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PETITIONER: COMMISSIONER OF INCOME-TAX, MADRAS

       Vs.

RESPONDENT: THE AMRUTANJAN LTD., MADRAS

DATE OF JUDGMENT: 28/04/1964

BENCH: SHAH, J.C. BENCH: SHAH, J.C. SUBBARAO, K. SIKRI, S.M.

CITATION:  1964 AIR 1804            1964 SCR  (8)   9

ACT: Income Tax-Object and scope of s. 23-A-"Company in which the public  are  substantially  interested"--Meaning   of-Indian Income Tax Act, 1922 (11 of 1922), s. 23-A.

HEADNOTE: The  Income-tax  Officer found that the  respondent  company had, declared during the three years ending March 31,  1947, March 31. -1948 (1)  [1964] 1 S.C.R. 553. 10 and  March 31, 1949, dividends which were considerably  less than  60%  of  the  amount  available  for  distribution  as computed  under  s. 23-A of the Income-tax  Act,  1922.   He served  a notice on respondent company to show cause why  an order under s. 23-A be not passed against it.  After hearing the  respondent the Income-tax Officer passed an order  that the  undistributed portion of the assessable income  of  the respondent  as computed for income-tax purposes and  reduced by  the  amount of income-tax and super-tax payable  by  the company  in respect thereof, shall be ’deemed to  have  been distributed as dividend among the share-holders.  The  order of the Income-tax Officer was upheld by the Appellate Assis- tant Commissioner and the Income-tax Appellate Tribunal. A reference was made to High Court and the relevant question referred  was  whether  the  provisions  of  s.  23-A   were correctly  applied for the three relevant years.   The  High Court  held  that respondent company was one  in  which  the public  were  substantially interested and,  therefore,  the Income-tax  Officer  had no jurisdiction to pass  the  order under  s.  23-A for any of the three years.   The  appellant came to this Court with certificate of fitness from the High Court.  Dismissing the appeal. HELD:-The  respondent  company was one in which  the  public were substantially interested and therefore, the  Income-tax Officer had no jurisdiction to pass an order under s. 23-A. The  Indian  Income-tax  Act,  1922  does  not  define   the expression  "company in which the Public  are  substantially interested".  Normally, a company would be deemed to be  one in which the public are substantially interested where  more than  half the voting power is vested in the public.   Where

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the controlling interest i.e. a minimum of 51% of the voting right  is  held  by  a  single  individual  or  a  group  of individuals acting in concert, the company would be regarded as one in which the public are not substantially interested. The distinction between the controlling group and public  is not  along the line which distinguishes directors  from  the remaining  members of the company.  If a director  does  not belong  to  a controlling group, he will be  regarded  as  a member  of the public for purposes of the third proviso  and explanation  to  s.  23-A, even though  such  ’director  was directly entrusted with the management of the affairs of the company. Section  23-A  was  enacted with the  object  of  preventing avoidance  of  super-tax by  share-holders  controlling  the affairs   of  a  company  in  which  the  public   are   not substantially  interested, by the expedient of  not  distri- buting  dividends out of the profits.  For many  years,  the rates  of super-tax applicable to companies were much  lower than  the higher rates applicable to other assessees.   That gave  inducement to Persons controlling companies  to  avoid the higher incidence of super-tax by transferring to  imited companies the businesses.  The profits of business could  be accumulated  till  they  were ’distributed in  the  form  of capital and in ’the meanwhile accumulations of undistributed profits remained available to them for the purposes of their other businesses.  Section 23-A was enacted with a view to full attempts made by persons holding cotnrolling 11 interests  in  companies  to  avoid  payment  of   super-tax applicable to noncorporate assessees by refusing to agree to distribution  of  profits.   Under  s.  23-A  an  Income-tax Officer  was  authorised  to  make  an  order  by  which  .a fictional or notional income which was not in fact  received by the ,share-holders, was deemed to be distributed and  was liable to tax as it had arisen or accrued to them.  However, no  such  order could be passed in respect of a  company  in which  the  public were substantially interested  and  to  a subsidiary  company  of such a company if the whole  of  the share  capital  of such subsidiary company was held  by  the parent company or by the nominee thereof

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 521-523  of 1963. Appeals from the judgment dated April 5, 1960 of the Madras    High Court in Case referred No. 80 of 1955. C.   K. Daphtary, Attorney-General, K. N. Rajagopal Sastri    and R. N. Sachthey, for the appellant (in all the appeals). S.   Narayanaswamy and R. Gopalakrishnan, for the respondent (in all the appeals). April 28, 1964.  The Judgment of the Court was delivered by SHAH,  J.-One  Nageswara Rao Panthulu set up a  business  of manufacturing  a  "pain-balm"  which was  marketed.  in  the trade-name   of   "Amrutanjan".   In  September   1936   the respondent  company was floated as a public limited  company under  the Indian Companies Act, 1913, to acquire and  carry on  the  business of manufacture and sale  of  "Amrutanjan". The  authorised  capital of the company was  7,000  ordinary shares and 3,000 preference shares of Rs. 100/each, and  the issued  and  paid-up capital was 2,500  ordinary  and  3,000 preference  shares.  The preference shareholders were  under

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the Articles of Association entitled to a fixed dividend  of 71  per cent on the face value of the shares, with no  right in the balance of the profits.  The respondent company  took over  the business conducted by Nageswara Rao  Panthulu  for Rs. 5,50,0001- paid in the form of 2,500 ordinary and  3,000 preference  fully paid-up shares.  This company was  managed by a firm which after the death of 12 Nageswara  Rao  Panthulu consisted of  Ramayamma,  widow  of Nageswara  Rao,  Kamakashamma,  his  daughter,   Ramayamma’s brother  Ramchandra  Rao and Kamaksham  ma’s  husband  Sambu Prasad.  Between April 1, 1946 to March 31, 1949  Ramayamma, widow of Nageswara Rao was holding 2,185 ordinary shares and her  daughter  Kamakhamma was holding 250  ordinary  shares. Out  of  the  preference shares only 385 were  held  by  the directors including Ramayamma and Kamakshamma. Under  the  Articles  of Association of  the  company,  both preference  and ordinary shareholders were entitled to  vote at  the  meeting  of  the  company--each  shareholder  being entitled to exercise one vote for each share.  In the course of  assessment  proceedings of the respondent  company,  the Income-tax  Officer  found that for the three  years  ending March  31,  1947,  March 31, 1948 and  March  31,  1949  the company  had  declared  each year a total  dividend  of  Rs. 38,750/-  at  the rate of 71/2 per cent  on  the  preference shares  and  61 per cent on the  ordinary  shares-which  was considerably  less  than  sixty  per  cent  of  the   amount available for distribution as computed under s. 23-A of  the Income-tax  Act.  as  it stood at the  material  time.   The Income-tax  Officer  served a notice,  after  obtaining  the approval of the Inspecting Assistant Commissioner of Income- tax,  reauiring the respondent company to show cause why  an order under s. 23-A of the Income-tax Act, 1922, should  not be  passed  against the company and  after  considering  the objections raised by the company ordered on March 31,  1953, that  the undistributed portion of the assessable income  of the company as computed for income-tax purposes and  reduced by  the  amount of income-tax and super-tax payable  by  the company  in  respect thereof, shall be deemed to  have  been distributed  as dividend amongst the shareholders as at  the date  of  the respective general meetings.  This  order  was confirmed in appeal by the Appellate Assistant  Commissioner and the Income-tax Appellate Tribunal. Several   contentions   were  raised  before   the   Revenue authorities  and the Tribunal challenging the competence  of the  income-tax  officer  to pass an  order  under  s.  23-A includ- 13 ing  the contention that the said provision was  unconstitu- tional  or  ultra vires.  These have been negatived  by  the Tribunal and also by the High Court and it is unnecessary to refer  to those contentions in these appeals as they do  not survive for determination. To  a reference made under s. 66(1) of the Indian  Incometax Act,  the  Tribunal  referred three questions  to  the  High ,Court  of Judicature at Madras.  The third question,  which alone is material in these apeals, reads as follows: "Whether  the provisions of s. 23-A were  correctly  applied for the three relevant years?" The  High Court held that the respondent company was one  in which  the public were substantially interested, and  there- fore the Income-tax Officer had no jurisdiction to pass  the order  under s. 23,-A of the Income-tax Act for any  of  the three years and on that footing answered the question in the negative.  Against the order passed by the High Court,  with

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certificate  of fitness the Commissioner of  Income-tax  has appealed to this Court. Section  23-A of the Indian Income-tax Act, 1922  before  it was amended by the Finance Act, 1955, stood as follows: "(1)  Where  the  Income-tax Officer is  satisfied  that  in respect   of  any  previous  year  the  profits  and   gains distributed as dividends by any company up to the end of the sixth  month after its accounts for that previous  year  are laid  before  the company in general meeting are  less  than sixty  per cent of the assessable income of the  company  of that  previous year, as reduced by the amount of  income-tax and  super-tax payable by the company in respect thereof  he shall,. . make with the previous approval of the  Inspecting Assistant   Commissioner  an  order  in  writing  that   the undistributed  portion  of  the  assessable  income  of  the company  of  that previous year as computed  for  income-tax purposes and reduced by the amount of income-tax and  super- tax payable by the company in respect thereof 14 shall  be  deemed  to have  been  distributed  as  dividends amongst  the  shareholders  as at the date  of  the  general meeting aforesaid Provided Provided further Provided  further that this sub-section shall not  apply  to any company in which the public are substantially interested or to a subsidiary company of such a company if the whole of the share capital of such subsidiary company is held by  the parent company or by the nominees thereof. Explanation.-For the purpose of this sub-section,-- a  company  shall  be deemed to be a company  in  which  the public are substantially interested it shares of the company (not  being  shares entitled to a fixed  rate  of  dividend, whether  with or without a further right to  participate  in profits) carrying not less than twenty-five per cent of  the voting  power  have been allotted  uncoiiditionally  to,  or acquired  unconditionally  by,  and are at the  end  of  the previous year beneficially held by the public (not including a  company  to  which the  provisions  of  this  sub-section apply) .............. The  section  was  enacted with  the  object  of  preventing avoidance  of  super-tax  by  shareholders  controlling  the affairs  of a company in which the public are  not  substan- tially  interested,  by the expedient  of  not  distributing dividend out of the profits.  Under the annual Finance  Acts for  many  years  the  rates  of  super-tax  applicable   to companies  were much lower than the higher rates  applicable to  other  assessees.  That gave an  inducement  to  persons controlling  companies  to  avoid the  higher  incidence  of super-tax   by  transferring  to  limited  companies   their businesses.  Thereby the sow ce of earning was secured,  the profits of the business could be accumulated till they  were distributed  in  the form of capital, and in  the  meanwhile accumula- 15 tions  of undistributed profits remained available  to  them for purposes of their other businesses.  With a view to foil attempts  made by persons holding controlling  interests  in companies  to avoid payment of super-tax applicable to  non- corporate assessees by refusing to agree to distribution  of profits,  s.  23-A  was enacted  by  the  Legislature.   The Incometax Officer was thereby authorised, if satisfied  when less  than  sixty per cent of the assessable income  of  the company,  subject to reductions permitted thereby,  was  not distributed,  to  pass an order under which the  income  was

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deemed  to  be distributed among the  shareholders  entitled thereto.   By  the  order so made a  fictional  or  notional income  which was not in fact received by  the  shareholders was  deemed  to  be distributed, and in  the  hands  of  the shareholders  such deemed income was liable to tax as if  it had arisen or accrued to them.  But by the express provision contained  in s. 23-A, as it stood at the material time,  no order could be passed in respect of any company in which the public  were  substantially interested and to  a  subsidiary company of such a company if the whole of the share  capital of  such subsidiary company was held by the parent  company, or by the nominees thereof. The Act, however, did not define the   expression   "company   in  which   the   public   are substantially  interested".   Normally a  company  would  be deemed  to  be  one in which the  public  are  substantially interested, where more than half the voting power is  vested in  the  public.   Where the controlling,  interest  i.e.  a minimum of fifty-one per cent of the voting right is held by a  single  individual or a group of  individuals  acting  in concert,  the company would be regarded as one in which  the public   are   not  substantially   interested.    But   the Legislature  by  the  Explanation has  raised  a  conclusive presumption  in  those  cases where shares  of  the  company carrying  not less than twenty-five per cent of  the  voting power are held by persons other than the controlling  group. For  the  purpose of computing twenty-five per cent  of  the voting power, however, rights of holders of shares  entitled to a fixed dividend have to be excluded. It  is  now settled law that the  distinction  between  the- controlling group and the public is not along the line which distinguishes directors from the remaining members of the 16 company.   If a director does not belong to the  controlling group, he will be regarded as a member of the public for the purposes of the third proviso and the Explanation to s. 23-A even  though such director was directly entrusted  with  the management of the affairs of the company. The Commissioner contends that the Explanation to sub-s. (1) of  s.  23-A  is in reality a clause which  defines  what  a company,  in which the public are substantially  interested, is.  In terms, however, the Explanation raises a presumption and  does  not  purport to define a company  in  which  the, public are substantially interested.  On an analysis of  the provisions  of  the  third  proviso  to  s.  23-A  and   its explanation, the following position emerges: (1)  Where  there  is  no individual member or  a  group  of members acting in concert holding fifty-one per cent or more of  the  voting  power,  which controls  the  working  of  a company, it is from its very nature a company in which there is  no controlling member or group and therefore the  public are substantially interested; (2)  Where  a shareholder holds or a group  of  shareholders acting  in  concert hold fifty-one per cent or more  of  the voting  power, the question is one of fact to be  determined in  each case, whether it is a company in which  the  public are  substantially interested, having regard to the  purpose for  which  the  holding of fifty-one per cent  or  more  is utilised; (3)  Where not less than twenty-five per cent of the  voting power  is  allotted  unconditionally  to,  or  is   acquired unconditionally by or is beneficially held by the public, it shall  be  presumed  that the company is one  in  which  the public  are  substantially interested.  But  in  considering whether  shares carrying not less than twenty-five per  cent of the voting right are held by the public, shares  entitled

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to a fixed rate of dividend have to be excluded. 17 The  reason of the rule which excludes from the  computation of  voting power holders of shares entitled to a fixed  rate of  dividend is that s. 23-A is directed  primarily  against the accumulation of undistributed dividends to avoid payment of  non-corporate rates of super-tax.  But shareholders  who are  entitled to a fixed rate of dividend are  not  directly interested  in such accumulation: it matters little to  them whether the dividend is immediately distributed to the ordi- nary  shareholders  or  is  accumulated,  and  therefore  in assessing whether the twenty-five per cent of the shares are vested  in  persons other than the  controlling  group,  the shares yielding a fixed rate of dividend have to be ignored. But for the purpose of ascertaining the voting power, voting rights  attached  to  all  the shares  must  be  taken  into account. No investigation has been made by the Income-tax  Department whether  there  is  any group  of  persons  controlling  the working  of  the  company.  It is true  that  Ramayamma  was holding 87-40 per cent of the ordinary shares issued by  the company,  and  there is obviously no person who  could  hold twenty-five per cent or more of the ordinary shares.  In the present   case,   as  already   observed,   the   preference shareholders  were entitled to vote at the meeting, and  the Articles  of Association of the Company made no  distinction between the preference and the ordinary shareholders in  the matter  of  exercise, of voting rights.   The  total  voting power  was  5,500-one  vote, for each  share,  ordinary  and preference  alike-and  twenty-five per cent of  that  voting power  is  1,375, but to invite the  presumption  under  the Explanation  this power must be exercisable only by the  or- dinary shareholders, and not by shareholders entitleci to  a fixed  rate  of  dividend.  The presumption  under  the  Ex- planation  could arise only, if twenty-five percent  of  the voting power was held by persons entitled to ordinary shares outside the controlling group. It  was suggested that the expression "twenty-five per  cent of the voting power" would mean not twenty-five per cent  of the total voting power, but power exercisable in respect  of shares  other  than  shares  entitled to  a  fixed  rate  of dividend.   Prima facie, such an interpretation is not  war- ranted if regard be had to the terms of the Explanation.  51 S. C-2 18 But  even that argument is of no value, for twenty-five  per cent of the voting power attached to the ordinary shares  is not  exercisable by the public.  This, therefore, is a  case in  which shares not entitled to a fixed  dividend  carrying not  less than twenty-five per cent of the voting power  are not  shown  to  have been allotted  unconditionally  to,  or acquired  unconditionally  by or beneficially  held  by  the public.  The Explanation, therefore, has no operation. Whether inview of the third proviso the company may be regarded asone in which the public are substantially interested, isa question to which no attention was paid by the Tribunal. Whether in fact there exists such a control- ling interest inthe hands of one shareholder or a group of shareholders  as would render the company one in  which  the public are not substantially interested is a question  which therefore cannot be decided by this Court. The order of the High Court must therefore be continned, but on different grounds.  The interpretation of the Explanation by  the  High  Court,  for  reasons  already  set  out,  was incorrect.   The Explanation had no application, because  no

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presumption on the facts found could arise thereunder.   The Revenue  authorities have not made any investigation on  the question whether there existed any controlling interest in a group  of persons. so as to bring the case within the  third proviso. The appeals must be dismissed with costs.  One hearing fee. Appeals dismissed.