# NA VNITLAL C. JA VERI v. K. K. SEN, APPELLATE ASSISTANT COMMISSIONER OF INCOME-TAX, 'D' RANGE, BOMBAY

- **Citation:** [1965] 1 S.C.R. 909
- **Court:** Supreme Court of India
- **Decided:** 1964-10-28
- **Bench:** P. B. Gajendragadkar C.J, K. N .. Wanchoo, M. Hidayatullah, R.Aghubar Dayal, R. Mudholkar
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/na-vnitlal-c-ja-veri-v-k-k-sen-appellate-assistant-commissioner-of-income-tax-d-3279
- **Pages:** 24

## Headnote

Constitution of India, 1950, List I, '·vu Schedule, Entry 82-Income--
Income-tax Act (11of1922), ss. 2(6'.)(e) and 12(18)-Legislative competence and constitutional validity.
··
The assessee was a share holder in a private limitod company whose ordinaiy business was not money-lending -~usiness. He took a loan amounting
to 1!fer Rs. 4 lakhs from a company. The Income-tax Officer computed
the assessee's income at Rs. 3 lakhs and odd, under s. 12(1B) read with
s. 2( 6A) ( c) of the Income-tax Act, 1922. That amount included a sum
of over Rs. 2 lakhs representing tho accumulated profits of the company.
The assessee's share in the accumulated profits, if distributed as dividend,
would be an amount proportionate to the number of shares held by him.
He therefore contended, that the balance of the accumulateu profits was
not his income and that the Legislature was not competent to enact the
two sectiO,!lS according to which that amount was also treated as his
income. His writ petition in the High Court challenging the constitutional
validity of the two sections \Vas dismissed.
He appealed to the Supre1ne
Court.
HELD (Per Gajendragadkar, C. J. Wanchoo, Hidayatullah and Mudholkar JJ.) : (i) The sections are not beyond the legislative competence of
Parliament.
The companies to which s. 12( lB) applies are companies in which at
least 75% of the voting power lies in the hands of persons other than the
public.
They are controlled by a group of persons allied together and
having the same interest. The controlling group can dete~mine \vhether the
profits made by the company should be distributed as dividends or not.
When they deliberately refused to distribute the accumulated profits as
dividends but adopted the deYice of advancing the profits by way of loan
to one of the shareholders, it was with the object of evading the pa}ment
of tax by the company on the accumul_ated protits. Section 12( IB) provides
that if a controlled company adopts 'the device of making a loan to one
of its shareholders, he will be deemed to have1 received the amount out of
the accumulated profits as dividend and would be liable to pay tax on his
'income. The word "income" in Entry 82 in List I of the 7th Schedule to
the Constitution must receive a wide interpretation depending on the facts
of each case.
Having regard to the fact that the Legislature was aware
of the devices to evade tax, it would be within its competence to devise a
fiction for treating an ostensible loan as the receipt of the dividend. [919
A-H: 920 H; 921 C-DJ
(ii) The absence of a provision enabling the. income-tax officer to
consider in each case whether the loan was genuine or the result of a
device does not make the section go. beyond the competence of the Legis"
lature. [921 D-EJ
If the Legislature thought that in almost every case the advances or
Joans were the result of a device to evade tax, it would be competent to·
•
910
SUPRnlE COURr REPORTS
[1%5] I S.C.R.
it to prescribe a fiction and hold that in cases of such advances or loans,
A
tax should be recovered fro1n the shareholder on the basis that he had
received a d1v1<le11d. [921 G-J;ll
(iiiJ Sec1ion 12(18) docs not impose an unreasonable restriction on
.l.
the appcdant's fundiimental rights under An. 19(1 )(() antl (g) ot the
Cons1itu1ion. [922 A]
l'hc sc..:tion doc5 not a!Tcct the appellant's right to borrcv• nl~)ncv. There
is no clcn1cnt of unfairness, because the orhcr .<1hJrcholt.lc1s
h·~1\'C deliberately agreed to make the loan or the advance and the shareholder to
whom lhe Ivan is ::i.dvanccd deliberately ta!~es it \Vith a view 10 assist the
company to evade the payment of tax ~nd to have the benefit of the use
of the amount subject to the payment of interest.
The company receives
interest, the shareholder enjoys the use of the money and in tlle process
I.he payment of tax is evaded.
Further, past tr<>.nsactions were excluded
1rom the or-cration of the sc..:tion,; by the i!:~uc oi a circular by t!1c Central
B::;ud u! Kc\ cnuc.
l9

## Text

_Characters 0–39,672 of 63,339. This is a partial read: ask again with offset=39672 for what follows._

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NA VNITLAL C. JA VERI
v.
K. K. SEN, APPELLATE ASSISTANT COMMISSIONER OF
INCOME-TAX, 'D' RANGE, BOMBAY
October 28, 1964
(P. B. GAJENDRAGADKAR C.J., K. N .. WANCHOO,
M. HIDAYATULLAH, R.AGHUBAR DAYAL AND
J, R. MUDHOLKAR JJ.)
Constitution of India, 1950, List I, '·vu Schedule, Entry 82-Income--
Income-tax Act (11of1922), ss. 2(6'.)(e) and 12(18)-Legislative competence and constitutional validity.
··
The assessee was a share holder in a private limitod company whose ordinaiy business was not money-lending -~usiness. He took a loan amounting
to 1!fer Rs. 4 lakhs from a company. The Income-tax Officer computed
the assessee's income at Rs. 3 lakhs and odd, under s. 12(1B) read with
s. 2( 6A) ( c) of the Income-tax Act, 1922. That amount included a sum
of over Rs. 2 lakhs representing tho accumulated profits of the company.
The assessee's share in the accumulated profits, if distributed as dividend,
would be an amount proportionate to the number of shares held by him.
He therefore contended, that the balance of the accumulateu profits was
not his income and that the Legislature was not competent to enact the
two sectiO,!lS according to which that amount was also treated as his
income. His writ petition in the High Court challenging the constitutional
validity of the two sections \Vas dismissed.
He appealed to the Supre1ne
Court.
HELD (Per Gajendragadkar, C. J. Wanchoo, Hidayatullah and Mudholkar JJ.) : (i) The sections are not beyond the legislative competence of
Parliament.
The companies to which s. 12( lB) applies are companies in which at
least 75% of the voting power lies in the hands of persons other than the
public.
They are controlled by a group of persons allied together and
having the same interest. The controlling group can dete~mine \vhether the
profits made by the company should be distributed as dividends or not.
When they deliberately refused to distribute the accumulated profits as
dividends but adopted the deYice of advancing the profits by way of loan
to one of the shareholders, it was with the object of evading the pa}ment
of tax by the company on the accumul_ated protits. Section 12( IB) provides
that if a controlled company adopts 'the device of making a loan to one
of its shareholders, he will be deemed to have1 received the amount out of
the accumulated profits as dividend and would be liable to pay tax on his
'income. The word "income" in Entry 82 in List I of the 7th Schedule to
the Constitution must receive a wide interpretation depending on the facts
of each case.
Having regard to the fact that the Legislature was aware
of the devices to evade tax, it would be within its competence to devise a
fiction for treating an ostensible loan as the receipt of the dividend. [919
A-H: 920 H; 921 C-DJ
(ii) The absence of a provision enabling the. income-tax officer to
consider in each case whether the loan was genuine or the result of a
device does not make the section go. beyond the competence of the Legis"
lature. [921 D-EJ
If the Legislature thought that in almost every case the advances or
Joans were the result of a device to evade tax, it would be competent to·
•
910
SUPRnlE COURr REPORTS
[1%5] I S.C.R.
it to prescribe a fiction and hold that in cases of such advances or loans,
A
tax should be recovered fro1n the shareholder on the basis that he had
received a d1v1<le11d. [921 G-J;ll
(iiiJ Sec1ion 12(18) docs not impose an unreasonable restriction on
.l.
the appcdant's fundiimental rights under An. 19(1 )(() antl (g) ot the
Cons1itu1ion. [922 A]
l'hc sc..:tion doc5 not a!Tcct the appellant's right to borrcv• nl~)ncv. There
is no clcn1cnt of unfairness, because the orhcr .<1hJrcholt.lc1s
h·~1\'C deliberately agreed to make the loan or the advance and the shareholder to
whom lhe Ivan is ::i.dvanccd deliberately ta!~es it \Vith a view 10 assist the
company to evade the payment of tax ~nd to have the benefit of the use
of the amount subject to the payment of interest.
The company receives
interest, the shareholder enjoys the use of the money and in tlle process
I.he payment of tax is evaded.
Further, past tr<>.nsactions were excluded
1rom the or-cration of the sc..:tion,; by the i!:~uc oi a circular by t!1c Central
B::;ud u! Kc\ cnuc.
l922 B-FJ
Prr R"ghub .. r Dayal J.
(disscntingi:
(il
Sections 2(6AI (e) and
12(18) ol the lncon1c-1ax Ac1, 1922 as thl'.y s1ood
in
19)5
a:·c
void.
[923 HJ
It is not open to the Legislature to describe any payment of money by
a company to a shareholder by the v.·ord "dividend" and then proYidc that
such payment wiH come \'1i1hin thi.: cxpre .... sion "income" in item 82, List I
of Schedule 7.
'fhc definitjon of di·1idcnd must ha\·c a rational connection \1:ith concept of dividend in the context ot the profits of 1he company
·and its di'iiribut:;ln :tn1onc'.'it 1he shareholders. 'fhc essence of an amoont
paid as di\'id..:nd is thai· it has to
rcp1e~cn1 the proportionate amount
a particular shareholder is 10 r.ct o:-i the basis of the shares held by him
out of the profits of the company set apan for p11yn1cn1 of dividend to
shareholders.
Any acl hoc payment of money to a shareholder as advance
or loan unrelated to his share in the accumulated profits cannot rationally
come within the expression dividend. [926 E-H]
(ii) The provisions oi \he ;mpugncd sections impose unrcasonahlc restrictions on the fundamental right to hold property under A11. 19( I )(f)
of the Constitution. [928 EJ
If any cn<iclmcnt provides that certain profits of the company. though
not distrihutcd a'i. dividend. he treated as used for the payment of di\ideods
il should necessarily follow that a panicular liharcholder be deemed to
have rcceiYed a proponionate amount of_ such profits.
It would be unreasonable to provide that a particular sharehol~er should be deemed to
have received an an1ount in excess of his proportionate share as <livideod.
It is unrcason:ihlc that a particular shareholder y,•ho receive-. a loan or
advance from a company be deemed to have rccci\·cd that entire amount as
dividend \Vhcn hi'i proportionate share v.1ould be much lcso;. [928 R-EJ
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Ntn·inchandra l~·fafat/(lf v. (:ommissioner of /ncon:e-tax, Bombay City,
(1955) 1 S_C~.R. 829. Sa,.dar /lo/dt'\" Sin1?h V. c·nmmis.~ioner l 1f Income-tax,
Delhi and A~'" ( 1961 J I S.C.R. 482 and /lalaii v. Income-tax Officer, Special
G
lnve.ft('!ation Circle, [1962] 2 S.C.R. 983, referred to.
ClvIL APPELLATE JURISOJCTION: Ci,;( Appeal No. 45
of
1964.
Appeal from the judgment and order dated July 30, 1962, of
the Bombay High Ccurt in Special Civil Application No. 69 of
1962:
H
G. S. Pathak, M. M. Gharekhan and /. N. Shroff, for the
appellant.
...
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NAVNJTLAL V. A.A.C., INCOME-TAX (Gajendragadkar C.l.)
911
A
C. K. Daphtary, Attorney-General, R. Ganapathy Iyer, Gopal
Singh and R. N. Sachthey, for the respondent.
'',,
The Judgments of P. B. GAJENDRAGADKAR C.J.,. K. N.
WANCHOO, M. 1-IIDAYATULLAH and J. R. MUDHOLKAR JJ. was
delivered by
GAJENDRAGADKAR
C.J.
RAGHUBAR
DAYAL
J.
B
delivered a dissenting Opinion.
Gajcndragadkar C.J.
This appeal arises from a writ petition filed by the appellant Navnit Lal C. Javeri in the Bombay High
Court in which he challenged the validity of section 12( 113) read
with s. 2(6A) (e) of the Indian Income-tax Act, 1922 (No. 11
c of 1922) (hereinafter called the Act) as it stood in 1955. The
High Court has rejected the appell~nt's contention that the said
section is invalid, and the appellant has come to this Court with
a certificate granted by the High Court.
The appellant holds 11 out of 845 shares in a private limited
D company named the Malegaon Electricity Co., (Private) Ltd.
(hereinafter referred to as the company). The value of each
sh?re is Rs. 100.
The business of the company is to supply
electricity to the residents of Malegaon. Some time during 1955,
the appellant took a loan amounting to over Rs. 4 !akhs from the
company. A notice was issued to· the appellant by tlie 8th IncomeE
Tax Oilicer under s. 22(2) of the Act calling upon him to make
his return for the assessment 'year 1956-57. The Income-tax
Officer computed his income at Rs. 3,58,460.
This amount
included a sum of Rs. 2,83,126 representing the accumulated
profits of the company. The Income-tax Officer took the view
that under s. 2 ( 6A )( e) the said am punt must be deemed to be
F
dividend received by the appellant, and as such, must be :included
in the total income of the appellant as income "from other sources
within the meaning of s. 12(1B) of the Act.
This order was
challenged by the appellant by preferring an appeal before the
Appellate Assistant Commissioner.
The appeal, however, failed
and was dismissed. The appellant then preferred a second appeal
G before the Income Tax Appellate Tribunal. Whilst this appeal
was pending before the said Tribunal, the appellant moved the
High Court under Articles 226 and 227 of the Constitution, and
contended that the relevant section under which the department
had purported to levy a5seS-Sment ,against him on the sum of
R~. 2,83, 126, was ultra vires.
That is how the only questioa
H
which the High Court had to decide in the present writ proceedings
was whether s. 12(1B) read withs. 2(6A) (e) was constitutionally valid.
912
SUPREME
COURT REPORTS
(1965] I S.C.R.
In order to deal with this point, it is ncce~sary to read the
A
two relevant provisions of the Act.
Section 2 ( 6C)
defines
"income" as including dividend. Section 2(6A) defines "dividend"
in an inclusive manner.
Section 2(6A) (e) provides:-
"Dividend" include'-
( e) any payment by a company, not being a com·
pany in which the public are substantially interested
within the meaning of s. 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 e'aent to
which the company in either case, possesses accumulated
profits; but dividend does not include-
( i)
(' i) 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 ai:d treated as a divide;id
within the meaning of sub-clause ( e), to the extent to
which it is so set off."
Thus. the inclusive definition of "dividend" takes in the payments
to which clause (e) of s. 2(6A) refers and makes them dividend
for the purpose of the Act.
Sectinn 12 (I) provides that the tax shall be payable by an
a-'cssce 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).
S~ction 12(1B) provides:-
"any payment by a company to a shareholder by way
nf advJnce or loan which would have been treated as
a dividend within the meaning of clause ( e) of subsection (6A) of s. 2 in any previous year relevant to
any assessment year
prior to the
assessment
year
ending on the 3 lst day of March, 1956, had that clause
been in force in that year, shall be treated as a dividend
re.:cived by him in the previous year relevant to the
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NAVNITLAL I'. A.A.C., lNCOME,TAX ( Gajendragadkar C.J.) 913
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assessment year ending on the 31st day of March, 1956,
if such Joan or advance remained outstanding on the
first day of such previous year".
Both these provisions viz., s. 2(6A) (e) and s. 12(1B) were
introduced in the Act by the Finance Act 15 of 1955 which came
B into operation on the 1st of April, 1955.
It is thus clear that the combined effect of these two provisions is that three kinds of payments made to the shareholder of
a company to which the said provisions apply, are treated as taxable dividend to the extent of the accumulated profits held by
the company. These three kinds of payments are: (1) payments
c made to the shareholder by way of advance or loan; (2) payments
made on his behalf; and (3) payments made for his individual
benefit. There are five conditions which must be satisfied before
s. 12 ( 1 B) can be invoked against a shareholder. The first condition is that the company in question must be one in which the
public are not substantially interested within the meaning of
D s. 23A as it stood in the year in which the loan was advanced.
The second condition is that the borrower must be a shareholder
at the date when the loan was advanced; it is immaterial what the
extent of his shareholding is. The third condition is that the loan
advanced to a shareholder by such a company can be deemed to
be dividend only to the extent to which it is shown that the comE pany possessed accumulated profit at the date of the Joan. This is
an important limit prescribed by the relevant section. The fourth .
condition is that the loan. must not have been advanced by the
company in .the ordinary course of its business. In other words,
this provision would not apply to cases where the company which
advances a Joan to its shareholder carries on the business of
F
money-lending itself; and the last condition is that the Joan must
have remained outsianding at the commencement of the shareholder's previous year in relation to the assessment year 1955-56.
In dealing with the question about the constitutionality of the
impugned provisions, it is necessary to bear in mind these respecG tive conditions which govern the application of the said provisions.
•'1
There is another material circumstance which cannot
be
ignored. It appears that when these amendments were introduced
in Parliament, the Hon'ble Minister for Revenue & Civil Expenditure gave an assurance that outstanding loans and
advances
which are ·Otherwise liable to be taxed as dividends in the assess·
rnent year 1955-56 will not be subjected to tax if it is shown that
they had been genuinely refunded to the respective companies
before the 30th June, 1955. It was realized by the Government
914
SUPREME COURT
REPORTS
(1965] I S.C.R.
that unless such a step was taken, the operation of s. 12 (lB)
would lead to extreme hardship, because it would have covered
the aggregate of all outstanding loans of past years and that may
have imposed an unreasonably high liability on the respective shareholders to whom the loans might have been advanced. In order
that the assurance given by the Minister in Parliament should be
carried out, a circular [No. 20(XXI-6)/55] was issued by the
Central Board of Revenue on the 10th May, 1955. It is clear
that a circular of the kind which was issued by the Board would be
binding on all officers and persons employed in the execution of
the Act under s. 5 ( 8) of the Act. This circular pointed out to all
the officers that it was likely that some of the companies might have
advanced loans to their shareholders as a result of genuine transactions of loans, and the idea was not to affect such transactions and
not to bring them within the mischief of the new provision. The
officers were, the.refore, asked to intimate to all the companies that
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if the loans were repaid before the 30th June, 1955 in a genuine
manner, they would not be taken into account in determining the
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tax liability of the shareholders to whom they may have been
advanced. In other words, past transactions which would normally
have attracted the stringent provisions of s. 12. ( 1 B) as it was
introduced in 1955, were substantially granted exemption from
the operation of the said provisions by making it clear to all the
companies and their shareholders :hat if the past loans
were
genuinely refunded to the companies, they would not be taken
into account under s. 12 (I B).
Section 12 ( lB) would, th.ere.-
fore, normally apply to loans granted by the companies to their
respective shareholders with full notice of the. provisions prescribed by it.
Mr. Pathak for the appellant contends that the
impugned
provision is constitutionally invalid, because it is beyond
the
legislative competence of Parliament.
He argues that Entry 82
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in List I of the Seventh Schedule which deals with "taxes on income
other than agricullural income" cannot justify the impugned provision, because a loan advanced to a shareholder by the
comG
pany cannot, in any legitimate sense, be treated as his income; and
so, the artificial manner in which such dividend is ordered to be
treated as income by the impugned provision is not ju.~tified by the
said Entry.
He also contends that the said provi~ion offends
Art. 19(1) (f) & (g) and cannot be said to be justified by clause
(5) or (6) of the said article.
There is no doubt that if the
impugned provision is beyond the legislative powers of Parliament,
it would be bad.
Similarly, it is now well-settled that even tax
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NAVNITLAL v. A.A.C., INCOME-TAX (Gajendragadkar C.J.)
915
A legislation must stand the scrutiny of the fundamental
rights
guaranteed by the Constitution, and so, there can be no doubt
that if the impugned provision invades the fundamental rights of
the appellant and the invasion is not constitutionally justified, it
would be invalid.
B
In dealing with this point, it is necessary to consider what
exactly is the denotation of the word "income" used in the relevant
Entry. It is hardly necessary to emphasise tl:\at the entries in the
Lists cannot be read in· a narrow or restricted sense, and
as
ohserved by Gwyer C.J. in the United Provinces v. Atiqa Begum(').
'·each general word should be held to extend to all ancillary or
c subsidiary matters which can fairly and reasonably be said to be
comprehended in it." What the entries in the List purport to di')
10 to confer legislative powers on the respective Legislatures in
respect of areas or fields covered by the said entries; and it is an
elementary rule of construction that the widest pos5ible construcD
.£
t:on must be put upon their words. This doctrine does not, however. mean that Parliament can choose to tax as income an item
which in no rational sense can be regarded as a citizen's income.
The item t<Lxed should rationally be capable of being considered ;m1
the income of a citizen.
But in considering the question as to
whether a particular item in the hands of a citizen can be regarded as his income or not, it would be inappropriate to apply the
tests traditionally prescribed by the Income-tax Act as such.
Jn Navinchandra Mafatlal v. The Commissioner of lncometax. Bombay City( 2 ), this Court had occasion to consider the
question as to whether capital gains could be treated as income
within the meaning of item 54 of List I of the Seventh Schedule
F
to the Government of India Act, 1935.
Section 12-B of
the
'
Indian Income-tax Act, 1922 which had been inserted in the said
Act by Act XXII of 1947, had imposed tax on 'capital gains'.
The validity cf this provision was challenged on the ground that
capital gains cannot be treated as income within the meaning of
entry 54.
This plea was rejected by this Court on the ground
G
that the words used in a constitutional enactment conferring legislative powers ought to be construed most liberally and in their
widest amplitude. Adopting this approach Das J. as he then was,
speaking for the Court, observed that the word "income" used in
the said entry must be givon its ordinary, natural and grammatical
meaning and that was, income is a thing that comes in.
On
H
this view, the Court found no difficulty in coming to the conclusion that income would include capital gains. If the traditional
(I) [194] F.C.R. 110.
• ,,,, .. .,./6S-
(2) [t9SS] I S.C.R. 129.
916
"'·
SUPREME COURl; REPORTS
(I 965] I S.C.R.
sense of income had been accepted, th~n1 of ·course, capit!ll gains
A
could not be treated as income. That, in fa£t, was the argument
which was pressed by Mr. Kolah who appeared 'for the appell!ln.! •• _
"If we hold'.', observed the learned Judge, "as w~ are asked to
[!
do, that the meaning of the worcj 'income' has become rigidly
crystallised by reason of the judicial interpretation of tqat word
appearing in the Income-tax Act, then logically no enlargement
B
of the scope of tqe l{lcome-tax Act, by amendment or otherwise,
will.be permissible in future." And he has significantly added that
a conclusion so. extravagant and astounding can scarcely be contemplated or countenanced.
This decision, therefore shows that
the word "income" used in entry 54 which corresponds to
the C
present entry 82 in List I of the 7th Schedule to our Constitution,
was liberally construed, and capital gains were deemed to
oe
included within its, scope.
This aspect of the matter has also been clearly enunciated by
Gwyer C.J. in In re : The Central Provinces and Berar Sales of D
Motor Spirit and Lubricants Taxation Act, 1938 (No. 14 of
1938J( 1 ). "I conceive", said the learned 'Chief Justice, "that a
broad and liberal spirit should inspire those whose duty it is to
interpret it (the Constitution); but I po ·not imply by this that
they ;•rt• free to stretch or pervert the language of the enactment
in th~ intcrc<b c•f uny legal or constitutional theory, or even for
the purpose of supplying omissions or o( correcting supposed
errors".
The next decision to which.we ougjit to refer deals withs. 23A
of the Act. In Sardar Baldev Singh v. Commissioner of Incometax, Delhi & Ajmer(") the validity of the said section was challenged.
Section 23A ( 1) provides, inter alia, that subject to the
provisions of sub-sections (3) and ( 4 ), where the
Income-tax
Officer is satisfied that in respect of any previous year the profits
and-gams distributed as diviqends by any company within
the
twelve months immediately following the expiry o.f that previous
year ate Jess than sixty per cent of the total income of the
company of that prcviom year as reduced by the amounts specified
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in cl au~ I a). ( b) & ( i:) of the said sub-section, the Income-tax
Officer sli"all, unless he is .sat;sfied that having regard to losses incurred by the company in earlier years· or to the smallness of the
profits made· .jn the prev.ious year, the paymept of a d!ividend or a
larger divideft!l than that declared would be unreasonable, make H
an order in W.:iting that the ·company shall,. apart from the sum
(fl 11939] F.C.R.)8 :it p. 37.
;(2) [1961] I S.C.R. 482.
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'v
NAVNITLAL v. A.A.C., INCOME-TAX (Gajendragadkar C.J.) 917
A determined as payable by it on the basis of the assessment under
s. 23, be liable to pay super-tax at the rate specified by the said
sub-section. The object of this section is to prevent avoidance
• ...i.
of super-tax by shareholders of a company in which the public
are not substantially interested.
As is well-known, the rates of
super-tax applicable to companies are much lower than the rates
B applicable to individual assessees.
The legislature thought that
mdividuals tried to avoid the payment of super-tax at a higher
rate by transferring to a private limited company in return tor
shares the sources of their income, and then the profits made oy
the company were allowed to accumulate in the hands of the
C company, dividends not being declared, and the said profits would
ultimately be distributed in a capital form by one device
or
another. The object of s. 23A was to defeat such attempts. The
main effect of the provisions of s. 23A appears to be that a company should not accumulate more than 40 per cent of its net
prolits to build up reserves or to provide for capital expenditure.
D It will be recalled that s. 2 ( 6A) has taken within. the detinitton
of "dividend" the accumulated profits of such companies, and so
s. 2JA attempts to reach such accumulated profits for the purpose
of taxation.
The argument which was urged before this Court in the case
E of Sardar Baldcv Singh (1) was that a company and its shareholders are different persons,"and so, s. 23A was ultra vires
inasmuch as it purported to tax the shareholders on the income of
the company in which they hold shares. If the accumulated
profits are distributed amongst the shareholders by way of dividends, the shareholders could legitimately be taxed in respect of
F the dividends received by them; but when s. 23A attempts to tax
the shareholders for accumulated profits even though they are not
distributed as dividends, what the section purports to do is to tax
the share-holders for the profits made by the company; and that,
according to the appellant, made s. 23A invalid. This argument
was repelled by this Court on the ground that the obvious intenG tion of s. 23A was to prevent evasion of tax, and it was held that
entry 54 should be read not only as authorising the imposition of
a tax, but also as authorising an enactment which prevents the tall
imposed being evaded; otherwise the power to tax a person on
his income might often be made infructuous by ingenious contrivances.
It would be noticed that s. 23A wanted to deal with a
H situation where shareholders did not deliberately distribute
the
accumulated profits as dividenqs amongst themselves. Section
(I) [1961] I S.C.R. 482.
918
SUPREME COURT REPORn
[1965J IS.CR.
23A, t!i.erefore, provides that these accumulated profits will
be
A
deemed to have been distributed to the shareholders and
tax
levied against them on that basis. It is likely that in such a case,
hardship may be caused in some honest cases; but this Court
made it perfectly clear that considerations of hardship are irrelevant for determining questions of legislative competence. It is thus
clear that the result of the decision of this Court in Sardar Ba/dev
II
Singh(') is that the income which technically belonged to
the company, was treated as income belonging to the shareholders in proportion to the shares they held in the company, and
on that footing tax was levied on them; and yet the said tax was held
to be constitutionally valid.
There is yet another case in whi•h a similar question was
considered. Jn Ba/aji v. Income-tax Officer, Special lnvest;gation
Circle,(') a person and his wife started business in partnership
c
and admitted their three minor sons to it.
In computing the total
income o' the said person for the purpose of assessment,
the
Income-tax Officer included the share of the income of h:s wife
I>
and three minor sons under s. 16 ( 3) (a) ( i) & (ii) of the Act.
The validity of this provision was challenged on the ground that
the impugned section purported to tax a person for the income of
other persons, namely, his wife and minor sons.
In rejecting the
contention raised against the validity of the impugned section, this
Court held that the Entries in the Legislative Lists arc not powers
but fields of legislation and the widest import and
significance
should be attached to them. On this view. the cnncI1.1,;n11 re<>ched
by this Court was that Entry 54 of the Federal Lcgi>!Jtil'e List
covered legislation like s. !6(3)(a)(i) & (ii), because it
wa•
intended to prevent evasion of tax. It appears from the judgment
that the validity of the said section was also challenged on the
f
ground that it contravened Articles 14 and 19 (I ) ( f) & ( g) of the
Constitution. This plea was also rejected. One of the considerations which weighed with the Court in repelling the said plea wa5
that the additional payment of tax made on the income of the
wife or the minor children would ultimately be borne by them in
G
the final accounting between them.
Having regard to this consideration and bearing in mind the fact that the mode of taxation
authorised by the impugned section, though harsh, was thou,2ht
to be necessary to prevent evasion of payment of tax, th!S Court
held that the said section was valid. It is in the light of these
decisions that we must procud to consider Mr. Pathak's argument
H
that s. 12 ( IB) of the Act is ultra vfrts.
(I) [196t] I i.C.R. 482.
(l) 11962]? S.C.R. 913.
l
-
....
•
NAYNITLAL V. A.A.C., INCOME-TAX (Gajendragadkar C.J.) 919
A
In dealing with Mr. Pathak's argument in the present case, let ·
us recall the relevant facts. The companies to which the impugned section applies are companies in which at least 7 5 per cent of
')
the voting power lies in the hands of persons other than the public,
and that means that the companies are controlled by a group of
persons allied together and having the same interest. In the case
B of such companies, the controlling group can do what it likes with
the management of the company 1 its affairs and its profits within
the limits of the Companies Act. It is for this group to determine
whether the profits made by the company should be distributed
as dividends or not.
The declaration of dividend is entirely
within the discretion of this group. When the legislature realized
C that though money was reasonably available with the company
in the form of profits, those in charge of the company deliberately refused to distribute it as dividends to the shareholders, but
adopted the device of advancing the said accumulated profits by
way of loan or advance to one of its shareholders, it was plain
0
that the object of such a loan or advance was to evade the payment of tax on· accumulated profits under. s. 23A. It will be
remembered that an advance or loan which falls within the mischief of the impugned section is advance or Joan made by
a
company which does not normally deal in money-lending and it
is made with full knowledge of the provisions contained in the
E impugned section.
The object of keeping accumulated profits
without distributing them obviously is to take the benefit of the
lower rate of super-tax prescribed for companies.
This object
was defeated by s. 23A which provides that in the case of undistributed profits, tax would be levied on the shareholders on
the basis that tho accnn::ulated profits will be deemed to have
F been distri):mted amongst them.
Similarly, s. 12(1B) provid°"
that if a controlled company adopts the device of making a loan
or advance to one of its shareholders, such shareh.older will be
deemed to have received the said amount out of the accumulated
profits and would be liable to pay tax on the basis that he hu
G received the said loan by way of dividend. It is clear that when
such a device is. adopted by a controlled company, the controlling group consisting of shareholders have deliberately decided to
adopt the device of making a Joan or advance. Such an arrangement is intended to evade the application of s. 23A. The loan
may carry interest and the said interest may . be received by the
H
company; but the main object underlying the loan is to avoid
payment of tax. It may ultimately be repaid to the company and
' when it is so. repaid, ·it may or may not be treated as part of
920
SUPREME COURT REPORTS
[1965] I S.C.R.
accumulated profits. It is this kind of a well-planned device which
s. 12(1B) intends to reach for the purpose of taxation.
It appears that such a device is adopted by private companies
in many countries.
Simon has referred to this device in these
words:-
"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
income 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 thr.reafter
received
the income from the assets concerned. The individual's
total income tor 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 mterest 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." ( 1 )
What Simon says about one-man company can be equally true
about the controlled company whose art'airs are controlled by a
group of persons closely knit ~nd having rhe same interest.
A
B
c
D
E
F
The question which now arises is, if the impugned secrion
G
treats the loan received by a shareholder as a dividend paid to
him by the company, has the legislature in enacting the section
exceeded the limits of the legislative fidd prescribed by
the
present Entry 82 in List I ?
As we have already noticed, the
word "income" in the context must rec~ive a wide' interpretation;
bow wide it should be it is unnecessary to consider, because such
H
an enquiry would be hypothetical. The question must be decided
--------
(I) Simon's Income-tax, 2nd Ed. Vol. 3, para 592, p. 341.
NAVNiTLAL v. A.A.C., INCOME-TAX (Ga;endragadkar C./.) 921
A on the facts of each case. There must no doubt be some rational
connection between the item taxed and the concept of income liberally construed. If the legislature realises that the private controlled companies generally adopt the device of making advances
or giving loans to their shareholders with the object of evading the
payment of tax, it can step in to meet this mischief, and in that
B connection, it has created a fiction bv which the amount ostensibly and nominally advanced to a sha;eholder as a loan is treated
in reality for tax purposes as the payment of dividend to him.
We have already explained how a smalJ number of shareholders
controlling a private company adopt this device. Having regard
C to the fact that the legislature was aware of such devices, would
it not be competent to the legislature to device a fiction for treating the ostensible loan as the receipt of dividend ? In
our
opinion, it would be difficult to hold that in making the fiction,
the iegi,lature has traveiled. beyond the legislative field assigned
to it by entry 82 in List I.
D
E
It is, however, urged by Mr. Pathak that while providing for
such a fiction, the iegislature should have required the Incometax Officer to consider in each case whether the loan was genuine,
or was the result of a device; and he argues that since no such
provision has been made. and a uniform presumption by fiction
is .sought to be raised, the legislature has gone beyond its legislative competence.
In support of thh argument, Mr.
Pathak
has referred to the fact that under s. 108 (1) of the Commonwealth Income-tax Act it is provided that the amount paid to
the shareholder by way of advance or loan can be taxed if in the
Qpinion of the Commissioner it represent~ dblributions of income
F Such a provision would have made the impugned section valid.
G
Mr. Pathak argue:; that omission of Parliament to exclude from
the operation of s. 12(1B) genuine loans or advances, and its
failure to distingu[,h between such loans and advances and loans
~nd advances made :is a device shows, tlmt it has acted blindly
and must, therefore, be held to have exceeded its le6islative power.
We are not inclined to accept this argurnenl.
If the legislature
thinks that the advances or loans are in ~Jmo,l every case the
resnlt of a device, it would be competent to :t to prescribe a
fiction and hold that in cases of such advances or Joans,
tex
should be recovered from the shareholder <)n the basis that he
has received the dividend.
Therefore, we arc satisfied that the
H High Court was ri3ht in coming to the c0nclusion that the impugned section is not beyond the legislative competence of the
legislature.
922
SUPREME
COURT
REPORTS
(1965] I S.C.R.
Then it is argued by Mr. Pathak that the impugned provision
A
contravenes the appellant's fundamental rights under Art. 19( I)
(f) & (g) and is not saved by clau<:cs (5) & (6) of the said
article.
It is not easy to appreciate this argument.
Art. 19(1)
lf) recognises the right of a citizen to ac4uire, hold and dispose
of property and Art. 19( I )(g) recognises the right to practise
ally profession, or to carry on any occupation, trade or business.
B
The impugned provision does not contravene either of
these
rights.
The shareholder's right to borrow money from his own
company cannot be said to be a fundamental right;
besides
all that the impugned section does is to provide that if a loan
is borrowed by a shareholder from a company to which the said c
provision applies, it will be deemed to be a receipt by him of the
dividend.
This provision does not affect the appellant's right to
borrow money from any other source; and his company
from
wttich he borrows docs not ordinarily do money-lending business.
That is why the restriction imposed by the section cannot be said
to be unreasonable at all.
In dealing with the question about
D
the reasonableness of this provision, we cannot also overlook the
fact that past transactions were excluded from its operation by
the issue of a circular to which we have already referred.
Ther
is no element of unfairness in the fiction, because the other shareholders have deliberately agreed to make the loan or the advance
and the shareholder to whom the loan is advanced deliberately
II.
takes it with a view to assist the company to evade the payment
of tax and to have the benefit of th~ use of the amount subject
to the payment of interest.
The company receives interest, the
shareholder enjoys the use of the money, and in the process the
payment of due tax is evaded. That is the assumption made by
the legislature in making this provision.
How can it be urged r
that either the shareholder who is taxed, or the other
shareholders who deliberately make the advance to a colle<:gue
of
theirs, are unfairly dealt with by the impugned provision. In our
opinion, there is no scope for arguing that the fundamental rights
of the shareholder under Art. 19(l)(f) & (g) have been contraG
vened by the impugned provision.
Therefore, we must
reject
Mr. Pathak's argument that the impugned provision is invalid
on the ground that it contravenes Art. !9(1)(f) & (g). There
is obviously no scope for suggesting that the impugned provision
contravenes Art. 14; and in fact Mr. Pathak has not raised this
point before us. In that connection, he himself fairly invited our
H
attention to the decision of the Madras High Court in K. M. S.
Lakshmana Aiyar v. Additional Income-tax
Officer,
Special
'
-.
•
NAVNITLAL V. A.A.C., INCOME·T~ (Raghubar Dayal J.) 923
A Circle. Madras, (1) where the challenge .to the validity of the impugned section on the ground that it contravened Art. 14 has
.,
been repelled .
..\
y.
The result is, the appeal fails and is dismissed with costs.
Raghubar Dayal J. I am of opinion that the appeal should
B be allowed as ss. 12(1B) and 2(6A) (e), of the Indian Incometax Ac/., 1922, hereinafter called the Act, as they stood in 1955,
are void.
The two provisions were enacted by Parliament in view of
Entry 82, List I, Seventh _Schedule of the Constitution which
C reads : "Taxes on income other than agricultural income". It is
not disputed that whatever wide connotation the word 'income' in
this Entry may have, the item taxed should really be capable of
being considered as income, that there be some rational connection between the item taxed· and tbe concept of "income" and that
it is not open to Parhament to choose to tax, as income, an item
D which in no rational sense can be regarded as income. ·It is also
not disputed that Parliament can enact a law dealing with the
evasion of payment of income-tax.
In Navinchandra Mafatlal v.