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The company paid no cash for the assets which it had acquired from Messrs. A. and J. C. Harvey. Of the Rs. 15,00,000 stated to be consideration Rs. 5,00,000 was satisfied by the issue of shares and the balance of Rs. 10,00,000 by the issue of debentures. On the 2nd June 1933 the company passed the following resolution :

"Resolved unanimously that the sum of Rs. 10,00,000 be raised by the issue of 2 debentures for Rs. 5,00,000 each bearing interest at 7 per cent. per annum charged upon its undertaking and all its property whatsoever and wheresoever both present and future including its uncalled capital if any an goodwill in the form now submitted to the Meeting and that in consideration of the Finchley Investments Limited, and the Kochadai Investments Limited, having each paid to the company the sum of Rs. 5,00,000 that the above mentioned two debentures be sealed and issued to the above companies."

The Finchley Investments Limited and Kochadai Investments Limited are two private companies registered in Canada and controlled by Messrs. A and J. C. Harvey through their wives. The Finchley Investments Limited has an authroized capital of $ 50,250, divided into 50 class A Cumulative Preferred shares of $ 5 each, and 10,000 class B shares of $ 5 each, of which all the class A shares and 5,990 of the class B shares have been issued. All the class B shares are held by Mr. A. Harvey. This company has taken authority to issue debentures to the value of $ 1,000,000 and has in fact issued $ 5,99,000, all of which are also held by Mrs. A. Harvey. The Kochadai Investments Limited has an authorized capital of $ 25,250 made up of 50 class A Cumulative Preferred shares of $ 5 each and 5,000 class B shares of $ 5 each, of which all the class A shares and 1,990 of class B shares have been issued. Mrs. J. C. Harvey is the holder of the 1,990 class B shares. This company has authority to issue debentures to the amount of $ 500,000. Of these debentures $ 199,000 have been issued and $ 6,000 of them have been redeemed. The outstanding debentures are all held by Mrs. J. C. Harvey. Of the debentures issued by the Finchley Investments Limited the amount of $ 169,000 was issued on the 17th October 1933, and of those issued by the Kochadai Investments Limited a similar amount was issued on the 12th October 1933.

On the passing of the resolution which I have just quoted, two cheque for Rs. 5,00,000 each were drawn by the firm in favour of the company, but it was not intended that they should be presented for payment. In the course of explanations given on behalf of the company in answer to questions put by the Income-tax authorities it was stated that the two cheque were issued by the firm on behalf of the Canadian companies in pursuance of an oral arrangement between Messrs. A and J. C. Harvey on the on side and the agents of the Canadian companies on the other with a view to avoiding costly cross remittances. It was also stated that Mrs. J. C. Harvey had received Rs. 5,00,000 from the Kochadai Investments Limited and that Mrs. A Harvey had received an equal sum from the Finchley Investments Limited. It turned out that the payments to these ladies did not represent cash, but merely the issue to them of debentures by the Canadian Companies. Therefore the position was that instead of the vendors receiving Rs. 10,00,000 in cash the Canadian companies which they controlled received debentures for this amount and the Canadian companies in turn issued their own debentures to the wives of the vendors. The fact that the vendors received by this roundabout way debentures in lieu of cash will not affect the legal position if the transaction is a genuine one, but the Income-tax authorities say that it is not. They contended that the issue of debentures represents an artificial transaction undertaken to give an appearance of reality to the inflation in the value of the assets acquired by the company and a scheme to defeat the payment of income-tax.

On behalf of the Company the learned Advocate General had contended that the court cannot go behind the contract and in support of this argument has quoted the decision of the House of Lords in Aron Salomon v. Salmon and Company Limited, but I fail to see what bearing that case has here. A leather merchant and a boot manufacturer sold his business to a limited company which had a nominal capital of 40,000 shares of pound 1 each. Before the incorporation of the company the vendor entered into a contract with the trustee of the future company settling the terms upon which the transfer was to be made. One of the conditions was that part payment might be made to the vendor in debentures of the company. The memorandum of association was signed by the vendor, his wife, a daughter and four sons all of whom subscribed for one shares each. In part payment of the purchase consideration debentures were issued to the vendor to whom was allotted 20,000 shares which were paid for out of the purchase money. The total number of shares issued was 20,007 and with his 20,000 shares the vendor had complete control of the company. At the time of the sale the business was solvent, but bad times came and the company was forced to go into liquidation. The question was whether the vendor as the holder of the debentures was entitled to preference over the other creditors of the company. Overruling the Court of Appeal the House of Lords held that it was not contrary to the true intent and meaning of the Companies Act, 1862 for a trader to sell his business to a limited liability company consisting of himself and the members of his family the business then being solvent all the terms of sale being known to and approved by the shareholders, and all the requirements of the Act being complied with. There had been no fraud upon the creditors or shareholders and the liquidator was not entitled to rescission of the contract of purchase.