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TMI Blog1956 (4) TMI 65X X X X Extracts X X X X X X X X Extracts X X X X ..... ch of the petitioners was liable to treat as part of his income, assessable in the year of assessment 1950-51 a sum of ₹ 16,411 (the dividend on 1350 shares) and pay income-tax on that basis under section 23A. Notices were issued to the petitioners under section 34 of the Act on 23rd March, 1955, and they were asked to show cause against revised assessment for the assessment year 1950-51. Each of the petitioners applied under article 226 of the Constitution for the issue of a writ of prohibition, to restrain the Departmental Authorities from taking any further proceedings to assess the petitioners under section 34. Though an interim stay of further proceedings was first granted, those orders were modified to permit the Department to complete the assessment within the period of limitation prescribed by section 34 of the Act. The learned counsel for the respondents, the Departmental Authorities, then represented that completion of the assessment during the pendency of the proceedings in this Court under article 226 would not be pleaded in bar of the investigation of the alleged invalidity of the initiation of proceedings under section 34 of the Act with the notices dated 23rd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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." The trouble, loss to the country's exchequer, was the same whether the company was controlled by one man or by a numerically larger group of persons, as distinct from the companies in which the public were substantially interested. In this class of controlled companies the company was a juristic person distinct from the shareholders who were each a separate juristic entity. The liability to tax on income was not the only legal obligation, to define and impose which Legislatures and Courts have been called upon in various countries to look at the human individuals covered by the mask of a juristic person like the company. Friedmann has discussed some aspects of this problem in his "Legal Theory", 3rd Edn., page 400. We are however concerned now only with the case in which the device of a corporate personality is used for evasion of tax obligations. The levy of Federal Income-tax in the United ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act to impose a separate penalty on the corporation; here the corporate entity was not ignored, but an additional tax burden was placed upon corporations . . . ." The learned author then referred to the change effected by the 1924 Act: "Furthermore, it offered an alternative remedy, viz. , the shareholders could agree with the Commissioner that tax could be levied on their distributive shares as if there were no corporation but rather a partnership or personal service corporation, and in that event there was no tax upon the corporation as such." After setting out the subsequent legislative history, the author recorded at page 335 : "The 1938 Act, which enacted what is substantially the present Code provision, continued the policy of levying a special tax on corporations formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation." One of the changes effected by the 1938 Act was : It was provided that the earnings or profits are accumulated beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax unless the corporation by th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of tax liability. Section 23A was included in the Indian Income-tax Act by the Amending Act XXI of 1930. As enacted in 1930, the relevant portions of clauses (1) and (2) of section 23A ran : "(1) Where the Income-tax Officer is satisfied that any firm or other association of individuals carrying on any business, other than a Hindu undivided family or a company, is under the control of one member thereof, and that such firm or association has been formed or is being used for the purpose of evading or reducing the liability to tax of any member thereof, he may, with the previous approval of the Assistant Commissioner, pass an order that the sum payable as income-tax by the firm or association shall not be determined, and thereupon the share of each member in the profits and gains of the firm or association shall be included in his total income for the purpose of his assessment thereon. (2) Where the Income-tax Officer is satisfied that a company is under the control of not more than five of its members and that its profits and gains are allowed to accumulate beyond its reasonable needs, . . . . without being distributed to the members, or that a reasonable part of its prof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a portion of a company's net income of the previous year was not distributed as dividends, the Income-tax Officer was bound in the circumstances specified in the section to make an order in writing that the undistributed income of the company should be deemed to have been distributed amongst the shareholders, and thereupon the proportionate share thereof of each shareholder was included in the total income of such shareholder for the purpose of assessing his total income. The Income-tax Officer had to apportion the undistributed profit among the shareholders who would have received it, and in the proportions in which they would have received it, if the whole amount had been distributed by the company by way of dividend in accordance with the rights of the members as defined in the memorandum and articles of association of the company. Thus this section in effect created fictional or notional dividend income which was not in fact received by the shareholder. The notional dividend was deemed to have been distributed as on the date on which the accounts of the previous year were laid before the company in general meeting. An order made under this section was not itself an ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion. It creates a notional income, which is wholly artificial, and which does not in fact exist in the pocket of any shareholder. Within the terms of that section this artificial income is to be deemed to have been distributed……We are not dealing with any thing concrete as no distribution has in fact taken place and no share holder has in fact received any income." Apart from the tax levied on the profits of a company, undisbursed profits of controlled companies have come in for a special levy of income-tax. The incidence of that tax was but incidental to that levy. In America the incidence first fell on the shareholder. Subsequently the incidence was shifted to the company. That was virtually the legislative pattern the Indian Legislature followed. Till 1955 the incidence was on the shareholder. Now it is on the company. In America for a time the shareholder could elect to bear the burden of the tax. That alternative has not so far been provided in the Indian statutes in that form. But it should be remembered that, though the incidence of the tax up to 1955 was on the shareholder, provision was made in section 23A(3) as it stood during that period for the colle ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lem of legislative competence, as if the power to enact section 23A in 1939 has to be tested with reference to the entry 54 in List I of the 7th Schedule to the Government of India Act, 1935. In Amina Umma v. Income-tax Officer [1954] 26 ITR 137, the learned judges quoted with approval the well settled rule of construction that was explained by Chagla, C.J., in Duggan v. Commissioner of Income-tax, Bombay City [1952] 21 ITR 458, at 463: "It is well settled now that a large and liberal interpretation must be placed upon all entries in the 7th Schedule of the Government of India Act, and that the widest import and significance must be given to the language used by Parliament in these various entries. It must not be forgotten that the Legislature created by the Government of India Act was a sovereign Legislature within its own sphere, and that, when a topic was assigned to a particular Legislature in respect of which it could legislate, then all possible powers with regard to that topic must be attributed to that Legislature." It was that principle that was reaffirmed by the Supreme Court in Navinchandra Mafatlal v. Commissioner of Income-tax, Bombay City [1954] 26 ITR 7 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fits, which constituted a part of the net profits of the company would still be a statutory provision to tax income. Legislative power to provide for a further levy on the same income, the income of the company, could not be denied. Whether the constitutional validity of such a levy could be challenged on other grounds would be a different problem. The expediency of such an additional levy is a problem which the Courts could not decide. So, what section 23A did was, in essence, to tax income, the income of the company. Only, the incidence of that tax was not on the company in the first instance but on the shareholder, who had no doubt no legal right to get his share of the un-disbursed profits of the company. Had the Legislature the competence in 1939 to provide for such an incidence would appear to be the real question. To what extent the incidence of the tax affects the question of legislative competence to levy the tax was discussed in a judgment of this Court, to which one of us was a party in Amina Umma v. Income-tax Officer [1954] 26 ITR 137. After referring to the observations of Viscount Finlay in John Smith and Son v. Moore [1930] 12 Tax Cas. 266, at 285, the judgment pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [1954] 26 ITR 758 ; [1955] 1 SCR 829 at 836 where he pointed out : "that the word income should be construed to extend the power to all ancillary or subsidiary matters which can fairly and reasonably be said to be comprehended in it. The legislative measures designed to prevent evasion of a tax on income would thus be within the scope of the legislative power to tax income." It was on Eisner v. Macomber 64 Law. Ed. 521, that Mr. Jagadisa Aiyar, learned counsel for the petitioners, relied to a considerable extent to support his contention that undisbursed profits in the hands of the company, of which the petitioners were shareholders, did not become income at all in the hands of the petitioners. He contended further that, if it was not the assessee's income, the legislature could not validly levy a tax on that sum treating it as "income" within the scope of entry 54 in List I. The question for decision in Eisner v. Macomber15 was formulated in these words : "This case presents the question whether, by virtue of the 16th Amendment, Congress has the power to tax, as income of the stockholder ………..a stock dividend made lawfully and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Court, in the negative. The law there in question, no doubt, differs from ours; but the luminous reasoning of Pitney, J., in that case is relevant to the question now under consideration, and compels my assent." Whether undisbursed profits of a company of a given year, and a controlled company at that, could fall within the scope of the term "income", and whether a proportionate share of those undisbursed profits, ascertained not by the company but by a Taxing Officer, could be treated notionally by the Legislature as the income of the shareholder, were not the questions that specifically arose for decision in Macomber's case (supra). No doubt Pitney, J., pointed out at page 533 : "………the government………..insisted as an alternative that, by the true construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon the stockholder's share of the undivided profits previously accumulated by the corporation ; the tax, being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the Act be constitutional ?" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nded to a case of notional distribution of undisbursed profits without the issue of a stock certificate. He contended that the position of a shareholder should not be worse if no scrip was issued. But this argument overlooks that the undisbursed profits, for taxing which section 23A provided, did not constitute capital accretions either in the hands of the company or notionally even with reference to the shareholder. The learned Advocate-General urged that the basic principle that underlay the decision in Macomber's case (supra), that distribution of accumulated profits of a company by the issue of stocks amongst its shareholders would only increase the value of the capital of the shareholder and would not represent a receipt of income by the shareholder of that company, could not apply to this country, in view of the decision of our Supreme Court in Navinchandra Mafatlal v. Commissioner of Income-tax, Bombay City [1954] 26 ITR 758; [1955] 1 SCR 829 where it was held that capital gains which became taxable under section 12B of the Act also fell within the scope of income in entry 54 of List I. At page 837 of the judgment of the Supreme Court, the learned Judge referred to Maco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... corporation, as was done by section 104. The penal nature of the imposition does not prevent its being valid, as the tax was otherwise permissible under the Constitution." The learned Advocate-General referred to cases where English Courts have upheld such a levy on undisbursed profits of controlled companies. But then they may not be of direct assistance to us in answering the question of legislative competence of the Indian Legislature to enact section 23A. As we pointed out, undisbursed profits constituted income, and section 23A taxed that income. The machinery for taxing that income involved the creation of the legal fiction that the proportionate share of those undisbursed profits was the income of the shareholder. He was assessed on that income. The primary incidence of the tax was on the shareholder. Section 23A(3) provided for an alternative incidence on the company itself. Neither of those provisions for the incidence of the tax altered the nature of the tax. It was still a tax on income, and that was well within the scope of entry 54 of List I of the 7th Schedule of the Government of India Act, 1935. Amina Umma v. Income-tax Officer [1954] 26 ITR 137 is a direct a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion by a person or group of persons by resort to the device of a corporate personality. The income does in reality belong to them, and is under their control all the time. The evasion of liability to super-tax is equally real. That in such companies there might be an individual member or two in a minority unable to force a factual distribution at any given point of time, cannot affect the reality of the situation which section 23A was designed to meet. The basic assumption that underlies section 23A is the identity of the interests of the shareholders and the controlled company. That assumption is founded on reality. The shareholder created a veil of a corporate personality as legally distinct from his juristic personality. That was legal. The Legislature countered that with a legal fiction. That was also legal. If both are forgotten the taxpayer and the tax gatherer proceed on the realities of the situation. The profits are taxed. We should like to guard ourselves against being understood to imply that unless the statutory fiction also corresponds to reality-it is almost a self-contradicting statement-the legal fiction would be beyond the legislative competence of the Legislature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is class of assessment under section 23A. We have already adverted to the substantial identity of interest of the controlled company and its shareholders. The company is entitled to notice. It is entitled to appeal against the order passed under section 23A. These provisions safeguard the interests of the shareholders as effectively, as provision for notice to the shareholder and a right of appeal separately conferred upon him would have done. Even if it is the form and not the substance alone that matters, the apparent discrimination is not, in our opinion, an unconstitutional discrimination. The third proviso to section 30(1) runs : "Provided further that a shareholder in a company in respect of which an order under section 23A has been passed by an Income-tax Officer, may not in respect of matters determined by such order appeal against the assessment of his own total income." The scope of the restricted right of appeal under this proviso was examined at length by Chagla, C.J., and Tendolkar, J., in Navinchandra Mafatlal v. Commissioner of Income-tax, Bombay City [1955] 27 ITR 245. It should be needless to set out that discussion over again. As the learned Advoca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 23A. What we have said about the restriction on the shareholder's right of appeal will apply also to the absence of a provision for a notice to the shareholder apart from the company before an order is passed under section 23A. The identity of interest runs through all the stages from that of accumulation of undisbursed profits to that of final payment of tax either by the shareholder in his own name or in the name of the company under clause (3) of section 23A. Mr. Jagadisa Aiyar complained that there was no specific provision for a shareholder to get his individual order of assessment corrected, if the appeal against the order passed under section 23A preferred in the name of the company succeeded in whole or in part. That was an additional ground on which he sought to sustain the charge of discrimination. The learned counsel apparently overlooked the specific provision made by the Act in section 35(7) for correction and rectification of such errors. We have refrained from examining the position, whether, even if the third proviso to section 30(1) was discriminatory and that that discrimination was unconstitutional, that would affect the validity of the liability of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of any tax liability imposed upon him, except where the matter is one such that a hearing thereon can have no effect upon the decision on any of these factors." The limitations of an appeal to the doctrine of due process in considering the constitutional validity of statutory provisions in this country have been explained by the Supreme Court. Independent of the authority of law which article 265 of our Constitution requires, there is no scope for the application of the doctrine of due process as it is understood in America. We are of opinion that section 23A does not infringe any fundamental right of the petitioners and the ban imposed by article 13 of the Constitution does not apply. We do not consider it necessary to consider whether, independent of the petitioner in W.P. No. 575 of 1955, the petitioner (Mr. Spencer) in W.P. No. 574 of 1955 could invoke article 19(1)(f) of the Constitution. The next question is whether section 34 of the Act could apply to either of the petitioners. We shall first set out the relevant dates. The account year of the petitioners ended on 31st March, 1950, and the relevant assessment year ended on 31st March, 1951. The undisbursed profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ider it quite necessary to express any agreement of ourselves with that view. It is a realm of fiction we have to deal with, a valid legal fiction, but none-the-less a fiction. What are the limits of that fiction ? Do they exclude the application of section 34 ? As a result of the legal fiction enacted by section 23A, the share income of the undisbursed profits of the company accrued to the petitioners on 23rd December, 1949. That income was not taxed in the hands of the petitioners in the assessment year 1950-51. Learned counsel for the petitioners urged that the mere factum of non-assessment in 1950-51 was not enough to establish that there was an escape of assessment in that year within the meaning of section 34. He relied on the observations of their Lordships of the Privy Council in Sir Rajendranath Mukherjee v. Commissioner of Income-tax, Bengal [1934] 2 ITR 71 at 77. Dealing with the argument, if an assessment is not made on income within the tax year then that income has escaped assessment within that year, and can be subsequently assessed only under section 34 within the prescribed period of limitation, their Lordships observed : "This involves reading the expres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as that the income in question accrued on 23rd December, 1949. It was a notional income. It was a fictional income. But none-the-less the effect of the fiction was an accrual on 23rd December, 1949. If there had been an accrual on 23rd December, 1949, the amount should have been assessed in the relevant assessment year. It was not assessed. The original assessment proceedings were not pending on the date notice was issued under section 34. It was therefore, in our opinion, a case of escaped assessment which fell within the scope of section 34(1)(b). The learned Advocate-General invited our attention to the observations of Jagannadhadas, J., in Chatturam Horilram Ltd. v. Commissioner of Income-tax [1955] 27 ITR 709 at 717. Commenting on the statutory provision that the Indian Finance Act of 1939 shall be deemed to have come into force in the area to which this Regulation extends on the 30th day of March, 1939, the learned Judge observed: "By virtue of this deeming provision the Indian Finance Act of 1939 must be assumed even factually to have come into operation on the date specified and the tax must be taken to have become chargeable in that very year, though the actual lia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g on the facts and circumstances on which assessment had been made or relief granted…….." As a fact no doubt it was on the subsequent event, the order under section 23A dated 11th March, 1955, that proceedings were initiated under section 34 against the petitioners. But then, we have also to give effect to the legal fiction enacted by section 23A. Once again we have to refer to that legal fiction enacted by section 23A and we have to equate it to a factual accrual on 23rd December, 1949. In that sense, it was not a case of a subsequent event at all. We respectfully agree with the final conclusion of the learned judges who decided Navinchandra Mafatlal v. Commissioner of Income-tax, Bombay City [1955] 27 ITR 245 and we hold that the claim of the Department to reopen the assessment for 1950-51 in the case of the petitioners came within the purview of section 34(1)(b) of the Act. The last contention of the learned counsel for the petitioners was that in any event, the notice dated 23rd March, 1955, issued under section 34 of the Act was barred by limitation. The fallacy that underlay this plea was, that the period of four years for which section 34(1) provided wa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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