Appeal No 45 of1964
Appeal from the judgment and order dated July 30 1962 of the Bombay High Court in Special Civil Application No 69 of 1962
GS Pathak M M Gharekhan and 1
N Shroff for the appellant
911 CK Daphtary Attorney General R Ganapathy Iyer Gopal Singh and R N Sachthey for the respondent
The Judgments of P B GAJENDRAGADKAR CJ K N WANCHOO M HIDAYATULLAH and J R MUDHOLKAR JJ was delivered by GAJENDRAGADKAR CJ RAGHUBAR DAYAL J delivered a dissenting Opinion
Gajendragadkar CJ
This appeal arises from a writ petition filed by the appellant Navnit Lal C Javeri in the Bombay High Court in which he challenged the validity of section 121B read with section 2 6A e of the Indian Income tax Act 1922 No 11 of 1922 hereinafter called the Act as it stood in 1955
The High Court has rejected the appellant s contention that the said section is invalid and the appellant has come to this Court with a certificate granted by the High Court
The appellant holds 11 out of 845 shares in a private limited company named the Malegaon Electricity Co Private Ltd hereinafter referred to as the company
The value of each share is Rs 100
The business of the company is to supply electricity to the residents of Malegaon
Some time during 1955 the appellant took a loan amounting to over Rs 4 lakhs from the company
A notice was issued to the appellant by the 8th Income Tax Officer under section 222 of the Act calling upon him to make his return for the assessment year 1956 57
The Income tax Officer computed his income at Rs 358460
This amount included a sum of Rs 283126 representing the accumulated profits of the company
The Income tax Officer took the view that under section 2 6A e the said amount must be deemed to be dividend received by the appellant and as such must be included in the total income of the appellant as income from other sources within the meaning of section 121B of the Act
This order was challenged by the appellant by preferring an appeal before the Appellate Assistant Commissioner
The appeal however failed and was dismissed
The appellant then preferred a second appeal before the Income Tax Appellate Tribunal
Whilst this appeal was pending before the said Tribunal the appellant moved the High Court under Articles 226 and 227 of the Constitution and contended that the relevant section under which the department had purported to levy assessment against him on the sum of Rs 283126 was ultra vires
That is how the only question which the High Court had to decide in the present writ proceedings was whether section 12 1B read with section 2 6A e was constitutionally valid
912 in order to deal with this point it is necessary to read the two relevant provisions of the Act
Section 26C defines income as including dividend
Section 2 6A defines dividend in an inclusive manner
Section 2 6A e provides Dividend includes e any payment by a company not being a company in which the public are substantially interested within the meaning of section 23A of any sum whether as representing a part of the assets of the company or otherwise by way of advance or loan to a shareholder or any payment by any such company on behalf or for the individual benefit of a shareholder to the extent to which the company in either case possesses accumulated profits but dividend does not include i ii any advance or loan made to a shareholder by a company in the ordinary course of its business where the lending of money is a substantial part of the business of the company iii any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub clause e to the extent to which it is so set off Thus the inclusive definition of dividend takes in the payments to which clause e of section 26A refers and makes them dividend for the purpose of the Act
Section 121 provides that the tax shall be payable by an assessee under the head Income from other sources in respect of income profits and gains of every kind which may be included in his total income if not included under any of the preceding heads
Section 12lB provides  any payment by a company to a shareholder by way of advance or loan which would have been treated as a dividend within the meaning of clause e of subsection 6A of section 2 in any previous year relevant to any assessment year prior to the assessment year ending on the 31st day of March 1956 had that clause been in force in that year shall be treated as a dividend received by him in the previous year relevant to the 913 assessment year ending on the 31st day of March 1956 if such loan or advance remained outstanding on the first day of such previous year
Both these provisions viz section 26Ae and section 12lB were introduced in the Act by the Finance Act 15 of 1955 which came into operation on the 1st of April 1955
It is thus clear that the combined effect of these two provisions is that three kinds of payments made to the shareholder of a company to which the said provisions apply are treated as taxable dividend to the extent of the accumulated profits held by the company
These three kinds of payments are 1 payments made to the shareholder by way of advance or loan 2 payments made on his behalf and 3 payments made for his individual benefit
There are five conditions which must be satisfied before section 12lB can be invoked against a shareholder
The first condition is that the company in question must be one in which the public are not substantially interested within the meaning of section 23A as it stood in the year in which the loan was advanced
The second condition is that the borrower must be a shareholder at the date when the loan was advanced it is immaterial what the extent of his shareholding is
The third condition is that the loan advanced to a shareholder by such a company can be deemed to be dividend only to the extent to which it is shown that the company possessed accumulated profit at the date of the loan
This is an important limit prescribed by the relevant section
The fourth condition is that the loan must not have been advanced by the company in the ordinary course of its business
In other words this provision would not apply to cases where the company which advances a loan to its shareholder carries on the business of money lending itself  and the last condition is that the loan must have remained outstanding at the commencement of the shareholder s previous year in relation to the assessment year 1955 56
In dealing with the question about the constitutionality of the impugned provisions it is necessary to bear in mind these respective conditions which govern the application of the said provisions
There is another material circumstance which cannot be ignored
It appears that when these amendments were introduced in Parliament the Hon ble Minister for Revenue  Civil Expenditure save an assurance that outstanding loans and advances which are otherwise liable to be taxed as dividends in the assessment year 1955 56 will not be subjected to tax if it is shown that they had been genuinely refunded to the respective companies before the 30th June 1955
It was realized by the Government 914 that unless such a step was taken the operation of section 121B would lead to extreme hardship because it would have covered the aggregate of all outstanding loans of past years and that may have imposed an unreasonably high liability on the respective shareholders to whom the loans might have been advanced
In order that the assurance given by the Minister in Parliament should be carried out a circular No 20XXI 655 was issued by the Central Board of Revenue on the 10th May 1955
It is clear that a circular of the kind which was issued by the Board would be binding on all officers and persons employed in the execution of the Act under section 58 of the Act
This circular pointed out to all the officers that it was likely that some of the companies might have advanced loans to their shareholders as a result of genuine transactions of loans and the idea was not to affect such transactions and not to bring them within the mischief of the new provision
The officers were therefore asked to intimate to all the companies that if the loans were repaid before the 30th June 1955 in a genuine manner they would not be taken into account in determining the tax liability of the shareholders to whom they may have been advanced
In other words past transactions which would normally have attracted the stringent provisions of section 12lB as it was introduced in 1955 were substantially granted exemption from the operation of the said provisions by making it clear to all the companies and their shareholders that if the past loans were genuinely refunded to the companies they would not be taken into account under section 12lB
Section 121B would therefore normally Apply to loans granted by the companies to their respective shareholders with full notice of the provisions prescribed by it
Mr Pathak for the appellant contends that the impugned provision is constitutionally invalid because it is beyond the legislative competence of Parliament
He argues that Entry 82 in List I of the Seventh Schedule which deals with taxes on income other than agricultural income cannot justify the impugned provision because a loan advanced to a shareholder by the company cannot in any legitimate sense be treated as his income and so the artificial manner in which such dividend is ordered to be treated as income by the impugned provision is not justified by the said Entry
He also contends that the said provision offends article 191 f  g and cannot be said to be justified by clause 5 or 6 of the said article
There is no doubt that if the impugned provision is beyond the legislative powers of Parliament it would be bad
Similarly it is now well settled that even tax 915 legislation must stand the scrutiny of the fundamental rights guaranteed by the Constitution and so there can be no doubt that if the impugned provision invades the fundamental rights of the appellant and the invasion is not constitutionally justified it would be invalid
In dealing with this point it is necessary to consider what exactly is the denotation of the word income used in the relevant Entry
It is hardly necessary to emphasis that the entries in the Lists cannot be read in a narrow or restricted sense and as observed by Gwyer CJ in the United Provinces vs Atiqa Begum1
 each general word should be held to extend to all ancillary or subsidiary matters which can fairly and reasonably be said to be comprehended in it
 What the entries in the List purport to do is to confer legislative powers on the respective Legislatures in respect of areas or fields covered by the said entries 
and it is an elementary rule of construction that the widest possible construction must be put upon their words
This doctrine does not however mean that Parliament can choose to tax as income an item which in no rational sense can be regarded as a citizen s income
The item taxed should rationally be capable of being considered as the income of a citizen
But in considering the question as to whether a particular item in the hands of a citizen can be regarded as his income or not it would be inappropriate to apply the tests traditionally prescribed by the Income tax Act as such
In Navinchandra Mafatlal vs The Commissioner of Income tax Bombay City1 this Court had occasion to consider the question as to whether capital gains could be treated as income within the meaning of item 54 of List I of the Seventh Schedule to the Government of India Act 1935
Section 12 B of the Indian Income tax Act 1922 which had been inserted in the said Act by Act XXII of 1947 had imposed tax on capital gains 
The validity of this provision was challenged on the ground that capital gains cannot be treated as income within the meaning of entry 54
This plea was rejected by this Court on the ground that the words used in a constitutional enactment conferring legis lative powers ought to be construed most liberally and in their widest amplitude
Adopting this approach Das J as he then was speaking for the Court observed that the word income used in the said entry must be given its ordinary natural and grammatical meaning and that was income is a thing that comes in
On this view the Court found no difficulty in coming to the conclusion that income would include capital gains
If the traditional 1 2 19551 SCR 829
Sup65 916 sense of income had been accepted then of course capital gains could not be treated as income
That in fact was the argument which was pressed by Mr Kolah who appeared for the appellant
If we hold observed the learned Judge as we are asked to do that the meaning of the word income  has become rigidly crystallised by reason of the judicial interpretation of that word appearing in the Income tax Act then logically no enlargement of the scope of the Income tax Act by amendment or otherwise will be permissible in future
 And he has significantly added that a conclusion so extravagant and astounding can scarcely be contemplated or countenanced
This decision therefore shows that the word income used in entry 54 which corresponds to the present entry 82 in List I of the 7th Schedule to our Constitution was liberally construed and capital gains were deemed to be included within its scope
This aspect of the matter has also been clearly enunciated by Gwyer CJ in In re The Central Provinces and Berar Sales of Motor Spirit and Lubricants Taxation Act 1938 No 14 of 1938 1
I conceive said the learned Chief Justice that a broad and liberal spirit should inspire those whose duty it is to interpret it the Constitution but I do not imply by this that they are free to stretch or pervert the language of the enactment in the interests of any legal or constitutional theory or even for the purpose of supplying omissions or of correcting supposed errors
The next decision to which we ought to refer deals with section 23A of the Act
In Sardar Baldev Singh vs Commissioner of Income tax Delhi  Ajmer1 the validity of the said section was challenged
Section 23A1 provides inter alia that subject to the provisions of sub sections 3 and 4 where the Income tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company within the twelve months immediately following the expiry of that previous year are less than sixty per cent of the total income of the company of that previous year as reduced by the amounts specified in clauses a b  c of the said sub section the Income tax Officer shall unless he is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profits made in the previous year the payment of a dividend or a larger dividend than that declared would be unreasonable make an order in writing that the company shall apart from the sum 1 at p 37
2  917 determined as payable by it on the basis of the assessment under section 23 be liable to pay super tax at the rate specified by the said sub section
The object of this section is to prevent avoidance of super tax by shareholders of a company in which the public are not substantially interested
As is well known the ratesof super tax applicable to companies are much lower than the rates applicable to individual assessees
The legislature thought that individuals tried to avoid the payment of super tax at a higher rate by transferring to a private limited company it
return for shares the sources of their income and then the profits made by the company were allowed to accumulate in the hands of the company dividends not being declared and the said profits would ultimately be distributed in a capital form by one device or another
The object of section 23A was to defeat such attempts
The main effect of the provisions of section 23A appears to be that a company should not accumulate more than 40 per cent of its net profits to build up reserves or to provide for capital expenditure
It will be recalled that section 26A has taken within the definition of dividend the accumulated profits of such companies and so section 23A attempts to reach such accumulated profits for the purpose of taxation
The argument which was urged before this Court in the cast of Sardar Baldev Singh1 was that a company and its share holders are different persons and so section 23A was ultra vires inasmuch as it purported to tax the shareholders on the income of the company in which they hold shares
If the accumulated profits are distributed amongst the shareholders by way of dividends the shareholders could legitimately be taxed in respect of the dividends received by them but when section 23A attempts to tax the shareholders for accumulated profits even though they are not distributed as dividends what the section purports to do is to tax the share holders for the profits made by the company and that according to the appellant made section 23A invalid
This argument was repelled by this Court on the ground that the obvious intention of section 23A was to prevent evasion of tax and it was held that entry 54 should be read not only as authorising the imposition of a tax but also as authorising an enactment which prevents the tax imposed being evaded otherwise the power to tax a person on his income might often be made in fructuous by ingenious contrivances
It would be noticed that section 23A wanted to deal with a situation where shareholders did not deliberately distribute the accumulated profits as dividends amongst themselves
Section 1  918 23A therefore provides that these accumulated profits will be deemed to have been distributed to the shareholders and tax levied against them on that basis
It is likely that in such a case hardship may be caused in some honest cases but this Court made it perfectly clear that considerations of hardship are irrelevant for determining questions of legislative competence
It is thus clear that the result of the decision of this Court in Sardar Baldev Singh1 is that the income which technically belonged to the company was treated as income belonging to the share holders in proportion to the shares they held in the company and on that footing tax was levied on them and yet the said tax was held to be constitutionally valid
There is yet another case in which a similar question was considered
In Balaji vs Income tax Officer Special Investigation Circle 2 a person and his wife started business in partnership and admitted their three minor sons to it
In computing the total income of the said person for the purpose of assessment the Income tax Officer included the share of the income of his wife and three minor sons under section 16 3 a i  ii of the Act
The validity of this provision was challenged on the ground that the impugned section purported to tax a person for the income of other persons namely his wife and minor sons
In rejecting the contention raised against the validity of the impugned section this Court held that the Entries in the Legislative Lists are not powers but fields of legislation and the widest import and significance should be attached to them
On this view the conclusion reached by this Court was that Entry 54 of the Federal Legislative List covered legislation like section 16 3 a i  ii because it was intended to prevent evasion of tax
It appears from the judgment that the validity of the said section was also challenged on the ground that it contravened Articles 14 and 191 f  g of the Constitution
This plea was also rejected
One of the considerations which weighed with the Court in repelling the said plea was that the additional payment of tax made on the income of the wife or the minor children would ultimately be home by them in the final accounting between them
Having regard to this con sideration and bearing in mind the fact that the mode of taxation authorised by the impugned section though harsh was thought to be necessary to prevent evasion of payment of tax this Court held that the said section was valid
It is in the light of these decisions that we must proceed to consider Mr Pathak s argument that section 121B of the Act is ultra wires
1  2  In dealing with Mr Pathak s argument in the present case let us recall the relevant facts
The companies to which the impugned section applies are companies in which at least 75 per cent of the voting power lies in the hands of persons other than the public and that means that the companies are controlled by a group of persons allied together and having the same interest
In the case of such companies the controlling group can do what it likes with the management of the company its affairs and its profit within the limits of the Companies Act
It is for this group to determine whether the profits made by the company should be distributed as dividends or not
The declaration of dividend is entirely within the discretion of this group
When the legislature realized that though money was reasonably available with the company in the form of profits those in charge of the company deliberately refused to distribute it as dividends to the shareholders but adopted the device of advancing the said accumulated profits by way of loan or advance to one of its shareholders it was plain that the object of such a loan or advance was to evade the payment of tax on accumulated profits under section 23A
It will be remembered that an advance or loan which falls within the mischief of the impugned section is advance or loan made company which does not normally deal in money lending is made with full knowledge of the provisions contained impugned section
The object of keeping accumulated without distributing them obviously is to take the benefit lower rate of super tax prescribed for companies
This was defeated by section 23A which provides that in the case distributed profits tax would be levied on the shareholders on the basis that the accumulated profits will be deemed to have been distributed amongst them
Similarly section 121B provides that if a controlled company adopts the device of making a loan or advance to one of its shareholders such shareholder will be deemed to have received the said amount out of the accumulated profits and would be liable to pay tax on the basis that he hag received the said loan by way of dividend
It is clear that when such a device is adopted by a controlled company the controlling group consisting of shareholders have deliberately decided to adopt the device of making a loan or advance
Such an arrangement is intended to evade the application of a 23A The loan may carry interest and the said interest may be received by the company but the main object underlying the loan is to avoid payment of tax
It may ultimately be repaid to the company and when it is so repaid it may or may not be treated as part of 920 accumulated profits
It is this kind of a well planned device which section 121B intends to reach for the purpose of taxation
It appears that such a device is adopted by private companies in many countries
Simon has referred to this device in these words  Generally speaking surtax is charged only on individuals not on companies or other bodies corporate
Various devices have been adopted from time to time to enable the individual to avoid surtax on his real total income or on a portion of it and one method involved the formation of what is popularly called a one man company 
He individual transferred his assets in exchange for shares to a limited company specially registered for the purpose which thereafter received the income from the assets concerned
The individual s total income for tax purposes was then limited to the amount of the dividends distributed to him as practically the only shareholder which distribution was in his own control
The balance of the income which was not so distributed remained with the company to form in effect a fund of savings accumulated from income which had not immediately attracted surtax
Should the individual wish to avail himself of the use of any part of these savings he could effect this by borrowing from the company any interest payable by him going to swell the savings fund and at any time the individual could acquire the whole balance of the fund in the character of capital by putting the company into liquidation
1 What Simon says about one man company can be equally true about the controlled company whose affairs are controlled by a group of persons closely knit and having the same interest
The question which now arises is if the impugned section treats the loan received by a shareholder as a dividend paid to him by the company has the legislature in enacting the section exceeded the limits of the legislative field prescribed by the present Entry 82 in List I
As we have already noticed the word income in the context must receive a wide interpretation how wide it should be it is unnecessary to consider because such an enquiry would be hypothetical
The question must be decided 1 Simon s Income tax 2nd Ed
3 para 592 p 341 921 on the facts of each case
There must no doubt be some rational connection between the item taxed and the concept of income liberally construed
If the legislature realises that the private controlled companies generally adopt the device of making advances or giving loans to their shareholders with the object of evading the payment of tax it can step in to meet this mischief and in that connection it has created a fiction by which the amount Ostensibly and nominally advanced to a shareholder as a loan is treated in reality for tax purposes as the payment of dividend to him
We have already explained how a small number of shareholders controlling a private company adopt this device
Having regard to the fact that the legislature was aware of such devices would it not be competent to the legislature to device a fiction for treating the ostensible loan as the receipt of dividend In our opinion it would be difficult to hold that in making the fiction the legislature has traveled beyond the legislative field assigned to it by entry 82 in List 1
It is however urged by Mr Pathak that while providing for such a fiction the legislature should have required the Income tax Officer to consider in each case whether the loan was genuine or was the result of a device and he argues that since no such provision has been made and a uniform presumption by fiction is sought to be raised the legislature has gone beyond its legislative competence
In support of this argument Mr Pathak has referred to the fact that under section 1081 of the Commonwealth Income tax Act it is provided that the amount paid to the shareholder by way of advance or loan can be taxed if in the opinion of the Commissioner it represents distributions of income Such a provision would have made the impugned section valid Mr Pathak argues that omission of Parliament to exclude from the operation of section 12lB genuine loans or advances and its failure to distinguish between such loans and advances and loans and advances made as a device shows that it has acted blindly and must therefore be held to have exceeded its legislative power
We are not inclined to accept this argument
If the legislature thinks that the advances or loans are in almost every case the result of a device it would be competent to it to prescribe a fiction and hold that in cases of such advances or loans tax should be recovered from the shareholder an the basis that he has received the dividend
Therefore we are satisfied that the High Court was right in coming to the conclusion that the impugned section is not beyond the legislative competence of the legislature
922 Then it is argued by Mr Pathak that the impugned provision contravenes the appellant s fundamental rights under article 191 f  g and is not saved by clauses 5  6 of the said article
It is not easy to appreciate this argument
article 191 f recognises the right of a citizen to acquire hold and dispose of property and article 191g recognises the right to practice any profession or to carry on any occupation trade or business
The impugned provision does not contravene either of these rights
The shareholder s right to borrow money from his own company cannot be said to be a fundamental right besides all that the impugned section does is to provide that if a loan is borrowed by a shareholder from a company to which the said provision applies it will be deemed to be a receipt by him of the dividend
This provision does not affect the appellant s right to borrow money from any other source and his company from which he borrows does not ordinarily do money lending business
That is why the restriction imposed by the section cannot be said to be unreasonable at all
In dealing with the question about the reasonableness of this provision we cannot also overlook the fact that past transactions were excluded from its operation by the issue of a circular to which we have already referred
There is no element of unfairness in the fiction because the other shareholders have deliberately agreed to make the loan or the advance and the shareholder to whom the loan is advanced deliberately takes it with a view to assist the company to evade the payment of tax and to have the benefit of the use of the amount subject to the payment of interest
The company receives interest the shareholder enjoys the use of the money and in the process the payment of due tax is evaded
That is the assumption made by the legislature in making this provision
How can it be urged that either the shareholder who is taxed or the other shareholders who deliberately make the advance to a colleague of theirs are unfairly dealt with by the impugned provision
In our opinion there is no scope for arguing that the fundamental rights of the shareholder under article 19 1 f   g have been contravened by the impugned provision
Therefore we must reject Mr Pathak s argument that the impugned provision is invalid on the ground that it contravenes article 191f  g
There is obviously no scope for suggesting that the impugned provision contravenes article 14 and in fact Mr Pathak has not raised this point before us
In that connection he himself fairly invited our attention to the decision of the Madras High Court in K M section Lakshmana Aiyar vs Additional Income tax Officer Special 923 Circle Madras 1 where the challenge to the validity of the impugned section on the ground that it contravened article 14 has been repelled
The result is the appeal fails and is dismissed with costs
Raghubar Dayal J
I am of opinion that the appeal should be allowed as sections 12 1B and 2 6A e of the Indian Income tax Act 1922 hereinafter called the Act as they stood in 1955 are void
The two provisions were enacted by Parliament in view of Entry 82 List 1 Seventh Schedule of the Constitution which reads  Taxes on income other than agricultural income
It is not disputed that whatever wide connotation the word income  in this Entry may have the item taxed should really be capable of being considered as income that there be some rational connection between the item taxed and the concept of income and that it is not open to Parliament to choose to tax as income an item which in no rational sense can be regarded as income
It is also not disputed that Parliament can enact a law dealing with the evasion of payment of income tax
In Navinchandra Mafatlal vs The Commissioner of Income tax Bombay City1 this Court had to consider the content of the word income as used in Entry 54 List 1 Seventh Schedule to the Government of India Act 1935 which is identical with Entry 82
List 1 Seventh Schedule to the Constitution in determining whether the imposition of a tax under the head capital gains by the Central Legislature was ultra vires
Section 12 B inserted in the Income tax Act by the Indian Income tax and Excess Profits Tax Amendment Act 1947 Act XXII of 1947 provided for the imposition of a tax on capital gains arising from certain transactions mentioned in the section
This Court said that income according to the dictionary means a thing that comes in and that in the United States of America and Australia the word income was used in a wide sense so as to include capital gains
It referred to certain cases of those countries in which a very wide meaning was ascribed to the word income as its natural meaning and held that its natural meaning embraces any profit or gain which is actually received
In the United States the word income was first defined in Stratton s Independence vs Howhert3 decided on December 1 1913 as gain derived from capital from labour or from both 1 2 1955 1 SCR 829
3 L Ed 285
924 combined
The court had to construe the word income as used in section 38 of the Corporation Excise Tax Act of August 5 1909 which imposed an excise tax equivalent to one per centum upon the entire net income  received by it from all sources during the year
In Eisner vs Macomber1 referred to by this Court in Mafatlal s case1 the court had to construe the word income as used in the XVI Amendment of the Constitution of the United States which is  The Congress shall have power to lay and collect taxes on incomes from whatever source derived without apportionment among the several States and without regard to any census or enumeration and observed at p 206  Congress cannot by any definition it may adopt conclude the matter since it cannot by legislation alter the Constitution from which alone it derives its power to legislate and within whose limitations alone that power can be lawfully exercised
For the present purpose we require only a clear definition of the term income  as used in common speech in order to determine its meaning in the Amendment and having formed also a correct judgment as to the nature of a stock dividend we shall find it easy to decide the matter at issue
After examining dictionaries in common use we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of August 5 1909 Income may be defined as the gain derived from capital from labour or from both combined  provided it be understood to include profit gained through a sale or conversion of capital assets
to which it was applied in the Doyle case Brief as it is it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy
 The definition of income given in this case has been followed in the other two cases referred to in Mafatlal s case2 ViZ Merchants  Loan  Trust Co vs Smietanka3 and United States 1252 US 18964 L Ed 521
2 19551 1 SCR 829
3  L Ed 751
925 vs Stewart1 cases which dealt with the taxation of gains from the sale of capital assets
The question in the Australian case viz Resch vs The Federal Commissioner of Taxation1 was about the validity of the provinces in the income tax legislation to the effect that distribution of profits in the course of winding up of a company would be treated on the same footing as the distribution by the company as a going concern
The provision was held valid as Parliament possessed power to bring to charge in an income tax Act all profits and gains accruing to a tax payer without distinguishing whether the profit or gain should be regarded as a receipt on capital or on income or revenue account
The word income has been interpreted in a natural sense in these cases and the definition given in Eisner s case is much narrower and limited in content than the widest meaning which is now sought to be given to it by the respondent
In Mafatlal s case 4 too this Court has not given such a wide meaning to the word income as to include anything which comes in and therefore to include the amount of a loan which may be said to come in the hands of the borrower
Loans borrowed by a shareholder from the company do not as such come within the above general definition of income
They do not represent gains from his labour or capital or profits gained through sale of capital assets
The borrower has to repay them
If a shareholder is really paid his share of the profits ostensibly as a loan such a nominal loan but really a share of profits can be taxed as income under an appropriate enactment
We may now consider the nature of what had been taxed in this case and to which objection has been taken on the ground that sections 2 6A e and 12  1 B are invalid
The appellant holds 11 out of 845 shares in a private limited company
The value of each share is Rs 100
In 1955 he took a loan of over Rs 400000 from the company
Rs 283126 the amount of accumulated profits the company had then have been added to the appellant s total income for the relevant assessment year in view of sections 26Ae and 121B of the Act
He appellant s share in the accumulated profits if distributed as dividend would be 11845the of Rs 283126 ie Rs 3686
Rs 279440 the balance would then be the dividend payable to the other co sharers
The appellant contends that Rs 279440 1   85 Ed 40 3  L Ed 521
2  4 1955 1 SCR 829
926 is not his income and that Parliament was not competent to enact sections 2 6A e and 12  1B which treat it as his income from dividend
Before dealing with the contention reference may be made to what the impugned sections provide
Section 2 6A e defines dividend in the circumstances mentioned in that clause to include any payment by a company of any sum by way of advance or loan to a shareholder or any payment by any Such company on behalf of or for the individual benefit of a shareholder to the extent to which the company in either case possesses accumulated profits
Section 121B provides that any such payment to a shareholder made by way of advance or loan in certain circumstances would be treated as dividend received by him in the previous year relevant to the assessment year ending March 31 1956 if such loan or advance remained outstanding on the first day of such previous year
Now the contention for the appellant is that though Parliament can enact a law dealing with evasion of payment of income tax it cannot tax what is not income that the amount in excess of his proportionate share in Rs 283126 if it had been actually distributed as profits by the company could not have been his income from dividend that he could not have evaded payment of income tax on this amount from its being not distributed as dividend and that therefore Parliament could not enact that such excess amount be treated as dividend paid to him and consequently as his income
The contention has force
The essence of an amount paid as dividend is that it has to represent the proportionate amount a particular shareholder is to get on the basis of the shares held by him out of the profits of the company set apart for payment of dividend to shareholders
Any ad hoc payment of money to a shareholder as advance or loan unrelated to his share in the accumulated profits cannot rationally come within the expression dividend
I am therefore of opinion that it is not open to the legislature to describe any payment of money by a company to a shareholder by the word dividend and then provide that such payment called dividend will come within the expression income for the purposes of any law enacted by virtue of Entry 82 List 1 Seventh Schedule to the Constitution
The definition of dividend must have rational connection with the concept of dividend in the context of the profits of a company and its distribution amongst shareholders at any time after the profits have been earned
Clauses a to d of section 2 6A may be said to have such a connection
927 It is conceivable and not disputed for the appellant I that attempts are made by persons to evade payment of income tax and that one mode of such attempts is that companies accumulate profits do not use them for payment of dividends and later pay the amount to shareholders by way of profits but in the form of advance of moneys or loans to some shareholders who pass on the ratable share of the remaining shareholders and the shareholders thus escape payment of super tax at a higher rate as their receiving such amounts could not be treated as dividends and so could not be added to their income 
At the same time it is not disputed for the respondent that there can be genuine cases of loans taken by shareholders from a company when the company was in a position to lend money out of its funds
In fact after the enactment of section 26Ae the Central Board of Revenue issued a Circular directing its officers to intimate to all companies that if loans advanced by them were repaid before June 30 1955 in a genuine manner they would not be taken into account in determining the tax liability of the shareholders to whom they had been advanced as it was likely that some companies might have advanced loans to their shareholders as a result of genuine transactions of loans and the idea was not to affect such transactions and not to bring them within the mischief of the new provision
The provisions of section 2 6A e take into account all cases of advances or loans made by companies to their shareholders be they bona fide or be they for the purpose of evading payment of super tax and make the borrower liable for the tax on even such amount of the loan as be in excess of his proportionate share in the accumulated profits up to the amount of the loan
Reference may be made to the fact that in other countries too notice has been taken of attempts to evade payment of income tax by similar devices and that enactments to defeat the devices have been made by the legislatures of those countries
We have been referred to section 108 of the Income Tax and Social Services Contribution Assessment Act 1936 53 of the Commonwealth of Australia which deals with loans to shareholders
Its provisions materially differ in one respect from those of the impugned sections
Only so much of the advances or loans are deemed to be dividends paid by the company as in the opinion of the Commissioner represents distributions of income
The entire amount of advance of loan is not treated as dividend received by the borrower shareholder
Imposition of a tax is a restriction on the right of an assessee 928 to hold property and a particular tax can be justified only as a reasonable restriction on the exercise of that right in the interests of the general public
The shareholder who takes a loan or advance from a company which possesses accumulated profits is under the impugned provisions treated to have received the amount of the loan or advance to the extent of the accumulated profits as dividend
As already stated the amount of profits set apart for dividends is to be proportionately distributed among the various shareholders
If any enactment provides that certain profits of the company though not distributed as dividend be treated as used for the payment of dividends it should necessarily follow that a particular shareholder be deemed to have received a proportionate amout of such profits as dividend
It would be unreasonable to provide that a particular shareholder should be deemed to have received an amount in excess of his proportionate share as dividend
The other shareholders should in the circum stances be deemed to have received their proportionate shares of the profits deemed to have been distributed as dividends
A reasonable law may provide for their assessment as wan on the amount of dividends deemed to have been distributed to them
It appears to me unreasonable that a particular shareholder who receives a loan or advance from a company be deemed to have received that entire amount as dividend when his proportionate share be much less
I would for this reason also consider the provisions of the impugned sections to amount to imposing unreasonable restrictions on the fundamental right to hold property under article 191f
I would now refer to certain cases on which reliance is placed for the proposition that this Court has held valid laws made to cover attempts for evasion of income tax and that therefore the impugned provisions enacted with the same object to cover attempts to evade payment of super tax should be held valid
These case are  Mafatlal s case1 already referred to Sardar Baldev Singh vs Commissioner of Income tax Delhi  Ajmer 2  and Balaji vs Income tax Officer Special Investigation Circlea
Mafatlal s case1 dealt with the validity of the tax on capital gains under section 12B of the Act
In that case what was taxed was what had been gained by the assessee as a result of some dealing in capital assets
The capital gain was to be computed after making certain deductions including the actual cost to the assessee of 11955 1 SCR 829
3  2  929 The capital assets and did not represent the entire amount that came in as a result of the transaction
This case is therefore an authority for the simple proposition that the word income in Entry 82 List 1 Seventh Schedule to the Constitution has wide connotation and is not to be restricted to have the same content as judicial decisions had given to that word as used in the Act
Income in the Act has been construed in the context of the scheme of the Act and has been considered to mean generally what one earns mostly in a recurring form from some existing sources
The profits that one earns from the transfer of a capital asset could be rationally considered as held by this Court to be income as it represented the amount in excess of what the transferor assessee had spent in acquiring that asset
Baldev Singh s case1 was concerned about the validity of the provisions of section 23A of the Act which authorised the Income tax Officer to order in writing that the undistributed portion of the ostensible income of a company calculated as profit therein shall be deemed to have been distributed as dividends amongst the shareholders as at the date of the general meeting aforesaid and that 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 Income tax Officer was to make such an order only when he was satisfied that the profits and gains distributed as dividends by any company up to the end of the sixth month after its accounts for the previous year are laid before the company in general meeting were less than 60 of the assessable income of the company and that payment of a larger dividend would not be unreasonable keeping in view the losses incurred by the company in the earlier years and of the smallness of the profits made
It will be noticed that the order of the Income tax Officer could not be to the effect that the undistributed profits would be deemed to be the dividend paid to any particular shareholder or shareholders but could be to the effect that they were distributed as dividends amongst all the shareholders
The validity of this provision was not questioned in the case
What was questioned in the case was that the proportionate share of Baldev Singh assessee in such undistributed profits could not be added to his total income of the particular year to which it was added
It was held that in view of the deeming provision with respect to the distribution of profits as dividends amongst shareholders the proportionate share of the dividends would be deemed to be 1 19611 SCR 482 930 income of the assessee and that therefore when it was not taxed would be deemed to have escaped assessment for the purposes of section 34 of the Act
The case is distinguishable on several grounds
One is that the Income tax Officer is to make the order when he is satisfied that a larger dividend could have been justifiably distributed a view necessarily leading to the inference that a lower dividend was distributed in order to escape payment of super tax by shareholders liable to pay such tax
The other is that the Income tax Officer was given power to make the order only when profits less than 60 of the assessable income were distributed as dividend
This indicates that the company could accumulate profits up to 40 of the assessable income for reasons which would be deemed to be genuine
This should lead to the inference that the accumulation of profits with respect to which no action has been taken under section 23A was justified and that therefore if in case a company could spare the money to advance to a shareholder for his needs that alone should not lead to the inference that the advance was made to evade the payment of super tax by the shareholder
The third point of distinction and of signi ficance is that no individual shareholder is made liable for tax on an amount of the undistributed profits in excess of his proportionate share in those profits
The shareholder is not thereby prejudiced
His income is increased by an amount which he could have legitimately got from the company if the persons in control had acted reasonably and had retained such profits undistributed as were necessary for the purposes of the company
Another objection taken in Baldev Singh s case1 was about the constitutionality of section 23A on the ground that it purports to tax the shareholders on the income of the company in which they held shares especially when it does not give a right to the shareholders to realise from the company the dividend which by the order is deemed to have been paid to them
The section was held to be constitutionally valid as it was enacted for preventing evasion of tax in view of the conditions of its applicability
In the circumstances of the cases covered by section 23A there was a reasonable connection between the amount deemed to be distributed as dividend and the possible attempt for evading payment of super tax
The assessee could not have been prejudiced if the persons in control of the management of the company had acted reasonably or actually distributed that amount as profits subsequent to the order of the Income tax Officer
1  931 In Balaji s case1 the validity of section 163 a clauses i and ii came up for consideration
These clauses provide that in computing the total income of any individual for the purpose of assessment there shall be included so much of the income of his wife or minor child as arises directly or indirectly from the membership of the wife in a firm of which her husband is a partner or from the admission of the minor to the benefits of partnership in a firm of which such individual is partner
These provisions were held valid
The Court left open the question whether A could be taxed on the income of B and formulated the question for decision as whether section 163 a clauses i and ii is a provision made by the Legislature to prevent evasion of tax and answered it in the affirmative as the husband or the father could nominally take his wife or minor child in partnership with him so that the tax burden may be lightened and as this device enabled the assessee to secure the entire income of the business and yet evade income tax which he would otherwise have been liable to pay
It was said at p 999 The scope of the provisions is limited only to a few of the intimate members of a family who ordinarily are under the protection of the assessee and are defendants of him
The persona selected by the provisions namely wife and minor children cannot also be ordi narily expected to carry on their business independently with their own funds when the husband or the father is alive and when they are under his protection
 It is therefore clear that the basis for holding section 163 a clauses i and ii valid was that in effect the husband or the father was the real person who ran the firm and that the others were made partners nominally and therefore the partnership was not genuine
In this view there could be no question of the provisions affecting the husband or the father prejudicially or including in his income amounts which were not his income
This however cannot be said in the present case or in cases which come within the purview of the impugned sections
In dealing with the contention that the provisions of section 16 3 a clauses i and ii contravened article 14 of the Constitution it was said at p 991  We have held that the object of the legislation was to prevent evasion of tax
A similar device would not ordinarily be resorted to by individuals by entering 1 1962 2 SCR 983
165 932 into partnership with persons other than those mentioned in the sub section as it would involve a risk of the third party turning round and asserting his own rights
The Legislature therefore selected for the purpose of classification only that group of persons who in fact are used as a cloak to perpetrate fraud on taxation
 Such a risk is always involved in a company making payments as advances or loans to a shareholder when it possesses accumulated profits as the other shareholders run the risk of not getting their proportionate share of profits which they would have got if they had been really distributed as dividends
This consideration again points to the conclusion that the probability of such an advance or loan being genuine would be dependent not so much on the existence of accumulated profits but on the number of shareholders in the company and the proportion of the number of shares the borrower has to the total number of shares held by the shareholders of the company
The lesser the proportion the greater is the chance of the advance or loan being genuine as there would in that case be greater risk of the other shareholders losing their share in the profits deemed to be distributed as dividends
I am therefore of opinion that the impugned sections viz sections 26A e and 121B of the Act are void and that this appeal should be allowed
Appeal allowed


Summary:
The assessee was a share holder in a private limited company whose ordinary business was not money lending business
He took a loan amounting to over Rs 4 lakhs from a company
The Income tax Officer computed the assessee s income at Rs 3 lakhs and odd under section 121B read with section 2 6A e of the Income tax Act 1922
That amount included a sum of over Rs 2 lakhs representing the accumulated profits of the company
The assessee s share in the accumulated profits if distributed as dividend would be an amount proportionate to the number of shares held by him
He therefore contended that the balance of the accumulated profits was not his income and that the Legislature was not competent to enact the two sections according to which that amount was also treated as his income
His writ petition in the High Court challenging
the constitutional validity of the two sections was dismissed
He appealed to the Supreme Court
HELD Per Gajendragadkar C J Wanchoo Hidayatullah and Mudholkar JJ  i The sections are not beyond the legislative competence of Parliament
The companies to which section 121B applies are companies in which at least 75 of the voting power lies in the hands of persons other than the public
They are controlled by a group of persons allied together and having the same interest
The controlling group can determine whether the profits made by the company should be distributed as dividends or not
When they deliberately refused to distribute the accumulated profits as dividends but adopted the device of advancing the profits by way of loan to one of the shareholders it was with the object of evading the payment of tax by the company on the accumulated profits
Section 121B provides that if a controlled company adopts the device of making a loan to one of its shareholders he will be deemed to have received the amount out of the accumulated profits as dividend and would be liable to pay tax on his income
The word income in Entry 82 in List I of the 7th Schedule to the Constitution must receive a wide interpretation depending on the facts of each case
Having regard to the fact that the Legislature was aware of the devices to evade tax it would be within its competence to devise a fiction for treating an ostensible loan as the receipt of the dividend
919 A H 920 H 921 C D ii The absence of a provision enabling the income tax officer to consider in each case whether the loan was genuine or the result of a device does not make the section go beyond the competence of the Legislature
921 D E If the Legislature thought that in almost every case the advances or loans were the result of a device to evade tax it would be competent to 910 it to prescribe a fiction and hold that in cases of such advances or loans tax should be recovered from the shareholder on the basis that he had received a dividend
921 G H iii Section 12lB doesnot impose an unreasonable restriction on the appellant s fundamental rights under article 191 f and g of the Constitution
922 A The section does not affect the appellant s right to borrow money
There is no element of unfairness because the other shareholders have deliberately agreed to make the loan or the advance and the shareholder to whom the loan is advanced deliberately takes it with a view to assist the company to evade the payment of tax and to have the benefit of the use of the amount subject to the payment of interest
The company receives interest the shareholder enjoys the use of the money and in the process the payment of tax is evaded
Further past transactions were excluded from the operation of the sections by the issue of a circular by the Central Board of Revenue
922 B F Per Raghubar Dayal J dissenting  i Sections 26A e and 12lB of the Income tax Act 1922 as they stood in 1955 are void
923 B It is not open to the Legislature to describe any payment of money by a company to a shareholder by the word dividend and then provide that such payment will come within the expression income in item 82 List I of Schedule 7
The definition of dividend must have a rational connection with concept of dividend in the context of the profits of the company and its distribution amongst the shareholders
The essence of an amount paid as dividend is that it has to represent the proportionate amount a particular shareholder is to get on the basis of the shares held by him out of the profits of the company set apart for payment of dividend to shareholders
Any ad hoc payment of money to a shareholder as advance or loan unrelated to his share in the accumulated profits cannot rationally come within the expression dividend
926 E H ii The provisions of the impugned sections impose unreasonable restrictions on the fundamental right to hold property under article 191f of the Constitution
928 E If any enactment provides that certain profits of the company though not distributed as dividend be treated as used for the payment of dividends it should necessarily follow that a particular shareholder be deemed to have received a proportionate amount of such profits
It would be unreasonable to provide that a particular shareholder should be deemed to have received an amount in excess of his proportionate share as dividend
It is unreasonable that a particular shareholder who receives a loan or advance from a company be deemed to have received that entire amount as dividend when his proportionate share would be much less
928 B E Navinchandra Mafatlal vs Commissioner of Income tax Bombay City 1955 1 SCR 829 Sardar Baldev Singh vs Commissioner of Income tar Delhi and Agra 1961 1 SCR 482 and Balaji vs Income tax Officer Special Investigation Circle   referred to