What is corporate veil?
The Corporate Veil Theory is a legal concept which separates the identity of the company from its members. Hence, the members are shielded from the liabilities arising out of the company’s actions.
Therefore, if the company incurs debts or contravenes any laws, then the members are not liable for those errors and enjoy corporate insulation. In simpler words, the shareholders are protected from the acts of the company.
What is lifting the corporate veil?
Lifting the Corporate Veil means looking beyond the company as a legal person. Or, disregarding the corporate identity and paying regard to humans instead.
Whenever the separate legal entity concept is misused then the court looks into who controls it and will punish the individual by lifting or piercing the corporate veil. Where a fraudulent & dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate personality.
The court will break through the corporate shell and apply the principles or doctrines of what is called as “lifting of the corporate veil”.
The court will look behind the corporate entity and take action as though no entity separate from the members entitled and make the members or the controlling persons liable for debts and obligations of the company.
Factors for lifting the corporate veil:
- The Existence of Fraud or Wrongdoing to the Third Parties
- Failure to Maintain the Separate Identities Among the Companies
- Failure to Maintain Separate Identities of the Company with its Owners or Shareholders.
- Inadequately Capitalize the Company
- Not in Accordance with the Corporate Formalities
Illustration: ABC Corp. transfers all of its assets to XYZ Corp. and XYZ Corp. operates a similar business with the same assets and same employees, it is likely that ABC Corp. engaged in fraudulent actions, by shutting down its business and reopening a new corporation. This is a classic example of a debtor who attempts to defraud its creditor, here the court will pass the judgement in favor of lifting of the corporate veil.
RELEVANT CASE LAWS
Salomon v. Salomon & Co., Ltd.(1897) AC 22 (HL)
Lee v. Lee’s Air Farming Ltd.[1960] 3 All ER 420
D Daimler Co., Ltd. v. Continental Tyre and Rubber Co. (G.B.), Ltd.[1916-17] All ER Rep. 191
Facts: Continental tyre company was incorporated under companies act with a capital of 10000L which was then subsequently increased 25000L in fully paid shares. This company was formed for the purpose of selling tyres in Germany. The Company held 23398 shares except the director of the company who held remaining shares.
Four directors held the shares of company, Mr. Wolter, secretary of who was born in Germany but residing in UK and got the citizenship of UK. 3 of them were residing in Germany and one of them in Britain who was also fled the country when the war proclaimed. Daimler claimed that providing money or trading with alien enemy during war is illegal and it contravenes the laws of the country. The respondent sued the appellant for the outstanding dues.
Issue: whether the corporate veil of the company would be lifted to determine the character of the company?
whether the co .had become an enemy company and could be barred from maintaining the action?
Judgement: The company in UK is a legal entity, a creation of law. It cant be either loyal or disloyal. There is a veil between the corporation and its members, directors, shareholders, etc. which protects its members from the liability of the company. In many cases, it seems like that the company and its members are the same so to determine that who is managing under the man of company this veil is removed to avoid fraud. The court held that the co. may assume an enemy character when person in de facto in control of such company are persons of an enemy country. Its real character was German. The corporate veil of the co. was pierced through and it was not allowed to maintain the action for recovering the trade debt.When there is peace or no war, the court believed that the character of individual shareholders cannot affect the character of the company. However, during a war, it is important to consider any agents or people who are following orders from such shareholders who are from an enemy nation to assess the character of the company.
The secretary only owns one of the company’s 25000 shares, which are from England, and the rest are from Germany, the court strongly held that it is the responsibility of the company to demonstrate that the secretary was not acting on instructions from other shareholders from an enemy nation.
In re Sir Dinshaw Maneckjee Petit BariAIR 1927 Bom. 371
Facts: Sir Dinshaw Maneckjee Petit was running four different companies, he derived his income from dividend and interest. In order to evade taxes, he established four companies and used his income in these 4 companies. He called these company as Family companies but no member of these companies ever received any benefit from it. He opened the account and invested all his income in the name of 4 different company’s name account and took it back in the form of loan. He did this just to evade his tax on the income that he had earn. The name of these four Companies were Petit Limited; the Bombay Investment Company Limited; the Miscellaneous Investment Limited; and the Safe Securities Limited. There are total of 498 shares, 254 were hold in his name and 200 were hold by his wife and the remaining 13 in the name of other nominees.
Issue: Whether the companies formed by Sir Dinshaw Maneckjee Petit were to be treated as separate legal entity?
Whether contention that Sir Dinshaw Maneckjee Petit’s newly formed companies was a sham is valid?
Judgement: Court found that the company was recognized under legislature and hence it is not sham just because of one person company. The company formed by Dinshaw was not a business but established just to evade taxes by handing over dividend and interest as pretended loans or in other words we can say that the intention of creating company was not to carry on business. The court inferred that Sir Dinshaw Maneckjee Petit’s companies was merely formed for evading supertax on his taxable income and the company was nothing more than the assessee himself. Under these circumstances, it cannot be regarded that the company was separate legal entity from the assessee.
It was held that the company was not a genuine company at all but merely he assessed himself disguised under the legal entity of a limited company. The business was not the business of the company but of the assessee himself, and that the alleged loans were not genuine loans. Hence, the corporate veil is lifted in this case.
CIT v. Sri Meenakshi Mills Ltd.(1967) 1 SCR 934 : AIR 1967 SC 819
Facts: There were three companies that used to manufacture and market the yarn. Each of the firm has branch in Pudukottai where they carry on their business. The Sale proceeds arising in Pudukottai was constantly was deposited in Madurai Bank. The shares of the company were majorly in the hands of Thayagraja Chettiar, and then Chairman of Bank, his two sons, and three assessee firms together. These assessee firms took out loan from Madurai bank guarantee on fixed deposits from their branches. But the loan amount exceeds to the profit available. Appellate Assistant Commissioner of Income Tax received an appeal from corporations.
Issue: Whether the taxing of the entire interest earned on the fixed deposit made out of the profits earned in Pudukottai by the assessee’s branches in the Pudukottai branch of State Bank of Madurai is correct?
Judgement: 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.
The Court further said that the Appellate Tribunal war 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 to British India after it was taken by the borrower outside the taxable territory.
The Court finally held that the company could lift the corporate veil if the corporate entity is used for tax evasion.
Workmen v. Associated Rubber Industry Ltd.(1985) 4 SCC 114
Facts: Associated Rubber Industry ltd. purchased the shares of INARCO ltd. It received the dividend of the profit and loss account of the INARCO ltd. The shares were transferred to the wholly owned subsidiary, Aril Bhavnagar Ltd. which generate no income from any source other than dividend. However, the dividend income was not transferred back to Associated Rubber Industries Ltd., resulting in reduced profits shown in the company’s accounts and subsequently affecting the bonus payable to the workmen. Workmen filed the suit against both the companies claiming that these two companies are same. But Lower Court and High Court of Gujarat ruled out that the companies were separate and the profit earned by Aril Bhavnagar ltd. was also separate and could not be considered by Associated Rubber Ind. ltd.
Issue: Is the transfer of shares of INARCO Ltd. by Associated Rubber Industry Ltd to Aril Holdings Ltd a device to avoid payment of a higher bonus to the company’s workmen?
Whether the companies, Associated Rubber Industry Ltd and Aril Holdings Ltd were two separate legal entities?
Judgement: Court held that to determine Associated Rubber Industry Ltd and Aril Holdings Ltd were two separate legal entities with distinct existences, authorises to discover the true state of affairs if such entities were being used to avoid tax obligations.
Court refer the various cases, in CIT vs Meenakshi Mills Ltd., it has been said that while companies are considered separate legal entities, there are exceptional circumstances where the corporate veil can be lifted to expose the economic realities behind legal arrangements, especially if they involve tax evasion or circumventing tax obligations.
Supreme court noted that Aril Ltd was created by Association Rubber Ind. Ltd. without any assets of it, solely to hold the shares transferred by the parent company and receive dividends from them.
Court found that the bonus of Workmen was literally been reduced by this arrangement.
Supreme Court held that the workmen were entitled to receive their rightful bonus at the rate of 16% for the year 1969. Court held that Worker’s rights should be protected and prevent the misuse of corporate structures for tax avoidance or other evasive purposes.
PRESENT CASE
Q. 2/2020. The corporate veil should be lifted and it include the dividend of AGROCHEM ltd. as a part of profit o fthe sterling ltd. The workmen’s claim is valid and the available surplus for computing the bonus should include the dividend income as it was before the transfer.
Q. 1/2018. Relying the judgement of TELCO Tata Engineering and Locomotive Co. Ltd. v. State of Bihar(1964) 6 SCR 885, it is held that once a company is formed, the business which is carried on by the said company is the business of the company and not the business of citizens who get the company formed or incorporated, and the rights of the incorporated body must be judged on that footing and not on the assumption that they are the rights attributable to the business of individual citizens. Hence, petition filed by the petitioners is incompetent.
Q. 1a/2017. The company is incorporated by ‘A’ has separate legal existence. Therefore, the widow of ‘A’ will succeed in claiming compensation if the company was not a sham (LEE vs LEE AIR FARMING LTD.).
