1. In this petition under article 226 and 227 of the Constitution of India, the petitioner has raised questions regarding the constitutionality of section 12(1B) read with section 2(6A)(e) of the Indian Income-tax Act (hereinafter referred to as the Act). The petitioner holds II shares out of 345 shares each of the value of Rs. 100 in a private limited company - the Malegaon Electricity Co. (Private) Ltd. The business of this company is supplying electricity to the citizens of Malegaon. It appears that some time during the year 1955 the petitioner had taken a loan amounting to over Rs. 4 lakhs from the company. For the assessment year 1956-57 a notice was issued by the 8th Income-tax Officer to the petitioner under section 22(2) of the Act calling upon him to file his return. The Income-tax Officer computed his income at Rs. 3,53,460. The said sum included a sum of Rs. 2,83,126 representing the accumulated profits of the company, which was, under the provisions of section 2(6A)(e), deemed to be dividend received by the petitioner and, therefore, the said sum of Rs. 2,83,126 was included in the total income of the petitioner as income from other sources within the meaning of section 12(1B) of the Act. Against the order of the Income-tax Officer, the petitioner filed an appeal before the Appellate Assistant Commissioner raising various grounds. But the appeal was dismissed by the Appellate Assistant Commissioner and now a second appeal is pending before the Income-tax Appellate Tribunal. The petitioner, however, has filed this petition also before this court challenging the constitutionality of the aforesaid two provisions of the Act. The petition, thus, is only limited to the contention of the petitioner as regards the constitutionality of these two provisions. As regards the correctness or otherwise of the order on merits is concerned, that will be a matter for the Tribunal to decide.
2. The challenge raised by Mr. Gharekhan, counsel for the petitioner, is four-fold. Firstly, it is his contention that it was beyond the legislative competence of Parliament to enact these two provisions. It is next urged that it is violative of article 14 of the Constitution. It is then urged that it is violative of article 19(1)(g) of the Constitution and, lastly, it is contended that the legislation so far as it relates to these provisions is a colourable piece of legislation and, therefore, void in law.
3. To appreciate the contentions raised on behalf of the parties, it would be convenient to refer to the impugned provisions at this stage. Section 2(6C) defines 'income'. It is an inclusive definition and the definition says that the dividend is included in the expression 'income'. Section 2(6A) defines 'dividend' and the material part is in the following terms :
2(6A) '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 - ...
(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 clause (e), to the extent to which it is so set off.'
Section 12(1) reads as follows :
'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)........
(1B) 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 sub-section (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 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.'
4. It may be stated that section 2(6A)(e) as well as section 12(1B) were introduced in the Act by the Finance Act of 1955 which came into operating on 1st April, 1955. Now the combined effect of these two provisions is that it brings to tax in the hands of the public are substantially interested, three kinds of payments, to the extent the company is in possession of accumulated profits. These three kinds of payment are :
(1) payment made to him by way of advance or loan;
(2) payment made on his behalf; and
(3) payment made for his individual benefit.
5. These three kinds of payment are brought to tax in the hands of a shareholder where they are made after the Act has come into force or before provided the loan was outstanding on the 1st day of the year previous to the assessment year ending on 31st March, 1956, by creating a legal function that it was a dividend received by the assessee.
6. Turning to the first contention raised by Mr. Gharekhan, as already stated, it is his contention that the said two provisions are beyond the legislative competence of Parliament and, therefore, bad in law. It is his argument that Entry 82 in the first list of the Seventh Schedule of the Constitution empowers Parliament to enact laws relating to 'Taxes on income other than agricultural income'. What Parliament here has done is not taxing income but has in fact taxed loans and, therefore, it is beyond its legislative competence. Mr. Gharekhan further argues that the accumulated profits, which were profits in the hands of the company, did not retain its character of profits when the loan was advanced by it to its shareholders but a new relationship of creditor and debtor had come into existence. The money in the hands of the shareholder, therefore, was a loan and could never be income. The shareholder under law was bound to repay the amount to the company. The amount, therefore, remained the property of the company and had not ceased to be its property, unless and until the company had written off the debt, and it in no event could be said to be the income of the shareholder borrowing the loan.
7. Mr. Joshi, appearing for the revenue, on the other hand, contends that Entry 82 is not to be interpreted in a narrow sense but has to be interpreted in its widest possible amplitude. The power conferred on Parliament to legislate in respect of the subject 'taxes on income other than agricultural income' includes power to enact provisions to arrest evasion or avoidance of payment of tax. He referred us to a decision in Sardar Baldev Singh v. Commissioner of Income-tax Alternatively, Mr. Joshi contends that even assuming that Parliament had no competence to enact the said two provisions under Entry 82 of the Constitution, it was competent to enact those provisions under the residuary Entry No. 97, 'any other matter not enumerated in List II or List III including any taxes not mentioned in any of those Lists'.
8. Article 245 of the Constitution empowers Parliament to make laws for the whole or any part of the territory of India and the Legislature of a State to make laws for the whole or any part of the State.
Clause (1) of article 246 provides :
'Notwithstanding anything in clause (2) and (3), Parliament has exclusive power to make laws with respect to any of the matters enumerated in List I in the Seventh Schedule (in this Constitution referred to as the 'Union List')'.
Clause (2) provides :
'Notwithstanding anything in clause (3), Parliament, and, subject to clause (1), the Legislature of any State also, have power to make laws with respect to any of the matters enumerated in List III in the Seventh Schedule (in this Constitution referred to as the 'Concurrent List').'
Clause (3) provides :
'Subject to clauses (1) and (2), the Legislature of any State has exclusive power to make laws for such State or any part thereof with respect to any of the matters enumerated in List II in the Seventh Schedule (in this Constitution referred to as the 'State List').'
Article 248 provides :
'(1) Parliament has exclusive power to make any law with respect to any matter not enumerated in the Concurrent List or the State List.'
Clause (2) of Article 248 provides :
'Such power shall include the power of making any law imposing a tax not mentioned in either of those Lists.'
9. The scheme of the Constitution thus is to have legislative topics apportioned between Parliament and the State Legislature. In respect of List II (State List), it is the State Legislature that alone is competent to legislate. As regards the topics in List I or the Union List, it is Parliament alone that is competent to legislate. In respect of List III or the Concurrent List it is both Parliament as well as the Legislature that will be competent to legislate. The legislative topics contained in the Three Lists may not fully cover the field of legislation and, therefore, the Constitution has invested Parliament with the residuary power to legislate in respect of any matter not enumerated in the Concurrent List or the State List; and has further provided that this residuary power shall also include the power of making any law imposing a tax not mentioned in either of those Lists. These provisions further indicate that no tax can be levied save and except by an Act passed by a competent legislature. In other words, the tax can only be levied by a competent legislature.
10. Now it is well settled that in interpreting the legislative topics mentioned in these three Lists, no narrow or restricted meaning is to be given to these words but the words used are to be interpreted in their widest amplitude which they are capable of bearing so as to include all subsidiary and ancillary matters including power to make provisions for arresting evasion or avoidance of tax. In J. N. Duggan v. Commissioner of Income-tax Chagla C.J. observed :
'It is well settled now that a large and liberal interpretation must be placed upon all entries in the Seventh Schedule of the Government of India Act, and that the widest import and significance must be given to the language used by Parliament in these various entries. It must not be forgotten that the Legislature created by the Government of India Act was a sovereign Legislature within its won sphere, and that, when a topic was assigned to a particular Legislature in respect of which it would legislate, then all possible powers with regard to that topic must be attributed to that Legislature.'
11. The principle contained in the aforesaid observation has later been affirmed by the Supreme Court in Navinchandra Mafatlal v. Commissioner of Income-tax. In construing Entry No. 54 in List I of the Seventh Schedule of the Government of India Act, 1935, which was identical in terms with Entry 82 in the Union List or List I of the Seventh Schedule of the Constitution, the Supreme Court in Sardar Baldev Singh v. Commissioner of Income-tax observed :
'As is well-known the legislative entries have to be read in a very wide manner and so as to include all subsidiary and ancillary matter. So 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. If it were not to be so read, then the admitted power to tax a person on his own income might often be made infructuous by ingenious contrivances. Experience has shown that attempts to evade the tax are often made.'
12. Now the aforesaid observation made by Chagla C.J. and the Supreme Court relate to entries in the legislative list under the Government with equal force in construing the language of the entries in the legislative list in the Seventh Schedule of the Constitution of India. We may here mention that the challenge raised to the legislative competence of Parliament in Sardar Baldev Singh's case related to the enactment of section 23A of the India Income-tax Act : provisions enacted to prevent one of the ways adopted by the shareholders of the controlled companies to avoid payment of tax.
13. It is thus clear that the power conferred on Parliament in Entry 82 t imposed taxes on income other than agricultural income would also include power to enact provision preventing evasion or avoidance of tax. It is the contention of Mr. Joshi that the these provision have been enacted with that objective and in our opinion there cannot be any doubt in this matter. The provisions apply to companies, not being companies in which the public are substantially interested. In other words, these provisions apply to companies in which voting power rests in the hands of a member or a group of members allied together in common interest and who act in concert. Super-tax is not levied on the income of company but it is levied on the income of an individual. It is well-known that forming themselves into controlled companies as a device to avoid payment of super-tax is often resorted to by businessmen to evaded payment of the taxes. A company and its members are two distinct and separate persons in the eye of law. It is not obligatory under the law for the company to declare dividends and distributed the profits made by it during the year. Unless dividends are declared the profits made by the company do not become the income of its members. Advantage of this legal position has been taken by the members of the controlled companies in not declaring the dividend and yet availing themselves of the profits made by the company and thus avoid payment of tax. One of the devices used by the members was to take the profits by way of loan in the name of one of its members holding insignificant number of shares and distribute it amongst themselves. Devices of these kinds used by businessman have been noticed by the Government not only in this country but also of other countries. The Supreme Court in Sardar Baldev Singh v. Commissioner of Income-tax has cited the following passage from Simon's Income-Tax, 2nd edition, volume 3, page 341 :
'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 or on a portion of it, and one method involved the formation of what is popularly called a 'one-man company'. The 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.'
14. What is said in the aforesaid passage about 'one-man company' is equally true in respect of controlled companies where members are more than one because in such companies the voting power rests in the hands of a group of members allied together in the same interest and who act in concert. It is only to prevent evasion of tax by members of such companies by resorting to the device of borrowing the accumulated profits of the company that the said provisions have been enacted. It is to be remembered that the provisions do not apply to companies, whose normal course of business or a substantial part thereof is money-lending. In the normal course of business a company should be distributing its distributable profits as dividends amongst its members. When it does not do so and when it is found that the affairs of the company are controlled by a group of persons allied together, who act in concert, a presumption would naturally arise that it was not suitable for the normal way. It is for these reasons and for purposes of preventing evasion of tax that these provisions have been made and, therefore, in our judgment Parliament was competent to enact these two provisions under Entry 82 in the Union List of the Seventh Schedule of the Constitution.
15. The legislative competence of Parliament to enact these provisions was challenge without any success in K. M. S. Lakshmana Aiyar v. Additional Income-tax Officer, special Circle, Madras At page 473 of the report it is observed :
'The reason for such a drastic provision is not far to seek. It is a familiar device of the tax evaders to take shelter under the corporate personality which law confers on a company. No company is bound to declare dividends; profits earned by the company could, therefore, be accumulated and the persons who would get the share, if dividends were declared in the normal course, adopt devices to get the benefit of such profits indirectly, e.g., a loan is taken from the company which is never repaid; the company meets an obligation of the shareholder or makes a payment for his benefit. Thus, the shareholder would get the benefit of the dividend, though in form the process of obtaining such benefit would be otherwise than by way of a declaration of dividend. Such receipt (prior to the amendment) would not be liable to tax, as it could not be said that any dividend was either declared or received. Such or similar subterfuges would be possible only in the controlled companies and not in those where the public have a substantial interest. It can be expected that in the latter category of companies the public would see to it that they get their dividends properly and in time. In the controlled companies, however, the persons controlling would decide what is to be done. Profits distributable to the shareholders could ostensibly be accumulated; the persons in control could nevertheless have the benefit of the money by taking it under the guise of a loan or advancing it to a shareholder who would make it over to them and thus avoid tax on dividends. It is to check this type of evasion that the legislature introduced sub-clause (e) to section 2(6A) which contained the definition of the term 'dividend'.'
16. This decision has also been followed by the same High Court in S. Kumaraswami v. Income-tax Officer, Nagercoil.
17. Mr. Joshi has also argued before us that even assuming Parliament had no legislative competence to enact these provisions under Entry 82, the legislation could be upheld under Entry 97 in the Union List. In view of our aforesaid finding, it is not necessary to consider this alternative submission made by Mr. Joshi and we do not propose to do so.
18. Mr. Gharekhan further argued that even assuming that under the said Entry 82, Parliament had competence to enact provisions to prevent evasion of tax, Parliament over-shot the mark. The result of the legislation is not that the member, who takes an advance or borrows, is taxed in respect of his income, but is taxed n respect of the income of others. He argues, on the facts of the present case, that here the petitioner holds only II shares out of the total 845 shares held by different members in the company. The entire accumulated profits of the company amounting to Rs. 2,83,126 have been advanced to the petitioner. The entire amount under the said provisions has been treated as dividends received by the petitioner which neither in fact nor in law is due to him, and yet he has been made to pay tax on the entire accumulated profits, which in the normal course would have been distributed amongst all the shareholders of the company in proportion to their holding. Had the legislature created a fiction that, in the event of accumulated profits being advanced to a member, the accumulated profits be deemed to have been distributed amongst the shareholders as dividends, its legislative competent in that event could not have been challenged. Such, however, is no the case in the present case. Tax is levied on a person in respect of income, which does not belong to him and, therefore, the legislation is bad.
19. It is indeed true that by the fiction created under section 2(6A)(e). the amount of loan borrowed by a member to the extent of the accumulated profits of the borrowed by the company is treated as dividend received by him and is taxed in his hands irrespective of his shareholding. But then it cannot be said that, in order to prevent evasion of tax, the legislature is not competent to create such a fiction, and the constitutionality of the legislation creating such a fiction has been upheld.
20. To illustrate, under section 16(3), in computing the total income of an individual for the purpose of assessment, the income of the wife or minor child of such individual as arises directly or indirectly from the membership of such individual as arises directly or indirectly from the membership of the wife in the firm of which he is a partner and from the admission of his minor child to the benefits of partnership in a firm of which he is a partner is included. Now, in law it is clear that the income of the wife or the income of the minor child is not the income of the husband or the father, but by a fiction created by the legislation, the income of the wife and minor child is so deemed and included in the income of the husband or the father. The reason, therefore, was that taking the wife as a partner in the business or admitting the minor child to the benefits of partnership was a device employed to avoid payment of tax. The constitutionality of this provision has also been upheld. It is not necessary to multiply instance of this kind by referring to sections which are embodied in the Act. Suffice it to say that creating a legislative fiction under which income of one is taxed in the hands of another does not render the legislation invalid on the ground of legislative incompetence when such a fiction is enacted to arrest evasion of tax. Looking at the Act and the substance of the provisions, the subject of tax is the accumulated and undistributed profits of a controlled company in the hands of the shareholders, which profits are taken by them by way of a loan. The reason, as already stated, for enacting these provisions is to arrest or prevent avoidance and evasion of payment of tax. This contention of Mr. Gharekhan should, therefore, fail.
21. It is next contended by Mr. Gharekhan that the legislation has raised an irrebuttable presumption that the loan taken by member would not be returned and on the basis of this presumption the amount is taxed in the hands of a member taking loan. The presumption raised being one of fact could have taken notice of possible situation; members who borrow loan from the company would be of two types : members who borrow and do not repay and the company writes off the loan, and members who borrow money from the company and also repay the loan. Both have been treated equally. A person, who repays the loan, has to pay the tax out of his pocket and not out of his share of income received from the company. That results in discrimination. These provisions, therefore, are violative of article 14 of the Constitution and, therefore, bad in law. Reliance is placed on a decision reported in K. T. Moopil Nair v. state of Kerala.
22. We find it difficult to accept this contention of Mr. Gharekhan. In considering how the legislation is discriminatory, it has to be seen whether it acts at the time of its operation on persons similarly situated. If it acts equally on all persons similarly situated, then the legislation cannot be treated as violative of article 14 of the Constitution by reason of any subsequent happening or event. Now, here the provisions operate equally on all members who borrow money from a controlled company, of which they re members to the extent of the accumulated profits in the hands of the controlled company. The tax is attracted at the point of time when the said loan is borrowed by the members. It acts equally on every member. In its operation it does not result in any discrimination. In our opinion, therefore, it cannot be said that it is violative of article 14 of the Constitution. Assuming that any of the members borrowing loan and who has been required to pay tax, returns the loan, the legislation may work hardship on him. But merely because it works hardship on some persons on whom the legislation acts, it cannot be said to be violative of article 14 of the Constitution. We might also observe that in our view the argument also is highly hypothetical and assumes that in reality there would be members, who resort to such borrowings, returning the loan. Nor would it, having regard to the various factors mentioned above, be reasonable to assume such a hypothetical case. Even in the instant case before us, the loan has been borrowed in the year 1955 and there in no averment in the petition that the petitioner has at any time repaid the loan. The decision on which reliance is placed is distinguishable on facts. Tax at the uniform rate was levied on all lands irrespective of the quality of those lands. In these circumstances the Act was held offending articles 14 of the Constitution, because it equally acted on lands unequally situated. Such, however, is not the case here. The provisions uniformly act on all members, who borrow. We may also here note that no pea had been raised by the petitioner in this form in his petition. For reasons stated above, this ground of attack must fail.
23. It is next argued that the provisions treat differently borrowers, who have repaid the loan prior to 30th June, 1955, and who might repay the loan after 30th June, 1955. The legislation was thus discriminatory in treating borrowers who repay loan differently. Again it may be stated that a plea in this form has not been raised. Even on merits there is no substance in it. It has to be noticed that the provisions were introduced by the finance Act of 1955, which came into operation on 1st April 1955. Prior to this date it was not known that the borrowings made by a member from the company to the extent of its accumulated profits would be treated as dividends. Therefore, persons, who had borrowed money prior to the coming into force of the Finance Act, 1955, had no notice that the borrowings would be chargeable to tax in their hands as dividends. It is only to avoid any possible hardship to such borrowers that an opportunity was given to those borrowers to repay the loan by 30th June, 1955, and avoid payment of tax. It is not that the legislature has created any two classes as borrowers who repay loan prior to 30th June, 1955, and borrowers who repay loan after 30th June, 1955, and has treated them differently. This Ground of attack also should fail.
24. Now, the challenge, which has been raised in the petition, is contained in only ground (i) of paragraph 14 of the petition which is in the following terms :
'That to tax only one shareholder in respect of the company amounts to discrimination and violates the provisions of article 14 of the Constitution of India'.
25. No arguments have been advanced by Mr. Gharekhan other than that to which we have referred above in support of this ground. It is, therefore, not necessary to deal with it separately.
26. It is next contended that it is violative of the petitioner's fundamental right to practise any profession or to carry on any occupation, trade or business enshrined in sub-clause (g) of clause (1) of article 19 of the Constitution. Mr. Gharekhan argued that to carry on any trade or business, a man must borrow. Now, here, when person borrows he has been made to pay tax on his borrowings. He may even repay the loan and yet he has to bear the burden of tax. That adversely affects him in exercise of his right to carry on any trade or business. The provisions of law thus offend article 19(1)(g) of the Constitution.
27. It may be said that no such plea in this form has been raised that the petitioner's right to carry on trade or business has been violated. On other hand, from the allegations in paragraph II it is abundantly clear that what is urged is that the company's fundamental right to carry on business is violated by these provisions. The plea in paragraph II is in the following terms :
'Every citizen has got a fundamental right to carry on his trade or business subject only to such reasonable restrictions as may be imposed by law. In the course of carrying on trade or business the company is entitled to give or take loans to or from shareholders. Legislation which changes the incidence of such loans is, it is submitted, an encroachment upon the fundamental right of a citizen under article 19 of the Constitution. It is submitted that the restriction imposed by the amendment in question is not the interest of general public nor is it reasonable....'
28. We fail to see how these provisions violate the company's right to practise any trade or carry on any business. It is to be remembered that the provisions operate where loan is advanced by a company, whose business, or the substantial part thereof, is not money-lending. We also fail to see how these provisions violate the petitioner's or any other borrower's right to practise any trade or carry on any business. It does not prohibit borrowing; it does not prohibit any person from practising any trade or business. All that it does is that if a member of a controlled company takes a loan from the company, then the loan in his hands, to the extent of the accumulated profits of the company, would be deemed to be dividend received by him and, therefore, liable to tax. It cannot be said that under article 19(1)(F) the member has a fundamental right to borrow loan from a controlled company of which he is a member from the accumulated profits of the company. This ground also therefore, fails,
29. Lastly, it is contended by Mr. Gharekhan that the provision are a piece of colourable legislation as under the guise of imposing tax on income, tax has been imposed on loan.
30. We have already observed that no tax has been levied on loan but o the other hand tax has been levied in respect of income and is not bad in law.
31. For the reasons stated above, in our judgment, the petition fails and is, therefore, dismissed. The petitioner shall pay the costs of the other side. Costs quantified at Rs. 250
32. Before parting with the case, it is necessary to mention that the petitioner had filed an affidavit in rejoinder. We are in this petition concerned only with the constitutionality of the impugned provisions and no occasion has arisen to place before the court any affidavit by way of a rejoinder. We also do not consider it necessary for the purpose of decision to admit any affidavit in rejoinder. The affidavit in rejoinder is, therefore, not accepted as a part of the records of the case.
33. Petition dismissed.