevertheless, these sales were a means
whereby the American company carried on its European business, and it was held
that the substance of the arrangement was that the American company traded in
England through the agency of its subsidiary. We, therefore, reject the
argument of Mr.
Venkataraman on this aspect of the case.
For the reasons expressed we hold that the
question referred to the High Court by the appellate Tribunal must be answered
in favour of the Income-tax Department and against the respective
assessee-companies and these appeals must be allowed with costs.
Y.P.
Appeals allowed.
Back
