Raghuvanshi Mills Ltd. vs Commissioner Of Income-Tax, Bombay

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: supreme-court

Case Number: Civil Appeal No. 30 of 1957

Decision Date: 7 December 1960

Coram: M. Hidayatullah, J.L. Kapur, J.C. Shah

In this matter, the Supreme Court of India heard an appeal filed by Raghuvanshi Mills Ltd. against the Commissioner of Income‑Tax, Bombay. The judgment was delivered on 7 December 1960. The case was authored by Justice M. Hidayatullah, and the bench was composed of Justices M. Hidayatullah, J. L. Kapur and J. C. Shah. The decision is reported in 1961 AIR 743 and in the Second Series of the Supreme Court Reports at page 978. Citator references identify the case as F 1961 SC1154 (6, 8), R 1967 SC 768 (13) and RF 1976 SC 1141 (3, 13). The central statutory provision involved was Section 23A of the Indian Income‑Tax Act, 1922 (the Eleventh of 1922), specifically the third proviso and its accompanying Explanation as it existed before the amendment effected by the Finance Act of 1955. The issue before the Court concerned whether the majority of shares held by the directors of the assessee company and their relatives could be treated as shares held by the public for the purpose of determining whether the public were substantially interested in the company.

The factual matrix revealed that one director, Maganlal Parbhudas, owned 6,344 of the company’s total 10,000 shares and transferred 1,000 shares each to his five sons as gifts. During the relevant accounting period the company had eight directors, including Mr Parbhudas and two of his sons, who collectively held 4,695 shares. The remaining shares, totaling 4,754, were possessed by relatives of some of the directors. Additionally, three of Mr Parbhudas’s sons served as directors of the managing company. The Income‑Tax Officer, applying Section 23A as it stood before the 1955 amendment, concluded that the company was not one in which the public were substantially interested. This assessment was upheld on appeal by both the Assistant Commissioner and the Tribunal. The High Court subsequently remitted the matter to the Tribunal for investigation into whether the directors exercised de facto control over other shareholders. The Tribunal found that the directors, particularly the three sons serving on the managing company’s board, were effectively under the control of their father. The High Court affirmed this finding and held that, on the facts, the shares held by the three sons could not be regarded as held by members of the public within the meaning of the Explanation to the third proviso of Section 23A. On further appeal, the Supreme Court held that the Explanation uses the term “public” in contrast to one or more persons acting in concert whose voting power forms a block. Where such a block controls more than seventy‑five per cent of the voting power, the company cannot be said to have public substantially interested. The Court referred to the precedent set in Sardar Baldev Singh v. Commissioner of Income‑Tax, Delhi and Ajmer, [1961] 1 S.C.R. 482, and affirmed that the initial test is to determine whether a controlling block of voting power exists.

The Court explained that the first step in applying the Explanation to the third proviso of Section 23A is to identify whether any individual or any group of persons exercises voting power as a single block. When such a block exists, the shares owned by that block cannot be described as being held “unconditionally” or “beneficially” by the public. Only those shares that are held both unconditionally and beneficially by members of the public who are not subject to the control of the identified block may be treated as public shares under the Explanation. The block may consist of directors, nominees of directors, or relatives of directors in any combination, but a person who belongs to that group cannot be said to hold shares unconditionally and beneficially for himself. Consequently, such a person falls outside the definition of “public”. The Court rejected the view that merely by being a director a person automatically stands outside the “public”. It cited Commissioner of Income‑Tax v. H. Bjørdal and held that mere relationship is irrelevant unless it is shown that the voting power of one relative is controlled by another. The principle established in Tatem Steam Navigation Co. v. Commissioner of Inland Revenue was also applied.

The appeal was filed in the Civil Appellate Jurisdiction as Civil Appeal No. 30 of 1957, seeking special leave to challenge the judgment and orders of the Bombay High Court dated 10 March 1953 and 1 September 1955. The High Court had first directed the Income‑Tax Tribunal to file a supplementary statement and allowed the parties to produce further evidence. Later, the High Court reframed the issue and answered it against the assessee. The appellant, Raghuvanshi Mills Ltd., a public limited company incorporated in Bombay, had an issued and subscribed capital of ten lakh rupees divided into ten thousand shares of one hundred rupees each at the relevant time. Before 14 November 1941, a director named Maganlal Parbhudas held 6,344 shares. On that date he gifted one thousand shares each to his five sons—Ravindra, Surendra, Bipinchandra, Hareshchandra, and Krishnakumar. The case concerned the accounting year 1 April 1942 to 31 March 1943, with the assessment year 1943‑44. During that year a dividend declared at the annual general meeting on 17 December 1943 fell short of the amount required under Section 23A of the Indian Income‑Tax Act. The pivotal question was whether the company fell within the ambit of Section 23A(1), taking into account the third proviso and its Explanation. The Court noted the shareholding pattern during the period, which formed the factual basis for determining the applicability of the statutory provision.

In this case, the Court recorded that the Company had eight directors and set out the number of shares each of them held. The first director, Shri Maganlal Parbhudas, owned 1,344 shares. The second director, Shri Ravindra Maganlal, owned 1,168 shares. The third director, Shri Surendra Maganlal, possessed 1,100 shares. The fourth director, Shri Amritlal Chunilal, held 833 shares jointly with Shri Babulal Chunilal, who in his own name owned 100 shares. The sixth director, Shri Bhagwandas Harakchand, owned 50 shares. The seventh director, Shri Haridas Purshottam, also owned 50 shares. The eighth director, Sir Chunilal B. Mehta, held 50 shares jointly with Lady Tapibai Chunilal. Altogether the directors held a total of 4,695 shares.

The Court then detailed that the balance of the Company’s share capital, amounting to 4,754 shares, was held by relatives of some of the directors. These relatives included Shrimati Kantabai Maganlal, the wife of a director, who held 771 shares; Shri Bipinchandra Maganlal, who owned 1,000 shares; Shri Hareshchandra Maganlal, a son of a director, who also owned 1,000 shares; and Shri Krishnakumar Maganlal, likewise holding 1,000 shares. Further, two daughters of a director, Shrimati Dhanlaxmi Mohanlal and Srimati Prabhavati Nanalal Harilal, together held 50 shares. Two brothers of a director, Shri Hirjibhai Purshottam and Shri Haridas Purshottam, owned a combined 25 shares, while another pair of brothers, Shri Dhanjibhai Purshottam and Shri Haridas Purshottam, held an additional unspecified amount. Finally, Shri Chimanlal Vithaldas, a cousin of a director, owned 833 shares. The total of these holdings by relatives summed to 4,754 shares.

The remaining 551 shares were held by members of the public who had no connection with any director of the Company. Prior to March 1942, the managing agents of the Company were Messrs Ravindra Maganlal and Bros., a firm solely owned by Maganlal Parbhudas. On 7 March 1942, the Company appointed Ravindra Maganlal & Co. Ltd. as its managing agents for a period of twenty years. The managing company had a total issued and subscribed capital of Rs 5,000, which had been equally subscribed by the five sons of Maganlal Parbhudas previously named. During the account year under consideration, Maganlal Parbhudas and two of his sons, Ravindra Maganlal and Surendra Maganlal, served as three of the Company’s directors, while Ravindra, Surendra and Bipinchandra were directors of the managing company. On the basis of these facts, the Income‑Tax Officer applied section 23A, as it stood before amendment by the Finance Act 1955, and held that the Company was not one in which the public were substantially interested. That order was affirmed on appeal by both the Appellate Assistant Commissioner and the Tribunal. The Tribunal also declined to state a case under section 66(1) of the Income‑Tax Act, but the Bombay High Court, acting under section 66(2), required a statement of the case on the question whether the provisions of section 23A of the Indian Income‑Tax Act (XI of 1922) applied to the petitioners. In doing so, the Tribunal observed that the better formulated question might have been whether the 1,000 shares each held by Bipinchandra, Haresh chandra and Krishnakumar in the capital of the assessee Company were held by members of the public within the meaning of the explanation to the third proviso of section 23A. The members of the Tribunal, in deciding the appeal before them, gave slightly different reasons. According to

The Accountant Member observed that the shares owned by persons having an interest in the Managing Company were actually under the control of the directors of the appellant Company, and therefore those persons could not be regarded as members of the public. The Judicial Member added that the directors were directing the shareholders of the Company, that the shareholders’ relatives were merely nominees whose voting power was dictated by the directors, and consequently the public could not be said to be substantially interested as required by the Explanation to the third proviso of the section. When the High Court examined the matter, the learned judges turned their attention to the proper meaning of the expression “held by the public” in the Explanation. They concluded that the purpose of the third proviso and its Explanation was to ensure that the voting power exercised by the public should be independent of any control exercised by the directors, and that the term “public” was intended to be used in contrast to the directors. The judges further thought that a holding by a director could not, in any event, be described as a holding by the public. The High Court thereafter formed a tentative opinion that both the Accountant Member’s and the Judicial Member’s tests were erroneous, and held that the law required an analysis of de facto control, that is, control that is actually exercised. The Court noted that the Tribunal had not made any finding on that point, and therefore remitted the case to the Tribunal for a fresh statement of the case to determine whether the directors were exercising de facto control over any of the other shareholders belonging to the second category previously indicated. The Tribunal subsequently restated the case, examined additional evidence, and concluded that the directors, particularly the three sons of Maganlal Parbhudas who were directors of the Managing Company, were themselves under the de facto control of their father. At no stage did the Tribunal alter the Department’s finding that the company’s shares were not freely transferable by the holders to members of the public. The High Court then reheard the matter and determined that there was sufficient evidence on which the Tribunal could hold that Maganlal Parbhudas exercised de facto control over his three sons. In view of this conclusion, the High Court held that the Tribunal’s order was correct, and answered the original question in the negative, reframing it as follows: “Whether, on the facts and circumstances of the case, the shares held by Bipinchandra, Harishchandra and Krishnakumar can be considered to be shares held by members of the public within the meaning of the explanation to the third proviso to Section 23A?” The High Court refused to grant a certificate; however, the company obtained special leave from this Court and filed the present appeal. It is first contended that …

The petitioners contend that the test applied by the Tribunal and the High Court, which assumes that shares held by the directors of a company are automatically excluded from the category of shares in which the public have a substantial interest, is erroneous. According to counsel for the petitioners, every authority cited by the lower forums has proceeded on this mistaken premise and has consequently failed to apply the correct test prescribed by the Explanation to the third proviso of Section 23A. It is undisputed that a total of 551 shares were actually held by members of the public. Given that the total issued share capital of the company amounted to 10,000 shares, the company could escape the operation of Section 23A only if the public owned shares representing at least twenty‑five per cent of the voting power, which translates to a minimum of 2,500 shares. The directors, taken together, possessed 4,695 shares, and the High Court characterised those shares as not being beneficially held by the public. Nevertheless, even if the remaining shares were deemed to be held by the public, the threshold of twenty‑five per cent would still be satisfied. The shares owned by the three sons of Maganlal—namely Bipinchandra, Harishchandra and Krishnakumar—were examined in this context. If those shares could be classified outside the category of shares beneficially held by the public, then, together with the directors’ shares, they would reduce the proportion of shares held by the other shareholders to below the required twenty‑five per cent. On this basis, the High Court remitted the matter back to the Tribunal for a further enquiry as to whether Maganlal Parbhudas exercised de facto control over these three shareholders. Consequently, two principal questions arise for consideration on this appeal. The first question asks whether shares held by directors must invariably be treated as not being held by the public. The second question seeks to determine the precise meaning of the provision stating that a company shall be deemed to be one in which the public are substantially interested if shares carrying not less than twenty‑five per cent of the voting power have been allotted unconditionally to, or acquired unconditionally by, and are at the end of the preceding year beneficially held by the public. In this connection, it is noteworthy that a ruling of the Privy Council appears to adopt a stance different from that of the High Court with respect to an Uganda Ordinance that is pari materia to the proviso and its Explanation, and a similar divergence of view is found in a decision of the House of Lords. Section 23A, as it stood before its amendment in 1955, reads, in the material portions, as follows: “23A. Power to assess individual members of certain companies.—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…”

In the provision, the Income‑Tax Officer was empowered to act when the dividends presented to a company at its general meeting were found to be less than sixty per cent of the assessable income of that previous year after deducting the income‑tax and super‑tax payable by the company. The officer could, unless he was convinced that, because of losses incurred in earlier years or because of the small amount of profit, it would be unreasonable to pay a dividend or a larger dividend than the one declared, obtain the prior approval of the Inspecting Assistant Commissioner and issue a written order. That order would deem the undistributed portion of the assessable income—computed for income‑tax purposes and reduced by the tax payable—to have been distributed as dividends among the shareholders as of the date of the general meeting. Consequently, each shareholder’s proportionate share of that deemed dividend would be included in his total income for the purpose of assessing his total tax liability. The provision further stipulated that this sub‑section would not apply to any company in which the public were substantially interested, nor to a subsidiary of such a company where the entire share capital of the subsidiary was held by the parent company or by nominees of the parent. The accompanying Explanation clarified the meaning of “public are substantially interested.” It stated that a company would be deemed to have substantial public interest if shares carrying at least twenty‑five per cent of the voting power had been allotted unconditionally to, or acquired unconditionally by, the public and were, at the end of the previous year, beneficially held by the public, and if during that year those shares had been dealt with on any stock exchange or were freely transferable by the holders to other members of the public. The Court observed that the third proviso clearly exempted from the sub‑section any company where the public were substantially interested. While the Explanation set a quantitative threshold of twenty‑five per cent of voting power, the Court emphasized that the essence lay in the terms “unconditionally” and “beneficially.” These terms signify that a person who holds shares not for his own benefit but for another’s, and who does not exercise his voting rights freely, cannot be counted as part of the “public.” The term “public” was therefore understood in contrast to one or more persons who act together in concert, exercising a block of voting power as a single entity.

The Court explained that when a block of persons holds a voting power constituting a single group, and that block controls more than seventy‑five percent of the total voting power, the company cannot be classified as one in which the public are substantially interested. The Court referred to the decision in Sardar Baldev Singh v. Commissioner of Income‑Tax, Delhi and Ajmer, observing that the statutory provision applies to a company where at least seventy‑five percent of the voting power is in the hands of persons other than the public, which necessarily implies a group of persons united by a common interest. Such a company is therefore one that is controlled by a group, and that group may exercise complete discretion over the affairs of the company, subject only to the limits imposed by the Companies Act, including the power to decide whether a dividend shall be declared. From this test, the Court noted that the controlling group may be formed by the directors acting in concert, by some directors acting together with other individuals, or even by shareholders who are not directors at all. For convenience, this group may be described as a “block”, and if its voting power reaches or exceeds seventy‑five percent, it can dominate any general or special meeting of the company. The Court further described the initial capital structure of a company, where promoters may subscribe to a portion of the capital and release the remaining shares unconditionally to the public, which constitutes an unconditional allotment of shares to the public. The public may also acquire unconditionally a portion of the shares previously held by the promoters. If, at the end of the preceding year, the public holds twenty‑five percent or more of the voting power, the company is eligible to rely on the third proviso. However, if more than seventy‑five percent of the shares revert to a block that acts as a single controlling interest, the third proviso no longer applies. The Court emphasized that there is no universal formula for determining the existence of such a controlling interest; the mere fact of being a director or a relative does not by itself decide the issue. Relatives who act jointly with others, without exercising their voting power freely, cannot be counted as part of the public as defined in the Explanation, whereas relatives who act independently may be regarded as public. Likewise, directors who do not act collectively with others are not automatically considered part of a controlling block. The Court cited Tatem Steam Navigation Co., Ltd. v. Commissioners of Inland Revenue to illustrate the first proposition, noting that in that case the assessing Commissioners had issued directions under section 21 of the Finance Act, 1922, which the company contested on the ground that…

It was held that the Company qualified as a public‑interest company because at least twenty‑five percent of its voting power was allotted unconditionally to, or acquired unconditionally by, persons who beneficially held the shares at the end of the relevant periods.

The Special Commissioners had decided that sixteen thousand shares given by Lord Glanely to his niece were not allotted or acquired by the public and therefore concluded that the Company was not a public‑interest company. That conclusion was found to be erroneous.

Lawrence, J. observed that the niece’s relationship to Lord Glanely did not deprive her of membership in the public, and the Court of Appeal affirmed that view.

The Court noted that other statutory provisions might describe relationships that create a presumption of control, but a niece did not fall within such a category. The Act under consideration did not define the type of relationship that would demonstrate control, and consequently the same principle applied.

The Court stressed that a mere familial relationship was irrelevant unless it could be shown that the voting power held by the relative was actually controlled by another relative.

The Bombay High Court’s test that Directors stand outside the “public” was also held not to be decisive.

In Commissioner of Income‑tax v. H. Bjordal, the Judicial Committee examined section 21(1) of the Income Tax Ordinance No 8 of 1940 (Uganda), as amended by section 5 of the Income Tax (Amendment) Ordinance 1943. That provision was regarded as identical in substance to section 23A of the present Act.

The case involved two brothers, H. Bjordal and S. Bjordal, who held respectively seventy‑three point nine six percent and twenty‑five point zero nine percent of the voting power, while five other shareholders together held four tenths of a percent.

The shares owned by S. Bjordal had been bought from his brother for full market value. No allegation was made that he acted as a nominee for the respondent or that he coordinated his voting with his brother.

Both brothers were also Directors of the Company. The Judicial Committee held that shareholders who are members of the public do not lose that status merely because they become Directors.

The Court observed that, similar to the Indian statute, the Ugandan Ordinance gave no definition of the term “public,” unlike the English statute discussed in the Tatem case.

In Jubilee Mills Ltd. v. Commissioner of Income‑tax, Chief Justice Chagla and Justice S. T. Desai, referring to the judgment under appeal and considering the Privy Council decision, remarked that their view might be erroneous and that, quite possibly, the Privy Council’s interpretation was the correct one.

In this case the Court explained that the first step is to determine whether a single person or a group exercises voting power as a single block. If such a block exists, the shares owned by that block are not regarded as being held unconditionally and beneficially by members of the public. Consequently, only those shares that are held unconditionally and beneficially by the public, meaning they are not under the control of any such block, may be counted as shares held by the public. The controlling block may consist of directors, their nominees, or relatives in various combinations, but a person who is a director or a relative remains part of that block unless he holds the shares for himself unconditionally and beneficially. Only persons who do not belong to such a controlling group can be properly described as outside the term “public”. Applying this principle, the Court held that the judgment and orders of the High Court could not be sustained. Directors cannot be excluded from the public merely because they are directors, and therefore the High Court’s conclusion was erroneous. The Tribunal, in its supplementary statement, found that the shares owned by Bipinchandra, Harishchandra and Krishnakumar were under the control of their father Maganlal Parbhudas. Those three held three thousand shares and Maganlal held an additional one thousand three hundred forty‑four shares, giving a total of four thousand three hundred forty‑four shares. Although the High Court correctly answered the question it framed in the negative, that answer did not finally resolve the dispute. The remaining issue is whether more than the prescribed percentage of the shares are not beneficially held by the public. Accordingly the Court set aside the judgment and orders of the High Court and directed that the High Court determine the original question it had posed: whether, based on the facts and circumstances, the provisions of section 23A of the Indian Income‑Tax Act, XI of 1922, apply to the petitioners. The High Court was authorized to request a supplemental statement from the Tribunal if it deems it necessary. The appeal was allowed, the respondents were ordered to bear the costs of the appeal, and the costs in the High Court were to follow the result of this decision.