Commissioner Of Income-Tax, Madras vs The Amrutanjan Ltd., Madras

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 521-523 of 1963

Decision Date: 28 April 1964

Coram: J.C. Shah, S.M. Sikri

In this case the Commissioner of Income‑Tax for Madras filed a petition against The Amrutanjan Ltd., also located in Madras, seeking a declaration dated 28 April 1964. The matter was heard before a bench of the Supreme Court of India consisting of Justice J. C. Shah and Justice S. M. Sikri. The citation of the decision is recorded as 1964 AIR 1804 and 1964 SCR (8) 9. The central issue concerned the object and scope of section 23‑A of the Indian Income‑Tax Act, 1922, particularly the meaning of the phrase “company in which the public are substantially interested.” The headnote explains that the income‑tax officer had determined that during the three years ending on 31 March 1947, 31 March 1948 and 31 March 1949 the company declared dividends that were considerably less than sixty per cent of the amount that, according to section 23‑A, was available for distribution. Consequently the officer served a notice on the respondent requiring it to show cause why an order under section 23‑A should not be made. After hearing the company, the officer issued an order deeming the undistributed portion of the assessable income—after reduction by the income‑tax and super‑tax payable—to have been distributed as dividend among the shareholders. This order was affirmed by the Appellate Assistant Commissioner and by the Income‑Tax Appellate Tribunal. The matter was then referred to the Madras High Court to determine whether the provisions of section 23‑A had been correctly applied for the three relevant years. The High Court held that The Amrutanjan Ltd. was a company in which the public were substantially interested and therefore the income‑tax officer lacked jurisdiction to make an order under section 23‑A for any of the years in question. The Commissioner appealed to the Supreme Court, attaching a certificate of fitness from the High Court. The Supreme Court dismissed the appeal, holding that the company was indeed one in which the public were substantially interested and that the officer therefore had no authority to pass an order under section 23‑A. The Court observed that the Act does not define the expression “company in which the public are substantially interested.” It explained that, ordinarily, a company is deemed to fall within this description when more than half of the voting power is vested in the public. Conversely, when a controlling interest—defined as at least fifty‑one per cent of the voting rights—is held by a single individual or a concerted group, the company is regarded as one in which the public are not substantially interested. The Court further clarified that the distinction between the controlling group and the public is not the same as the distinction between directors and other members of the company; a director who is not part of the controlling group is to be treated as a member of the public for the purposes of the third proviso and explanation to section 23‑A.

In this case the Court explained that although a director might be directly entrusted with managing the affairs of a company, the provision of section 23‑A was designed to stop shareholders who controlled a company in which the public were not substantially interested from evading the higher super‑tax that applied to non‑corporate assessees. For many years the super‑tax rates imposed on companies were considerably lower than the higher rates that applied to other taxpayers, and this created an incentive for persons who controlled companies to avoid the higher tax burden by moving their business into limited companies. The profits of such businesses could be retained within the company and accumulated until they were eventually distributed as capital, while the undistributed profits remained available for use in the owners’ other enterprises. Section 23‑A was therefore enacted to counter attempts by persons holding controlling interests in companies to avoid paying the super‑tax that applied to non‑corporate assessees by refusing to distribute profits. Under section 23‑A an Income‑tax Officer was empowered to issue an order deeming a fictional or notional income, which had not actually been received by the shareholders, as if it had been distributed and therefore taxable as having arisen or accrued to them. However, such an order could not be made in respect of a company in which the public were substantially interested, nor in respect of a subsidiary of such a company where the entire share capital of the subsidiary was held by the parent company or its nominee. The judgment concerned civil appeals numbered 521 to 523 of 1963, which were appeals from a Madras High Court judgment dated 5 April 1960 in case referred number 80 of 1955. Counsel for the appellant included the Attorney‑General and two other representatives, while counsel for the respondent were also appointed. The judgment was delivered on 28 April 1964 by Justice Shah. The factual background involved Nageswara Rao Panthulu, who founded a business manufacturing a pain‑balm marketed under the trade‑name “Amrutanjan”. In September 1936 the respondent company was incorporated as a public limited company under the Indian Companies Act, 1913, with the purpose of acquiring and carrying on the business of manufacturing and selling Amrutanjan. The authorised capital comprised 7,000 ordinary shares and 3,000 preference shares, each having a face value of one hundred rupees, while the issued and paid‑up capital consisted of 2,500 ordinary shares and 3,000 preference shares. The articles of association provided that preference shareholders were entitled to a fixed dividend of 71 per cent on the face value of their shares and had no right to the balance of profits. The respondent company purchased Panthulu’s business for five hundred and fifty thousand rupees, paying the amount through the issue of fully paid‑up ordinary and preference shares. After Panthulu’s death, the company’s management was undertaken by a firm that included his widow Ramayamma, his daughter Kamakshamma, Ramayamma’s brother Ramchandra Rao, and Kamakshamma’s husband Sambu Prasad.

The Court noted that after the death of Nageswara Rao, the company was managed by his widow Kamakshamma, his daughter Kamakshamma, Ramayamma’s brother Ramchandra Rao, and Kamakshamma’s husband Sambu Prasad. Between 1 April 1946 and 31 March 1949, Ramayamma, the widow of Nageswara Rao, held 2,185 ordinary shares, while her daughter Kamakshamma held 250 ordinary shares. Of the preference shares, only 385 were held by the directors, which included both Ramayamma and Kamakshamma. According to the company’s Articles of Association, both preference and ordinary shareholders were entitled to vote at meetings, each share carrying one vote. During the assessment of the respondent company, the Income‑tax Officer discovered that for the three financial years ending on 31 March 1947, 31 March 1948 and 31 March 1949, the company declared a total dividend of Rs 38,750 each year, calculated at a rate of 7 ½ per cent on the preference shares and 6 per cent on the ordinary shares. This dividend rate was considerably lower than sixty per cent of the amount that was available for distribution as computed under section 23‑A of the Income‑tax Act as it stood at the relevant time. The Officer, after obtaining approval from the Inspecting Assistant Commissioner, served a notice requiring the company to show cause why an order under section 23‑A should not be made against it. After considering the company’s objections, the Officer ordered on 31 March 1953 that the undistributed portion of the assessable income, after deducting income‑tax and super‑tax, be deemed to have been distributed as dividend among the shareholders as of the date of the respective general meetings. This order was affirmed on appeal by the Appellate Assistant Commissioner and subsequently by the Income‑tax Appellate Tribunal. Various contentions were raised before the revenue authorities and the Tribunal, challenging the officer’s competence to pass an order under section 23‑A, including arguments that the provision was unconstitutional or ultra vires. The Tribunal rejected those contentions, as did the High Court, rendering the issues unnecessary for further determination. Under section 66(1) of the Income‑tax Act, the Tribunal referred three questions to the Madras High Court, the third of which concerned whether the provisions of section 23‑A had been correctly applied for the three years in question. The High Court held that the respondent company was one in which the public had a substantial interest; consequently, the Income‑tax Officer lacked jurisdiction to pass an order under section 23‑A for any of the three years, and therefore answered the question in the negative. The order of the High Court was then appealed, with a certificate of fitness attached, to the Supreme Court.

In this matter, the Commissioner of Income‑tax filed an appeal before the Supreme Court. The provision that was the subject of the dispute was Section 23‑A of the Indian Income‑tax Act, 1922, as it existed prior to its amendment by the Finance Act of 1955. That subsection read in full as follows: “(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, with the previous approval of the Inspecting Assistant Commissioner, make 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. 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. Explanation—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).”

The legislative intent behind Section 23‑A was to prevent the avoidance of super‑tax by shareholders who controlled companies in which the public did not have a substantial interest. For many years the annual Finance Acts set the rate of super‑tax on companies considerably lower than the higher rates that applied to other categories of assessees. This disparity created an incentive for persons who controlled companies to transfer their business activities to limited companies so as to benefit from the lower super‑tax rates. By doing so, they could retain the source of earnings within the company, accumulate profits without distributing them as dividends, and later draw on those retained earnings for other business ventures. The statute therefore sought to thwart the practice of controlling shareholders refusing to declare dividends in order to evade the higher super‑tax that would otherwise have been payable by non‑corporate assessees. Section 23‑A empowered the Income‑tax Officer, upon finding that less than sixty per cent of the assessable income (after deducting income‑tax and super‑tax) had been distributed as dividends, to deem the undistributed portion as having been distributed among the shareholders. This deemed distribution created a notional income for the shareholders that was subject to tax as though it had actually been received. However, the provision expressly excluded from its operation any company in which the public were substantially interested, as well as any subsidiary of such a company where the parent or its nominees owned the entire share capital. The Act did not, at that time, provide a definition for the phrase “company in which the public are substantially interested.”

The Court noted that the Legislature had empowered the Income‑tax Officer to issue an order deeming income to be distributed among shareholders when, after applying any reductions permitted by law, less than sixty per cent of the assessable income of a company had actually been distributed. By such an order, a notional or fictional amount of income that had not been received by the shareholders was treated as if it had been distributed, and each shareholder was taxed on that deemed amount as though it had actually arisen or accrued to them. However, the provision in section 23‑A, as it existed at the relevant time, expressly barred the issuance of such an order in respect of any company in which the public were substantially interested, and also in respect of 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 Act did not provide a definition for the term “company in which the public are substantially interested.” In ordinary interpretation, a company would be regarded as one in which the public are substantially interested where more than half of the voting power is held by the public. Conversely, when a controlling interest—defined as at least fifty‑one per cent of the voting rights—is held by a single individual or a concerted group of individuals, the company would be considered not to have the public substantially interested. The Legislature, through the Explanation to the provision, introduced a conclusive presumption for situations where persons other than the controlling group hold shares carrying at least twenty‑five per cent of the voting power. For the purpose of calculating that twenty‑five per cent, the voting rights attached to shares that are entitled to a fixed dividend must be excluded. Established case law holds that the distinction between the controlling group and the public does not follow the line that separates directors from other members of the company. Thus, a director who does not belong to the controlling group is treated as a member of the public for the purposes of the third proviso and the Explanation to section 23‑A, even though that director may be directly involved in managing the company’s affairs. The Commissioner argued that the Explanation to sub‑section (1) of section 23‑A functions as a clause that defines what constitutes a company in which the public are substantially interested. The Court, however, observed that the Explanation merely raises a presumption and does not aim to provide a definition of such a company. After analysing the third proviso to section 23‑A and its Explanation, the Court derived the following principles: first, where no single member or group of members acting together holds fifty‑one per cent or more of the voting power that controls the company’s operations, the company is deemed, by its very nature, to be one without a controlling member or group and therefore the public are substantially interested.

In this case the Court explained that the statutory provisions require a three‑step analysis. First, if a company has no individual member or no concerted group of members that controls more than fifty‑one percent of the voting power, the company is, by its very nature, one in which no controlling member or group exists and consequently the public are substantially interested. Second, where a shareholder alone or a group of shareholders acting together holds at least fifty‑one percent of the voting power, the question must be answered on a factual basis in each case as to whether the public are substantially interested, taking into account the purpose for which the majority holding is employed. Third, the statute creates a presumption that the public are substantially interested when not less than twenty‑five percent of the voting power is allotted unconditionally to, acquired unconditionally by, or beneficially held by the public. However, the Court noted that shares that carry a fixed rate of dividend must be excluded from the calculation of the twenty‑five percent because the provision is primarily aimed at preventing the accumulation of undistributed dividends that would attract a non‑corporate super‑tax, and holders of fixed‑rate dividend shares are not directly affected by such accumulation; for them it makes little difference whether the dividend is paid immediately or accumulated. Nevertheless, for the purpose of determining the total voting power, the voting rights attached to all shares, including those with a fixed dividend, must be taken into account.

The Court observed that the Income‑Tax Department had not undertaken any investigation to ascertain whether any group of persons was controlling the workings of the company. It was a matter of record that Ramayamma held eighty‑seven point four percent of the ordinary shares issued by the company, and consequently no other person could hold twenty‑five percent or more of the ordinary shares. In the present proceedings the Court pointed out that the preference shareholders were also entitled to vote at meetings and that the Articles of Association made no distinction between preference shareholders and ordinary shareholders as to the exercise of voting rights. The total voting power of the company amounted to five thousand five hundred votes, each share, whether ordinary or preference, carrying one vote. Twenty‑five percent of this total voting power equals one thousand three hundred seventy‑five votes. To invoke the statutory presumption under the Explanation, this voting power must be exercisable solely by ordinary shareholders and not by shareholders entitled to a fixed rate of dividend. The presumption could arise only if at least twenty‑five percent of the voting power were held by persons holding ordinary shares who were outside the controlling group. An argument was raised that the phrase “twenty‑five percent of the voting power” might be interpreted to mean something other than a straight twenty‑five percent of the total voting power, but the Court noted that such an interpretation was not supported by the terms of the Explanation.

In this case, the Court examined the meaning of the phrase “total voting power” and considered whether it should be limited to the power that could be exercised with respect to shares that do not carry a fixed rate of dividend. The Court found that, on a preliminary examination, such a narrowed interpretation was not supported by the language used in the Explanation. Moreover, the Court held that the argument advanced on that basis was ineffective because the twenty‑five per cent share of the voting power that is attached to ordinary shares cannot be exercised by members of the public. Consequently, the matter involved shares that are not entitled to a fixed dividend yet represent at least twenty‑five per cent of the total voting power, and the record showed that those shares had not been allotted without conditions, nor had they been acquired without conditions, nor were they held beneficially by the public. Because those conditions were not satisfied, the Explanation could not be given effect. The Court further noted that the Tribunal had not considered the issue of whether, under the third proviso, the company could be classified as one in which the public holds a substantial interest. Likewise, the Court observed that it was not in a position to determine whether a controlling interest existed in the hands of a single shareholder or a group of shareholders that would disqualify the company from being regarded as one in which the public has a substantial interest. Accordingly, the Court affirmed the order of the High Court, but on different reasoning. It reiterated that the High Court’s construction of the Explanation was erroneous, as explained earlier, and that the Explanation did not apply because the facts did not give rise to any presumption contemplated by that provision. The Court also pointed out that the revenue authorities had failed to investigate whether a controlling interest in a group of persons existed, which would have brought the case within the scope of the third proviso. On these grounds, the Court dismissed the appeals, ordered the payment of costs, and required the payment of one hearing fee.