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

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 17 September 1962

Coram: A.K. Sarkar, J.L. Kapur, M. Hidayatullah

The appeal before the Supreme Court of India was filed by the Commissioner of Income Tax, Bombay, against Jubilee Mills Limited, Bombay. The judgment was recorded on 17 September 1962 and was authored by Justice Hidayatullah, with the bench consisting of Justices A.K. Sarkar, J.L. Kapur and M. Hidayatullah. The appeal arose from a certificate of fitness issued by the High Court of Bombay, which set aside an earlier decision of that Court dated 13 March 1958, a decision that had been made following a reference from the Income Tax Appellate Tribunal. In the present proceedings, the Commissioner of Income Tax, Bombay City, acted as the appellant while Jubilee Mills Limited, Bombay, was the respondent. The sole issue presented for consideration was whether section 23A of the Income‑Tax Act should be applied to the assessee company.

Jubilee Mills Limited was a limited liability company whose paid‑up capital amounted to Rs 15,25,000. This capital comprised three categories of shares: (i) one lakh ordinary shares with a face value of Rs 10 each, amounting to Rs 10,00,000; (ii) five thousand cumulative preference shares with a paid‑up value of Rs 25 each, amounting to Rs 1,25,000; and (iii) four thousand second preference shares with a face value of Rs 100 each, wholly paid‑up, amounting to Rs 4,00,000. The second preference shares did not carry voting rights, so the total number of voting shares in the company was 1,05,000 as of 30 June 1947. The matter concerned the assessment year 1948‑49, which corresponded to the financial year ending on 30 June 1947. For that year the company was assessed on a total income of Rs 7,47,639. The Income‑Tax Officer computed the tax liability at Rs 3,27,091, leaving a balance of Rs 4,20,548 available for distribution as surplus. If section 23A were applicable, the company would have been required to distribute sixty percent of this surplus, that is, Rs 2,52,329. Instead, the company actually declared dividends totaling Rs 24,750. Acting with the prior approval of the Inspecting Assistant Commissioner, the Income‑Tax Officer applied the provisions of section 23A and held that the company was deemed to have declared a dividend of Rs 3,97,788.

The management of the assessee company was entrusted to a firm known as Mangaldas Mehta & Co., which consisted of fourteen partners. Of these partners, seven also served as directors of Jubilee Mills Limited. The directors who were partners in the managing firm collectively held 35,469 ordinary shares and 880 first preference shares. The remaining seven partners, who were not directors of the company, held 41,659 ordinary shares and 370 first preference shares respectively. In addition, Girdhardas & Co. Ltd. held seventy‑five shares, a holding that was acknowledged to be subject to section 23A. Certain partners of the managing firm held shares on behalf of minor children or joint families, amounting to 9,899 ordinary shares and 937 first preference shares. The Court was provided with a detailed breakdown of these shareholdings, organized into categories labelled ‘A’, ‘B’ and ‘C’, which listed the specific share numbers held by each partner and director. This detailed schedule formed part of the evidence on which the Court would base its consideration of the applicability of section 23A.

In the records the Court noted the composition of the equity held by the managing‑agents firm. The first set of data, identified as Category A, listed the shareholdings of the directors who were also partners in the managing‑agents partnership. The individuals named were Shri Homi Mehta, who held fifty ordinary shares and eight preference shares, and the other six directors—Sheth Mathuradas, Madanmohan, Madhusudan, Mahendra, Surendra and Indrajit—each of whom held no ordinary shares and no preference shares. Thus, within Category A the only share ownership recorded was that of Shri Homi Mehta.

The Court then described the holdings classified as Category B, which represented the shares owned by the partners of the managing‑agents firm who were not directors. For each partner the Court gave the number of ordinary shares, the fraction of preference shares out of a total of one hundred twenty‑eight, and the number of first‑preference shares held. Shri Harshavadan Mangaldas possessed eleven thousand fifty‑three ordinary shares, fourteen preference shares out of the one‑hundred‑twenty‑eight allotment, and two hundred seventy‑four first‑preference shares. Mrs Savitagavri Chamanlal Parekh owned three thousand seven‑hundred fifty ordinary shares, seven preference shares, and sixteen first‑preference shares. A minor, Virendra, who was under the guardianship of his mother Mrs Savitagavri Chamanlal Parekh, held six thousand three‑hundred twenty‑eight ordinary shares, seven preference shares, and twenty first‑preference shares. Shri Manmohan Chamanlal Parekh, identified as a “do‑” partner, owned four thousand four‑hundred sixty‑two ordinary shares, seven preference shares, and twenty first‑preference shares. Similarly, Shri Kamalnayan Chamanlal Parekh held four thousand nine‑hundred sixty‑two ordinary shares, seven preference shares, and twenty first‑preference shares. Shri Nutan Chamanlal Parekh, also a “do‑” partner, possessed another four thousand nine‑hundred sixty‑two ordinary shares, seven preference shares, and twenty first‑preference shares. Finally, Shri Hussein Essa held six thousand one‑hundred forty‑two ordinary shares, eight preference shares, and no first‑preference shares. The Court thereby detailed the complete distribution of both ordinary and preference equity among the non‑director partners of the managing‑agents firm.

Next, the Court turned to Category C, which related to the shares that were held in trust or on behalf of minor members of families connected with the directors. The Court specified that Sheth Madhusudan Chamanlal Parekh, listed as number 4 in Category A, acted as Karta of the joint‑family estate of Sheth Chamanlal and accordingly held a first‑preference share. Sheth Mathuradas, also appearing in Category A, was described as the guardian and father of the minor Ben Purnima Mathuradas, and held one thousand first‑preference shares on his behalf. The same guardian status applied to the minors Ben Veena and Ben Sunita, each of whom was allotted one thousand first‑preference shares. Likewise, the minor Jagatkumar Mathuradas received one thousand first‑preference shares under the same guardian. Further, Sheth Surendra, another director from Category A, acted as guardian and father of the minor Darshan Surendra Parekh, holding one thousand first‑preference shares for him, and similarly held one thousand first‑preference shares for the minor Ben Babi Surendra Parekh. The Court listed these trust holdings to illustrate the manner in which the company’s equity was distributed among family members and minors.

Finally, the Court observed that the assessee company had previously suffered substantial losses, which compelled it to reconstruct its capital in the year 1930. At that time the company’s profit and loss account showed a debit balance of twelve lakh seventy‑five thousand rupees, a deficit that required the company to absorb the loss by reducing its capital. Accordingly, with the sanction of the High Court, the face value of each ordinary share was reduced from one hundred rupees to ten rupees, and the face value of each preference share was reduced from one hundred rupees to twenty‑five rupees. The Court noted that this reconstituted capital had already been detailed earlier in the judgment.

The Court further recorded that the Income‑Tax Officer had granted the company a rebate of one anna under proviso (a) to paragraph (B) of part (I) of the Second Schedule of the Finance Act, 1948. This specific rebate was intended for companies for which section 23A of the Income‑Tax Act was not applicable. Subsequently, the same Income‑Tax Officer applied section 23A to the assessee company, leading the company to argue that the officer was incompetent to do so because the earlier rebate implied that section 23A should have been considered inapplicable. The Court reproduced the pre‑1955 wording of section 23A, which provided the Income‑Tax Officer with the power to assess individual members of certain companies when the officer was satisfied that the undistributed portion of the previous year’s assessable income, after deducting tax, was effectively treated as dividend for the purpose of taxation.

Section 23A of the Finance Act, as it stood before its amendment in 1955, reads as follows: “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 she 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: … … … … … … … … Provided further that this sub‑section shall not apply to any company in which the public are substantially interested or to a subsidiary company of such a company if the whole of the share capital of such subsidiary company is held by the parent company or by the nominees thereof.” The provision is followed by an Explanation, which states: “For the purpose of this sub‑section, a company shall be deemed to be a company in which the public are substantially interested if shares of the company (not being shares entitled to a fixed rate of dividend, whether with or without a further right to participate in profits) 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 previous year beneficially held by the public (not including a company to which the provisions of this sub‑section apply), and if any such shares have in the course of such previous year been the subject of dealings in any stock exchange in the taxable territories or are in fact freely transferable by the holders to other members of the public.” The court indicated that its immediate concern was the application of this Explanation to the facts of the present case. It reiterated that, for the purposes of the Inquiry, a company is regarded as one in which the public are substantially interested when at least twenty‑five per cent of the voting power is represented by shares that have been unconditionally allotted or acquired by the public, and that these shares are beneficially held by the public at the end of the preceding year. The Income‑tax Officer, after examining the shareholding pattern, concluded that the company in question did not fall within the category of a company in which the public are substantially interested. Consequently, the Officer held that the conditions of the Explanation were not satisfied and therefore proceeded to apply section 23A despite having earlier granted a rebate under the finance provision.

The Income‑tax Officer concluded that the company was not one in which the public were substantially interested and held that his earlier grant of a rebate did not prevent him from applying section 23A of the Act to the company. Both the Appellate Assistant Commissioner and the Tribunal affirmed the Officer’s order on these two points. Subsequently the assessee company sought a reference, and the Tribunal referred three specific questions to the High Court for determination. The first question asked whether, given the facts and circumstances, the Income‑tax Officer was competent to issue an order under section 23A(1) after having allowed a rebate of one anna per rupee in the assessment under proviso (a) to paragraph (B) of Part I of the Second Schedule of the Finance Act, 1948. The second question concerned whether, on the same facts and circumstances, the assessee company qualified as a company in which the public were substantially interested for the purposes of section 23A. The third question inquired whether the loss of Rs 12,75,000 incurred by the company before its reconstruction in 1930 could be taken into account when applying section 23A(1). The High Court, in the judgment under appeal, answered the first two questions affirmatively and, relying on the positive answer to the second question, deemed it unnecessary to address the third question. The Commissioner of Income Tax obtained a certificate of fitness and thereafter filed the present appeal.

The Court noted that the answer to the first question was favorable to the Commissioner of Income Tax and that the opposing side had not filed an appeal. Counsel for the assessee, Mr Viswanath Sastri, conceded before the Court that the High Court’s findings on the first question were correct. Because the third question depended on the resolution of the first, and the High Court had not addressed it, the Court considered it unnecessary to revisit that issue at this stage and turned its attention to the second question. In examining whether the public held at least twenty‑five per cent of the voting power in the assessee company, the Tribunal had relied on a Privy Council decision in Commissioner of Income Tax v H Bjordal, [1955] 28 I.T.R. 25, holding that although directors remain members of the public, the collective holding of the fourteen individuals forming the Managing Agency firm of Mangaldas Mehta & Co. could not be counted as public ownership for the purposes of the Explanation. The Tribunal further opined that this group possessed a “juristic personality” and should be treated as a single entity when determining where controlling power vested, consistent with the test articulated by the Privy Council. The High Court, however, reversed the Tribunal’s decision, following its earlier authority in Raghuvanshi Mills Ltd. v Commissioner of Income Tax, [1953] 24 I.T.R. 338, thereby setting a different approach to the determination of public interest in the company.

In this matter the Court referred to the earlier decision reported in Raghuvanshi Mills Ltd. v. Commissioner of Income Tax [[1953] 24 I.T.R. 338]. That decision held that directors, when considered strictly as directors, must be distinguished from the public. The Court said that if the directors possessed more than seventy‑five percent of the voting power, the company could be characterised as one in which the public did not have a substantial interest. The Court further explained that the managing agents acted under the control of the directors, and that unless the directors themselves exercised voting power exceeding the limit specified in the Explanation, the company must be treated as one in which the public retained a substantial interest.

Applying the same analytical test to the case before it, the Court observed that the directors, taken together, held only the shares shown in the tabular schedule under category “A”. Because the quantity of those shares fell short of 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 furnish a supplemental statement indicating whether any person belonging to categories “B” or “C” was so dominated by the directors that the shares could not be held unconditionally or beneficially by that person. The Court rejected this request, observing that allowing such an inquiry would give the Department a second opportunity to introduce further evidence. In line with the House of Lords decision in Thomas Fattorini (Lancashire) Ltd. v. Inland Revenue Commissioners [[1942] A.C. 643], the Court also declined to take action under section 66(4).

The Court noted that the Privy Council, in the Bjordal case referred to above, had articulated a test for determining the meaning of “public” that differed from the test set out in Raghuvanshi Mills. However, the Court held that after 1950 decisions of the Privy Council were only persuasive, and that, in the absence of a decision by this Court, the judgment of the Bombay High Court remained binding. Accordingly, the Court applied the high court’s own decision in Raghuvanshi Mills to resolve the present dispute. The Court also pointed out that the high court had acknowledged the Privy Council’s viewpoint, remarking, “It may be that our 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.”

Finally, the Court reiterated that section 23A does not apply to a company in which the public are substantially interested. The Explanation defines a “substantial” interest of the public, requiring that the public’s shareholding must not be less than twenty‑five percent of the total number of shares, subject to the additional condition that no person can be regarded as belonging to the “public” unless he holds the shares unconditionally and beneficially for himself.

The term “public” applies only to persons who hold shares outright and for their own benefit, without any conditions attached to the ownership. A person cannot be regarded as belonging to the public unless the shares are held unconditionally and beneficially for himself. The meanings of “unconditionally” and “beneficially” were explained by this Court in an appeal that reviewed the Bombay High Court’s decision in the Raghuvanshi Mills case, reported in [1961] 41 I.T.R. 613. The Court observed that the words indicate that the voting power attached to the shares must be free from the control of any other shareholder and that the registered holder must not be merely a nominee. This interpretation was reiterated in Shri Changdeo Sugar Mills Ltd. v. Commissioner of Income Tax (Bombay), [1961] 41 I.T.R. 667, where the Court added that “unconditional” and “beneficial” holdings mean that the shares are owned solely for the holder’s own benefit and are not subject to direction by another person.

The Court also accepted the Privy Council’s ruling in the Bjordal case, which held that directors, by virtue of their office, are not automatically excluded from the public category. The inquiry, therefore, must determine whether an individual or a concerted group controls the company’s affairs through its voting power, thereby excluding that person or group from the definition of “public.” The Court stressed that there is nothing inherent in the office of director that obliges directors to act collectively; directors are individuals in whom shareholders place confidence and to whom shareholders confer powers under the Companies Act. Those powers must be exercised independently for the shareholders’ benefit, and directors function as trustees of those powers. Consequently, no statutory requirement compels directors to act in unison. In the Raghuvanshi Mills case, the Court clarified that a controlling block may consist of directors, their nominees, relatives in various combinations, or even persons who are not directors, provided they together hold a controlling interest. The test therefore begins by identifying whether an individual or a concerted group holds a controlling share—generally defined as owning more than fifty‑one percent of the total shares—and whether that group can direct the company’s affairs at its discretion. If such control exists, the company cannot be said to have a substantial public interest, even though the statutory threshold for public interest requires a shareholding of more than seventy‑five percent by the controlling group.

In this case the Court explained that for a group to be regarded as controlling, its shareholding had to exceed seventy‑five percent of the total voting shares. The group could comprise any person—whether a director, a non‑director, a relative of a director, a promoter of the company, or even a stranger—provided that the person was either a member of the group or held shares as a nominee for someone who belonged to the group. The Court then recalled the correct test for determining a controlling group, a test that it found had not been applied by the Bombay High Court in the earlier Raghuvanshi Mills case reported in 1953, and it noted that the present decision reversed that earlier judgment. Applying this test, the Court sought to determine whether such a group existed in the company under review. It observed that the directors classified in category ‘A’ could not be automatically excluded from the “public” merely because of their status as directors. Moreover, there was a close relationship between category ‘A’ and category ‘B’, since both sets of persons were members of the Managing Agency firm. Consequently, the Court recognized the existence of another distinct group: the shareholders who together formed the Managing Agency firm. The Court agreed with the High Court that Managing Agents operated under the control and direction of the directors and that the Managing Agents themselves were appointed by the company. While ordinarily the directors held the reins of company affairs, the Court noted that in certain situations Managing Agents, by virtue of a larger shareholding, might be able to appoint the directors and thereby shape the directors’ views. If the Managing Agents possessed only a small shareholding, they would not be capable of exercising an overriding power, and additional evidence would be required to show that, in concert with others, they were running the company to the exclusion of the public. However, when the Managing Agents held fifty‑one percent or more of the shares, the controlling interest clearly lay with them. The Court further clarified that when the Managing Agents, either alone or together with parties acting in concert, held shares above the seventy‑five percent threshold, they formed a group that could not be counted as “public”. In such circumstances, the Holding of the Managing Agents above seventy‑five percent could demonstrate that the public did not have a substantial interest in the company. The argument was raised before the Court that even among the Managing Agents some individuals might take an independent view. The Court observed, however, that Managing Agencies are normally created by parties for the purpose of mutual gain, and the commonality of interest gives the body cohesion enabling it to act in its own interest. When such a body possessed voting power exceeding seventy‑five percent, the company was essentially run according to the wishes of the Managing Agents. The Court noted that the Managing Agency could easily select its own directors, rendering those directors mere nominees of the Managing Agents. This led to the irresistible inference that the group could operate the company at its will, controlling both shareholder voting and the actions of the directors, and that no member of the Managing Agency could be regarded as belonging to “the public”. Consequently, the company fell within the ambit of section 23A.

The Court observed that when the directors are merely nominees of the Managing Agents, those directors cannot be regarded as independent persons. In such a situation the inference is unavoidable that a single group can control the company entirely: the group not only dominates the voting at the shareholders’ meeting, but also selects its own directors, thereby ensuring that the directors act according to the group’s wishes. Consequently no member of that Managing Agency can be considered a member of “the public”, and the company therefore falls within the scope of section 23A. Applying this test to the facts of the present case, the Court noted that the Managing Agents together held 77,128 of the 100,000 ordinary shares, a number that already exceeded the statutory threshold. In addition they possessed 1,250 of the 5,000 First Preference Shares, which also carried voting rights, and another 75 shares were owned by Girdhardas & Co. Ltd., a holding that is expressly covered by section 23A. The aggregate of these holdings amounted to 78,453 shares. Since 75 percent of the total voting shares equals 78,750, the Managing Agents’ shareholding fell short of the required figure by only 298 shares for the purpose of applying the Explanation to section 23A. However, when category “C” was considered, it was found that the members of the Managing Agency held an additional 6,000 shares on behalf of minor children, with the voting power of those shares exercised by the members themselves as guardians. The Court therefore concluded without doubt that more than 75 percent of the voting power was in the hands of persons who form a group, as defined in the earlier Raghuvanshi Mills decision. Those shares were effectively held by the partners of the Managing Agency or by persons under their control, and it was apparent that the partners would exercise their voting power in a manner that maximised their profit. Although the Managing Agents might technically be described as servants of the company rather than its masters, and although a managing‑agents firm is ordinarily tasked with administrative duties under the direction of the company's directors, the Court found these characterisations irrelevant and contrary to the reality in this case, where the partners of the Managing Agency practically owned the company. At the hearing a submission was made that it must be proved as a fact that the persons constituting the group owning more than seventy‑five percent of the voting power acted in unison. The Court clarified that the test is not whether the group had actually acted together, but whether the surrounding circumstances are such that ordinary human experience would safely lead to the conclusion that they are acting together.

In its discussion the Court observed that the statutory provision in question is engaged only when the persons who control the majority of voting power are acting together, and that the law does not require a precise catalogue of the type of proof that must be produced to demonstrate such concerted action. The Court emphasized that every matter must be decided according to the particular facts that are established in the case at hand. It further explained that the removal of the word “public” from the language of the provision, taken together with a situation where more than seventy‑five percent of the voting shares are held by a single individual or by a group that acts in concert, is the circumstance that brings the matter within the ambit of section 23(A). After considering the arguments, the Court concluded that the High Court had been incorrect in answering the second question in the affirmative. Accordingly, the Court allowed the present appeal, set aside the High Court’s answer, and held that the question should be answered in the negative. The order also directed that the respondent pay the costs of both the present proceedings and the earlier proceedings before the High Court. The appeal was therefore allowed.