JUGGI LAL KAMLAPAT versus COMMLISIONER OF INCOME-TAX, U.P.

JUGGI l,AL KAMLAPAT

COMML'iSIONER OF INCOME-TAX, U.P.

September 4, 1968 [J. C. SHAH, V. RAMASWAMI AND A. N. GROVER, JJ.J

lncon1e-tax-Assessee firm managing a1:ent-A1annginR agency ter-miw.ted and Corpornlion appointed in its place-Partners of assessee firm n1ajor shaN·holders and directors of Corporation-Payment to firm b.v managed cornpany co111pr.nsation for premc.ture 1e1mina:1on of 1nana1Jing agency--!/_ revenue receipt.

Corporate \:eil-When can be pierced for finding the transaction.

nalure of

The asscsscc-firm \\'<IS the managing agent of company. ·rhrce of the partners in the asscsscc-finn were brothers \•1~,1 held :1 51 per cCDl share in the finn. They and the members of their families held large majority of the shares in the managed companv and also in Corp0ration. On the false allegation that the managing agent had to provide finance to the company and as the assessec "-'as not able to do .'\O, the 1nan3gcd com· pany resolved that the only alte"rnative was to seek party who might be willing to finance even if such course oecesst~ate<l change of n1anaging agents. TIY.!re~tfter, lhc managed company te;·1n:n~teJ the managing agency of the asscssee, appointed the Corporari0n :ts the managing agent and paid the a'\~cssce sum of Rs. 2 lacs as ..:on1pensa:ion for premature termination or the managing agency. The assc.\:-.ce claimed that this ~um of Rs. 2 lacs \\'as no! revenue receipt and \'t:J.S not liable to tax .under the Income-tax Act. 1922. and Excess Profits Tax Act, 1940. The Income-tax Officer. the Appellate Assistant Comniis.sionc'r, and tho:! Appellate Tribun;1l held against the assessee. The High Court. on reference, held that lhcrc was material on \vhich the ·rribunal could hold that the receipt was revenue rccci!'t liable to tax.

In ar1nal to this Court. it was contended th•t : (I) As the a.sessee-firm and the Corporation were two di<;tinct legal entities the mere fact that the partners in the a.~sessee.firm held .;::c:~siderah!e proportion of the shares in the Corporation should not have led to 1he inference that the rights of the assessce·firm were not dcslioyc.t, steirilized or lost on account of the transaction; (2) the mere intention on the part of the asscssee to cv;1de income-ta:t will not nullify an otherwise lawful transac-tion; and (3) there y.·as no material heforc tl:c ·rrihunal for holding that the amount of Rs. 2 lacs v.·as revenue rcceilJ~· liable to tax.

HELi) : ( 1) From juristic point of view the Corporation may be legal personality distinct from its members. Hut the Court is entitled to lilt the mask of corporate entity if the con;;cp1ion is used for tax evasion, or 10 circumvent tax obligation or 10 perpetrate fraud. The real intention in the present case \\"as that the three hrothers Y.·ho were partners in the assessce-firm should continue to carry on lhe managing agency in d"."lminant capacitv in the guise of limited company and there was in fact no loss or de~truction of the profit yiclclin~ apparatu~, namely, the managing agency, (995 E-F; 996 E-F; 997 G-H]

Apthorope v. Peter Schoenhofrn HrewinR Co., 4 T.C. 41 and Fireston~ Tyre and R11bbcr Co v. Ucwel/in, ( 1957) I W.L.R. 464 applied.

(2) The transaction of termination was not lawful termination but sham and colourable one._ collusive device was practised by the managed company and the assessee-firm for the purpose of evading income-tax, bo'h in the hands of the payer and th·e oayee, by handing over sum of Rs. 2 lacs to the assessce-firm. [995 D-E; 997 F-G]

(3) As result of the apparent termination of the assessee's managing agency and the appointment of the Corporation, the individuals who con-B stituted the assessee-firm undertook the conduct of the managing agency business in the capacity o'f directors and shareholders of the Corporation. They continued to benefit from the profits of that business, fto\ving to them in the shape df dividends instead of as share of profits. from the assessee-firm. There was thus material beiore the Tr:bunal in suppdrt of ils finding that the amount of R·s. 2 lacs \V3S received by the assessee~ furn by virtue of its office of managing agency and in the course of its managing agency business and that therefore lt was revenue receipt.

[997 B-F]

CIVIL APPELLATE JURISDICTION : Civil Appeals Nos. 968 and 969 of 1967.

Appeals by special leave from the judgment and order dated July 10, 1962 of the Allahabad High Court in Misc. Case No. 2 of 1955 connected with income-tax Misc. Cases Nos. 255 and 256 of 1955.

Sukumar Mitra, A. N. Pareekh and B. P. Maheshwari, for the appellant (in both the appeals).

C. K. Daphtary, Attorney-Genera/, T. A. Ramachandran, R. N. Sachthey and B. D. Sharma, for the respondent (in both the appeals) .

The Judgment of the Court was delivered by

Ramaswami, J. These appeals are brought by special leave from the judgment of the Allahabad High Court dated July 10, 1962 in Income Tax Miscellaneous Cases Nos. 255 and 256 of 1955.

The appellant, M/s. Juggi Lal Kamlapat, hereinafter called !he 'asses.see'. was registered partnership firm having the fo!low-mg conslitutlon :

• The share--holding of the three Singhania brothers was 51 per cent constituting majority of the share holding in the partnership

[1969] 1 s.c.R .

• firm. The partners of the said firm floated company, namely, M/s. J. K. Iron and Steel Company Ltd. the constitution of which • was that the three Singhania brothers and their wives had 166 shares while Sri S. M. Bashir and his wife had 42 shares. In consideration of the fact that the assessce firm promoted the com-pany the assessee was appointed the managing agent of M/s. 1. K. Iron and Steel Company Ltd. for period of 25 years under Managing Agency agreement dated December 15, 1938. It was provided in this agreement that the assessee will continue to be the managing agent until it resigned or it was removed from its ol!ice of managing agency by majority of 3/4th of the share-holders of the managed company. According to the terms of the agreement the Managing Agent>, remuneration was Rs. 1500 per month and commission of 10 per cent on net profit of the company after deducting ail expenses and after charging depre-ciation. There was no provision in the Articles of Association of the managed company for terminating the managing agency ellcept in the case of the managed company being wound up in which case, the managing agents were to receive compensation for loss of appointment. There was also the exception provided under the general law in case of fraud or gross negligence on the part of the managing agents. The relevant terms of the manag-ing agency agreement were as follows :

"Para 2(m). It shall be lawful for the firm to assign their office as Agents and all the rights and obli-gations as such agents and in the event of assignment, the assignee or assignees shall be deemed to have been appointed Agents of the company with like powers and authorities remuneration and emoluments and subject to like terms and conditions as are herein contain-ed ...... "

"Para 2(c). The firm may at their option from time to time lend and advance to and for the use of the Company, money on interest to any extent as they may like, the same to run at minimum rate of five per cent per annum provided that if the bank rate pre-vailing at the date of advance is higher than five per cent the firm may charge interest at one per cent above the bank rate."

On August 12, 1943 meeting of the Board of Directors of the managed company was held. The Directors present were : ( 1) Sri Padampat Singhania, (2) Sri Lakshmipat Singhania a~d (3) Shri S. M. Bashir with Sri Padampat Singhania in the chair. At this meeting letter dated August 3, 1943 from M/s. Juggilal Kamlapat, Bankers, the financiers of the managed company ask-ing for repayment of advances made by the financier to the c~m- • pany exceeding Rs. 5 lacs was discussed. Sri S. M. Bashir pmnt-

ed out that the managing agents were under no obligation to • provide finance for the company at the latter's direction. It was the option of the firm to provide or not to provide finance and • also to determine the extent of the advance. Sri Padampat Singhania, thereupon pointed out that even though the matter. of providing finance might be at the discretion of the managmg agents but "it was the usual practice with companies under the management of the managing agents to obtain their finance from the managing agents". Accordingly the meeting decided to ask the assessee to arrange for advance of such sums of moneys as would be necessary to pay off the loan of the financiers M/ s. Juggilal Kamlapat Banker and also to equip the company with working capital. resolution was accordingly passed at the meeting to that effect. On August 19, 1943, the company ad-dressed letter to the assessee informing it of the resolution and asking it to make immediate arrangement for an amount which would not only reduce the account of . M/ s. Juggilal Kamlapat Bankers to figure of Rs. 5 lacs but must also provide the com-pany with .,.rorking capital. The assessee replied to this commu· nication by letter dated August 31, 1943 in which the assessee pointed out that under the terms of the managing agency agree-ment it was not obligatory upon it to make advances to the managed company. The assessee stated that it had been specially constituted to act as the managing agent of the managed company and had no capital of its own. It had no assets also on the security of which it could raise sum of Rs. 30 lacs which would be necessary to reduce the amount of Mis. Juggilal Kamlapat Bankers to the limit required by the managed company and to equip the company with working capital. The letter of the assessee was considered by the managed company at the meeting of its Board of Directors on September 2, 1943. Sri Lakshmipat Singhania, one of the Directors of the managed company reported in the meeting that new floated company under the name and style of J. K. Commercial Corporation was willing to make ad-vance provided it was appointed the managing agent of the com-pany. Sri Bashir pointed out that the managed company had reached stage when it would make substantial profits and en-able the assessee to earn better remuneration and that it would be unjust to ask the assessee to relinquish office on ground which did not constitute term of the contract between the assessee and the managed company. Sri Padampat Singhania who' presided over the meeting recognised that the assessee would be adversely affected and he therefore suggested that the company should pay fair compensation in consideration of the premature termina-H tion of the managing agency. compensation of Rs. 2 lacs was worked out and Sri Bashir agreed to accept the amount for the • termination of the managing agency on behalf of the assessee . It was decided that the sum of Rs. 2 lacs should be paid as soon

•as ~n agreement was arrived at "".ith the J. K. Commercial Corpo-A • ral!on for taking over the managing agency of the company. Tbc managing agency of the assessee was thereafter tenninated with effect from November I, 1943 and M/s. J. K. Conunercial Cor-poration were appointed the managing agents with effect from that date:

The constitution of M/s. J. K. Commercial Corporation was as follows :

It is ·apparent from this constitution tha.t the ~hares of the three Singhania brothers. their wives and children m. J. K. Com-mercial Corporation Ltd. were 6,600 'A'. Class onhnary shares out of 8.580 and 11.000 out of 15,000 'B Class ordmar~ shares. The remainin" shares were allotted to the Personal 0ss1stant to Sri Padampat "singhania, Munim of the firm of Jugg1la! Kamla-pat, Director of th_e managed company, one S. D. Garg and to Director of an alhed concern.

M/s. J. K. Commercial Corporation Ltd. were appointed • mru111aging agents for period of 20 years, renewable thereafter for term not exceeding 20 years at time. The remuneration was to be an office allowance of Rs. 1,000/ per month, com-mission of 10 % on the net annual profits of the company and commission of 2t% on the gross sales of the products of the company. Para 8 of the Managing Agency Agreement states :

"The Managing Agents shall from time to time lend and advance to and for the use of the Company such moneys as may from time to time be required by the Company up to an amount not exceeding Rs. 20,00,000 at any one time, but they may, however at their option lend and advance even more money if so required by the Company. The Company shall pay to the Manag-ing Agents, interest on moneys so lent and advanced at rate to be mutually agreed upon from time to time."

The amount of Rs. 2 lacs compensation paid to the assessee firm was worked out on the basis of 5 preceding years profits of the managing agency from November 1, 1938 to October 31, 1943. The sum of Rs. 2 lacs was paid to the assessee on Octo-ber 31, 1943. The amount was claimed by the assessee as com-pensation for loss of office not liable to tax under the Income Tax Act as capital receipt. The receipt of this sum of Rs. 2' lacs, though incorporated in its books by the assessee, was not dis-E closed at the time when the assessment was originally made against it on April 6, 1945. Later on when it was discovered that the assessee had received the sum from the managed com-pany the assessment was reopened under s. 34 of the Income Tax Act and proceedings were also taken under s. 15 of the Excess Profits Tax Act for the corresponding chargeable accounting period and the amount was included in the total computation of the assessee's business income. The assessee challenged these assessments on the ground that the proceedings under s. 34 of the Income Tax Act ahd under s. 15 of the Excess Profits Tax Act were invalid and on merits therefore there was no justification for the inclusion of the sum of Rs. 2 lacs as its business income liable to tax. Both these contentions were rejected by the Income Tax Officer and by the Appellate Assistant Commissioner in' appeal. The assessee thereafter preferred second appeals to the Income Tax Appellate Tribunal. In these appeals the assessee abandon-ed the contention regarding the legalitv of the proceedings under s. 34 of the Income Tax Act and s. 15 of the Excess Profits Tax Act and confined its argument merely to the point that the sum was not liable to be charged to tax. The AppeUate Tribunal came to the following findings of fact :-The three Singhania • brothe.rs, Padampat, Lakshmioat and Kailashpat held 51 per cent share m the assessee firm. They and the members of their family

(1969) I SC.R.

• held large majority of shares both in J. K. Commercial Corpo-A • ration Ltd. and in the managed company. There was no con-tract by reason of which the assessee was under any obligation to finance the business of the company. It was false allegation on the company's part that it would be derogatory to its reputa-tion to mortgage the property of the company to raise finance and the only alternative was to seek party who might be willing and able to finance the company even if such course warranted change of the managing agents. For the new managing agents advanced loan to the company only on the pledge of the goods of the company ( vide balance sheets of the company annexures I. J. and K.). It will also appear from these balance sheets that Juggilal Kamlapat Bankers still continued to be the creditors of the company in the three years for which the balance sheets have been filed in the sums of Rs. 3, 13, 169-11-6, Rs. 8,89,323-13-6 and Rs. 6,06,691. On these findings the Appellate Tribunal came to the conclusion that the reasons given by the assessec for terminating the managing agency were not true and the sum of Rs. 2 lacs was not compensation for Joss of office but was pay-ment referable to the business of the assesscc as managing agents of the Company. The Appellate Tribunal described the transac-tion of the termination of the managing agency as "collusive" and "not genuine" and that the "payment was not compensation for any loss" as in the view of the Appellate Tribunal no loss was sustained by the assessee. At the instance of the assessee the Appellate Tribunal stated case to the High Court under s. 66 ( 1 ) of the Income Tax Act on the following question of law :

"Whether there was material on which the Tribunal could hold that the receipt of Rs. 2,00,000 by the assessee was revenue receipt liable to tax under the Income Tax Act and the Excess Profits Tax Act?"

By its judgment dated July I 0, 1962 the High Court answered the question against the asscssee and in favour of the Commis-sioner of Income Tax, U.P. The High Court took the view that the amount of Rs. 2 lacs was received by the assessee "by virtue of its office" and "related to the work of the managing agency" even though the payment was collusive and there was no real termination of the managing agency agreement. It was pointed out by the High Court that the collusive payment could not have been made if the asscssce had not been the managing agent of the managed company and the managing agency business of the asscssee was exploited for getting the amount of Rs. 2 lacs.

On behalf of the appellant Mr. Sukumar Mitra stressed the argument that the High Court failed to appreciate that the assessee firm was distinct legal entity and was different from J. K. Commercial Corporation which was separate legal entity

J. L. KAMLAPAT v. C.I.T. (Ramaswami, J.)

in the eye of law and the mere fact that the share Jioldings of !he · partners of the assessee firm in the J. K. Commercial Corpora~on was of considerable proportion should not have led the High Court to the inference that the rights of the assessee firm were not destroyed, sterilized or lost on account of the transaction. To put it differently, the contention of the appellant was that the High Court was not entitled to go behind the legal form of the transaction and to find out what was the substance. We are unable to accept the argument of Mr. Sukumar Mitra as correct. In the present case, the Appellate Tribunal has found that the transaction of termination of the managing agency was colour-able transaction and· the real purpose was to hand over sum of Rs. 2 lacs to the assessee firm. It was also found that the pay-C ment was collusive and the partners of the firm continued to run and enjoy the benefit of managing agency as shareholders and Directors of the newly formed company by reason of their holding majority of shares in that company. It was also held by the Appellate Tribunal that the reason for terminating the managing agency was not true reason but was merely fake one and the whole transaction was hoax for the purpose of evading income-tax. In other words, it was collusive device practised by the managed company and the assessee firm for the purpose of evad-ing income-tax both in the hands of the payer and of the payee. The Appellate Tribunal also found that there was only change of personnel in the managing agency and not change in office and that the assessee had no right of compensation for any loss of office. In· matter of this description it is well-established that the Income-tax authorities are entitled to pierce the veil of cor-porate entity and look at the reality of the transaction. It is true that from juristic point of view the company is 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 bome 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 disrei;ard the cor-porate entity if it is used for. tax evasion or to circumvent tax obligation or to perpetrate fraud. For instance, in Apthorpe v . Peter Schoenhofen Brewing Co.(') the Income Tax Commis-sioners had found as 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 New York law. All but three of the New York company's shares 'were held by the English company, and as the Commis-H sioners also found, if the business was technically that of the New •York company, the latter was merely the agent of the English· (I) 4 T.C. 41.

company. In the light of these findings the Court of Appeal, despite the argument based on Salomon's(') case held that the New York business was that of the English company which was !ia"1e for English ·income tax accordingly. In another case-Firestone Tyre and Rubber Co. v. L/ewel/in(')-an American company had an arrangement with its distributors on the Conti-nent of Europe whereby they obtained supplies from the English manufacturers, its wholly owned subsidiary. The English com-pany credited the American company with the price received after deducting the costs plus 5 per cent. It was conceded that the subsidiary was· separate legal entity and not mere cmana-don of the American ;_,Jrcnt, and that it was selling its own goods as principal. and not its parent's goods as agent. Nevertheless, the.<c sales \f·"'e means whereby the American company carried on its European business, and it was held by the House of Lords 1ha1 the substance of the arrangement was that the American company traded in England through the agency of its subsidiary. It was accord\"::'v held that the trade of selling tyres to persons outside the Um:~ Kingdom was carried on within the Unitc:J Kin!!dom and was exercis.:xl by the American company .through the English Co. as its agent. Therefore. the tax was chargeable in respect of that trade under Schedule D, para 1 (a) (iii), to the Income Tax Act, 1918, and the English Co. was the regular agent of the American Co. in whose name it was properly assessed to tax on profits of that trade under rules 5 and I 0 of the All Sche-dules Rules. In our opinion the principle applies to the present case. and 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 fraud. We accordingly reject the argument of Mr. Sukumar Mitra on this aspect of the case. We proceed to consider the next argument addressed on behalf of the assessec, viz., that the amount of Rs. 2 lacs cannot be held to be revenue receipt e\•en though the tramaction of termina-tion of the managing agency was collusive and the intention of the parties was to evade income tax. The argument put forward on behalf of the appellant was that even if the transaction was collu-sive and not genuine, it was legally permissible for the assessce to arrange its affairs in such wav as to avoid the incidence of tax. It was argued that even upon. the facts found by the Appellate Trihunal the amount of Rs. 2 lacs paid to the assessec firm was not taxable as income in its hands because there was an actual termination of the first managing agency agreement and the amount of Rs. 2 lacs was actually paid to the assessee firm for the tennination of the managing agency contract. The argument was II stressed that the assessec firm had no other husiness activity except the managing agency in question and that the managing • -·-··-(I) 11897] A.C. 22. (2) (1957] I W.l.IL 464.

.. J: .. L. KAMLAl'AT·v:·c.I.T. (RamasWami, J.)

agency contituted the capital assets of the 11ssessee :firin and on the termination_ of the managing agency contract the capital assets were "destroyed or s.terilized" and the compensation received was therefore of the nature of capital receipt. In our opinion, there is no warrant for the argument addressed by Mr. Sukumar Mitra. On the facts found in this case, it is manifest that the managing agency business carried on by the assessee firm was not des-troyed or lost to the four individual partners who constituted the assessee firm. What happened was that the individuals who constituted the assessee firm became the Directors of . the newly formed company namely, J. K. Commercial Corporation and in this new capacity they undertook the conduct of the managing agency business and as shareholders continued to benefit from the profits of that business flowing to them in the shape of divi-dend instead of as share of profits from the assess.... firm. In other words, the managing agency asset was enjoyed by the four individual partners in different capacity with the same object of profit-making. There was, therefore, no destruction of the apparatus of the profit-making asset i,e., the m· ·ging agency contract. The Appellate Tribunal has found that the amount of Rs. 2 lacs was received by the assessee firm "by virtue of its office" and "related to the work of the managing agency" even though the tennination of the contract was not genuine and the payment was collusive and the managing agency business of the assessee firm was exploited for gaining Rs. 2 lacs. It is obvious that there is an intimate connection in this case between the managing agency business of the assessee firm and the payment of sum of. Rs. 2 lacs and there was therefore proper material before the Appellate Tribunal in support of its finding that the receipt of Rs. 2 lacs by the assessee firm was receipt in the course of its managing agency business and was hence revenue receipt.

On behalf of the appellant it was said by Mr. Sukumar Mitra that mere intention on the part of the assessee to evade income-tax will not nullify an otherwise lawful transaction. But we have already shown that the Appellate Tribunal has found in the pre-sent case that the transaction of termination of the managing agency contract was sham transaction and was stage-manag~ merely with view to evade income-tax and the real intention was that the three Singhariia brothers should continue to carry on the managing agency in dominant capacity in the guise of limited company and there was in fact no loss of office or des-truction of profit yielding apparatus. Reference should be made in this connection to the following observations of Lord Greene. M.R. in Lord Howard De Walden v. Commissioners of Inland Revenue:(').

~llut even if the only alternative to Mr. Tucker's construction is the second of the three constructions, we are not prepared to say that it is necessarily as unjust as he contends. The section is penal one and its consequences whatever they may be, are intended to be an effective deterrent which will put stop to prac· tices which the Legislature consid_ers to be against the public interest. For years battle of manoeuvre ha.' been waged between the Legislature and those who are minded to throw the burden of taxation off their own shoulders on to those of their fellow subjects. In that battle the Legi;lature has often been worsted by the skill, determination and resourcefulness of its opponents, of whom the present Appellant has not been the least successful. It would not shock us in the least to find that the Legislature has determined to put an end to the struggle by imposing the severest of penalties. It. scar-cely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers."

We therefore reject the argument of Mr. Sukumar Mitra on this point.