Case: Navnitlal C. Javeri Vs. K. K. Sen, Appellate Assistant Commissioner Ofincome-Tax

with respect to which no action has been taken under S. 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 significance, 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 there by 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.39. Another objection taken in Baldev Singhs Case; (1961) 1 SCR 482 : (AIR 1961 SC 736 ), was about the constitutionality of S. 23A on the ground that it purports to tax the shareholders on the income of the company in which they held share, 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 S. 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.40. In Balajis Case, (1962) 2 SCR 983 : (AIR 1962 SC 123 ), the validity of S. 16(3)(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 to whether S.16(3) (a), clauses (i) and (ii), is a provision made by thy 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 (of SCR) : (at p. 129 of AIR) :"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 dependants of him. The persons selected by the provisions, namely, wife and minor children, cannot also be ordinarily 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 S. 16(3) (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.41. In dealing with the contention that the provisions of S. 16(3)(a), clauses (i) and (ii), contravened Art. 14 of the Constitution, it was said at p. 991 (of SCR) : (at p. 126 of AIR) :"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 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 perpetuate 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.42. I am, therefore, of opinion that the impugned sections, viz., Ss. 2 (6A) (e) and 12 (1B) of the Act are void and that this appeal should be allowed.

Decision (1 = appeal accepted, 0 = rejected): 0

Explanation:
0[ds]5. 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: (I) 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 S. 12(1B) 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 S. 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 profits, 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 shareholders 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 saidis 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 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 becompanies 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 profits 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 realised 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 S. 3A. It will be remembered that an advance or loan which falls within the mischief of the impugned section is advance or loan made by a company which does not normally deal in money lending, and it is made with full knowledge of the provisions contained in the impugned section. The object of keeping accumulated profits without distributing them obviously is to take the benefit of the lower rate of super-tax prescribed for companies. This object was defeated by S. 23A which provides that in the case of undistributed 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, S. 12(1B) 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 has 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 S.23A. The loan may carry interest and the said interest may be received by the company; but the main object underlying the loans 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 accumulated profits. It is this kind of well planned device which S. 12(1B) intends to reach for the purpose ofwe 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 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 explainer 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 travelled beyond the legislative field assigned to it by entry 82 in Listare 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 on 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 theis not easy to appreciate this argument. Article 19(1)(f) recognises the right of a citizen to acquire, hold and dispose of property Art.19(1)(g) 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 shareholders 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 appellants 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 Art. 19(1)(f) and (g) have been contravened by the impugned provision. Therefore, we must reject Mr. Pathaks argument that the impugned provision is invalid on the ground that it contravenes Art. 19(1)(f) and (g). There is obviously no scope for suggesting that the impugned provision contravenes Art. 14; and in fact Mr. Pathak has not raised this point before us.