TaxTMI 
TaxTMI 
1964 (10) TMI 16
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....fter referred to as the company). The value of each share is Rs. 100. The business of the company is to supply electricity to the residents of Malegaon. Some time during 1955, the appellant took a loan amounting to over Rs. 4 lakhs from the company. A notice was issued to the appellant by the 8th Income-tax Officer under section 22(2) of the Act calling upon him to make his return for the assessment year 1956-57. The Income-tax Officer computed his income at Rs. 3,58,460. This amount included a sum of Rs. 2,83,126 representing the accumulated profits of the company. The Income-tax Officer took the view that under section 2(6A)(e) the said amount must be deemed to be dividend received by the appellant and, as such, must be included in the total income of the appellant as income from other sources within the meaning of section 12(1B) of the Act. This order was challenged by the appellant by preferring an appeal before the Appellate Assistant Commissioner. The appeal, however, failed and was dismissed. The appellant then preferred a second appeal before the Income-tax Appellate Tribunal. Whilst this appeal was pending before the said Tribunal, the appellant moved the High Court under ....
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.... the previous year relevant to the assessment year ending on the 31st day of March, 1956, if such loan or advance remained outstanding on the first day of such previous year. Both these provisions, viz., section 2(6A)(e) and section 12(1B), were introduced in the Act by the Finance Act, 1955 (15 of 1955), which came into operation on the 1st of April, 1955. It is thus clear that the combined effect of these two provisions is that three kinds of payments made to the shareholder of a company to which the said provisions apply, are treated as taxable dividend to the extent of the accumulated profits held by the company. These three kinds of payments are: (1) payments made to the shareholder by way of advance or loan ; (2) payments made on his behalf ; and (3) payments made for his individual benefit. There are five conditions which must be satisfied before section, 12(1B) can be invoked against a shareholder. The first condition is that the company in question must be one in which the public are not substantially interested within the meaning of section 23A as it stood in the year in which the loan was advanced. The second condition is that the borrower must be a shareholder at th....
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....d the idea was not to affect such transactions and not to bring them within the mischief of the new provision. The officers were, therefore, asked to intimate to all the companies that if the loans were repaid before the 30th June, 1955, in a genuine manner, they would not be taken into account in determining the tax liability of the shareholders to whom they may have been advanced. In other words, past transactions which would normally have attracted the stringent provisions of section 12(1B) as it was introduced in 1955, were substantially granted exemption from the operation of the said provisions by making it clear to all the companies and their shareholders that if the past loans were genuinely refunded to the companies, they would not be taken into account under section 12(1B). Section 12(1B) would, therefore, normally apply to loans granted by the companies to their respective shareholders with full notice of the provisions prescribed by it. Mr. Pathak for the appellant contends that the impugned provision is constitutionally invalid, because it is beyond the legislative competence of Parliament. He argues that entry 82 in List I of the Seventh Schedule which deals with " ....
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.... Government of India Act, 1935. Section 12B of the Indian income-tax Act, 1922, which had been inserted in the said Act by Act XXII of 1947, had imposed tax on " capital gains ". The validity of this provision was challenged on the ground that capital gains cannot be treated as income within the meaning of entry 54. This plea was rejected by this court on the ground that the words used in a constitutional enactment conferring legislative powers ought to be construed most liberally and in their widest amplitude. Adopting this approach, Das J., as he then was, speaking for the court, observed that the word " income " used in the said entry must be given its ordinary, natural and grammatical meaning and that was, income is a thing that comes in. On this view, the court found no difficulty in coming to the conclusion that income would include capital gains. If the traditional sense of income had been accepted, then, of course, capital gains could not be treated as income. That, in fact, was the argument which was pressed by Mr. Kolah who appeared for the appellant. " If we hold ", observed the learned judge, " as we are asked to do, that the meaning of the word ' income ' has become ri....
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....ce of super-tax by shareholders of a company in which the public are not substantially interested. As is well known, the rates of super-tax applicable to companies are much lower than the rates applicable to individual assessees. The legislature thought that individuals tried to avoid the payment of super-tax at a higher rate by transferring to a private limited company in return for shares the sources of their income, and then the profits made by the company were allowed to accumulate in the hands of the company, dividends not being declared, and the said profits would ultimately be distributed in a capital form by one device or another. The object of section 23A was to defeat such attempts. The main effect of the provisions of section 23A appears to be that a company should not accumulate more than 40 per cent. of its net profits to build up reserves or to provide for capital expenditure. It will be recalled that section 2(6A) has taken within the definition of " dividend the accumulated profits of such companies ; and so, section 23A attempts to reach such accumulated profits for the purpose of taxation. The argument which was urged before this court in the case of Sardar Bald....
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.... and three minor sons under section 16(3)(a)(i) and (ii) of the Act. The validity of this provision was challenged on the ground that the impugned section purported to tax a person for the income of other persons, namely, his wife and minor sons. In rejecting the contention raised against the validity of the impugned section, this court held that the entries in the Legislative Lists are not powers but fields of legislation and the widest import and significance should be attached to them. On this view the conclusion reached by this court was that entry 54 of the Federal Legislative List covered legislation like section 16(3)(a)(i) and (ii), because it was intended to prevent evasion of tax. It appears from the judgment that the validity of the said section was also challenged on the ground that it contravened articles 14 and 19(1)(f) and (g) of the Constitution. This plea was also rejected. One of the considerations which weighed with the court in repelling the said plea was that the additional payment of tax made on the income of the wife or the minor children would ultimately be borne by them in the final accounting between them. Having regard to this consideration and bearing in....
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....emed to have received the said amount out of the accumulated profits and would be liable to pay tax on the basis that he has received the said loan by way of dividend. It is clear that when such a device is adopted by a controlled company, the controlling group consisting of shareholders have deliberately decided to adopt the device of making a loan or advance. Such an arrangement is intended to evade the application of section 23A. The loan may carry interest and the said interest may be received by the company ; but the main object underlying the loan is to avoid payment of tax. It may ultimately be repaid to the company and when it is so repaid, it may or may not be treated as part of accumulated profits. It is this kind of a well-planned device which section 12(1B) intends to reach for the purpose of taxation. It appears that such a device is adopted by private companies in many countries. Simon has referred to this device in these words : " Generally speaking, sur-tax is charged only on individuals, not on companies or other bodies corporate. Various devices have been adopted from time to time to enable the individual to avoid surtax on his real total income or on a portio....
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.... regard to the fact that the legislature was aware of such devices, would it not be competent to the legislature to devise a fiction for treating the ostensible loan as the receipt of dividend ? 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. It is, however, urged by Mr. Pathak that while providing for such a fiction, the legislature should have required the Income-tax Officer to consider in each case whether the loan was genuine, or was the result of a device ; and he argues that since no such provision has been made and a uniform presumption by fiction is sought to be raised, the legislature has gone beyond its legislative competence. In support of this argument, Mr. Pathak has referred to the fact that under section 108(1) of the Commonwealth Income-tax Act it is provided that the amount paid to the shareholder by way of advance or loan can be taxed if in the opinion of the Commissioner it represents distributions of income. Such a provision would have made the impugned section v. and. Mr. Pathak argues that omission of Parliament to exclude from the opera....
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....the use of the amount subject to the payment of interest. The company receives interest, the shareholder enjoys the use of the money, and in the process the payment of due tax is evaded. That is the assumption made by the legislature in making this provision. How can it be urged that either the shareholder who is taxed, or the other shareholders who deliberately make the advance to a colleague of theirs, are unfairly dealt with by the impugned provision. 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 ; and in fact Mr. Pathak has not raised this point before us. In that connection, he himself fairly invited our attention to the decision of the Madras High Court in K. M. S. Lakshmana Aiyar v. Additioital Income-tax Officer, Special Circle, Madras, where the challenge to the validity of the impugned section on the ground tha....
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....August 5, 1909, which imposed an excise tax " equivalent to one per centum upon the entire net income.... received by it from all sources during the year. " In Eisner v. Macomber referred to by this court in Mafatlal's case the court had to construe the word " income " as used in the XVI Amendment of the Constitution of the United States, which is : " The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration " ; and observed, at page 206 : " Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised. ...For the present purpose we require only a clear definition of the term 'income,' as used in common speech, in order to determine its meaning in the Amendment ; and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue. After examining dictionaries in common use.... we find little ....
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.... which objection has been taken on the ground that sections 2(6A) (e) and 12(1B) are invalid. The appellant holds 11 out of 845 shares in a private limited company. The value of each share is Rs. 100. In 1955 he took a loan of over Rs. 4,00,000 from the company. Rs. 2,83,126, the amount of accumulated profits the company had then, have been added to the appellant's total income for the relevant assessment year, in view of sections 2(6A)(e) and 12 (1B) of the Act. The appellant's share in the accumulated profits, if distributed as dividend, would be 11/845ths of Rs. 2,83,126, i.e., Rs. 3,686. Rs. 2,79,440, the balance, would then be the dividend payable to the other co-sharers. The appellant contends that Rs. 2,79,440 is not his income and that Parliament was not competent to enact sections 2(6A)(e) and 12(1B) which treat it as his " income " from dividend. Before dealing with the contention, reference may be made to what the impugned sections provide. Section 2(6A)(e) defines " dividend ", in the circumstances mentioned in that clause, to include any payment by a company of any sum by way of advance or loan to a shareholder, or any payment by any such company on behalf of or fo....
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....er pay the amount to shareholders by way of profits but in the form of advance of moneys or loans to some shareholders who pass on the rateable share of the remaining, shareholders and the shareholders thus escape payment of super-tax at a higher rate as their receiving such amounts could not be treated as " dividends " and so could not be added to their " income ". At the same time, it is not disputed for the respondent that there can be genuine cases of loans taken by shareholders from a company when the company was in a position to lend money out of its funds. In fact, after the enactment of section 2(6A)(e), the Central Board of Revenue issued a circular directing its officers to intimate to all companies that if loans advanced by them were repaid before June 30, 1955, in a genuine manner, they would not be taken into account in determining the tax liability of the shareholders to whom they had been advanced as it was likely that some companies might have advanced loans to their shareholders as a result of genuine transactions of loans and the idea was not to affect such transactions are not to bring them within the mischief of the new provision. The provisions of section 2(6A)....
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....n the amount of dividends deemed to have been distributed to them. It appears to me unreasonable that a particular shareholder who receives a loan or advance from a company be deemed to have received that entire amount as dividend when his proportionate share be much less. I would, for this reason also, consider the provisions of the impugned sections to amount to imposing unreasonable restrictions on the fundamental right to hold property under article 19(1)(f). I would now refer to certain cases on which reliance is placed for the proposition that this court has held valid laws made to cover attempts for evasion of income-tax and that therefore the impugned provisions enacted with the same object to cover attempts to evade payment of super-tax should be held valid. These cases are : Mafatlal's case, already referred to ; Sardar Baldev Singh v. Commissioner of Income-tax and Balaji v. Income-tax Officer, Special Investigation Circle. Mafatlal's case dealt with the validity of the tax on capital gains undersection 12B of the Act. In that case what was taxed was what had been gained by the assessee as a result of some dealing in capital assets. The capital gain was to be compute....
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....e of Baldev Singh, assessee, in such undistributed profits, could not be added to his total income of the particular year to which it was added. It was held that in view of the deeming provision with respect to the distribution of profits as dividends amongst shareholders, the proportionate share of the dividends would be deemed to be income of the assessee and that therefore when it was not taxed, would be deemed to have escaped assessment for the purposes of section 34 of the Act. The case is distinguishable on several grounds. One is that the Income-tax Officer is to make the order when he is satisfied that a larger dividend could have been justifiably distributed, a view necessarily leading to the inference that a lower dividend was distributed in order to escape payment of super-tax by shareholders liable to pay such tax. The other is that the Income-tax Officer was given power to make the order only when profits less than 60 per cent. of the assessable income were distributed as dividend. This indicates that the company could accumulate profits up to 40 per cent. of the assessable income for reasons which would be deemed to be genuine. This should lead to the inference that t....
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....or decision as to whether section 16(3)(a), clauses (i) and (ii), is a provision made by the legislature to prevent evasion of tax and answered it in the affirmative ; as the husband or the father could nominally take his wife or minor child, in partnership with him, so that the tax burden may be lightened and as this device enabled the assessee to secure the entire income of the business and yet evade income-tax which he would otherwise have been liable to pay. It was said at page 999 : " The scope of the provisions is limited only to a few of the intimate members of a family who ordinarily are under the protection of the assessee and are dependants of him. The persons selected by the provisions, namely, wife and minor children, cannot also be ordinarily expected to carry on their business independently with their own funds, when the husband or the father is alive and when they are under his protection. " It is therefore clear that the basis for holding section 16(3)(a), clauses (i) and (ii), valid was that in effect the husband or the father was the real person who ran the firm and that the others were made partners nominally and, therefore, the partnership was not genuine. I....