CIT v. Sri Meenakshi Mills Ltd.(1967) 1 SCR 934 : AIR 1967 SC 819

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Case Summary

Full Case Details

All the three respondents (“the assesse companies”) were public limited companies
engaged in the manufacture and sale of yarn at Madurai. Each of the assessee Companies had
a branch at Pudukottai engaged in the production and sale of cotton yarn. The sale-proceeds
of the branches were periodically deposited in the branch of Madurai Bank Ltd. (the “Bank”)
at Pudukottai, a former native State either in the current accounts or fixed deposits which
earned interest for the various assessment years.
All the three assessee companies borrowed moneys from the Madurai branch of the bank
and on the security of the fixed deposits made by their branches with the Pudukottai branch of
the Bank. The loans granted to the assessee companies were far in excess of the available
profits at Pudukottai. In the assessment proceedings of the assessee companies for the various
years under dispute, the Income Tax Officer was of the view that the borrowings in British
India on the security of the fixed deposits made at Pudukottai amounted to constructive
remittances of the profits by the branches of the assessee companies to their Head Offices in
India within the meaning of Section 4 of the Indian Income Tax Act, 1922 (“the Act”).
Accordingly he included the entire profits of the assessee companies including the interest
receipts from the Pudukottai branches in the assessment of the assessee companies, since the
overdrafts availed of by the assessee Companies in British India far exceeded the available
profits. The assessee companies appealed to the Appellate Assistant Commissioner of Income
Tax. After examining the constitution of the assessee companies and the Bank and the figures
of deposits and overdrafts, the Appellate Assistant Commissioner found that the deposits
made by the assessee companies and other companies closely allied to them formed a
substantial part of the total deposits received by the Bank. He was also of the view that the
Pudukottai branch of the Bank had transmitted the funds so deposited for enabling the
Madurai branch to advance loans at interest to the assessee companies and that the
transmissions of the funds were made with the knowledge of the assessee Companies who
were major shareholders of the Bank. The Appellate Assistant Commissioner also considered
that the Pudukottai branch of the Bank had no other appreciable transactions except the
collection of funds and on the facts found Section 42(1) of the Act applied to the case. The
assessee Companies took the matter in appeal to the Appellate Tribunal which took note of
the position that the head office and the branch – whether of the assessee companies or of the
Bank – constituted only one unit and that Thyagraja Chettiar occupied a special position in
both the concerns and the establishment of the branch of the Bank at Pudukottai was intended
to help the financial operations of Thyagaraja Chettiar in the concerns in which he was
interested. After detailed consideration of the deposits and overdrafts and the inter-branch
transactions of the Bank the Appellate Tribunal held that Section 42(1) of the Act was
applicable to the facts of the case and that the assessee companies must be attributed with the
knowledge of the activity of their branches at Pudukottai and of the remittances made by the
Pudukottai branch of the Bank to Madurai head office, and that the entire transactions formed
part of an arrangement or scheme.

At the instance of the assessee companies the Appellate Tribunal referred the following
question of law for the determination of the High Court:
“Whether on the facts and in the circumstances of the case, the taxing of the
entire interest earned on the fixed deposits made out of the profits earned in
Pudukottai by the assessee’s branches in the Pudukottai branch of the Bank of
Madurai is correct?”

5. The High Court answered the question in favour of the assessee companies holding that
   it was not established that there was any arrangement between the assessee companies and the
   Bank whether at Pudukottai or at Madurai for transference of moneys from Pudukottai branch
   to Madurai and the facts on record did not establish that there was any transfer of funds
   between Pudukottai and Madurai for the purpose of advancing moneys to the assessee
   companies. The High Court further took the view that the transactions represented ordinary
   banking transactions and there was nothing to show that the amounts placed in fixed deposits
   in the branch were intended to, and were in fact transferred to head office for the purpose of
   lending them out to the depositor himself.
   V. RAMASWAMI, J. – 6. On behalf of the appellant Mr Sen submitted at the outset that
   the High Court was not legally justified in interfering with the findings of fact reached by the
   Appellate Tribunal and in concluding that there was no arrangement or scheme between the
   lender and the borrower for the transference of funds from Pudukottai to Madurai. In our
   opinion, there is justification for the argument put forward on behalf of the appellant and the
   High Court erred in law in interfering with the findings of the Appellate Tribunal in this case.
   We therefore proceed to decide the question of law raised in these appeals upon the findings
   of fact reached by the Appellate Tribunal.
6. Section 42 of the Act states as follows:
   “All income, profits or gains accruing or arising whether directly or indirectly
   through or from any money lent at interest and brought into the taxable territories in
   cash or in kind … shall be deemed to be income accruing or arising within the
   taxable territories ….”
   This section accordingly requires, in the first place, that any money should have been lent
   at interest outside the taxable territory. In the second place, income, profits or gains should
   accrue or arise directly or indirectly from such money so lent at interest, and, in the third
   place, that the money should be brought into the taxable territories in cash or in kind. If all
   these conditions are fulfilled, then the section lays it down that the interest shall be deemed to
   be income accruing or arising within the taxable territories. This section was the subjectmatter of interpretation by the Federal Court in A.H. Wadia v. CIT [17 ITR 63]. It was held
   by the majority of the Judges in that case that the provision in Section 42(1) of the Act, which
   brings within the scope of the charging section interest earned out of money lent outside, but
   brought into, British India was not ultra vires the Indian legislature on the ground that it was
   extra-territorial in operation. It was pointed out that the section contemplated the bringing of
   money into British India with the knowledge of the lender and borrower and this gave rise to
   a real territorial connection. The learned Chief Justice took the view that the nexus was the
   knowledge to be attributed to the lender that the borrower had borrowed money for the

purpose of taking it into British India and earning income on that money. Mukherjea and
Mahajan, JJ. took a somewhat different view. Mahajan, J. considered that there must be an
arrangement between the lender and the borrower to bring the loan into British India, and
Mukherjea, J. further emphasised the point by stating that it must be the basic arrangement
underlying the transaction that the money should be brought into British India after it is taken
by the borrower outside his territory. But all the learned Judges agreed that the knowledge of
the lender and the borrower that the money is to be taken into British India must be an integral
part of the transaction. That is the ratio of the decision of the Federal Court with regard to the
construction of Section 42(1) of the Act.

8. Having examined the findings of the Appellate Tribunal in the present case we are
   satisfied that the test prescribed by the Federal Court in Wadia case is fulfilled and the
   Appellate Tribunal was right in its conclusion that there was a basic arrangement or scheme
   between the assessee Companies and the Bank that the money should be brought into British
   India after it was taken by the borrower outside the taxable territory. The Appellate Tribunal
   has pointed out that the assessee companies had a preponderant, if not the whole, voice in the
   creation, running and management of the Bank and that Pudukottai was neither a cotton
   producing area nor had it a market for cotton and except that it was a non-taxable territory
   there was nothing else to recommend the carrying on of the cotton spinning or weaving
   business there. The Tribunal further remarked that having regard to the special position of
   Thyagaraja Chettiar and the balance sheets of the Bank and lack of investments in Pudukottai,
   it was reasonable to conclude that the Bank itself was started at Madurai and a branch was
   opened at Pudukottai only with a view to helping the financial operations of Thyagaraja
   Chettiar and the mills in which he was vitally interested. The Tribunal found that Pudukottai
   branch of the Bank had transmitted funds deposited by the assessee companies for enabling
   the Madurai branch to advance loans at interest to the assessee companies and the
   transmission of the funds was made with the knowledge of the assessee companies who were
   the major shareholders of the Bank. In the context of these facts it must be held that the entire
   transactions formed part of a basic arrangement or scheme between the creditor and the debtor
   that the money should be brought into British India after it was taken by the borrower outside
   the taxable territory. We are accordingly of the opinion that the principle laid down in Wadia
   case is satisfied in this case and that the Income Tax Authorities were right in holding that the
   entire interest earned on fixed deposits was taxable.
9. In the course of argument Mr Venkataraman contended that even if Thyagaraja
   Chettiar, a Director of the assessee companies, knew in his capacity as Director of Madurai
   Bank that money placed in fixed deposit by the assessee companies would be transferred to
   the taxable territory, that knowledge cannot be imputed to the assessee companies and so it
   cannot be said that the transfer was part of an integral arrangement of the loan transaction. In
   the present case the question at issue is entirely different. The Appellate Tribunal has, upon
   examination of the evidence, found that the transference of funds from Pudukottai to Madurai
   was made as part of the basic arrangement between the Bank and the assessee companies and
   that Thyagaraja Chettiar who was the moving figure both in the Bank and in each of the
   assessee companies had knowledge of this arrangement. It is well established that in a matter
   of this description the Income Tax Authorities are entitled to pierce the veil of corporate

entity and to look at the reality of the transaction. It is true that from the juristic point of view
the company is a 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 borne 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 disregard the corporate entity if it is used for tax evasion
or to circumvent tax obligation. For instance, in Apthorpe v. Peter Schoenhofen Brewing Co.
[4 TC 41], the Income Tax Commissioners had found as a 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 Commissioners also found, if the business was
technically that of the New York company, the latter was merely the agent of the English
company. In the light of these findings the Court of Appeal, despite the argument based on
Salomon case [(1897) AC 22], held that the New York business was that of the English
company which was liable for English income tax accordingly. In another case – Firestone
Tyre and Rubber Co. v. Llewellin [(1957) 1 WLR 464] – an American company had an
arrangement with its distributors on the Continent of Europe whereby they obtained supplies
from the English manufacturers, its wholly owned subsidiary. The English company credited
the American with the price received after deducting the costs plus 5 per cent. It was
conceded that the subsidiary was a separate legal entity and not a mere emanation of the
American parent, and that it was selling its own goods as principal and not its parent’s goods
as agent. Nevertheless, these sales were a means whereby the American company carried on
its European business, and it was held that the substance of the arrangement was that the
American company traded in England through the agency of its subsidiary. We, therefore,
reject the argument of Mr Venkataraman on this aspect of the case.

10. For the reasons expressed we hold that the question referred to the High Court by the
    Appellate Tribunal must be answered in favour of the Income Tax Department and against the
    respective assessee companies and these appeals must be allowed with costs.