Commissioner of Income-Tax, Bombay vs Jubilee Mills Ltd.

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

Court: supreme-court

Case Number: Not extracted

Decision Date: 17 September 1962

Coram: Hidayatullah J.

In this appeal, the Court considered a petition filed by the Commissioner of Income‑Tax, Bombay, against Jubilee Mills Ltd., Bombay, dated 17 September 1962. The judgment was delivered by Justice Hidayatullah. The matter arose from a certificate of fitness that the High Court of Bombay had granted in respect of a judgment it delivered on 13 March 1958, which itself was made on a reference from the Income‑Tax Appellate Tribunal. The Commissioner of Income‑Tax for Bombay City acted as the appellant, while Jubilee Mills Ltd. was the respondent. The sole issue raised before the Court was whether section 23A of the Income‑Tax Act should be applied to the assessee company. The assessee was a limited‑liability company with a paid‑up capital of Rs 15,25,000, consisting of the following components: one lakh ordinary shares of Rs 10 each amounting to Rs 10,00,000; five thousand cumulative preference shares of Rs 25 each amounting to Rs 1,25,000; and four thousand second‑preference shares of Rs 100 each amounting to Rs 4,00,000. The second‑preference shares carried no voting rights, so the total number of voting shares of the company stood at 1,05,000 as on 30 June 1947. The assessment year under consideration was 1948‑49, which corresponded to the financial year ended on 30 June 1947. For that year the company was assessed on a total income of Rs 7,47,639 and the Income‑Tax Officer computed tax payable of Rs 4,20,548. If section 23A were applicable, the company would have been required to distribute sixty percent of the tax, i.e., Rs 2,52,329, as dividends. In reality the company declared dividends totalling only Rs 24,750. The Income‑Tax Officer, relying on the provisions of section 23A, deemed that the company had in fact declared dividends of Rs 3,97,788.

The management of the assessee company was entrusted to a firm known as Mangaldas Mehta & Co., which comprised fourteen partners, seven of whom also served as directors of Jubilee Mills Ltd. The directors‑who‑were‑partners held, in total, 35,469 ordinary shares and 880 first‑preference shares. The remaining seven partners, who were not directors, held 41,659 ordinary shares and 370 first‑preference shares. Additionally, Girdhardas & Co. Ltd. held seventy‑five shares, and it was acknowledged that section 23A applied to that company as well. Certain partners of the managing‑agent firm held shares on behalf of their minor children or family members, amounting to 9,899 ordinary shares and 937 first‑preference shares. The Court was provided with a detailed breakdown of shareholdings. Category A comprised shares held by directors who were also partners in the managing‑agent firm. Under this category, the ordinary shares held and the corresponding partnership interest were as follows: Shri Homi Mehta held no ordinary shares; Sheth Mathurdas Mangaldas Parekh held 6,466 ordinary shares; Madan Mohan Mangaldas held 11,052 ordinary shares; Madhusudan held an unspecified amount (the record is incomplete). The breakdown continued for the remaining directors, indicating the precise number of shares each held, thereby illustrating the distribution of voting power and the extent of control exercised by the managing partners in relation to the application of section 23A.

The Court recorded in detail the shareholding pattern of the managing‑agents firm that acted for the assessee. In Category A, which comprised the ordinary shares held by directors who were also partners in the firm, the total ordinary shareholding amounted to thirty‑five thousand four hundred sixty‑nine shares. The individual holdings were as follows: Shri Chamanlal Parekh owned three thousand six hundred sixteen ordinary shares; Shri Mahendra Chamanlal Parekh also held three thousand six hundred sixteen shares; Shri Surendra Mangaldas Parekh possessed seven thousand fifty‑three shares; and Shri Indrajit Chamanlal Parekh held three thousand six hundred sixteen shares. Category B related to the ordinary shares owned by partners of the managing‑agents firm who were not directors. In this category the ordinary shareholding totalled forty‑one thousand six hundred fifty‑nine shares and there were no preference shares. The partners’ holdings were: Shri Harshavadan Mangaldas – eleven thousand fifty‑three shares; Mrs Savitagavri Chamanlal Parekh – three thousand seven hundred fifty shares; Shri Virendra, a minor, represented by his mother and guardian Mrs Savitagavri Chamanlal Parekh, held six thousand three hundred twenty‑eight shares; Shri Manmohan Chamanlal Parekh – four thousand four hundred sixty‑two shares; Shri Kamal‑Nayan Chamanlal Parekh – four thousand nine hundred sixty‑two shares; Shri Nutan Chamanlal Parekh – four thousand nine hundred sixty‑two shares; and Shri Hussein Essa – six thousand one hundred forty‑two shares. Category C comprised the shares that were represented by the directors themselves. In this category the ordinary shareholding summed to nine thousand eight hundred ninety‑nine shares. The specific allocations were: Sheth Madhusudan Chamanlal Parekh (identified as number 4 in Category A) acted as the karta of the joint family estate of Sheth Chamanlal Girdhardas Parekh and held three thousand eight hundred ninety‑nine shares; Sheth Mathuradas Mangaldas Parekh (number 2 in Category A) as guardian and father of the minor Ben Purnima Mathuradas held one thousand shares; the same guardian held one thousand shares each for the minors Ben Veena, Ben Sunita and Jagatkumar Mathuradas; Sheth Surendra Mangaldas Parekh (number 6 in Category A) as guardian and father of the minor Darshan Surendra Parekh held one thousand shares; and likewise he held one thousand shares as guardian for the minor Ben Babi Surendra Parekh.

The Court further observed that the assessee company had suffered heavy losses in the past, which forced it to reconstruct its capital in the year 1930. At that time the profit‑and‑loss account showed a debit balance of twelve lakh seventy‑five thousand rupees, an amount that was required to be written off against capital. To achieve the reconstruction, the company reduced the face value of its ordinary shares from one hundred rupees to ten rupees each, and reduced the face value of its preference shares from one hundred rupees to twenty‑five rupees each, after obtaining the necessary approval of the High Court. The reconstituted capital thus created was reflected in the earlier part of the judgment. The Court also noted that the Income‑Tax Officer had granted the assessee a rebate of one anna under proviso (a) to paragraph (b) of Part I of the Second Schedule of the Finance Act, 1948. That particular rebate was available only to those companies to which the provisions of section 23A were not applicable. Subsequently, the Income‑Tax Officer applied section 23A to the company, and it was contended that the Officer was incompetent to do so because, by granting the rebate, he had implicitly held that section 23A did not apply. The Court reproduced the wording of section 23A as it existed before its amendment in 1955, which provided: “23A. Power to assess individual members of certain companies. – (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, unless he is satisfied that, having regard to losses incurred by the company in earlier years or to the smallness of the profit made, the payment of a dividend or a larger dividend than that declared would be unreasonable, 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 shall be deemed to have been distributed as dividends amongst the shareholders as at the date of the general meeting aforesaid, and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purpose of assessing his total income….”

The provision required that, for the previous financial year, after reducing the assessable income of the company by the amount of income tax and super‑tax payable on that income, the Income‑Tax Officer must, unless he is satisfied that, because of losses incurred in earlier years or because of the small amount of profit made, paying the declared dividend or a larger dividend would be unreasonable, issue a written order. This order could be made only after obtaining prior approval from the Inspecting Assistant Commissioner. The written order would declare that the undistributed portion of the assessable income, computed for income‑tax purposes and reduced by the tax and super‑tax due, shall be treated as if it had been distributed as dividends to the shareholders on the date of the general meeting. Consequently, each shareholder’s proportionate share of that deemed dividend would be added to his total income for the purpose of assessing his total income under the Act.

Further, the sub‑section was expressly excluded from applying to any company in which the public were substantially interested, to any subsidiary of such a company where the public were substantially interested, or to a subsidiary of such a company if the entire share capital of that subsidiary was held by the parent company or by nominees of the parent company.

The accompanying Explanation clarified the meaning of “public are substantially interested.” It stated that, for the purposes of this sub‑section, a company would be deemed to have the public substantially interested if shares of that company—excluding shares that carry a fixed rate of dividend, whether or not they carry a further right to participate in profits—representing at least twenty‑five per cent of the voting power had been allotted unconditionally to, or acquired unconditionally by, and were at the end of the previous year beneficially held by, the public. The public in this definition did not include a company to which the provisions of this sub‑section applied. Moreover, if any such shares had, during the preceding year, been traded on any stock exchange within the taxable territories or were freely transferable among members of the public, the condition of public substantial interest would be satisfied.

The Court noted that the central issue in the present case was the application of this Explanation to the facts before it. According to the Explanation, as relevant to the present purpose, a company must have shares representing at least twenty‑five per cent of voting power that have been allotted or acquired unconditionally by the public and are beneficially held by the public. The Income‑Tax Officer held that the company involved was not a company in which the public were substantially interested. He also held that the earlier grant of a rebate of one anna per rupee did not prevent him from applying section 23A to the company. Both the Appellate Assistant Commissioner and the Tribunal affirmed the Officer’s order on these two points. Dissatisfied, the assessee company sought a decision from the High Court, raising questions about the competence of the Income‑Tax Officer to pass an order under section 23A(1) after granting the rebate, whether the company was a public‑interest company within the meaning of section 23A, and whether losses incurred prior to its reconstruction could be considered for the purposes of applying the provision.

In this case the Court first examined whether, given the particular facts, the Income Tax Officer possessed the authority to issue an order under section 23A (1) of the Act after the Officer had permitted a rebate of one anna per rupee in the assessment pursuant to proviso (a) to paragraph (B) of Part I of the Second Schedule of the Finance Act, 1948. The Court then considered a second question: assuming an affirmative answer to the first query, did the facts and circumstances demonstrate that the assessee company qualified as a company in which the public were substantially interested for the purposes of section 23A of the Act. A third question was whether the loss of twelve lakh seventy‑five thousand rupees incurred by the company before its reconstruction in 1930 could be taken into account in determining the applicability of section 23A (1) of the Act. The High Court, in the judgment that is now before this Court, answered the first two questions affirmatively and, relying on the positive answer to the second question, deemed it unnecessary to decide the third question. The Commissioner of Income Tax obtained a certificate of fitness and subsequently filed the present appeal. The Court noted that the answer to the first question now lies in favour of the Commissioner, while the other party did not file an appeal; the counsel for the assessee conceded before the Court that the High Court’s decision on the first two questions was correct. Because the third question depends on the answer to the first question and the High Court had not addressed it, the Court held that it was not required to resolve that issue at this stage. Turning to the second question, the Tribunal, when addressing whether the public held at least twenty‑five percent of the voting power in the assessee company, referred to the Privy Council decision in Commissioner of Income‑Tax v Bjordal. The Tribunal concluded that although directors remain members of the public in their personal capacity, the collective holding of a group of fourteen individuals who together formed the managing agency firm of Mangaldas Mehta & Co. could not be treated as public holding for the purposes of the Explanation. The Tribunal further expressed the view that this group possessed a “juristic personality” and should be regarded as a single entity when assessing where controlling power resides, applying the test articulated by the Privy Council in the cited case. The Tribunal reiterated that the group’s juristic personality required it to be considered as a unit in determining control. The High Court, however, reversed the Tribunal’s finding, relying on its earlier decision reported in Raghuvanshi Mills Ltd. v. Commissioner of Income Tax. In that precedent the High Court held that directors, in their capacity as directors, must be distinguished from the public, and that if directors alone held more than seventy‑five percent of the voting power, the company would not be one in which the public were substantially interested. The High Court’s view further explained that the managing agents acted under the direction of the directors and, unless the directors themselves controlled the voting power above the threshold specified by the Explanation, the company should be deemed to have substantial public interest.

Above the limit specified in the Explanation, a company must be treated as one in which the public have a substantial interest. Applying that same test to the facts before it, the High Court observed that the directors, taken together, possessed only the shares that were displayed in the table under the heading “A”. Because the quantity of those shares did not reach the threshold required to invoke section 23A, the Court answered the second question in favour of the assessee company. The department had asked that the Tribunal be required to file a supplemental statement indicating whether any person belonged to categories “B” or “C”. The High Court rejected that request, holding that the issue was so closely within the directors’ control that it could not be said that the shares were held unconditionally or beneficially by any one individual, and further noting that allowing such a request would give the department a second opportunity to introduce additional evidence. In line with the House of Lords decision in Thomas Fattorini (Lancashire) Ltd. v. Inland Revenue Commissioners, the Court declined to proceed under section 66(4). The High Court also observed that the Privy Council in the Bjordals case had set out a test for determining the meaning of “public”, a test that differed from the one articulated in the earlier Raghuvanshi Mills case. However, the Court held that after 1950 the Privy Council’s decisions possessed only persuasive authority and that, in the absence of a Supreme Court ruling, the Bombay High Court’s decision remained binding. Consequently, the Court applied its own ruling in Raghuvanshi Mills and decided the present matter accordingly. While noting that the Privy Council’s view might be correct, the High Court stated, “It may be that out view is erroneous and it may be – and very probably it is – that the view taken by the Privy Council is the right one. But, as we have said, so long as the judgment of the Bombay High Court stands, it was the duty both of the department and of the Tribunal to give effect to that decision.”

Section 23A does not apply to a company in which the public are substantially interested. The Explanation defines “substantial” public interest as a shareholding that is not less than twenty‑five per cent of the total number of shares held by the public, unless those shares are held unconditionally and beneficially by the holder. The meanings of “unconditionally” and “beneficially” were explained by this Court in an appeal concerning the High Court’s decision in Raghuvanshi Mills, reported in [1961] 41 I.T.R. 613. In that decision, the Court clarified that the terms indicate that the voting power attaching to the shares is exercised freely, without being subject to the control of another shareholder, and that the registered holder is not merely a nominee. Thus, when shares are held unconditionally and beneficially, the voting power arising from those shares is the holder’s own, free from external domination.

In this case the Court explained that shares must be held free of any control by another shareholder, and the registered owner must not be acting as a nominee for anyone else. The Court reiterated the principle stated in Shree Changdeo Sugar Mills Ltd. v. Commissioner of Income‑Tax, namely that an “unconditional” and “beneficial” holding means that the shares are owned for the holder’s own benefit and are not subject to the direction of any other person. The Court also endorsed the Privy Council’s decision in the Bjordals case, observing that directors, in their capacity as directors, are not automatically outside the public sphere. What must be determined, the Court said, is whether an individual or a group acting in concert possesses enough voting power to control the company’s affairs to the exclusion of others. Such an individual or group does not satisfy the description of “public.” The Court noted that nothing inherent in the office of a director requires directors to act in unison; directors are persons in whom shareholders place confidence and to whom shareholders have conferred powers under the Companies Acts. Those powers must be exercised for the benefit of the shareholders, and the directors function, in a sense, as trustees of those powers. It is therefore the directors’ duty to use those powers according to their independent judgment, and there is no rule obligating them to act collectively. Referring to the Raghuvanshi Mills case, the Court pointed out that a controlling group may consist of directors, their nominees, relatives, or even persons who are not directors, provided they form a block that holds the controlling interest. Consequently, the first step is to ascertain whether an individual or a concerted group holds a controlling interest capable of directing the company’s affairs at will. Such controlling interest is effective only when the group owns at least fifty‑one percent of the total shares. Nevertheless, the company can still be regarded as one in which the public has a substantial interest unless the group’s shareholding exceeds seventy‑five percent. Any person—whether a director, a non‑director, a relative of a director, a promoter, or a stranger—may be part of the controlling group, but only if they belong to that group or hold shares as nominees for someone in the group. The Court emphasized that the proper test, which the Bombay High Court failed to apply in the Raghuvanshi Mills decision, was the one just explained, and applying this test leads to the conclusion that the existence of such a controlling group must be examined.

In the present company, the Court observed that the group designated as category “A”, which consisted of the directors, could not be treated as being outside the “public” merely because of their status as directors. However, the Court noted an intimate connection between category “A” and category “B”, since both categories were members of the managing agency firm. This connection indicated the existence of an additional collective, namely the shareholders who together formed the managing agency firm. The Court agreed with the High Court that the managing agents operate under the control and direction of the directors, and that the managing agents themselves are appointed by the company. Ordinarily, the directors hold the primary control over the affairs of a company, but the Court recognised that there are circumstances in which the managing agents, by virtue of a superior holding of shares, may be able to appoint the directors and to influence the directors’ views. When the managing agents possess only a small shareholding, the Court explained that such a holding is insufficient to confer an overriding power, and therefore additional evidence would be required to demonstrate that the managing agents, together with others, are running the company’s affairs to the exclusion of the public. In contrast, where the managing agents admittedly hold fifty‑one percent or more of the shares, the Court stated that the controlling interest belongs to the managing agents, either alone or in concert with those acting with them, and that a shareholding above the seventy‑five percent threshold would mean that the group could not be counted as “public”. In such a situation, a holding by the managing agents that exceeds seventy‑five percent would provide proof that the public are not substantially interested in the company.

The Court also addressed the contention that some managing agents might take an independent view. It observed that, normally, managing agencies are not informed by external parties except for purposes of mutual gain, and that the shared interest among the members creates a cohesion which enables the body to act in its own interest. When such a body holds more than seventy‑five percent of the voting power, the Company is effectively run according to the wishes of the managing agents. The Court explained that a managing agency in this position could readily select its own directors, and those directors would act as nominees rather than as independent persons. Consequently, the inference is irresistible that a single group exists that can operate the company at its will, controlling both the shareholders’ voting and the directors’ actions. No member of such a managing agency firm can be regarded as belonging to “the public”, and when this circumstance arises the Company falls within the scope of section 23A. Applying this test to the facts of the present case, the Court found that the managing agents, taken together, held seventy‑seven thousand one hundred twenty‑eight of the one hundred thousand ordinary shares, a holding well above the fifty‑one percent threshold and approaching the seventy‑five percent limit.

In the matter before the Court, the shareholdings of the managing agents were examined in detail. The agents possessed ordinary shares that were well above the statutory limit. In addition to those ordinary shares, they held 1,250 first‑preference shares out of a total of 5,000 first‑preference shares, and those first‑preference shares also carried voting rights. Moreover, the agents owned an additional 75 shares that were held by Girdhardas & Co. Ltd., a company to which section 23A was admittedly applicable. When the ordinary shares, the first‑preference shares, and the 75 shares of Girdhardas & Co. Ltd. are aggregated, the total holding amounts to 78,453 shares. The statutory threshold for the application of section 23A is reached when a party controls 75 percent of the total voting shares, which in this case would be 78,750 shares. Consequently, the managing agents fell short of the threshold by 298 shares if the plain arithmetic of section 23A were applied without further analysis.

However, the Court turned to the holdings classified under category “C.” It was found that the members of the managing agency held, on behalf of minor children, an additional 6,000 shares. The voting power attached to those shares was exercised by the members of the managing agency in their capacity as guardians of the minors. Because the guardians exercised the votes personally, those shares effectively added to the voting strength of the managing agency. Accordingly, the Court observed that there was no doubt that, in the present fact pattern, shares carrying more than 75 percent of the voting power were held either by the Court in the earlier Raghuvanshi Mills case or by the present Court. The essential reason for this conclusion was that the shares representing more than three‑quarters of the voting power were owned by the partners of the managing‑agency firm or by persons who were under the firm’s control.

The Court further noted that it was in the economic interest of the partners of the managing‑agency firm to exercise their voting power in a manner that maximised their profit from the company. While it is true that, in theory, managing agents act as servants of the company rather than its masters, and that a managing‑agency firm is ordinarily tasked with performing administrative duties under the direction of the company’s directors, the Court found that this general description did not correspond to the factual situation before it. In reality, the partners of the managing‑agency firm practically owned the company.

During the hearing, it was contended that the party asserting the application of section 23A must prove that the persons forming the group that owned more than 75 percent of the voting shares acted in unison. The Court clarified that the relevant test was not whether the members had actually acted in concert, but whether the surrounding circumstances were such that ordinary human experience would lead to the inference that they must be acting together. The Court stated that it was unnecessary to specify the precise nature of the evidence that would establish such concerted action; each case must be decided on its own facts.

The Court reiterated that the exclusion of “public” shareholders, when more than 75 percent of the voting shares are concentrated in the hands of a single person or a group acting in concert, triggers the operation of section 23A. In the Court’s opinion, the High Court was incorrect in answering the second question affirmatively. Accordingly, the appeal was allowed, the High Court’s answer was set aside, and the question was answered in the negative. The respondent was ordered to pay the costs incurred in both the present proceedings and in the High Court, and the appeal was granted.