Madras High Court
Deputy Commissioner (Ct) vs Cheran Transport Corporation Ltd. on 6 December, 1990
JUDGMENT Mishra, J.
1. This case has to be disposed of on a short question but of far-reaching consequences. The assessee-respondent corporation reported a certain taxable turnover, but when checked it was found that it had to include in its turnover, the turnover of the Cheran Engineering Corporation Limited, Pollachi, which once was, under some misapprehension, treated as a separate assessee. Accordingly, the Appellate Assistant Commissioner thought that both the assessments should be clubbed together and a single assessment order should be passed. He remanded the matter to the Assessing Officer to reconsider this aspect and pass suitable orders. Against that order, the assessee moved the Sales Tax Appellate Tribunal (Additional Bench), Coimbatore. The Sales Tax Appellate Tribunal took notice of certain facts and events, particularly the fact that the Government of Tamil Nadu decided to implement a certain scheme by forming separate corporations under the control of the road corporations in the State and accordingly approved the scheme of Cheran Transport Corporation Limited for the formation of a separate engineering corporation to provide employment opportunities to the unemployed technicians as also to provide maintenance facilities for its bus service. So thus it found that it is clear that, in pursuance of the Government scheme, Cheran Engineering Corporation has been formed separately though the overall supervision at the initial stage was vested with Cheran Transport Corporation Limited. On the said basis and on the basis that the two corporations are separate legal entities, the Tribunal has held that it will be wrong to say that they formed part of the same legal entity.
2. The question herein, therefore, is whether Cheran Transport Corporation Limited, Coimbatore, and Cheran Engineering Corporation, Pollachi, which, under a Government scheme, are said to be two separate legal entities will be assessed separately on their respective turnovers or Cheran Engineering Corporation shall be treated as an agency of the Cheran Transport Corporation for the purpose of sales tax liability ?
3. There is some dispute before us whether the Cheran Engineering Corporation had acquired a distinct and separate legal personality of its own in the assessment year in question or not. We, however, do not propose to go into this controversy and proceed in the instant case on the presumption that Cheran Transport Corporation, Coimbator, and Cheran Engineering Corporation, Pollachi, are separate legal entities.
4. There could be little doubt that each separate legal personality shall be a separate entity and they shall have separate legal obligations. This, however, shall be true only until it is demonstrated that they existed as independent organs and that any one of them has no dependence upon the other. The orthodox approach has given way to a new doctrine of piercing the corporate veil to know the true character of a person. This has been applied more to the situations where a certain statutory obligation is in jeopardy. Pennington, in his book on Company Law, fourth edition, at page 50, has taken notice of such decided cases where the court disregarded the legal personality of the company because it was formed or used to facilitate evasion of legal obligations. He has noticed :
"There are only two decided cases where the court has disregarded the separate legal personality of a company because it was formed or used to facilitate the evasion of legal obligations. In the first of these cases, the defendant had been employed by the plaintiff and had entered into a valid agreement not to solicit the plaintiff's customers or to compete with it for a certain time after leaving its employment. After this happened, the defendant formed a company which carried on a competing business, and caused the whole of its shares to be allotted to his wife and an employee of the company, who were appointed to be its directors. It was held that since the defendant in fact controlled the company, its formation was a mere 'cloak or sham' to enable him to break his agreement with the plaintiff, and an injunction was issued against him and against the company he had formed restraining them from soliciting the plaintiff's customers. In the second case, a vendor of land sought to evade specific performance of a contract for sale by conveying the land to a company which he 'bought' for the purpose. The company had been formed by third parties, and the vendor purchased the whole of its shares from them, had the shares registered in the name of himself and a nominee, and had himself and the nominee appointed directors. It was held again that the acquisition of the company and the conveyance of the land to it was a mere 'cloak or sham' for the evasion of the contract of sale, and specific performance of the contract was, therefore, ordered against the vendor and the company."
5. Pennington has further observed that American courts have been far readier to disregard a company's separate legal personality. Whenever they found that a certain company was formed to facilitate the breach of the general law or of a contractual obligation, they thought the veil should be pierced. How their attitude hardened in this regard has been stated by Pennington in the words of Sanborn J.
"... A corporation will be looked upon as a legal entity as a general rule ... but when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons."
6. Pennington has referred to a judgment of Atkinson J. and quoted :
"'I find six points which were deemed relevant. The first point was : were the profits treated as the profits of the company ? - when I say 'the company' I mean the parent company - secondly, were the persons conducting the business appointed by the parent company ? Thirdly, was the company the head and brain of the trading venture ? Fourthly, did the company govern the adventure, decide what should be done and what capital should be embarked on the venture ? Fifthly, did the company make the profits by its skill and direction ? Sixthly, was the company in effectual and constant control ?' In that case, Atkinson J. held that a holding company was in occupation of premises, and was consequently entitled to compensation for the disturbance of its business on the compulsory purchase of the premises by a local authority, even though the business was carried on at the premises in the name of a subsidiary. The subsidiary had been formed simply in order to separate formally the business carried on in its name from another business carried on by the holding company. The freehold in the premises and the assets of the business were never transferred by the holding company to the subsidiary. All the subsidiary's shares were held by or in trust for the holding company, and the subsidiary's directors were all directors of the holding company. Accounts in respect of the business carried on in the subsidiary's name were kept as part of the holding company's accounts, and the subsidiary's profits were dealt with as though they had been earned by the holding company. It is difficult to imagine a more complete identification of a holding company with its subsidiary, and it would have been a clear denial of justice to refuse the holding company compensation for loss suffered in respect of a business which was in substance its own. But in a business sense the identification of the holding company with its subsidiary was equally as close in ... yet the court there refused to treat the subsidiary as the holding company's agent so that the holding company might be deemed the owner of the subsidiary's property."
7. We do not, however, propose to go beyond our land to find out judgments supporting our approach as we find in India that the Supreme Court has by now in quite a few judgments indicated how a court should determine the nature of such corporations and companies. In McDowell and Co. Ltd. v. CTO , the Supreme Court has said (at page 161 of 154 ITR) :
"It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of "emerging' techniques of interpretation as was done in W. T. Ramsay's case [1981] 2 WLR 449; [1982] AC 300, Burmah Oil Co. Ltd.'s case [1982] Simon's Tax Cases 30 and Dawson's case [1984] 1 All ER 530; [1984] 2 WLR 226 (HL) to expose the devices for what they really are and to refuse to give judicial benediction."
8. The Supreme Court has quoted the observations in Dawson's case [1984] 1 All ER 530; [1984] 2 WLR 226 (HL) (at page 157 of 154 ITR) :
"The fact that the court accepted that each step in a transaction was a genuine step producing its intended legal result did not confine the court to considering each step in isolation for the purposes of assessing the fiscal results."
9. In CIT v. Meenakshi Mills Ltd. [1967] 63 ITR 609, the Supreme Court has stated (at page 616) :
"It is true that from the juristic point of view, the company is a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or borne by its members. But in certain exceptional cases the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal facade. For example, the court has power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation. For instance, in Apthorpe v. Peter Schoenhoffen Brewing Co. [1899] 4 TC 41 (CA), the Income-tax Commissioners had found as a fact that all the property of the New York company, except its land, had been transferred to an English company, and that the New York company had only been kept in being to hold the land, since aliens were not allowed to do so under the New York law. All but three of the New York company's shares were held by the English company, and as the Commissioners also found, if the business was technically that of the New York company, the latter was merely the agent of the English company. In the light of these findings, the Court of Appeal, despite the argument based on Salomon's case [1897] AC 22 (HL), held that the New York business was that of the English company which was liable for English income-tax accordingly. In another case, Firestone Tyre and Rubber Co. v. Lewellin [1957] 1 WLR 464; [1958] 33 ITR 741, an American company had an arrangement with its distributors on the continent of Europe whereby they obtained supplies from the English manufactures, its wholly owned subsidiary. The English company credited the American with the price received after deducting the costs plus 5 per cent. It was conceded that the subsidiary was a separate legal entity and not a mere emanation of the American parent and that it was selling its own goods as principal and not its parent's goods as agent. Nevertheless, these sales were a means whereby the American company carried on its European business and it was held that the substance of the arrangement was that the American company traded in England through the agency of its subsidiary. We, therefore, reject the argument of Mr. Venkataraman on this aspect of the case."
10. In Workmen of Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. [1986] 59 Comp Cas 134; AIR 1986 SC 12, after referring to the judgment in CIT v. Meenakshi Mills Ltd. and McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148, the Supreme Court has observed (at p. 136 of 59 Comp Cas) :
"It is true that in law the Associated Rubber Industry Ltd., and Aril Holdings Ltd., were distinct legal entities having separate existence. But, in our view, that was not an end of the matter. It is the duty of the court, in every case where ingenuity is expended to avoid taxing and welfare legislations, to get behind the smoke-screen and discover the true state of affairs. The court is not satisfied with form and leave well alone the substance of a transaction."
11. In CIT v. Meenakshi Mills Ltd. [1967] 63 ITR 609, the judicial approach to such problems is stated as follows (page 137 of 59 Comp Cas) :
"It is true that from the juristic point of view, the company is a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or borne by its members. But in certain exceptional cases the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal facade."
12. The Supreme Court has thus said (page 138 of 50 Comp Cas) :
"If we look at the facts of this case, what do we find ? A new company is created wholly owned by the principal company, with no assets of its own except those transferred to it by the principal company, with no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the gross profits of the principal company. These facts speak for themselves. There cannot be direct evidence that the second company was formed as a device to reduce the gross profits of the principal company for whatever purpose. An obvious purpose that is served and which stares one in the face is to reduce the amount to be paid by way of bonus to workmen. It is such an obvious device that no further evidence, direct or circumstantial, is necessary."
13. In one of the latest judgments of Union of India v. Playworld Electronics Pvt. Ltd., , once again the Supreme Court has reiterated the law in these words (at page 208) :
"It is true, as Shri Rao drew our attention, that even though the corporation might be legal personality distinct from its members, the court is entitled to lift the mask of corporate entity if the conception is used for tax evasion or to circumvent tax obligation or to perpetrate a fraud. In this connection, reference may be made to the observations of this court in Juggi Lal Kamlapat v. CIT . In the background of the facts found we, however, need not get ourselves bogged with the controversy as to judicial approach to tax avoidance devices as was pointed out McDowell and Co. Ltd. v. CTO , where this court tried to discourage colourable devices. It is true that tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. It is also true that in order to create the atmosphere of tax compliance, taxes must be reasonably collected and when collected, should be utilised in proper expenditure and not wasted. See the observations in CWT v. Arvind Narottam . It is not necessary, in the facts of this case, to notice the change in the trend of judicial approach in England : Sherdley v. Sherdley [1987] 2 All ER 54. While it is true, as observed by Chinnappa Reddy J. in McDowell and Co. Ltd. v. CTO , that it is too much to expect the Legislature to intervene and take care of every device and scheme to avoid taxation and it is up to the court sometimes to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and to expose the devices for what they really are and to refuse to give judicial benediction, it is necessary to remember as observed by Lord Reid in Greenberg v. IRC [1971] 47 TC 240 (HL), that one must find out the true nature of the transaction. It is unsafe to make bad laws out of hard fact and one should avoid subverting the rule of law. Unfortunately, in the instant case, facts have not been found with such an approach by the lower authorities and the High Court had no alternative on the facts as found but to quash the show cause and the demand notices."
14. On the strength of the authorities aforementioned, it can be said that it is not enough that it is found that the Transport Corporation and the Engineering Corporation are two separate legal entities. It will be necessary to examine also whether they are truly separate and independent or one is dependent on the other or is a colourable device for avoiding legal obligations. Since this is a new approach that the courts in India have accepted, it cannot be said that the Appellate Assistant Commissioner committed any gross illegality in thinking that the two corporations were in reality one and, therefore, their income should be clubbed for one point taxation. The Tribunal adopted the orthodox approach and became too technical in identifying the two corporations separately and so acknowledging without trying to ascertain the true character of the relationship of the one with the other and noting that they have separate tax liabilities.
15. Learned counsel for the respondent-assessee, however, has drawn out attention to the fact that although there has been some mention of the background facts in the order of the Appellate Assistant Commissioner, there has actually been no examination of the case by any of the authorities in the light of the cardinal test that have been indicated invariably in the judicial pronouncements.
1. Were the turnovers treated separately for each corporation ?
2. Were the persons conducting the business guided by the same head and brain ?
3. Were the persons conducting the business of the Engineering Corporation the same persons conducting the business of the Transport Corporation ?
4. Did the Engineering Corporation decide what should be done and what capital should be embarked on the venture ?
5. Did the business turnover of the Engineering Corporation stand separately and independently ?
6. Who effectually controlled the Engineering Corporation ?
16. Since we propose to remand the case, we do not ourselves go into each of these aspects to find out the true character of the Engineering Corporation. It needs no emphasis that any decision will have to be made in this regard on the overall examination and assessment of the real character of the Engineering Corporation and its relationship with the Transport Corporation and the Assessing Officer shall be in a better position to appreciate the implications of the business transactions of the two corporations and their relationship with each other.
17. Since we have come to the conclusion that the Appellate Tribunal has not tested the case in accordance with law and since we also notice that the Appellate Assistant Commissioner also did not apply himself to the tests that would reveal the real character of the Engineering Corporation, we set aside the order of the Appellate Tribunal and affirm the order of the Appellate Assistant Commissioner with the modification that the Assessing Officer shall afford an opportunity to the parties to bring such evidence as they may deem fit and proper and determine in accordance with law as to whether the Engineering Corporation is subsidiary of the Transport Corporation and, although it has got a separate legal identity, it does not act of its own but acts for and on behalf of the Transport Corporation.
18. In the result, this tax case revision is allowed. The order of the Appellate Tribunal and that of the Appellate Assistant Commissioner, to the extent indicated above, are set aside. The case is remitted to the assessing officer for disposal in the light of the observations made above and in accordance with law. No costs.