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PETITIONER: THE COMMISSIONER OF INCOME-TAX, MADRAS

       Vs.

RESPONDENT: SRI MEENAKSHI MILLS LTD. & ORS.

DATE OF JUDGMENT: 25/10/1966

BENCH: RAMASWAMI, V. BENCH: RAMASWAMI, V. SHAH, J.C. BHARGAVA, VISHISHTHA

CITATION:  1967 AIR  819            1967 SCR  (1) 934  CITATOR INFO :  E          1969 SC1160  (5)  R          1986 SC   1  (4)  RF         1986 SC1370  (90)  R          1986 SC1483  (4)

ACT: Indian Income-tax Act (11 of 1922), s. 42-Scope--Finding  of fact  by  Tribunal-Interference by  High  Court,  validity,- Corporate entity, if Court can lift veil--

HEADNOTE: The  assessee-companies, carried on business in Madurai  and each  had  a branch at Pudukottai, a  former  native  State. They hold majority share in a Bank which, too, had its  head office  at Madurai and branch at Pudukottai.  T, who  was  a shareholder  of  the  Bank, was the  moving  figure  in  the assessee-companies.  The assessees borrowed moneys from  the Madurai  head  office of the Bank on the security  of  fixed deposits made by the assessees’ branches with the Pudukottai branch  of  the Bank.  The loans were far in excess  of  the available  profits  at Pudukottai.  The  Income-tax  Officer held that the borrowings in British India on the security of the   fixed   deposits  made  at  Pudukottai   amounted   to constructive  remittance of the profits by the  branches  of the assessee-companies to their Head Office in India  within the meaning of s. 4 of the Income-tax Act, and this view the Appellate  Assistant  Commissioner  upheld.   The  assessees appealed  to  the Trbunal which took note  that  the  branch whether  of  the assessee of the Bank constituted  only  one unit,  and  the establishment of the branch of the  Bank  at Pudukottai was intended to help the financial operations  of T  in  the  concerns in which he was  interested.,  and  the Pudukottai   branch  of  the  Bank  had  transmitted   funds deposited  by the assessees for enabling the Madurai  branch to  advance  loans  at interest to  the  assessees  and  the transmission  of  the funds was made with the  knowledge  of assessees.   The  Tribunal  held  that  the  assessees  were rightly assessed.  In reference the High Court answered  the question  in  favour  of the assessees holding  it  was  not established  that  there  was any  arrangement  between  the assessees  and the Bank whether at Pudukottai or at  Madurai

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for transference of moneys from Pudukottai branch to Madurai and the facts on record did not establish that there was any transfer  of  funds between Pudukottai and Madurai  for  the purpose  of  advancing  moneys to  the  assessees,  and  the transactions  represented ordinary banking transactions  and there  was nothing to show that the amounts placed in  fixed deposits  in  the branch were intended to and were  in  fact transferred  to head office for the purpose of lending  them out  to  the depositor himself.  In appeals by  the  Commis- sioner, this Court, HELD: The appeals must be allowed The High Court erred in law in interfering with the findings of  the appellate Tribunal.  In a reference the  High  Court must  accept the findings of fact reached by  the  appellate Tribunal and it is for the party who applied for a reference to challenge those findings of fact first by an  application under s. 66(1).  If the party failed to file an application, under  s.  66(1) expressly raising the  question  about  the validity of the findings of fact, he is not entitled to urge before the High Court that the findings are vitiated for any reason. [938 H-939 B] India  Cements Ltd. v. Commissioner of  Income-tax,  Madras, 60, I.T.R. 52, relied on. 935 In  the context of the facts as found by the  Tribunal,  the entire  transactions formed part of a basic  arrangement  or scheme  between the creditor and the debtor that  the  money should  be brought into British India after it was taken  by the borrower outside the taxable territory. [940 B-C] Section  42 requires, in the first place, that money  should have been lent at interest outside the taxable territory, in the second place, income, profits or gains should accrue  or arise  directly  or indirectly from such money  so  lent  at interest,  and in the third place, that the money should  be brought into the taxable territories in cash or in kind.  If all  these conditions are fulfilled, then the  section  lays down  that  the  interest shall be  deemed  to  be  interest accruing or arising within the taxable territories. [939 D] The provision in s. 42(1), which brings within the scope  of the  charging  section  interest earned out  of  money  lent outside, but brought into British India, was not ultra vires the  Indian  Legislature on the ground that  it  was  extra- territorial in operation. [939 F] The section contemplates the bringing of money into  British India with the knowledge of the lender and borrower and this gives rise to a real territorial connection.  This knowledge must be an integral part of the transaction. [940 A] A.   H.  Wadia  v.  Commissioner of  Income-tax,  Bombay  17 I.T.R. 63, approved. In  certain exceptional cases the Court is entitled to  lift the veil of corporate entity and pay regard to the  economic realities  behind the legal facade.  For example, the  Court has  power to disregard the corporate entity if it  is  used for tax evasion or to circumvent tax obligation. [941 E] Devid  Payne & Co. Ltd. in re, Young v. David Payne  &  Co., Ltd. [1904] 2 Ch.  D. 608. distinguished. Case law referred to.

JUDGMENT: CIVIL  APPELLATE JURISDICTION : Civil Appeals Nos.  1084  to 1097 of 1965. Appeals  by special leave from the judgment and order  dated January 8, 1963 of the Madras High Court in Tax Case No. 108

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of 1960. B.   Sen, A. N. Kirpal, S. P. Nayyar and R. N. Sachthey, for the appellant (in all the appeals). R.   Venkataraman and R. Ganapathy Iyer, for the  respondent (in all the appeals). The Judgment of the Court was delivered by Ramaswami,  J. These appeals are brought, by special  leave, from the judgment of the High Court of Madras dated  January 8, 1963 in Tax Case No. 108 of 1960. All the three respondents (hereinafter called the aassessee- companies’)  are  public limited companies  engaged  in  the manufacture  and  sale  of  yam at  Madurai.   Each  of  the assessee-companies had a branch at Pudukottai engaged in the production and 936 sale of cotton yarn.  The sale-proceeds of the branches were periodically  deposited in the branch of Madurai  Bank  Ltd. (hereinafter  referred  to as the ’Bank’)  at  Pudukottai  a former native State either in the current accounts or  fixed deposits  which earned interest for the  various  assessment years as follows:      Assessment years    MeenakshiRajendra   Saroja           Mills millsmills                   Rs.       Rs.     Rs. ----------------------------------------------------      1946-47   1,08,902  25,511      1947-48   1,18,791  24,953    30,620      1948-49   1,50,017  33,632    36,890      1949-50   42,36941,393      195-0-51  1,27,314  41,957    42,092 The Bank aforesaid was incorporated on February 8, 1943 with Thyagaraja  Chettiar  as founder Director, the  Head  Office being at Madurai.  Out of 15,000 shares of this bank  issued 14,766  were held by Thyagaraja Chettiar, his two  sons  and the three assessee-companies as shown below:                                              Share                                            holding             1. Thyagaraja Chettiar         1,008             2. Manickavasagam                250             3. Sundaram                      250             4. Meenakshi Mills             5,972             5. Rajendra Mills              3,009             6. Saroja Mills                4,177 All  the three assessee companies borrowed moneys  from  the Madurai branch of the bank and on the security of the  fixed deposits  made by their branches with the Pudukottai  branch of the Bank.  It is the admitted case that the loans granted to  the  assessee-companies  were  far  in  excess  of   the available   profits  at  Pudukottai.   In   the   assessment proceedings of the assessee-companies for the various  years under  dispute, the Income-tax Officer was of the view  that the borrowings in British India on the security of the fixed deposits   made  at  Pudukottai  amounted  to   constructive remittances of the profits by the branches of the  assessee- companies to their Head Offices in India within the  meaning of  s.  4 of the Indian Income-tax  Act,  1922  (hereinafter called  the  ’Act’).   Accordingly he  included  the  entire profits  of  the assessee-companies including  the  interest receipts  from the Pudukottai branches in the assessment  of the  assessee-companies, since the overdrafts availed of  by the  assessee-companies  in British India far  exceeded  the available  profits.  The assessee-companies appealed to  the Appellate  Assistant  Commissioner  of  Income-tax.    After examining the constitu- 937

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tion of the assessee-companies and the Bank and the  figures of   deposits  and  overdrafts,  the   Appellate   Assistant Commissioner  found that the deposits made by the  assessee- companies and other companies closely allied to them  formed a  substantial  part of the total deposits received  by  the Bank.  He was also of the view that the Pudukottai branch of the Bank had transmitted the funds so deposited for enabling the  Madurai  branch  to advance loans at  interest  to  the assessee-companies  and that the transmissions of the  funds were  made with the knowledge of the assessee-companies  who were   major  shareholders  of  the  Bank.   The   Appellate Assistant  Commissioner also considered that the  Pudukottai branch  of  the Bank had no other  appreciable  transactions except  the  collection of funds and on the facts  found  S. 42(1)  of  the  Act  applied to  the  case.   The  assessee- companies  took  the  matter  in  appeal  to  the  appellate Tribunal  -which  took note of the position  that  the  head office  and the branch-whether of the assessee-companies  or of  the  Bank-constituted only one unit and  that  Thyagraja Chettiar  occupied a special position in both  the  concerns and  the  establishment  of  the  branch  of  the  Bank   at Pudukottai was intended to help the financial operations  of Thyagaraja  Chettiar  in  the  concerns  in  which  he   was interested.   After detailed consideration of  the  deposits and overdrafts and the inter-branch transactions of the Bank the  appellate  Tribunal held that s. 42(1) of the  Act  was applicable  to the facts of the case and that the  assessee- companies  must  be  attributed with the  knowledge  of  the activity  of  their  branches  at  Pudukottai  and  of   the remittances  made  by the Pudukottai branch of the  Bank  to Madurai head office, and that the entire transactions formed part of an arrangement or scheme. In  the  course  of its  judgment,  the  appellate  Tribunal observed as follows:               "Even so, it seems to us, we cannot escape the               fact  that Thyagaraja Chettiar, his  two  sons               and the three Mills had a preponderant, if not               the whole, voice in the creation, running  and               management of the Bank.  We cannot also forget               that Pudukottai is neither a cotton  producing               area nor has a market for cotton; except  that               it  was  a non-taxable  territory,  there  was               nothing  else to recommend the carrying on  of               the  business  in cotton spinning  or  weaving               there.   There is yet another aspect to  which               our attention was drawn by the learned counsel               for  the assessee.  That being, a  non-taxable               area, there were many very rich men there with               an  influx  of funds to invest  in  banks  and               industries.  By the same token, it appears  to               us  it was not necessary for the Madurai  Bank               which  was  after all a  creation  of  certain               people  which started with a small capital  of               Rs.  32,800  to have gone  to  Pudukottai  for               opening  a branch.  If there was an influx  of               money in Pudukottai               Sup.C.I./66-14               938               because  of  the finances, nobody  would  have               agreed to borrow money from it.  At any  rate,               it  is  clear it would have had no  field  for               investment  in Pudukottai the only  source  of               investment being outside Pudukottai."               The appellate Tribunal further stated:               "But having regard to the special position  of

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             Thyagaraja Chettiar and the balance sheets  of               the  bank  referred to above and the  lack  of               investments  in  Pudukottai  itself  of’   the               moneys   borrowed   there,   it   seems   more               reasonable  to conclude that the  bank  itself               was started at Madurai and a branch of it  was               opened at Pudukottai only with a view to  help               the   financial   operations   of   Thyagaraja               Chettiar and the mills in which he was vitally               interested."               At the instance of the assessee-companies  the               appellate  Tribunal  referred  the   following               question  of law for the determination of  the               High Court:               "Whether on the facts and in the circumstances               of the case, the taxing of the entire interest               earned  on the fixed deposits made out of  the               profits earned in Pudukottai by the assessee’s               branches in the Pudukottai branch of the  Bank               of Madurai is correct?"               The High Court answered the question in favour               of the assessee-companies holding that it  was               not established that there was any arrangement               between  the assessee-companies and  the  Bank               whether  at  Pudukottai  or  at  Madurai   for               transference of moneys from Pudukottai  branch               to  Madurai  and the facts on record  did  not               establish that there was any transfer of funds               between Pudukottai and Madurai for the purpose               of advancing moneys to the assessee-companies.               The High Court further took the view that  the               transactions   represented  ordinary   banking               transactions  and  there was nothing  to  show               that  the amounts placed in fixed deposits  in               the branch were intended to, and were in  fact               transferred to head office for the purpose  of               lending them out to the depositor himself.               On  behalf of the appellant Mr. Sen  submitted               at  the  outset that the High  Court  was  not               legally  justified  in  interfering  with  the               findings  of  fact reached  by  the  appellate               Tribunal  and in concluding that there was  no               arrangement  or scheme between the lender  and               the  borrower  for the transference  of  funds               from  Pudukottai to Madurai.  In our  opinion,               there  is justification for the  argument  put               forward  on  behalf of the appellant  and  the               High  Court erred in law in  interfering  with               the findings of the appellate Tribunal in this               case.  In India Cements Ltd., v. Commissioner                             939 of  Income-tax, Madras(1) it was pointed out by  this  Court that in a reference the High Court must accept the  findings of fact reached by the appellate Tribunal and it is for  the party  who.  applied  for a  reference  to  challenge  those findings of fact first by an application under s. 66(1).  If the party concerned has failed to file an application  under s.  66(1) expressly raising the question about the  validity of  the findings of fact, he is not entitled to urge  before the  High  Court  that the findings  are  vitiated  for  any reason.  We therefore proceed to decide the question of  law raised in these appeals upon the findings of fact reached by the appellate Tribunal. Section 42 of the Act states as follows:               "All  income,  profits or  gains  accruing  or

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             arising whether directly or indirectly through               or from any money lent at interest and brought               into  the  taxable territories in cash  or  in               kind shall be deemed to be income accruing  or               arising within the taxable territories This section accordingly requires, in the first place,  that any  money  should have been lent at  interest  outside  the taxable territory.  In the second place, income, profits  or gains  should  accrue or arise directly or  indirectly  from such  money  so lent at interest, and, in the  third  place, that   the  money  should  be  brought  into   the   taxable territories in cash or in kind.  If all these conditions are fulfilled,  then the section lays it down that the  interest shall be deemed to be income accruing or arising within  the taxable territories.  This section was the subject-matter of interpretation  by  the  Federal Court in  A.  H.  Wadia  v. Commissioner  of  Income-tax, Bombay(2) It was held  by  the majority of the Judges in that case that the provision in s. 42(1)  of  the  Act, which brings within the  scope  of  the charging section interest earned out of money lent  outside, but  brought  into, British India was not  ultra  vires  the Indian  Legislature  on  the  ground  that  it  was   extra- territorial  in  operation.   It was pointed  out  that  the section  contemplated  the bringing of  money  into  British India with the knowledge of the lender and borrower and this gave  rise  to a real territorial connection.   The  learned Chief Justice took the view that the nexus was the knowledge to  be  attributed  to  the lender  that  the  borrower  had borrowed  money  for the purpose of taking it  into  British India  and  earning  income on that  money.   Mukherjea  and Mahajan,  JJ. took a somewhat different view.   Mahajan,  J. considered  that  there must be an arrangement  between  the lender  and  the  borrower to bring the  loan  into  British India,  and  Mukherjea, J. further emphasised the  point  by stating that it must be the basic arrangement underlying the transaction  that the money should be brought  into  British India  after  it  is  taken  by  the  borrower  outside  his territory.  But all (1) 60 I.T.R. 52.  (2) 17 I.T.R. 63. 940 the  learned Judges agreed that the knowledge of the  lender and the borrower that the money is to be taken into  British India must be an integral part of the transaction.  That  is the  ratio of the decision of the Federal Court with  regard to the construction of s. 42(1) of the Act. Having  examined the findings of the appellate  Tribunal  in the  present case we are satisfied that the test  prescribed by the Federal Court in Wadia’s case(1) is fulfilled and the appellate  Tribunal was right in its conclusion  that  there was  a  basic arrangement or scheme  between  the  assessee- companies and the Bank that the money should be brought into British India after it was taken by the borrower outside the taxable  territory.  The appellate Tribunal has pointed  out that  the assessee-companies had a preponderant, if not  the whole, voice in the creation, running and management of  the Bank and that Pudukottai was neither a cotton producing area nor had it a market for cotton and except that it was a non- taxable  territory there was nothing else to  recommend  the carrying  on  of  the cotton spinning  or  weaving  business there.  The Tribunal further remarked that having regard  to the special position of Thyagaraja Chettiar and the  balance sheets of the Bank and lack of investments in Pudukottai, it was reasonable to conclude that the Bank itself was  started at Madurai and a branch was opened at Pudukottai only with a

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view  to  helping  the financial  operations  of  Thyagaraja Chettiar  and the mills in which he was vitally  interested. The  Tribunal found that Pudukottai branch of the  Bank  had transmitted  funds deposited by the  assessee-companies  for enabling the Madurai branch to advance loans at interest  to the assessee,companies and the transmission of the funds was made  with the knowledge of the assessee-companies who  were the major shareholders of the Bank.  In the context of these facts  it must be held that the entire  transactions  formed part  of a basic arrangement or scheme between the  creditor and the debtor that the money should be brought into British India after it was taken by the borrower outside the taxable territory.   We  are  accordingly of the  opinion  that  the principle laid down in Wadia’s(1) case is satisfied in  this case  and  that  the Income-tax authorities  were  right  in holding  that the entire interest earned on  fixed  deposits was taxable. In  the course of argument Mr. Venkataraman  contended  that even  if  Thyagaraja Chettiar, a Director of  the  assessee- companies,  knew in his capacity as Director of the  Madurai Bank  that  money placed in fixed deposit by  the  assessee- companies  would  be transferred to the  taxable  territory, that  knowledge cannot be imputed to the  assessee-companies and  so it cannot be said that the transfer was part  of  an integral arrangement of the loan transaction.  In support of this  argument learned Counsel referred to the decision.  of the Court of Appeal in David Payne & Co. Ltd., In re.  Young v. (1)  17 I.T.R. 63. 941 David  Payne  &  Co. Ltd.,(1) We are unable  to  accept  the argument  of  the respondents as correct.  The  decision  in David Payne & Co’s (1) case, has no bearing on the  question presented  for determination in the present case.  In  David Payne & Co’s (1) case, supra, the question at issue  related to  the powers and duties of Directors and it was held  that because  the  same  person  is  a  common  director  of  two companies,  the  one company has not necessarily  notice  of everything  that  is  within the  knowledge  of  the  common director, which knowledge he has acquired as director of the other company.  In the present case the question at issue is entirely  different.   The  appellate  Tribunal  has,   upon examination of the evidence, found that the transference  of funds  from  Pudukottai to Madurai was made as part  of  the basic  arrangement  between  the  Bank  and  the   assessee- companies  and that Thyagaraja Chettiar who was  the  moving figure  both  in  the  Bank and in  each  of  the  assessee- companies  had  knowledge of this arrangement.  It  is  well established that in a matter of this description the Income- tax authorities are entitled to pierce the veil of corporate entity and to look at the reality of the transaction.  It is true  that from the juristic point of view the company is  a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subjected to duties  which are not the same as those enjoyed or borne  by its members.  But in certain exceptional cases the Court  is entitled  to  lift the veil of corporate entity and  to  pay regard  to the economic realities behind the  legal  facade. For example, the Court has power to disregard the  corporate entity  if it is used for tax evasion or to  circumvent  tax obligation.  For instance, in Apthorpe v. Peter  Schoenhofen Brewing  Co.(2) the Income Tax Commissioners had found as  a fact  that all the property of the New York company,  except its  land, had been transferred to an English  company,  and that  the  New York company had only been kept in  being  to

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hold the land, since aliens were not allowed to do so  under New  York  law.   All but three of the  New  York  company’s shares  were  held by the English company, and as  the  Com- missioners also found, if the business was technically  that of the New York company, the latter was merely the agent  of the  English  company.  In the light of these  findings  the Court of Appeal, despite the argument based on  Salomon’S(3) case,  held  that  the New York business  was  that  of  the English  company  which was liable for  English  income  tax accordingly.  In another case-Firestone Tyre and Rubber  Co. v. Llewellin(4)--an American company had an arrangement with its  distributors on the Continent of Europe  -whereby  they obtained supplies from the English manufacturers, its wholly owned subsidiary.  The English company credited the American with the price received after deducting the costs plus 5 (1)  [1904] 2 Ch.  D. 608. (3)  [1897] A.C. 22. (2)  4 T.C. 41. (4)  [1957] 1 W.L.R. 464. 942 per  cent.   It  was  conceded that  the  subsidiary  was  a separate  legal  entity  and not a  mere  emanation  of  the American  parent, and that it was selling its own  goods  as principal   and   not   its   parent’s   goods   as   agent. Nevertheless, these sales were a means whereby the  American company  carried on its European business, and it  was  held that the substance of the arrangement was that the  American company  traded  in  England  through  the  agency  of   its subsidiary.   We,  therefore,  reject the  argument  of  Mr. Venkataraman on this aspect of the case. For the reasons expressed we hold that the question referred to the High Court by the appellate Tribunal must be answered in  favour  of  the Income-tax Department  and  against  the respective  assessee-companies  and these  appeals  must  be allowed with costs. Y.P.                                     Appeals allowed. 943