Appeals Nos 1837 and 1838 of 1968
369 Appeals from the judgment and order dated February 10 1965 and July 17 1967 of the Calcutta High Court in Income tax Reference Nos 274 of 1961 and 114 of 1963 respectively
D Pal R K Choudhry N R Khaitan Krishna Sen and B P Maheshwari for the appellant in both the appeals
B Sen R N Sachthey and B D Sharma for the respondent in both the appeals
The Judgment of the Court was delivered by Grover J
These appeals by certificate from a judgment of the Calcutta High Court arise out of Income Tax References in which the main point involved was whether the assessee company could be regarded as one in which the public are substantially interested within the meaning of the Explanation in section 23A of the Indian Income Tax Act1922 hereinafter called the Act
The appeals relate to the assessment years 1952 53 and 1954 55
The assessee is a public company incorporated under the Indian Companies Act 1913
Article 37 of its Articles of  Association provided as follows The Directors may at any time in their absolute and uncontrolled discretion and without assigning any reason decline to register any proposed transfer of shares
 The Income Tax Officer held that the assessee was a company in which the public were not substantially interested within the meaning of the Explanation in section 23A of the Act
Accordingly he applied the provisions of that section
The assessee appealed to the Appellate Assistant Commissioner
The appeal relating to the assessment year 1952 53 was dismissed but with regard to the subsequent year it was alqowed
The Appellate Tribunal upheld the contention that Article 37 of its Articles of Association did not operate as a bar to the free transferability of the shares and therefore it was a company in which the public were substantially interested within the meaning of the Explanation in section 23A of the Act
Thereupon the Tribunal was moved by the Commissioner of Income tax for stating the case and referring the following question of law which was referred by it to the High Court in the case relating to the assessment year 1952 53  Whether on a true interpretation of Article 37 of the Articles of Association the assessee Company can be regarded as one in which the public are substantially interested within the meaning of the third proviso to section 23A1
3 7 0 A similar question was referred in the case relating to the assessment year 1954 55
The High Court following a judgment of the same court in Commissioner of Income tax West Bengal vs Tona Jute Co Ltd answered the questions referred against the assessee and in favour of the Revenue
In that case the Calcutta High Court had expressed the view that a public company whose Directors had absolute discretion to refuse to register the transfer of any share to any person whom it shall in their opinion be undesirable in the interest of the company to admit to membership and were not obliged to give any reason for refusal to register was not a company the shares of which were freely transferable to other members of the public within the meaning of the Explanation in section 23A of the Act
Section 23A of the Act confers power to assess companies to super tax on undistributed income in certain cases
Sub section 9 inter alia provides that nothing contained in the section shall apply to any company in which the public are substantially interested
Explanation 1 which was so renumbered by section 7 of the Finance Act of 1957 to the extent it is material is as follows  For the purposes of this section a company shall be deemed to be a company in which the public are substantially interested a     b if it is not a private company as defined in the Indian Companies Act 1913 VII of 1913 and i       ii the said shares were at any time during the previous year the subject of dealing in any recognised stock exchange in India or were freely transferable by the holder to other members of the public and iii    
The Calcutta High Court referred to the relevant provisions of the Indian Companies Act 1913 according to which unless the Article provided otherwise the shareholder had a free right to transfer his shares to whomsoever he liked
But it was considered that where the Articles contained a power under which the Directors could decline to register any transfer of shares the Tight of free transfer was cut down by that Article and this affected the question of free transferability of the shares
Moreover the 1 371 transfer of shares was not complete until the registration of the name of the transferee and if such a registration could not be insisted on as a matter of right it could not be said that the shares were freely transferable
The Madras High Court in East India Corporation Ltd vs Commissioner of Income tax Madras1 and the Bombay High Court in Raghuvanshi Mills Ltd vs Commissioner of Income tax Bombay1 took the contrary view and dissented from the opinion expressed in the Calcutta case that in the presence of an Article similar to Article 37 of the Articles of Association of the assessee the shares would not be freely transferable within the meaning of clause ii to Explanation 1 in section 23A 9 of the Act
It may be mentioned that before its amendment by the Finance Act 1955 the corresponding provision appeared in the Explanation in section 23A1 after the third proviso
But instead of the word were the word are was employed
The question therefore which has to be examined is whether the shares could be regarded as freely transferable to other members of the public In our opinion the following observations in the East India Corporation case represent the correct view about the meaning of the word transferable   Transferable ex facie is not to be equated to transferred
The word imports a quality a legal effect arising out of or inherent in the character and nature of the shares themselves
This quality does not stand by itself for the section says are in fact freely transferable
We have to give effect to each of these words and if we did so transferability is qualified by the fact which in the context to out minds means a factual tendency which is unrestricted and which ensures transferability
In other words we understand by the words are in fact freely transferable not that there should necessarily be actual transfers of shares but a factual tendency towards free transfer of shares subject of course to reasonable restrictions by holders to other members of the public The Directors have certainly been given a discretion by Article 37 to decline to register any proposed transfer of shares but that does not mean that the shares cease to be transferable
The said Article does not confer any uncontrolled or unrestricted discretion upon the Directors to refuse to register the transfer of shares in a given case
In other words the Directors cannot act arbitrarily or capriciously
It is well known that the power conferred by such an
Article is of a fiduciary nature which has to be exercised by the 1 2 3 72 Directors in the best interests of the company for preventing any undesirable person becoming a member if that is likely to be prejudicial to the company
It is a power which has to be reasonably exercised for protecting the interests of the company
It cannot be assumed that the discretion conferred on the Directors will be abused for ulterior purposes
The discretion which has been conferred for being exercised in the interest of thecompany cannot take away the tendency of the free transferability of the shares in the absence of cogent material or other factors from which it can be inferred that the shares were not capable of being freely transferred
Article 37 can by no stretch of reasoning be regarded by itself to be a restriction on the transfer of shares by one shareholder to another
Free transferability of shares is a normal and common feature of limited companies
Indeed there would hardly be any public company in the memorandum of articles of which an article similar to Article 37 will not be found
This article appears even in the standard Articles of Association prescribed under the Companies Act itself
The purposes as has been noticed before is only to give power to the Directors for declining to register the transfer of a share when the paramount interests of the company so require
There may be cases where it can be shown that the Directors have been exercising that power very freely and have virtually eliminated the element of free transferability
In such cases it may be possible to hold that in fact the shares were not freely transferable
But in the Pr sent case there is no evidence of the Directors having acted in the aforesaid manner nor is there any restriction in the other Articles of Association interfering with the free transfer of shares by one shareholder to another
We are unable therefore to uphold the judgment of the Calcutta High Court that the mere existence of an article like Article 37 would affect the free trans ferability of the shares within the meaning of the Explanation
In the result the appeals are allowed and the decision of the High Court is set aside
The question referred in each case is answered in favour of the assessee and against the Revenue
The assessee shall be entitled to one set of costs in this Court
GC Appeal allowed


Summary:
The assessee was a public limited company
 Under article 37 of its
Articles of Association the Directors could at any time in their discretion and without assigning any reason decline to register any proposed transfer of shares
The question in income tax proceedings relating to the assess ment years 1952 53 and 1954 55 was whether on a true interpretation of article 37 the assessee company could be regarded as one in which the public were substantially interested within the meaning of the third proviso to section 23A1 of the Income tax Act 1922
In reference the High Court answered the question in favour of the revenue on the view that the shares of the company were not freely transferable and therefore it was not a company in which the public were substantially interested
In the assessee s appeal by special leave HELD  Article 37 could not by any stretch of reasoning be regarded by itself to be a restriction on the transfer of shares by one shareholder to another
Free transferability of shares is a normal and common feature of limited companies
Indeed there would hardly be any public company in the memorandum of articles of which an article similar to article 37
will not be found
This article appears even in the standard Articles of Association prescribed under the Companies Act itself
The purpose is only to give power to the Directors for declining to register the transfer of a share when the paramount interest of the company so require
There may be cases where it can be shown that the Directors have been exercising the power very freely and have virtually eliminated the element of free transferability
In such cases it may be possible to hold that in fact the shares were not freely transferable
But in the present case there was no evidence of the Directors having acted in the aforesaid manner nor was there any restriction in the other Articles of Association interfering with the free transfer of shares by one shareholder to another
 The High Court was therefore in error in holding that the mere existence of an article like article 37 would affect the free transferability of the shares within the meaning of the Explanation 1 to section 23A9 of the Act
372 C F East India Corporation Ltd vs Commissioner of income tax Mad as and Raghuvanshi Mills Ltd vs Commissioner of Income tax Bombay  approved
Commissioner of Income tax West Bengal vs Tona litte Co Ltd 48 ITR 902 disapproved