1. Challenge to the constitutional validity of Section 12(1B) read with Section 2(6A)(e) of the Indian Income-tax Act, 1922, regarding loans to shareholders treated as deemed dividends. (Para 1 , 2 )
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1964 Supreme(SC) 278
SUPREME COURT OF INDIA
28th October 1964
P.B. GAJENDRAGADKAR, C.J.I., K.N. WANCHOO, M. HIDAYATULLAH, RAGHUBAR DAYAL, AND J.R. MUDHOLKAR, JJ.
Navnit Lal C. Javeri, Appellant
Versus
K. K. Sen, Appellate Assistant Commissioner of Income-tax, Bombay, Respondent.
Civil Appeal No. 45 of 1964
Advocates appeared
Mr. G. S. Pathak, Senior Advocate (M/sM. M. Charekhan and I. N. Shroff, Advocates with him), for Appellant; Mr. C. K. Daphtary, Attorney General for India (M/s. R. Ganapathy Iyer, Gopal Singh and R. N. Sachthey, Advocates with him), for Respondent.
Advocates:
C.K.DAFTARY, G.S.PATHAK, Gopal Singh, I.M.SHROFF, M.M.CHAREKHAN, R.Ganapathy Iyer, R.N.SACH
C.K.DAFTARY, G.S.PATHAK, Gopal Singh, I.M.SHROFF, M.M.CHAREKHAN, R.Ganapathy Iyer, R.N.SACH
The court held that "income" under Entry 82, List I of the Constitution must be interpreted liberally, allowing Parliament to create a legal fiction treating loans to shareholders of controlled companies as dividends to prevent tax evasion, which does not violate fundamental rights.
Headnote:(A) Indian Income-tax Act, 1922 - Sections 12(1B) and 2(6A)(e) - Constitution of India - Entry 82, List I, Seventh Schedule - Articles 14, 19(1)(f) and 19(1)(g) - Validity of provisions treating loans to shareholders as dividends - The term "income" in the legislative entry must be construed liberally and in its widest amplitude (Paras 8, 9) - Parliament is competent to create a legal fiction to treat loans advanced by a controlled company to its shareholders as dividends to prevent tax evasion, provided there is a rational connection between the item taxed and the concept of income (Paras 14, 16).
(B) Fundamental Rights - Right to borrow money from a company is not a fundamental right - Treating such loans as dividends for tax purposes does not violate the right to acquire, hold, and dispose of property or the right to carry on trade or business under Article 19(1)(f) and (g), as it constitutes a reasonable restriction (Para 18).
(C) Dissenting View - A loan is not "income" in a rational sense as it must be repaid - Treating a loan as a dividend regardless of the shareholder's proportionate share in accumulated profits is unreasonable and violates the fundamental right to hold property (Paras 27, 31, 34).
Facts of the case:
A shareholder of a private limited company took a loan from the company. The tax authorities treated the loan, to the extent of the company's accumulated profits, as a dividend and included it in the shareholder's total income. The validity of the provisions enabling this treatment was challenged on the grounds of legislative competence and violation of fundamental rights.
Findings of Court:
The impugned sections are constitutionally valid. They fall within the legislative competence of Parliament under Entry 82, List I, and do not violate the fundamental rights guaranteed under the Constitution.
Issues: Whether Section 12(1B) read with Section 2(6A)(e) of the Indian Income-tax Act, 1922 is ultra vires the Constitution; whether it exceeds legislative competence under Entry 82, List I; and whether it violates Articles 19(1)(f) and (g).
Ratio Decidendi: The term "income" in the Constitution must be given a wide and liberal interpretation. To prevent tax evasion by controlled companies, the legislature is competent to create a fiction treating loans to shareholders as dividends, provided there is a rational connection to the concept of income. Such a provision is a reasonable restriction and does not infringe upon fundamental rights.
Result: Appeal dismissed with costs.
Legal Category Hierarchy
Table of Contents
2. Whether the impugned provisions exceed legislative competence under Entry 82, List I, and whether they violate fundamental rights under Article 19(1)(f) and (g) of the Constitution. (Para 7 , 17 , 18 )
3. The term income must be liberally construed, allowing the legislature to create fictions to prevent tax evasion by treating loans from controlled companies as deemed dividends. (Para 8 , 9 , 10 , 11 , 12 , 13 , 14 , 15 , 16 )
4. Legislative competence under Entry 82, List I extends to creating legal fictions to treat ostensible loans as dividends to prevent tax evasion in controlled companies. (Para 16 , 17 )
5. Appeal dismissed; the impugned sections of the Indian Income-tax Act, 1922, are held to be constitutionally valid. (Para 19 , 43 )
6. How should the term income be interpreted for determining legislative competence under Entry 82, List I of the Seventh Schedule?
The term income must be construed liberally and in its widest amplitude, extending to all ancillary or subsidiary matters that can reasonably be comprehended within it, provided there is a rational connection between the item taxed and the concept of income. (Para 8 , 9 , 10 )
7. Can the legislature create a legal fiction to treat a loan as a dividend for tax purposes?
Yes, if the legislature identifies a device used to evade tax, it is competent to create a fiction treating an ostensible loan as a dividend to reach such transactions for taxation, provided it falls within the legislative field. (Para 14 , 16 , 17 )
8. Does treating a loan as a deemed dividend violate the fundamental right to hold property or carry on business under Article 19?
No, the right to borrow money from a company is not a fundamental right, and such provisions are reasonable restrictions intended to prevent tax evasion and are not unfair. (Para 18 )
Judgment
GAJENDRAGADKAR, C.J.I. [On behalf of himself and K. N. Wanchoo, M. Hidkyatullah and J. R. Mudholkar, JJ.] : 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 S.12(1 B) read with S. 2(6A) (e) of the Indian Income-tax Act, 1922 (No. 11 of 1922), (hereinafter called the Act) as it stood in 1955. The High Court has rejected the appellant s contention that the said section is invalid, and the appellant has come to this Court with a certificate granted by the High Court.
2. The appellant holds 11 out of 845 shares in a private limited company named the Malegaon Electricity Co. (Private) Ltd. (hereinafter referred to as the company). The value of each share 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 lakhs from the company. A notice was issued to the appellant by the 8th Income-tax Officer 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 amount must be deemed to be 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 section 12(lB) 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 before the Income-tax Appellate Tribunal. Whilst this appeal was pending before the said Tribunal, the appellant moved the High Court under Arts. 226 and 227 of the Constitution, and contended that the relevant section under which the department had purported to levy assessment against him on the sum of Rupees 2,83,126 was ultra vines. That is how the only question which the High Court had to decide in the present writ proceedings was whether section 12(1B) read with S. 2(6A) (e) was constitutionally valid.
3. In order to deal with this point, it is necessary to read the two relevant provisions of the Act. Section 2(6C) defines "income" as including dividend. S. 2(6A) defines"dividend" in an inclusive manner. Section 2(6A) (e) provides :
"Dividend"includes -
(e) any payment by a company, not being a company 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 sharehholder, to the extent to which the company in either case, possesses accumulated profits; but dividend does ant include -
(i)
(ii) any advance or loan made to a shareholder by a company in the ordinary course of its business where the lending of money it 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 and treated as a dividend 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.
4. Section 12(1) provides that the tax shall be payable by an assessee 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 proceeding heads).
Section 12(1B) provides :-
"any payment by a company to a shareholder by way of advance or loan which would have been treated as a dividend within the meaning of clause (e) of su
