Commissioner of Income-Tax, Bombay City II vs Shakuntala and Two Others Etc

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 125, 231 and 447 of 1960

Decision Date: 18 July 1961

Coram: S.K. Das, M. Hidayatullah, J.C. Shah

In this case the Supreme Court of India heard a petition filed by the Commissioner of Income‑Tax for Bombay City II against Shakuntala and two other respondents. The judgment was delivered on 18 July 1961. The bench consisted of Justice S K Das, Justice M Hidayatullah and Justice J C Shah. The case is reported in the 1966 volume of the All India Reporter at page 719 and also in the 1966 Supplement to the Supreme Court Reporter at page 871. The reference numbers of the Income‑Tax Appeals are 125, 231 and 447 of 1960, each of which arose from a judgment and order dated 25 September 1957 of the Bombay High Court. The appellant was represented by counsel K N Rajagopal Sastri and D Gupta, while the respondents were represented by counsel A V Viswanatha Sastri and J B Dadachanji. The matter concerned the assessment of income under the Indian Income‑Tax Act of 1922, specifically section 23A, which deals with shares held by members of a Hindu undivided family and the treatment of undistributed income as deemed dividends.

The headnote of the reported judgment explains that a Hindu undivided family was the beneficial owner of 1 842 shares in a company, although the legal title to the shares was held in the names of various family members. For the assessment year 1949‑50 the Income‑Tax Officer applied the provisions of section 23A as they stood at that time and deemed that the portion of the company’s assessable income that remained undistributed was to be treated as dividend distributed among the shareholders. The deemed dividend, after being grossed up, was added to the income of the joint family. The family argued that the dividend deemed to have been distributed under section 23A should be taxed in the hands of the shareholders who were registered as owners, rather than in the hands of the family as a whole. The Court held that the statutory language of section 23A restricts the inclusion of such notional income to the individuals whose names appear in the company’s register of shareholders. Consequently, the Hindu undivided family itself was not a shareholder within the meaning of the section, and the deemed dividend could not be assessed as income of the family. The Court relied on earlier decisions, including S C Cambatta v. Commissioner of Income‑Tax, Bombay (1946) 14 I T R 748, Shree Shakti Mills Ltd. v. Commissioner of Income‑Tax, Bombay (1948) 16 I T R 187, Howrah Trading Co. Ltd. v. Commissioner of Income‑Tax, Central Calcutta (1959) 36 I T R 215 and Oharandas Haridas v. Commissioner of Income‑Tax, Bombay (1960) 39 I T R 202, which were cited as authority for the principle that the legislative fiction created by the statute must be confined to its plain terms. The judgment proceeds to recount the facts of the first reference, noting that One Nanalal Haridas was the karta of the Hindu undivided family which admittedly was the…

J. B. Dadachanji appeared for the respondents. The judgment was pronounced on 18 July 1961 and was delivered by Justice S. K. Das. The three appeals, which were taken up by this Court with special leave, were heard together because they all arose from Income‑tax References filed in the High Court of Bombay. The references involved were Income‑tax Reference No. 29 of 1957, Income‑tax Reference No. 30 of 1957 and Income‑tax Reference No. 37 of 1957. In each of the three references the factual background was substantially the same and the legal question that the High Court was required to answer was identical. The High Court answered the question in its principal judgment in Reference No. 29 of 1957, and thereafter disposed of References 30 and 37 on the basis of that same answer. For the purpose of deciding the present appeals it is sufficient to set out the facts of Reference No. 29, to state the specific question of law that arose for determination, and to record the answer that the High Court gave to that question.

The facts concerned a Hindu undivided family whose karta was Nanalal Haridas. The family was the acknowledged beneficiary of one thousand eight hundred forty‑two shares in a company named Cotton Export and Import Limited, hereinafter referred to as “the Company”. The shares were held in the names of different family members as follows: eight hundred seventy‑seven shares were held in the name of Tribhuvandas Haridas; eight hundred fifteen shares were held in the name of Nanalal Haridas; and one hundred fifty shares were held jointly in the names of Nanalal Haridas and Tribhuvandas Haridas. The Company was not a public‑interest enterprise, and its shares were not substantially held by the public. For the assessment year 1949‑50 the Income‑tax Officer applied section 23A of the Indian Income‑tax Act, 1922, as it existed before the amendment of 1955. He ordered that the undistributed portion of the Company’s assessable income for the relevant previous year, after reduction by the tax and surcharge payable by the Company, be deemed to have been distributed as dividend to the shareholders as of the date of the relevant general meeting of the Company. The proportionate dividend attributable to the one thousand eight hundred forty‑two shares, after grossing up, amounted to Rs 54,307. The Income‑tax Officer added this deemed dividend amount to the total income of the Hindu undivided family. The family, as the assessee, contended that the dividend deemed to have been distributed under section 23A should be assessed in the hands of the actual shareholders—that is, the persons whose names appeared on the share registers of the Company—and not in the hands of the Hindu undivided family, even though the family was the beneficial owner of the shares. Both the Income‑tax Officer and the Appellate Assistant Commissioner rejected the family’s contention. The dispute was then taken on appeal to the Income‑tax Appellate Tribunal. Before the Tribunal the Department argued that, in view of the purpose of section 23A and the ordinary dictionary meaning of the term “shareholder”, there was no reason why the Hindu undivided family could not be considered the shareholder within the meaning of that section.

By an order dated 15 February 1957, the Tribunal stated that adopting the interpretation of section 23A favoured by the assessee would frustrate the essential purpose of that provision; nevertheless, the Tribunal considered itself bound by the earlier decision of the Bombay High Court in S C Cambatta v. Commissioner of Income‑Tax, Bombay (1). Consequently, the Tribunal permitted the appeal and instructed the Income‑Tax Officer concerned to remove the deemed dividend income from the taxable income of the Hindu undivided family. Following this, the Commissioner of Income‑Tax, Bombay, moved the Tribunal to refer a specific question of law to the High Court of Bombay, namely whether the dividend amount of Rs 54,307/‑ should be assessed in the hands of the assessee, that is, the Hindu undivided family. The Tribunal agreed that the question arose from its own order and accordingly referred it to the High Court. The High Court, by an order dated 25 September 1957, answered the question in favour of the assessee. It held that when an income is deemed to be distributed under the terms of section 23A, the statute expressly provides that the proportionate share of the shareholders in such a distribution must be included in their respective incomes; since the Hindu undivided family was not, and could not be, a registered shareholder of the company, the amount could not be treated as the family’s income under that section. The High Court reaffirmed the view it had earlier expressed in S C Cambatta v. Commissioner of Income‑Tax, Bombay (1). After refusing leave to appeal this decision to this Court, the Commissioner of Income‑Tax, Bombay, applied to this Court for special leave. Upon obtaining such leave, the appeals were brought before this Court. At this stage, it became necessary to read the relevant portion of section 23A as it stood before its amendment by the Finance Act, 1955. Section 23A, titled “Power to assess individual members of certain companies,” provides in sub‑section (1) that where the Income‑Tax Officer is satisfied that, for any previous year, the profits and gains actually distributed as dividends by a company up to the end of the sixth month after its accounts for that year are laid before the company in a general meeting and amount to less than sixty per cent of the assessable income of that company for the year (the assessable income being reduced by any income‑tax and super‑tax payable by the company in respect thereof), the Officer, unless convinced that, because of losses incurred in earlier years or the smallness of profits, paying a dividend or a larger dividend would be unreasonable, shall, with prior approval of the Inspecting Assistant Commissioner, issue a written order declaring that the undistributed portion of the assessable income for that year shall be deemed to have been distributed as dividend among the shareholders as at the date of the relevant general meeting, and that each shareholder’s proportionate share shall be included in that shareholder’s total income for assessment purposes.

The provision stipulated that the amount of assessable income, after deducting income‑tax and super‑tax payable by the company, would be treated as having been distributed as dividend to shareholders on the date of the general meeting. Consequently, each shareholder’s proportionate share of that deemed dividend had to be included in his total income for the purpose of assessing his personal taxable income. The provision further provided that the sub‑section would not apply to any company in which the public were substantially interested or to a subsidiary whose entire share capital was held by its parent or by nominees of the parent. The effect of this section was to create a fictional or notional dividend income that shareholders did not actually receive in cash. The notional dividend was deemed to have been distributed on the date when the previous year’s accounts were laid before the company in a general meeting. It was clear from the language of the provision that an order made under it was not itself an assessment order, but required a subsequent assessment of the shareholder. Such subsequent assessment had to be made either under section 23 or under section 34 of the Income‑Tax Act. The Bombay High Court, referring to its earlier decision in S.C. Cambatta v. Commissioner of Income‑Tax, Bombay (1) (1946) 14 I.T.R. 748, held that where a share was registered in the names of two or more persons, the registered holders formed an association of persons and were to be treated as the shareholder under section 23A. The court further observed that section 23A did not address equities or beneficial ownership; it was a procedural provision rather than a charging provision. Accordingly, the notional dividend represented an entirely artificial income that did not actually exist in the pocket of any shareholder. In a later decision, Shree‑Shakti Mills Ltd. v. Commissioner of Income‑Tax, Bombay City (2) (1948) 16 I.T.R. 187, the same High Court held that the term “shareholder” in section 18(5) of the Act meant the person whose name appeared in the company’s register of members. This interpretation was adopted by this Court in Howrah Trading Co., Ltd. v. Commissioner of Income‑Tax, Central Calcutta (1), where it ruled that there was no valid reason to give the word “shareholder” a different meaning in section 23A than in the Companies Act, 1913. The judgment also reiterated the Bombay High Court’s earlier decision in Shree‑Shakti Mills Ltd.

The Court referred to the decision of the Commissioner of Income‑tax, Bombay City (2) and other authorities that had addressed the same issue. It observed that there was no reason to attribute a different meaning to the term “shareholder” in section 23A than the meaning already given to it in section 18(5). Accordingly, the Court held that “shareholder” in section 23A should be understood as a person whose name appears in the register of shareholders of the company. To give the term a divergent meaning in the two provisions would create an inconsistency, because it would imply that a Hindu undivided family that was treated as a shareholder for the purposes of section 23A would not be able to enjoy the benefit provided by section 18(5). Counsel for the appellant advanced two lines of argument to support a broader interpretation of “shareholder” in section 23A. The first argument was that the purpose of section 23A was to prevent the avoidance of a higher tax rate by the shareholders of a company; therefore, if the beneficial owner of the shares were a Hindu undivided family, that family would fall outside the scope of section 23A because a Hindu undivided family, in its legal form, could not be a shareholder of a company. The counsel claimed that a narrow construction of section 23A would frustrate the very object of the provision. The second argument relied on the principle that a legal fiction must be taken to its logical conclusion, a principle reflected in the authorities (1) (1959) 36 I.T.R. 215 and (2) (1948) 16 I.T.R. 187. The legal fiction created by section 23A is that the profits of the company are deemed to have been distributed as dividend among the shareholders as of the date of the general meeting. The counsel urged that this fiction should be extended so that the dividend is treated as actually distributed and received by the Hindu undivided family. He further noted that, if the dividend were actually paid, it would become income in the hands of the Hindu undivided family and would be subject to tax whether the income were real or deemed.

The Court indicated that neither of the appellant’s arguments was decisive. It explained that the real issue was a matter of statutory interpretation of section 23A, which must be read in its own terms. The provision unequivocally states that “the proportionate share of each shareholder shall be included in the total income of the shareholder for the purpose of assessing his total income.” The language expressly refers to “shareholder” and makes no mention of the “beneficial owner” of the share. Consequently, the term “shareholder” must be given its ordinary meaning as a person entered in the company’s register. The Court then examined section 18(5), which deals with the gross‑up of dividends, and observed that two expressions appear in that provision: “owner of the security” and “shareholder.” While the phrase “owner of the security” might conceivably encompass a beneficial owner, the Court noted that the established interpretation of “shareholder” under section 18(5) was that it referred to the registered shareholder. Therefore, there was no justification for assigning a distinct meaning to “shareholder” in section 23A, and the provision should be applied consistently with the interpretation already adopted for section 18(5).

The Court observed that it had earlier declared that the expression “shareholder” used in section 18(5) denotes the person whose name is entered in the company’s register of members. In the same vein, the Court found no satisfactory reason to treat the word “shareholder” in section 23A differently, and therefore it should be given the identical meaning. Sub‑sections (3) and (4) of section 23A reinforced this view, because they refer expressly to members of the company, and a Hindu undivided family does not qualify as a member of a company. The Court also recalled its earlier decisions in Charandas Haridas v. Commissioner of Income‑Tax, Bombay and in Commissioner of Income‑Tax, Bombay v. Nandlal Gandalal, wherein the position of a Hindu undivided family in relation to a partnership was examined. It was uncontested that, in the present matter, the Hindu undivided family was not a shareholder of the company. Consequently, for the purpose of determining the notional income, the Court held that the language of section 23A must be applied as it stands, and any gap in the wording cannot be filled by a forced interpretation. The issue, the Court noted, was not to be resolved by applying principles of partnership law or Hindu law, as was argued in Commissioner of Income‑Tax, Bombay v. Nandlal Gandalal, but solely by construing the statutory terms. The legislative fiction created by the statute must be limited to the plain words of the provision, and the Court rejected the contention that interpreting “shareholder” to mean only a registered shareholder would defeat the purpose of the section. The provision will still operate with respect to registered shareholders, and the notional income calculated under section 23A will be added to their assessable income. The Court refused to accept the argument that a legal fiction must be extended beyond the clear language of the statute or that “shareholder” should be given a broader meaning. For these reasons, the Court affirmed that the High Court had correctly answered the question referred to it, and that the second question did not fall for consideration. Accordingly, all three appeals were dismissed, with costs awarded and one hearing fee imposed.