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PETITIONER: SHREE KRISHNA AGENCY LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX CENTRAL, CALCUTTA

DATE OF JUDGMENT24/08/1971

BENCH: GROVER, A.N. BENCH: GROVER, A.N. HEGDE, K.S.

CITATION:  1972 AIR  156            1972 SCR  (1) 465  1971 SCC  (3) 526  CITATOR INFO :  R          1973 SC1030  (5)

ACT: Income-tax  Act, 1922, s. 23A(9)-Explanation (1)  cl.  (ii)- Free--transferability  of shares--Directors having  absolute discretion to refuse to register transfer of shares  without giving any reasons-Shares whether freely transferable-Public whether substantially interested in company.

HEADNOTE: The assessee was a public limited company., Under Art. 37 of its. Articles of Association the Directors could at any time in  their  discretion  -and  without  assigning  any  reason decline  to register any proposed transfer -of shares.   The question  in income-tax proceedings relating to the  assess- ment  years  1952-53  and  1954-55 was  whether  on  a  true interpretation  of  Art. 37 the assessee  company  could  be regarded  as  one in which the  public  -were  substantially interested  within  the meaning of the third proviso  to  S. 23A(1)  of the Income-tax Act, 1922.  In reference the  High Court answered the question in favour of the revenue on  the view  that  the  shares  of  the  company  were  not  freely transferable and therefore it was not a company in which the public  were  substantially interested.  In  the  assessee’s appeal by special leave, HELD  : Article 37 could not by any stretch of reasoning  be regarded  by itself to be a restriction on the  transfer  of shares by one shareholder to another.  Free  transferability of  shares  is  a  normal and  common  feature  ,of  limited companies.. Indeed there would hardly be any public  company in the memorandum of articles of which an article similar to Art.  37. will not be found.  This article appears  even  in the  standard Articles of Association prescribed  under  the Companies Act itself.  The purpose is ,only to give power to the  Directors for declining to register the transfer -of  a share when the paramount interest of the company so require. There may be cases where it can be shown that the  Directors have  been  exercising  -the  power  very  freely  and  have virtually  eliminated the element of free  -transferability. In  such cases it may be possible to hold that in  fact  the shares  were not freely transferable.  But in  -the  present case there was no evidence of the Directors having acted  in

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the  aforesaid manner nor was -there any restriction in  the other  Articles  of Association interfering with  -the  free transfer  of  shares by one shareholder to another.,  -  The High  Court was therefore in error in holding that the  mere existence  of an article like Art. 37 would affect the  free transferability  of  the shares within the  meaning  of  the Explanation (1) to s. 23A(9) of the Act. [372 C-F] East  India Corporation Ltd. v. Commissioner of  income-tax, Mad?-as,  61  I.T.R.  16  and  Raghuvanshi  Mills  Ltd.   v. Commissioner of Income-tax, Bombay, 74 I.T.R. 823, approved.  Commissioner  of Income-tax, West Bengal v. Tona litte  Co. Ltd. 48 -I.T.R. 902, disapproved.

JUDGMENT: CIVIL  APPELLATE JURISDICTION: Civil Appeals Nos.  1837  and 1838 of 1968. 369 Appeals from the judgment and order dated February 10,  1965 and  July 17, 1967 of the Calcutta High Court in  Income-tax Reference Nos. 274 of 1961 and 114 of 1963 respectively. D.   Pal, R. K. Choudhry, N. R. Khaitan, Krishna Sen and B.   P. Maheshwari, for the appellant (in both the appeals). B.   Sen,  R.  N.  Sachthey  and  B.  D.  Sharma,  for   the respondent (in-both the appeals). The Judgment of the Court was delivered by Grover,  J. These appeals by certificate from a judgment  of the  Calcutta High Court arise out of Income Tax  References in  which the main point involved was whether  the  assessee company  could  be regarded as one in which the  public  are substantially   interested   within  the  meaning   of   the Explanation  in  s. 23A of the Indian Income  Tax  Act,1922, hereinafter called the "Act". The appeals relate to the assessment years 1952-53 and 1954- 55. The assessee is a public company incorporated under  the Indian Companies Act, 1913.  Article 37 of its Articles  of’ Association provided as follows               "The  Directors  may  at  any  time  in  their               absolute   and  uncontrolled  discretion   and               without   assigning  any  reason  decline   to               register any proposed transfer of shares." The Income Tax Officer held that the assessee was a  company in which the public were not substantially interested within the  meaning  of  the  Explanation in s.  23A  of  the  Act. Accordingly he applied the provisions of that section.   The assessee appealed to, the Appellate Assistant  Commissioner. The  appeal  relating  to the assessment  year  1952-53  was dismissed  but  with regard to the subsequent  year  it  was alqowed.  The Appellate Tribunal upheld the contention  that Article 37 of its Articles of Association did not operate as a  bar  to  the  free  transferability  of  the  shares  and therefore  it  was  a  company  in  which  the  public  were substantially   interested   within  the  meaning   of   the Explanation  in s. 23A of the Act.  Thereupon  the  Tribunal was moved by the Commissioner of Income tax for stating  the case  and referring the following question of law which  was referred by it to the High Court in the case relating to the assessment year 1952-53 :               "Whether  on a true interpretation of  Article               37   of  the  Articles  of  Association,   the               assessee  Company  can be regarded as  one  in               which the public are substantially  interested               within  the  meaning of the third  proviso  to               section 23A(1)".

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3 7 0 A similar question was referred in the case relating to  the assessment  year  1954-55.   The  High  Court  following   a judgment  of the same court in Commissioner of  Income  tax, West  Bengal  v.  Tona  -Jute  Co.  Ltd.,(")  answered   the questions referred against the assessee and in favour of the Revenue.  In that case the Calcutta High Court had expressed the view that a public company whose Directors had  absolute discretion  to refuse to register the transfer of any  share to any person whom it shall in their opinion be  undesirable in  the interest of the company to admit to  membership  and were not obliged to give any reason for refusal to  register was  not  -a  company  the  shares  of  which  were   freely transferable  to  other members of the  public,  within  the meaning of the Explanation in s.   23A of the Act. Section 23A of the Act confers power to assess companies to super  tax on undistributed income in certain  cases.   Sub- section  (9) inter alia provides that nothing  contained  in the section shall :apply to any company in which the  public are substantially interested.  Explanation (1) which was  so renumbered by s. 7 of the Finance Act of 1957 to the  extent it is material is as follows :               "For  the purposes of this section, a  company               shall  be deemed to be a company in which  the               public are substantially interested."               (a).........................               (b)   if  it  is  not  a  private  company  as               defined  in  the Indian Companies  Act,  1913,               (VII of 1913), and               (i)...................................               (ii)  the said shares were at any time  during               the  previous year the subject of  dealing  in               any recognised stock exchange in India or were               freely  transferable  by the holder  to  other               members of the public; and               (iii)............................ The Calcutta High Court referred to the relevant  provisions of  the Indian Companies Act 1913 according to which  unless the  Article provided otherwise the shareholder had  a  free right to transfer his shares to whomsoever he liked.  But it was  considered  that where the Articles contained  a  power under  which  -the Directors could decline to  register  any transfer  of shares the Tight of free transfer was cut  down by  that  Article and this affected -the  question  of  free transferability of the shares.  Moreover the (1)  48 I.T.R. 902. 371 transfer  of shares was not complete until the  registration of  the  name of the transferee and if such  a  registration could  not be insisted on as a matter of right it could  not be  said  that  the shares were  freely  transferable.   The Madras  High  Court  in  East  India  Corporation  Ltd.   v. Commissioner  of Income-tax, Madras(1) and the  Bombay  High Court in Raghuvanshi Mills Ltd., v. Commissioner of  Income- tax, Bombay(1) took the contrary view and dissented from the opinion expressed in the Calcutta case that in the  presence of  an  Article  similar to Article 37 of  the  Articles  of Association  of the assessee the shares would not be  freely transferable   within   the  meaning  of  clause   (ii)   to Explanation 1 in s. 23A (9) of the Act.  It may be mentioned that  before  its  amendment, by the Finance  Act  1955  the corresponding  provision appeared in the Explanation  in  s. 23A(1)  after,-the third proviso.  But instead of  the  word "were"   the  word  "are"  was  employed.    The   question, therefore,  which has to be examined is whether  the  shares

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could be regarded as freely transferable to other members of the public, In our opinion the following observations in the East India Corporation case represent the correct view about the meaning of the word "transferable" :               "  "Transferable",  ex  facie, is  not  to  be               equated to "transferred".  The word imports  a               quality,  a  legal effect arising  out  of  or               inherent  in the character and nature  of  the               shares  themselves.   This  quality  does  not               stand by itself, for the section says "are  in               fact  freely transferable".  We have  to  give               effect  to each of these words, and if we  did               so,  transferability is qualified by the  fact               which  in the context, to out minds,  means  a               factual  tendency  which is  unrestricted  and               which   ensures  transferability.   In   other               words, we understand by the words "are in fact               freely  transferable"  not that  there  should               necessarily be actual transfers of shares; but               a  factual tendency towards free  transfer  of               shares,  subject,  of  course,  to  reasonable               restrictions  by holders to other  members  of               the public." The  Directors  have certainly been given  a  discretion  by Article  37 to decline to register any proposed transfer  of shares  but that does not mean that the shares cease  to  be transferable.    The  said  Article  does  not  confer   any uncontrolled  or unrestricted discretion upon the  Directors to  refuse  to register the transfer of shares  in  a  given case.   In other words the Directors cannot act  arbitrarily or capriciously.  It is well known that the power  conferred by such an. Article is of a fiduciary nature which has to be exercised by the (1) 61 I.T.R. 16. (2) 74 I.T.R. 823. 3 72 Directors   in  the  best  interests  of  the  company   for preventing any undesirable person becoming a member if  that is  likely to be prejudicial to the company.  It is a  power which  has  to be reasonably exercised  for  protecting  the interests  of  the company.  It cannot be assumed  that  the discretion  conferred  on the Directors will be  abused  for ulterior purposes.  The discretion which has been  conferred for  being exercised in the interest of  the.company  cannot take  away the tendency of the free transferability  of  the shares  in the absence of cogent material or  other  factors from  which  it  can be inferred that the  shares  were  not capable  of being freely transferred.  Article 37 can by  no stretch  of  reasoning  be  regarded  by  itself  to  be   a restriction on the transfer of shares by one shareholder  to another.   Free  transferability of shares is a  normal  and common  feature  of limited companies.  Indeed  there  would hardly  be any public company in the memorandum of  articles of which an article similar to Article 37 will not be found. This  article  appears  even in  the  standard  Articles  of Association prescribed under the Companies Act itself.   The purposes, as has been noticed before, is only to give  power to the Directors for declining to register the transfer of a share  when  the  paramount  interests  of  the  company  so require.  There may be cases where it can be shown that  the Directors  have been exercising that power very  freely  and have    virtually   eliminated   the;   element   of    free transferability.   In such cases it may be possible to  hold that  in fact the shares were not freely transferable.   But in  the Pr--sent case there is no evidence of the  Directors

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having  acted  in  the aforesaid manner  nor  is  there  any restriction in the other Articles of Association interfering with  the  free  transfer of shares by  one  shareholder  to another.   We are unable, therefore, to uphold the  judgment of  the  Calcutta High Court that the mere existence  of  an article  like  Article  37  would  affect  the  free  trans- ferability   of  the  shares  within  the  meaning  of   the Explanation. In  the result the appeals are allowed and the  decision  of the High Court is set aside.  The question referred in  each case  is answered in favour of the assessee and against  the Revenue.  The assessee shall be entitled to one set of costs in this Court. G.C.                                                  Appeal allowed. 3 7 3