TMI Blog1964 (10) TMI 16X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. In our opinion, it would be difficult to hold that in making the fiction, the legislature has travelled beyond the legislative field assigned to it by entry 82 in List I. In our opinion, there is no scope for arguing that the fundamental rights of the shareholder under article 19(1)(f) and (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 contravenes article 19(1)(f) and (g). There is obviously no scope for suggesting that the impugned provision contravenes article 14. Appeal dismissed. - C.A. 45 OF 1964 - - - Dated:- 28-10-1964 - Judge(s) : P. B. GAJENDRAGADKAR., K. N. WANCHOO., M. HIDAYATULLAH., RAGHUBAR DAYAL., J. R. MUDHOLKAR JUDGMENT [The judgment of Gajendragadkar C. J., Wanchoo, Hidayatullah and Mudholkar JJ. was delivered by Gajendragadkar C.J. Raghubar Dayal J. delivered a separate judgment.] GAJENDRAGADRAR C.J.--This appeal arises from a writ petition filed by the appellant, Navnit L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by a company, not being a company, in which the public are substantially interested within the meaning of section 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--... (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 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 section 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 g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 impupugned 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 and Civil Expenditure gave 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 realised by the Government that unless such a step was taken, the operation of section 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en tax 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 emphasise that the entries in the Lists cannot be read in a narrow or restricted sense, and as observed by Gwyer C.J. in United Provinces v. Atiqa Begum, 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 tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n clearly enunciated by Gwyer C. J. in In re Central Provinces and Berar Sales of Motor Spirit and Lubricants Taxation Act, 1938. " 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 section 23A of the Act. In Sardar Baldev Singh v. Commissioner of Income-tax 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) and (c) of the said sub-sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, made section 23A invalid. This argument was repelled by this court on the ground that, the obvious intention of section 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 infructuous by ingenious contrivances. It would be noticed that section 23A wanted to deal with a situation where share holders did not deliberately distribute the accumulated profits as dividends amongst themselves. Section 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 is that the income which technically belonged to the company, was treated as income belonging to the share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olled 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 profits 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 realised 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 section 23A. It will be remembered that an advance or loan which falls within the mischief of the impugned section is advance or loan made by a company which does not normally deal in money-lending, and it is made with the full knowledge of the provisions contained in the impugned section. The object ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... racted 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 ". 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 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ht in coming to the conclusion that the impugned section is not beyond the legislative competence of the legislature. Then it is argued by Mr. Pathak that the impugned provision contravenes the appellant's fundamental rights under article 19(1)(f) and (g) and is not saved by clauses (5) and (6) of the said article. It is not easy to appreciate this argument. Article 19(1)(f) recognises the right of a citizen to acquire, hold and dispose of property and article : 19(1)(g) recognises the right to practise any professional 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 the 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Commissioner of Income-tax 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 I, Seventh Schedule to the Constitution), in determining whether the imposition of a tax under the head " capital gains" by the Central Legislature, was ultra vires. Section 12B inserted in the Income-tax Act by the Indian Income-tax and Excess Profits Tax (Amendment Act, 1947 (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 incl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iz., Merchants' Loan and Trust Co. v. Smietanka and United States v. Stewart cases, which dealt with the taxation of gains from the sale of capital assets. The question in the Australian case, viz., Resch v. Federal Commissioner of Taxation, was about the validity of the provision in the income-tax legislation to the effect that distribution of profits in the course of the 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 taxpayer, without distinguishing whether the profit or gain should be regarded as a receipt on capital or on income or revenue account. 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in excess of his proportionate share is 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 adhoc 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 I, Seventh Sch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 08 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 or loan is not treated as dividend received by the borrower-shareholder. Imposition of a tax is a restriction on the right of an assessee 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring 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 was concerned about the validity of the provisions of section 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 per cent. of the assessable income of the company and that payment of a larger ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 was about the constitutionality of section 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 section 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. In Balaji's case the validity of section 16(3)(a), clauses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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