Case Summary
| Citation | Workmen v. Associated Rubber Industry Ltd.(1985) 4 SCC 114 |
| Keywords | rubber industries, shares, dividend, invested, income, bonus, Aril Bhavnagar Ltd. |
| 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. |
| Issues | 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? |
| Contentions | Workmen’s Contention: The workmen argued that both Associated Rubber Industries Ltd. and Aril Bhavnagar Ltd. were effectively under the same management and control. They contended that the transfer was a deliberate attempt to reduce the profits available for bonus calculation, resulting in an unfair reduction of their entitled bonus.The workmen contended that the court should lift the corporate veil and look beyond the separate legal personalities of the two companies to establish the economic reality of their relationship. Association Rubber Ind. ltd. Contention: Associated Rubber Industries Ltd. argued that it and Aril Bhavnagar Ltd. were two distinct legal entities, each having its own separate legal existence. The transfer of shares to the subsidiary was a legitimate business decision, and both companies operated independently with their own management, assets, and liabilities.It did not receive any income from the dividend generated by the transferred shares in Aril Bhavnagar Ltd. |
| Law Points | 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. |
| Judgement | 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. |
| Ratio Decidendi & Case Authority |
Full Case Details
O. CHINNAPPA REDDY, J. – 2. The Associated Rubber Industry Ltd. had purchased,
some years back, shares of INARCO Ltd. by investing a sum of Rs 4,50,000. They were
getting annual dividends in respect of these shares and the amount so received was shown in
the profit and loss account of the company year after year. It was taken into account for the
purpose of calculating the bonus payable to the workmen of the company. Some time in the
course of the year 1968, the company transferred the shares of INARCO Ltd. held by it to
Aril Bhavnagar Ltd. (changed to the Aril Holdings Ltd.), a subsidiary company wholly owned
by The Associated Rubber Industry Ltd. Aril Holdings Ltd. had no other capital except the
shares of INARCO Ltd. transferred to it by the Associated Rubber Industry Ltd. It had no
other business or source of income whatsoever except receiving the dividend on the shares of
INARCO Ltd. The dividend income from the shares of INARCO Ltd. was not transferred to
The Associated Rubber Industry Ltd. and therefore, it did not find place in the profit and loss
account of the company with the result that the available surplus for the purposes of payment
of bonus to the workmen of the company became reduced. The net result of the exercise was
that bonus at the rate of 4% only was paid to the workers for the year 1969 instead of at the
rate of 16% to which they would have otherwise been entitled. We may mention here that Aril
Holdings Ltd. was itself wound up in the year 1971 and amalgamated with The Associated
Rubber Industry Ltd.
- The workmen of The Associated Rubber Industry Ltd., Bhavnagar raised an industrial
dispute claiming that they were entitled to be paid bonus at the rate of 16% for the year 1969.
According to them, the transfer of the shares of INARCO Ltd. to Aril Holdings Ltd. was no
more than a device to avoid payment of higher bonus to the workmen. The Industrial Tribunal
and thereafter the High Court of Gujarat under Article 226 of the Constitution, held that The
Associated Rubber Industry Ltd. and Aril Holdings Ltd. were two independent companies
with separate legal existence and therefore, the profits made by Aril Holdings Ltd. could not
be treated as profits of The Associated Rubber Industry Ltd. for the purpose of computing the
gross profits earned by The Associated Rubber Industry Ltd. It was further held that there was
no evidence to show that the transfer of shares to Aril Holdings Ltd. was only a device to
avoid payment of bonus to the workmen. - It is true that in law The Associated Rubber Industry Ltd. and Aril Holdings Ltd. were
distinct legal entities having separate existence. But, in our view, that was not an end of the
matter. It is the duty of the court, in every case where ingenuity is expended to avoid taxing
and welfare legislations, to get behind the smoke-screen and discover the true state of affairs.
The court is not to be satisfied with form and leave well alone the substance of a transaction.
In CIT v. Sri Meenakshi Mills Ltd. [AIR 1967 SC 819], the judicial approach to such
problems was stated as follows:
“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 Commissioner 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.”
More recently we have pointed out in McDowell & Co. Ltd. v. CTO [(1985) 3 SCC 230]:
“It is up to the Court to take stock to determine the nature of the new and
sophisticated legal devices to avoid tax and consider whether the situation created by the
devices could be related to the existing legislation with the aid of ‘emerging’ techniques
of interpretation as was done in Ramsay, Burmah Oil and Dawson, to expose the devices
for what they really are and to refuse to give judicial benediction.”
- If we now look at the facts of the case, what do we find? A new company is created
wholly owned by the principal company, with no assets of its own except those transferred to
it by the principal company, with no business or income of its own except receiving dividends
from shares transferred to it by the principal company and serving no purpose whatsoever
except to reduce the gross profits of the principal company. These facts speak for themselves.
There cannot be direct evidence that the second company was formed as a device to reduce
the gross profits of the principal company for whatever purpose. An obvious purpose that is
served and which stares one in the face is to reduce the amount to be paid by way of bonus to
workmen. It is such an obvious device that no further evidence, direct or circumstantial, is
necessary. It was argued that in 1971, the Aril Holdings Ltd. was wound up and amalgamated
with The Associated Rubber Industry Ltd. and that this circumstance showed that the initial
creation of Aril Holdings Ltd. was not a device of avoidance. Probably, after Aril Holdings
Ltd. was created, some unforeseen difficulties arose which have not been brought to light
before us and it became necessary to wind it up and amalgamate it with The Associated
Rubber Industry Ltd. We are therefore, satisfied that the amount of dividend from INARCO
Ltd. received by the Aril Holdings Ltd. should be taken into account in assessing the gross
profit of The Associated Rubber Industry Ltd. for the purpose of calculating the rate of bonus
payable to the workmen of The Associated Rubber Industry Ltd. The appeal is allowed and it
is declared that the workmen of the Associated Rubber Industry Ltd., Bhavnagar are entitled
to be paid bonus at the rate of 16% for the year 1969.
