1. One Nageswara Rao Panthulu set up a business of manufacturing a'pain-balm' which was marketed in the trade-name of'Amrutanjan'. In September 1936 the respondent company was floated asa public limited company under the Indian Companies Act, 1913, to acquire andcarry on the business of manufacture and sale of 'Amrutanjan'. Theauthorised capital of the company was 7,000 ordinary shares and 3,000preference shares of Rs. 100/- each, and the issued and paid-up capital was2,500 ordinary and 3,000 preference shares. The preference shareholders were underthe Articles of Association entitled to a fixed dividend of 7 1/2 per cent onthe face value of the shares, with no right in the balance of the profits. Therespondent company took over the business conducted by Nageswara Rao Panthulufor Rs. 5,50,000/- paid in the form of 2,500 ordinary and 3,000 preferencefully paid-up shares. This company was managed by a firm which after the deathof Nageswara Rao Panthulu consisted of Ramayamma, widow of Nageswara Rao,Kamakashamma, his daughter, Ramayamma's brother Ramchandra Rao andKamakshamma's husband Sambu Prasad. Between April 1, 1946 to March 31, 1949Ramayamma, widow of Nageswara Rao was holding 2,185 ordinary shares and herdaughter Kamakhamma was holding 250 ordinary shares. Out of the preferenceshares only 385 were held by the directors including Ramayamma and Kamakshamma.
2. Under the Articles of Association of the company, both preference andordinary shareholders were entitled to vote at the meeting of the company -each shareholder being entitled to exercise one vote for each share. In thecourse of assessment proceedings of the respondent company, the Income-taxOfficer found that for the three years ending March 31, 1947, March 31, 1948and March 31, 1949 the company had declared each year a total dividend of Rs.38,750/- at the rate of 7 1/2 per cent on the preference shares and 6 1/2 percent on the ordinary shares - which was considerably less than sixty per centof the amount available for distribution as computed under s. 23-A of theIncome-tax Act, as it stood at the material time. The Income-tax Officer serveda notice, after obtaining the approval of the Inspecting Assistant Commissionerof Income-tax, requiring the respondent company to show cause why an orderunder s. 23-A of the Income-tax Act, 1922, should not be passed against thecompany and after considering the objections raised by the company ordered onMarch 31, 1953 that the undistributed portion of the assessable income of thecompany as computed for income-tax purposes and reduced by the amount ofincome-tax and super-tax payable by the company in respect thereof, shall bedeemed to have been distributed as dividend amongst the shareholders as at thedate of the respective general meetings. This order was confirmed in appeal bythe Appellate Assistant Commissioner and the Income-tax Appellate Tribunal.
3. Several contentions were raised before the Revenue authorities and theTribunal challenging the competence of the Income-tax Officer to pass an orderunder s. 23-A including the contention that the said provision wasunconstitutional or ultra vires. These have been negatived by the Tribunal andalso by the High Court and it is unnecessary to refer to those contention inthese appeals as they do not survive for determination.
4. In a reference made under s. 66(1) of the Indian Income-tax Act, theTribunal referred three questions to the High Court of Judicature at Madras.The third question, which alone is material in these appeals, reads as follows:
'Whether the provisions of s. 23-A were correctlyapplied for the three relevant years ?'
5. The High Court held that the respondent company was one in which thepublic were substantially interested, and therefore the Income-tax Officer hadno jurisdiction to pass the order under s. 23-A of the Income-tax Act for anyof the three years and on that footing answered the question in the negative.Against the order passed by the High Court, with certificate of fitness theCommissioner of Income-tax has appealed to this Court.
6. Section 23-A of the Indian Income-tax Act, 1922 before it was amended bythe Finance Act, 1955, stood as follows :
'(1) Where the Income-taxOfficer is satisfied that respect of any previous year the profits and gainsdistributed as dividends by any company up to the end of the sixth month afterits accounts for that previous year are laid before the company in generalmeeting are less than sixty per cent of the assessable income of the company ofthat previous year, as reduced by the amount of income-tax and super-tax payableby the company in respect thereof he shall,.... make with the previous approvalof the Inspecting Assistant Commissioner an order in writing that theundistributed portion of the assessable income of the company of that previousyear as computed for income-tax purposes and reduced by the amount ofincome-tax and super-tax payable by the company in respect thereof shall bedeemed to have been distributed as dividends amongst the shareholders as at thedate of the general meeting aforesaid,........
Provided further that thissub-section shall not apply to any company in which the public aresubstantially interested or to a subsidiary company of such a company if thewhole of the share capital of such subsidiary company is held by the parentcompany or by the nominees thereof.
7. Explanation. - For the purpose of this sub-section, -
a company shall be deemed to be a company in which thepublic are substantially interested if shares of the company (not being sharesentitled to a fixed rate of dividend, whether with or without a further rightto participate in profits) carrying not less than twenty-five per cent of thevoting power have been allotted unconditionally to, or acquired unconditionallyby, and are at the end of the previous year beneficially held by the public(not including a company to which the provisions of this sub-sectionapply)......................'
8. The section was enacted with the object of preventing avoidance ofsuper-tax by shareholders controlling the affairs of a company in which thepublic are not substantially interested, by the expedient of not distributingdividend out of the profits. Under the annual Finance Acts for many years the ratesof super-tax applicable to companies were much lower than the higher ratesapplicable to other assessees. That gave an inducement to persons controllingcompanies to avoid the higher incidence of super-tax by transferring to limitedcompanies their businesses. Thereby the source of earning was secured, theprofits of the business could be accumulated till they were distributed in theform of capital, and in the meanwhile accumulations of undistributed profitsremained available to them or purposes of their other businesses. With a viewto foil attempts made by persons holding controlling interests in companies toavoid payment of super-tax applicable to non-corporate assessees by refusing toagree to distribution of profits, s. 23-A was enacted by the Legislature. TheIncome-tax Officer was thereby authorised, if satisfied when less than sixtyper cent of the assessable income of the company, subject to reductionspermitted thereby, was not distributed, to pass an order under which the incomewas deemed to be distributed among the shareholders entitled thereto. By theorder so made a fictional or notional income which was not in fact received bythe shareholders was deemed to be distributed, and in the hands of theshareholders such deemed income was liable to tax as if it had arisen oraccrued to them. But by the express provision contained in s. 23-A, as it stoodat the material time, no order could be passed in respect of any company inwhich the public were substantially interested and to a subsidiary company ofsuch a company if the whole of the share capital of such subsidiary company washeld by the parent company, or by the nominees thereof. The Act, however, didnot define the expression 'company in which the public are substantiallyinterested'. Normally a company would be deemed to be one in which thepublic are substantially interested, where more than half the voting power isvested in the public. Where the controlling interest i.e. a minimum offifty-one per cent of the voting right is held by a single individual or agroup of individuals acting in concert, the company would be regarded as one inwhich the public are not substantially interested. But the Legislature by theExplanation has raised a conclusive presumption in those cases where shares ofthe company carrying not less than twenty-five per cent of the voting power areheld by persons other than the controlling group. For the purpose of computingtwenty-five per cent of the voting power, however, rights of holders of sharesentitled to a fixed dividend have to be excluded.
9. It is now settled law that the distinction between the controlling groupand the public is not along the line which distinguishes directors from theremaining members of the company. If a director does not belong to thecontrolling group, he will be regarded as a member of the public for thepurposes of the third proviso and the Explanation to s. 23-A even though suchdirector was directly entrusted with the management of the affairs of thecompany.
10. The Commissioner contends that the Explanation to sub-s. (1) of s. 23-Ais in reality a clause which defines what a company, in which the public aresubstantially interested, is. In terms, however, the Explanation raises apresumption and does not purport to define a company in which the public aresubstantially interested. On an analysis of the provisions of the third provisoto s. 23-A and its explanation, the following position emerges :
(1) Where there is no individualmember or a group of members acting in concert holding fifty-one per cent ormore of the voting power, which controls the working of a company, it is fromits very nature a company in which there is no controlling member or group andtherefore the public are substantially interested;
(2) Where a shareholder holds ora group of shareholders acting in concert hold fifty-one per cent or more ofthe voting power, the question is one of fact to be determined in each case,whether it is a company in which the public are substantially interested,having regard to the purpose for which the holding of fifty-one per cent ormore is utilised;
(3) Where not less thantwenty-five per cent of the voting power is allotted unconditionally to, or isacquired unconditionally by or is beneficially held by the public, it shall bepresumed that the company is one in which the public are substantiallyinterested. But in considering whether shares carrying not less thantwenty-five per cent of the voting right are held by the public, share entitledto a fixed rate of dividend have to be excluded.
11. The reason of the rule which excludes from the computation of votingpower holders of shares entitled to a fixed rate of dividend is that s. 23-A isdirected primarily against the accumulation of undistributed dividends to avoidpayment of non-corporate rates of super-tax. But shareholders who are entitledto a fixed rate of dividend are not directly interested in such accumulation :it maters little to them whether the dividend is immediately distributed to theordinary shareholders or is accumulated, and therefore in assessing whether thetwenty-five per cent of the shares are vested in persons other than thecontrolling group, the shares yielding a fixed rate of dividend have to beignored. But for the purpose of ascertaining the voting power, voting rightsattached to all the shares must be taken into account.
12. No investigation has been made by the Income-tax Department whetherthere is any group of persons controlling the working of the company. It istrue that Ramayamma was holding 87.40 per cent of the ordinary shares issued bythe company, and there is obviously no person who could hold twenty-five percent or more of the ordinary shares. In the present case, as already observed,the preference shareholders were entitled to vote at the meeting, and theArticles of Association of the Company made no distinction between thepreference and the ordinary shareholders in the matter of exercise of votingrights. The total voting power was 5,500 - one vote for each share, ordinaryand preference alike - and twenty-five per cent of that voting power is 1,375,but to invite the presumption under the Explanation this power must beexercisable only by the ordinary shareholders, and not by shareholders entitledto a fixed rate of dividend. The presumption under the Explanation could ariseonly, if twenty-five percent of the voting power was held by persons entitledto ordinary shares outside the controlling group.
13. It was suggested that the expression 'twenty-five per cent of thevoting power' would mean not twenty-five per cent of the total votingpower, but power exercisable in respect of shares other than shares entitled toa fixed rate of dividend. Prima facie, such an interpretation is not warrantedif regard be had to the terms of the Explanation. But even that argument is ofno value, for twenty-five per cent of the voting power attached to the ordinaryshares is not exercisable by the public. This, therefore, is a case in whichshares not entitled to a fixed dividend carrying not less than twenty-five percent of the voting power are not shown to have been allotted unconditionallyto, or acquired unconditionally by or beneficially held by the public. TheExplanation, therefore, has no operation.
14. Whether in view of the third proviso the company may be regarded as onein which the public are substantially interested, is a question to which noattention was paid by the Tribunal. Whether in fact there exists such acontrolling interest in the hands of one shareholder or a group of shareholdersas would render the company one in which the public are not substantiallyinterested is a question which therefore cannot be decided by this Court.
15. The order of the High Court must therefore be confirmed, but on differentgrounds. The interpretation of the Explanation by the High Court, for reasonsalready set out, was incorrect. The Explanation had no application, because nopresumption on the facts found could arise thereunder. The Revenue authoritieshave not made any investigation on the question whether there existed anycontrolling interest in a group of persons, so as to bring the case within thethird proviso.
16. The appeals must be dismissed with costs. One hearing fee.
17. Appeal dismissed.