Rental income and capital gains of a foreign company cannot be taxed as the personal income of Indian resident shareholders.

The respondents, an Indian resident couple, held a 40% combined shareholding (with their daughters holding the remaining 60%) in Carmichael Capital Limited (CCL), a company incorporated in the British Virgin Islands

CCL purchased three residential properties in London using investment from the respondents (remitted via the RBI’s Liberalized Remittance Scheme) and bank loans from HSBC UK

Following a search on March 2, 2017, the Assessing Officer (AO) discovered documents regarding the upkeep and leasing of these properties

The AO "pierced the corporate veil," concluding that the respondents were the "real beneficial owners" of the assets and taxed CCL’s rental income and capital gains in the respondents' individual hands

The Income Tax Appellate Tribunal (ITAT) reversed this, holding the income was not assessable to the shareholders

Whether the Assessing Officer was legally justified in taxing rental income and capital gains arising from properties owned by a foreign company in the hands of its Indian resident shareholders by applying the "substance over form" doctrine.

The court primarily applied the principle that a company is a juristic person and a separate legal entity from its members, as codified in Section 9 of the Companies Act, 2013

The court relied on the Supreme Court precedents of McDowell & Co. Ltd. v. CTO, Union of India v. Azadi Bachao Andolan, and Vodafone International Holdings BV v. Union of India, which establish that taxpayers may arrange their affairs to minimize tax liability and that the "piercing of the corporate veil" or "substance over form" principle can only be invoked if the Revenue establishes that a transaction is a sham or fraudulent

The court also noted that fiscal statutes must be interpreted strictly, and liability cannot be created through deeming fictions not present in the Income Tax Act, 1961

The Court observed that the investment in CCL was made through legal banking channels and approved under the RBI’s Liberalized Remittance Scheme (LRS), indicating a valid investment rather than a sham

The Court rejected the AO's attempt to apply "substance over form," noting that CCL was a distinct legal entity that owned the properties and had already paid applicable taxes in the United Kingdom

The Court reasoned that shareholders own shares, not the company’s underlying assets; therefore, the company's income cannot be treated as the shareholders' income unless it is distributed as dividends

It further held that the documents found during the search regarding property maintenance were insufficient to prove the company was a mere "cover," as shareholders naturally take an interest in their investments

Consequently, the Revenue failed to prove the structure was a fraudulent device for tax evasion

The Court affirmed the Tribunal's decision, ruling that the AO's attempt to pierce the corporate veil was misplaced and lacked statutory backing under the Act of 1961. The appeals by the Revenue were dismissed