Full Judgment Text
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 8
PETITIONER:
THE COMMISSIONER OF INCOME-TAX, MADRAS
Vs.
RESPONDENT:
SRI MEENAKSHI MILLS LTD. & ORS.
DATE OF JUDGMENT:
25/10/1966
BENCH:
RAMASWAMI, V.
BENCH:
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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 8
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 Commis-
sioner, 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 extra-
territorial 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.
JUDGMENT:
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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 8
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 aassessee-
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 assessee-
companies 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 constitu-
937
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 8
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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 8
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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 8
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 extra-
territorial 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 assessee-
companies 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 non-
taxable 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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 8
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 assessee-
companies, knew in his capacity as Director of the Madurai
Bank that money placed in fixed deposit by the assessee-
companies 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 assessee-
companies 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 Income-
tax 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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 8
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 Com-
missioners 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.
943