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‘Piercing the Corporate Veil in Taxation Matters’

(India & International Transactions with special reference to

Direct Tax Codes)

A Code to Decode Greed

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Table of Content

Sr No. Title Pg No.

I. Abstract 4

1 Scope 4

III. Research Object 4

1. Introduction 5

2. Method of Research 5

3. Theories of Corporation 6

3.1. Fiction Theory 6

3.2. Realist Theory 6

3.3. Bracket Theory 6

3.4. Concession Theory 7

3.5 Purpose Theory 7

4 Concept of Separate Legal Personality 7

4.1. Principle of Separate Legal Entity 8

4.2. Characteristic of a Body Corporate 8

4.2.1. Limited liability 9

4.2.2. Perpetual Succession 9

4.2.3. Separate property 10

4.2.4 Transferability of Shares 10

4.2.5. Contractual Rights 11

4.2.6 Capacity to Sue and be Sued 11

5. Doctrine of Piercing the Corporate Veil 11

5.1. Evolution of the Concept of Corporate Veil 11

5.2. Meaning of Piercing the Corporate Veil 12

5.3. Nature and Scope of the Doctrine 13

5.4. Limited Liability v. Piercing the Corporate Veil 13

6. Circumstances in Which the Court can Pierce The Veil 13

6.1. Alter Ego 13

6.2. Enemy Character 14

6.3. Fraudulent conduct 14

6.4. Holding and Subsidiary company 14

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6.5. Liability for Ultra-Vires Act 15

6.6. Facade or Sham or Cloak 15

6.7. Non Payment of Tax 16

6.8. Piercing for Justice 16

7. Piercing the Corporate Veil an Indian Experience 16

7.1. Statutory Provisions in relation to the Lifting of Corporate Veil 16

7.1.1 Section 45 16

7.1.2 Section 62 & 63 17

7.1.3. Section 69(5) 17

7.1.4. Section 147 17

7.1.5. Section 212 17

7.1.6. Section 247 17

7.2 Judicial Pronouncement on Piercing the Corporate Veil 17

8 Where the Court refused to lift the Veil of Corporation 18

8.1 Indian Context 19

8.2 International Context 19

9 Piercing the Corporate Veil under Taxation Laws 20

9.1. Lifting or Piercing of Corporate Veil in Taxation Matters Indian 20

9.2. Piercing of Corporate Veil in Tax Matters

International Context.

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10. Piercing of Corporate Veil under Direct Tax Code 23

10.1 Reasons for Introducing GAAR 24

10.2. Provisions of General Anti Avoidance Rule 24

10.3. Conditions under which GAAR may be invoked 25

10.4 Comparative Study (In International Context) 25

10.4.1 Canadian GAAR 26

10.4.2 UK GAAR 27

10.5 Criticism of GAAR 28

11. Recommendations 29

12. Conclusion 29

13 Bibliography 30

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Abstract:

With the liberalisation of the Indian Economy, the expansion of the global market, and the

increasing number of cases of tax evasion by the corporate bodies, the need of the hour is to

go behind the curtain of corporation and see the real nature of the transaction, by piercing the

veil of corporation.

Keywords: Lifting of corporate veil; tax evasion; direct tax code.

Scope:

Present project covers the provision of Company law, specifically covers doctrine of Separate

Legal Personality and Piercing of Corporate Veil. There is also reference made to the Income

Tax Act, 1961 and proposed Direct Tax Code Bill, 2011. Project also covers the GAAR

provision adopted across the globe. In reference to the penalty reference is also made to the

criminal and evidence law. Thus the present project cover the above said laws and also

examine the apparent correlation among these laws.

Research Objective:

• To study, understand and analyse the historical and conceptual aspect of a Body

Corporate.

• To study and understand and evaluate the basic features of a Corporation .

• To study, understand and analyse the Feature of Separate Legal Personality.

• To study, understand and examine the situation where the veil can be lifted and the

abuse of the corporate personality can be casted out.

• To understand the common law principle that the piercing of corporate veil is

exceptional where the Doctrine of Separate legal Personality is essential.

• To examine the basic stances and the specific provision where the court can life the

veil.

• To examine the situations where the Taxing authority or Court can lift the veil in the

tax evasion matter.

• To evaluate the Direct Tax Code bill, 2011 and the Income Tax Act, 1971 where the

court can pierce the veil.

• To evaluate the applicability of the General Anti Avoidance Rule in the context of

lifting of corporate veil.

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1. Introduction:

“Black Money and tax evasion is like a cancerous growth on the country`s economy which if

not checked in time, is sure to ruin it.”1

Adam Smith, in the 18th Century, in his classic, The Wealth of Nations, pointed out the

following four main objectives should be borne in mind by the State in levying taxes- equity,

convenience of the taxpayer, economy and lastly certainty. Out of the aforesaid objectives

convenience of taxpayer and certainty have been wholly overlooked by the Union and the

States. The proposed Direct Tax Code tries to overcome these shortcomings.

The concept of Corporate Veil is increasingly applied by the revenue authorities globally.

The income Tax Act, 1961, as it stands today, does not have the explicit provisions for

‘looking through’ the transactions. However the General Anti Avoidance Rules (GAAR)

provisions embedded in the above mentioned Code has implicit provisions for the lifting of

corporate veil.

2. Method of Research:

We know that the objective of legal research is not only to propose suggestions for legal

reform. It may be carried on for many other purposes as well. Where, however, the object of

research is only to indicate in which way it is to carried on, such a research is termed as

critical research is termed as critical research because in such cases the objective is to

ascertain a common principle or norm and hence, it is also termed as ‘normative research’. In

this kind of research gathered material is thoroughly becomes the basic norm.

For the purposes of critical research, the necessary material is obtained from codified law,

judicial observations and pronouncements and academic writings. In matters of critical

research, public opinion also plays an important role and public opinion must be ascertained

in a proper manner.2

1 Wanchoo Committee Report, P. 6

2 Dr. S.R.Myneni, Legal Research Methodology 130(Pioneer Books 2nd ed. 2001)

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3. Theories of Corporation:

a. Fiction Theory - This theory is expounded mainly by Savigny, Salmond, Coke, Blackstone

and Holland. According to this theory, a corporation is clothed with legal personality. The

personality of a corporation is different from that of its members. Savigny regarded

corporation as an exclusive creation of law having no existence apart from its individual

members who form the corporate group and whose who acts by fiction are attributed to the

corporate entity.3 Gray justifies fiction theory on the ground that the main object of

incorporation is to protect the interest of persons having common objectives. Like fictitious

personality the will of the corporation is also an imaginary creation of law.4

The fiction theory thus believes that incorporation is a fictitious extension of personality

resorted to for the purpose of facilitating dealings with property owned by a large body of

natural persons. The fiction theory however fails to answer satisfactorily the civil and

criminal liability of corporations.5

b. Realist Theory - This theory is also known as the ‘Organic Theory’. The founder of this

theory was a noted German jurist Johannes Althusius, who believed that every collective

group has a real mind, a real will, and a real power of action. A corporation therefore, has a

real existence, irrespective of the fact whether it is recognised by the state or not. The

corporate will of the corporation finds expression through the acts of its directors,

employees and agents. The existence of a corporation is real and is not based on any fiction.

Dicey also contends that the personality of a group is a reflection of its consciousness and

will. Thus group personality is as real as the personality of an individual.6

c. Bracket Theory – The Bracket theory is associated with the well known German jurist

Ihring. According to this theory juristic personality is only a symbol to facilitate the

working of the corporate bodies. Only the members of the corporation are ‘persons’ in real

sense and the bracket is put around them to indicate that they are to be treated as one single

unit when they form themselves into a bracket.

3 Savigny: System of Modern Roman Law (Translated by Ratingon). p.181.

4 Gray: Nature and Sources of Law. p.55.

5 Dr N.V Paranjape: Studies in Jurisprudence and Legal theory. p 358.

6 Miraglia: Comparative Legal Philosophy. p.371.

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d. Concession Theory – The theory is basically linked with the philosophy of sovereign state.

It pre- supposes that corporation as a legal person has great importance because it is

recognised by the State or the law. According to this theory, juristic personality is a

concession granted to corporations by the State. It is entirely at the discretion of the State to

recognise or not a juristic person.

e. Purpose Theory – The main exponent of this theory was the noted German jurist Brinz, E.I

Bekker, Alloys and Demilius also support. The theory is founded on the view that

corporations are treated as ‘persons’ for certain specific purposes. The assumption that only

living persons can be subject matter of rights and duties, would have deprived imposition of

rights and duties on corporations which are non living entities. It therefore, became

necessary to attribute ‘personality’ to corporation for the purpose of being capable of having

rights and duties.

4. Concept of Separate Legal Personality:

Corporate Personality is the creation of law. Legal personality of corporation is recognised

both in English and Indian law. A corporation is an artificial person enjoying in law rights

and duties. A company is a “legal person” or “legal entity” separate from, and capable of

surviving beyond the lives of, its members. Like any juristic person, a company is legally an

entity apart from its members, capable of rights and duties of its own and endowed with the

potential of perpetual succession7.In other words, it has “legal personality” and is often

described as an artificial person in contrast with a human being, a natural person.8

The said principle was laid down in the case of Salomon v. Salomon9 where it was decided

that a corporate body has its own existence or personality separate and distinct from its

members and therefore, a shareholder cannot be held liable for the acts of the company even

though he holds virtually the entire share capital. The case also recognised the principle of

limited liability of a company.

7 Hahlo`s CASEBOOK ON COMPANY LAW, 42(2nd Edn, by Hahlo and Trebilock).

8 Gower and Davies, Principles of Modern Company Law, Sweet & Maxwell (8Th

Edition,2008.) Pg. no.193.

9 [1895-99]All ER Rep 33

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In the words of Chief Justice Marshal – “A corporation is an artificial being invisible,

intangible existing only in the contemplation of law. Being a mere creation of law, it

possesses only the properties which the Charter of its creation confers upon it, either

expressly or as incidental to its very existence”.

In India the legal status and position of a company has been well explained by the Supreme

Court of India in Tata Engineering & Locomotive Company Ltd v. State of Bihar10, wherein

it observed “the corporation in law is equal to a natural person and has a legal entity of its

own”.

4.1 Principle of Separate Legal Entity:

Section 34 of the Companies Act, 1956 recognises the independent corporate existence

of a company as explained in and emphasised by House of Lords in the case of Salomon v.

Salomon & Co. Ltd. In that case Salomon a leather merchant and manufacturer of boots was

the owner of a business. He was solvent. He converted his business into a limited liability

company under the name and style of “Salomon & Company Limited”. Of the total share

capital he took 20,000 shares and his wife and five children took one share each. No other

share was issued. Salomon received mortgage debentures of £ 10,000 in part payment for

the purchase of his business by the company. The company was in financial difficulty due

to trade depression. The company went into liquidation, Salomon claimed preferential right

being the debenture holder over certain unsecured creditors of the company. The unsecured

creditors disputed his right to priority on the ground that the company was a “one man

company” and a sham. The trial judge held the company was a mere alias or agent for

Salomon and that Salomon was bound to pay the unsecured creditors. The Appeal Court

affirmed the decision. On further appeal, the House of Lords reversed the decision on the

ground that there was nothing in the Act as to the degree of interest which may be held by

each of the seven or as to the proportion or interest or influence possessed by one or

majority of the shareholders over the others. As a result, Salomon had a priority, being a

debenture holder, over other unsecured creditors. Salomon case established that (a) provided

the formalities of the Act are complied with, a company will be validly incorporated, even if

10 AIR 1965 SC 40

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it is only a “one person” company and (b) the courts will be reluctant to treat a shareholder

as personally liable for the debts of the company by “piercing the corporate veil11”

4.2 Characteristic of a Body Corporate: A number of other characteristics are also

inherited by a Company on its incorporation; a few have been discussed below:

4.2.1 Limited liability : One of the principle advantage of trading through the medium of a

limited company is that the members of the company are only liable to contribute towards

payment of its debt to a limited extent. A corporation is a separate person that its members

are not as such liable for its debts.12 If the company is limited by shares, the shareholders

liability is measured by the nominal value of share he holds, so that once he or someone who

held the shares previously has paid that nominal value plus any premium agreed on when the

shares were issued, he is no longer liable to contribute anything. In case of company limited

by guarantee, the liability of each member shall be determined by the guarantee amount i.e.

he shall be liable to contribute up to the amount guaranteed by him. If the guarantee company

also having share capital, the liability of each share holder shall be determine in terms of not

only the amount guaranteed but also the amount remaining unpaid on the share held by a

member. Thus limited liability facilitates the investment by public, who are not professional

investors, of their surplus funds, which would not be the case if the full range of their

personal assets are put at risk.

Indeed, the concept of limited liability is not absolute. The extensive publicity and

disclosure obligations placed upon limited liability companies must be seen in this light.13

4.2.2 Perpetual Succession: A Company being an artificial person can neither be

incapacitated by illness nor is it limited by a fixed life span. Being distinct from members, the

death, insolvency or retirement of its members leaves the company unaffected. Members may

come and go but the company keeps on functioning. Thus, the company shall continue to

11 Gower and Davies, Principles of Modern Company Law, Sweet & Maxwell (8Th

Edition,2008.)Pg No. 35.

12 This sentence was quoted and relied on by Kerr L.J. in Rayner (Mincing lame) ltd. V Department of Trade

[1989] Ch 72 at 176 as ab accurate statement of English Law although as he pointed out, it is not accurate in

relation to most Civil Law Countries-including Scotland so far as partnerships are concerned- or to

international law. 13

Grower Supra note 11 Pg. No.40.

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exist indefinitely. Under Indian law the companies Act, 1956 vide under section 34 (2)

bestows this characteristic on a company.

4.2.3 Separate property: One obvious characteristic of a company is that it enables the

property of the association to be more clearly distinguished from that of its members. In other

words, a company being a separate entity is capable of owning its fund and other assets. “The

property of the company is not the property of its share holders, it is the company”.14 In the

eyes of law, even a member holding majority of shares or a managing director of a company

is held liable for criminal misappropriation of the funds or property of the company, if he

unauthorisedly uses it. In India, this principle of separate property was best laid down by the

Supreme Court in Bacha F.Guzdar v. CIT, Bombay15 it was held by the apex court that a

shareholder is not the part owner of the company or its property, he is only given certain

rights by law, for example to vote or to attained meetings or to receive dividends.

In Macaura V. Northern Assurance Co. Ltd.16 It was held that a member does not even have

an insurable interest in the property of the company. In this case, Macaura held all except one

share of timber company, he had also advanced substantial amount to the company. He

insured the company’s timber in his own name. On timber being destroyed by fire, his claim

was rejected for want of insurable interest. The court observed “no share holder has any right

to any item of property owned by the company for he has no legal or equitable interest

therein.”

4.2.4 Transferability of Shares: Incorporation, with the resulting separation of the business

from its members, greatly facilitates the transfer of the member’s interests.17 With an

incorporated company freedom to transfer of members’ interest, both legally and practically,

can be readily attained. The company can be incorporated with its liability limited by shares

and these shares constitute items of property which are freely transferable in the absence of

express provision to the contrary and in such away such transfer drops out.18 One particular

reason for the popularity of joint stock companies has been that their shares can be 14 Gramophone& Typewriter Co. V. Stanley, (1906) 2 K.B. 856 at p. 869.

15(1955) 25 Comp Case. 1 (SC)

16 (1925) AC 619

17 Supra Note Gower Pg No. 44

18 CA 2006, S 544. Subject only to a possible liability under section ss 74 and 76 of the Insolvency Act 1986 if

liquidation follows within a year and the shares were not fully paid up or were redeemed or purchased out of

capital. Section 82 of Indian Companies Act made such provisions too.

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transferred. The Act in section 82 echoes this feature by declaring “the shares, debentures or

other interest of any member in a company shall be movable property, transferable in the

manner provided by the articles of the company”. As soon as a shareholder transfers his

shares to another person, the transferee steps into the shoes of the transferor and acquires all

the rights in respect of those shares, thus a change in the ownership of a company does not

affect its functioning.

4.2.5 Contractual Rights: A company being a separate legal entity different from its

members, can enter into contracts for the conduct of the business. A shareholder cannot

enforce a contract made by his company, neither is he a party to the contract as a company is

not a trustee for its shareholders. As held in British Thompson Huston Company v. Sterling

Accessories Ltd19, a member of a company cannot sue in respect of torts committed against it,

nor can he be sued for torts committed by the company.

Thus the rights and duties of a company are distinct from those of its constituent members.

4.2.6 Capacity to Sue and be Sued: The separate legal personality of a company gives it the

right to sue and be sued in its own name.20

5. Doctrine of Piercing the Corporate Veil:

The doctrine of piercing or lifting of the veil of a Corporate Personality makes a change in

the attitude of law as originally adopted towards the concept of separate legal personality or

entity of the corporation. In Ansuman Singh v. State of U.P21, the court held that in suitable

cases, the court will lift the corporate veil.

5.1 Evolution of the Concept of Corporate Veil : Salomon`s case established beyond doubt

that in law a registered company is an entity distinct from its members, even if one person

holds almost all the shares in the company. Common lawyers have not engaged in much

philosophical speculation about the nature of corporate personality. Our law with its

immensely fertile concept of trust and the well developed doctrines of agency and vicarious

19 (1924) 2 Ch.33

20 It has been recognised that a company can be allowed to sue in forma pauperis under Order 33, Rule 3 of the Civil

Procedure Code. Union Bank of India v. Khaders International Constructions Ltd [1993] 2 Comp LJ 89 Ker.

21 AIR 2004 All. 260

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liability has not needed to do more than treat the corporation as far as possible as if it were a

natural person. The law has developed according to the needs and public policy of the day22.

Whenever, in the view of the courts, justice demands a different result from what would

follow from a rigid application of the principle of separate corporate existence of the

company apart from its members and officers, they have not hesitated to take a decision

which seems fair enough even if it means lifting or piercing the veil of corporation and

having regard to the realities behind the facade of separate corporate entity23. By their

yardstick of public policy, the courts have determined, case by case, whether and to what

extent the rules relating to natural persons should be applicable to artificial persons. The

courts have not been alone in lifting the veil of corporation, the legislation too has played its

part, especially in the field of taxation.24

Prof. Gower has observed that at the time of determination whether to lift the veil, the

courts ought to be guided by the policy of statute in question, and so the decision arrived at is

likely to vary from statute to statute. Nevertheless, it is difficult to avoid the conclusion that

the courts are committed to the preservation of separate legal entity of companies except

where the statutory wordings clearly requires this. Therefore, the court refused to apply said

doctrine in Nokes v Doncaster Amalgamated Collieries and Lee v Lee’s Air Farming Ltd.

cases taken into consideration the relevant facts and the permissible limit doctrine of Separate

Legal Personality.

5.2 Meaning of Piercing the Corporate Veil : The chief advantage of incorporation is

Separate legal entity of the company from which all other follow. The foregoing decisions

manifest that there exists veil of incorporation between the company and its members. This

veil is opaque and impassable as a curtain, it is a partition between the company and the

members. Following this principle the courts used to refuse to go behind this curtain and go

behind the real person responsible. The doctrine of Piercing the Corporate Veil means to lift

that curtain and catch hold of the real person responsible for the wrong committed.

Piercing the corporate veil refers to the process whereby the statutory guarantee of limited

22 W.S Holsworth, History of English Law (3rd ed., 1944), Vol. lX, 70, and R.D Lumb, Corporate Personality (1964) 4

U.Q.L.J. 418.

Reference should also be made to Gilford Motor Co Ltd v. Horne [1933] Ch. 935.

23 L.C.B Gower, Modern Company Law (3rd edition. 1969), 189 – 217.

24 Reference is being made to the Acts Interpretation Act 1924, ss 4 and 6, to the Crimes Act 1952, s 2, and Underwood v.

Bank of Liverpool [1924] 1 K.B. 775 in relation to the scope of the Bills of Exchange Act 1908, s.82.

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liability for shareholders is lifted and the “veil of the “corporate fiction” of the corporation is

“pierced” and the individual (or corporate shareholder) is exposed to personal liability. Thus

in cases where the corporate personality of the company is used to commit frauds, improper

or illegal acts, the corporate personality might have to be removed to identify the persons

who are really guilty, this is known as ‘piercing the corporate veil’.

5.3.Nature and Scope of the Doctrine: The veil of corporation is to be lifted in exceptional

cases and in no way should it limit the generality of the principle embodied in Salomon`s

case. It is not possible to offer a principle under which these cases can be subsumed.

The Karnataka High Court has observed in Cotton Corporation of India Ltd v. G.C

Odusumathd25 that the lifting of Corporate veil of a Company as rule is not permissible in law

unless otherwise provided in clear words of the statute or by very compelling reasons such as

where fraud is to be prevented or trading with enemy company is sought to be defeated.

5.4. Limited Liability v. Piercing the Corporate Veil:

6. Circumstances in which Court may Pierce the Corporate Veil:

Professor Gower and Davis has observed it is crucial to distinguish the situations where the

court is applying the terms of a statute (other than companies Act) or less often, a contract,

from those where, as a matter of common law, the veil is lifted.

6.1 Alter Ego: Although Salomon made it clear that a company is not automatically the agent

of its shareholders, in exceptional cases such a relationship can exist, and it will be a question

of fact whether there is a relationship of agency in any particular case, so that it is appropriate

25 [1999] 22 SCL 228 (Kar)

Limited Liability Piercing the Corporate Veil

General Rule Exception to the Rule

Motive: encourage investment by

general public.

Motive: to deter private interest under

the cover of public interest.

Bestows right. Limits those rights.

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to pierce the veil. Questions of agency most often arise in the context of associated or group

companies, and so the two areas are here considered together. The principles leading to a

finding of agency were considered by Atkinson J in Smith, Stone & Knight Ltd v. Birmingham

Corporation26, in the context of whether a subsidiary company was the agent of its holding

company. That was a case where agency was established and the veil lifted.

6.2 Enemy Character: The courts would lift the veil to ascertain the enemy character. The

number of enemy shareholders is essential in ascertaining the status.27 This condition is well

explained in Daimler Co Ltd. V. Continental Tyre & Rubber Co Ltd28: C, a private company

incorporated in England had a capital of 25000 £1 shares. Shares were majorly held by a

German Company. House of Lords held that the company was an enemy company for the

purpose of trading with enemy legislation because its effective control was in enemy hands.

6.3 Fraudulent conduct: Where it appears that any business of the company has been

carried on with the intent to defraud creditors of the company or any other person, or for any

fraudulent purpose, those who are knowingly parties to such conduct of business may, if the

court thinks it proper to do so, be made personally liable without any limitation as to liability

for all or any debts or other liabilities of the company. In Gilford Motors Company v. Horne29

the court refused to acknowledge the ‘separate legal personality’ as the defendant formed a

company only to escape the contractual obligation.

6.4. Holding and Subsidiary company: A company qualifies as a holding company when it

has the power to control the composition of the board of directors of another company or

holds a majority of its shares it has been seen that a subsidiary company, even a 100%

subsidiary, is a separate legal entity and its creator and controller is not to be held liable for

its act. In Freewheels (India) Ltd. V. Veda Mitra(Dr.)30A 52% subsidiary company proposed

to issue further capital which , following section 81 was offered to the existing holders of

equity shares. The holding company requested the court that its subsidiary should be

26 [1939] 4 All ER 116

27 C.R Datta, COMPANY LAW, 583(6th ed. 2008).

28 (1916)2A.C307. see also V/O Sovfracht v. Van Udens Scheepvaart [1943]1 All E.R.76 Where the ‘control’ test was

applied and the remarks of Mc.Nair J. in Kuenigl v. Donnersmark(1955)1Q.B.515, where the learned judge was of the

opinion that a company might have enemy character and yet remain subject to the Crown under the Companies Act.

29 [1933] 1 CH 935

30 AIR1969 DEL.258

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restrained from going ahead with the issue as it would deprive its parent of their controlling

interest and would also depreciate the value of its shares.

KAPUR J. Refused to issue the injection prayed for and said “here the parent holds

only a nominal majority in the share capital of the subsidiary. With the meagre majority alone

I am not prepared to hold, even if it were possible to do so for such a purpose. That the

subsidiary company has lost its identity as separate legal entity”31.A holding company was

not allowed to interfere in the disinvestment decision of a subsidiary company even if one of

the effects of the disinvestment could have been the loss of position as a holding company32.

Even under Companies Act, 1956 Section 212 provides that every holding company shall

attach to its balance sheet, copies of the balance sheet and profit and loss account etc in

respect of each subsidiary company. it amounts to lifting the corporate veil because in the

eyes of law a subsidiary company is a separate legal person and through this mechanism their

identity is known.

6.5 Liability for Ultra-Vires Act : Directors and other officers of the company will be

personally liable for all those acts which they have done on behalf of a company if the same

are ultra vires the company.

In Weeks v. Propert33the directors of Railway Company which had fully exhausted its

borrowing powers advertised for money to be lent on the security of debentures. ‘W’ lent

£500 upon the faith of advertisement and received a debenture. Held, the debenture was void

but ‘W’ could sue the directors for breach of warranty of authority (since they had by

advertisement warranted that they had the power to borrow which in fact they did not have).

6.6 Facade or Sham or Cloak : In Delhi Development Authority v. Skipper Construction

Company Pvt. Ltd34, the Supreme court held that the fact that the director and members of his

family had created several corporate bodies did not prevent the court from treating all of them

as one entity belonging to and controlled by the director and his family if it was found that

these corporate bodies were mere cloaks and that the device of incorporation was really a

ploy adopted for committing illegalities and / or to defraud people.

31 Id. at 143 of Comp LJ. See also decision of the supreme court in the state of U.P V. Renusagar Power

Co.1989Supp.(2)SCC312, where a subsidiary company was created for the purpose of generating and supplying power only

to its parent company and the two were treated as one for excise purposes.

32 BDA Breweries v. Cruickshonk &co.ltd.(1996)85Comp.Cas.325 Bom.

33 (1873)L.R 8 C.P 427.

34 (1996) 4 SCALE 202 (SC)

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6.7 Non Payment of Tax: When any private company is wound up any tax assessed on the

company whether before or in course of liquidation, in respect of any previous year cannot be

recovered, every person who was director of that company at any time during the relevant

previous year shall be jointly and severally be liable for payment of tax.

A company transferred its business to another company which was not taxable, but the

company was carrying on some other business which was taxable. The company remained

liable to pay the tax applicable to such business and lifting of Corporate Veil was permitted

even in the absence of any statutory provision in this regard.35

6.8 Piercing for Justice: Although the interest of justice may provide the policy impetus for

creating exceptions to the doctrine of separate legal personality and limited liability, as an

exception in itself it suffers from the defect of being inheritably vague and providing to

neither courts nor those engaged in business any clear guidance as to when the normal

company law rules should be displaced. Consequently, it is difficult to find cases in which

“the interest of justice” have represented more than simply a way of referring to the grounds

identified above in which the veil of incorporation has been pierced.

7. Piercing the Corporate Veil an Indian Experience

Though the concept of ‘Separate Legal Personality’ was emanated from Salomon`s case36 ,

but it found its way in the Indian legal system long back in 192737 even before the current

Companies Act 1956, came into existence. Today the principle is well established in

company law.

7.1 Statutory Provisions in relation to the Lifting of Corporate Veil: Notwithstanding the

cardinal principles of “Limited Liability” and “Corporate Personality”, the Companies Act

1956 has specifically provided that in certain cases the advantages of distinct entity and

limited liability may not be allowed to be enjoyed. Such cases are:

7.1.1 Section 45: Where the number of members falls below the statutory minimum and the

company carries on business for more than six months while the number is so reduced, every

person who is a member of the company during the time the company so carries on business

after those six months and is aware of that fact shall be severely liable for the payment of

company`s debts contracted during that time.

35 India Waste Energy Development Ltd v. Government NCT of Delhi (2003) 114 Comp Cases 82 (Del).

36 Supra Note. 7

37 Mc Dowell & Co. Ltd v. CTO AIR 1986 SC 649.

17

7.1.2 Section 62 & 63: In case of misrepresentation in a prospectus, every director, promoter

and every other person, who authorises such issue of prospectus incurs liability towards those

who subscribed for shares on the faith of untrue statement.

7.1.3 Section 69(5): In case of first allotment of shares in a Public company if minimum

subscription has not been received within 120 days of issue of prospectus, the directors shall

be personally liable to pay money with interest, if application money is not repaid within the

next 10 days of closure of the issue.

7.1.4 Section 147: Where an officer of a company signs on behalf of the company any

contract, bill of exchange, promissory note, cheque or order for money, such person shall be

personally liable to the holder of the name of the company is either not mentioned, or is not

properly mentioned. Thus, where on a cheque, the name of a company was stated as ‘LR

agencies Ltd’ whereas the real name of the company was ‘L&R Agencies Ltd’. The

signatories’ directors were held personally liable.38

7.1.5 Section 212: A holding company is required to disclose to its members the accounts of

its subsidiaries. Under this section it is provided that every holding company shall attach to

its balance sheet, copies of the balance sheet, profit and loss account, directors report and

auditors’ report etc in respect of each subsidiary company. It amounts to lifting the corporate

veil because in the eyes of law a subsidiary is a separate legal person and through this

mechanism their identity is known.

7.1.6 Section 247: The Central Government may appoint one or more inspectors to

investigate and report on the membership of any company for the purpose of determining the

true persons who are financially interested in the company and who control its policy or

materially influence it.

7.2 Judicial Pronouncement on Piercing the Corporate Veil: Ever since the concept of

‘Separate legal Personality’ and ‘Limited Liability was laid down in the famous judgment of

Salomon v. Salomon 39, the courts have been reluctant to pierce the corporate veil and hold

the members of the company liable. Nevertheless the courts in a number of cases have

considered it necessary to ignore the separate legal entity of a company. A few such cases are

discussed below:

38 Hendon v. Adelman 1973 New Delhi LR 637.

39 Supra Note 7.

18

In Dinshaw Manakjee Petit40 , the assessee who was a very rich man, enjoyed large dividend

and interest income. He formed four private companies and agreed with each to hold a block

of investment as an agent for it. The income received was credited in the accounts of the

company but the company handed back the amount to him as a pretended loan. This way he

divided his income in four parts in order to reduce his tax liability. It was held that ‘the

company was formed by the assessee purely and simply as a means of avoiding super- tax

and the company was nothing more than the assessee himself, it did no business...’. The

Court decided to disregard the corporate entity as it was used for tax evasion.

Avoidance of Welfare legislation is as common as avoidance of taxation and the

approach in considering problems arising out of such avoidance has necessarily to be the

same and therefore, where it was found that the sole purpose for the formation of the new

company was to use it as a device to reduce the amount to be paid by way of bonus to

workmen the Supreme Court in The Workmen Employed in Associated Rubber Industries Ltd,

Bhavnagar v. The Associated Rubber Industries Ltd, Bhavnagar and another41 upheld the

piercing of the veil to look at the real transaction.

In Calcutta Chromotype Ltd. v. Collector of Central Excise, Calcutta42 : the Court held that

there is no bar on the authorities to lift the veil of a company, whether a manufacturer or a

buyer, to see it as not wearing that mask, or not being treated as related person, when, both,

the manufacturer and the buyer, are in fact the same persons. It held that tax planning may be

legitimate provided it is within the framework of law but colourable devices cannot be part of

tax planning. Dubious methods resorting to artifice or subterfuge to avoid payment of taxes

on what really is income can today no longer be applauded and legitimised as a splendid

work by a wise man but has to be condemned and punished with severest of penalties and for

that purpose if a person is found to indulge therein the lifting of veil would also be justified.

8. Where the Court refused to lift the Veil of Corporation:

The theory of corporate entity is still the basic principle on which the whole law of

corporations is based.

40 AIR 1927 Bom. 371

41 AIR 1986 SC 1.

42 1998(99)ELT202(SC)

19

A. Indian Context: The shareholders cannot ask for lifting the veil for their purposes: This was

upheld in Premlata Bhatia v. UOI43 wherein the premises of a shop were allotted on a license

to the individual. She set up a wholly owned private company and transferred the premises to

that company with the consent of the Government. She could not remove the illegality by

saying that she and her company were virtually the same person.

Holding Company`s Subsidiary with Substantial Interest: The question of piercing the veil

was held irrelevant where the holding company`s subsidiary had a substantial interest,

particularly when it had not accepted any such liability. 44

Azadi Bachao Aandolan vs. Union of India45 In this landmark judgment, the court held that

even if a transaction has been entered into with the primary motive of avoiding tax, such

transaction would not become a colourable device and thus not result in disqualification.

Here, the courts relied on the judgment of the Westminster case which laid down the

principle “an act which is otherwise valid in law can be treated as non est merely on the basis

of some underlying motive supposedly resulting in some economic detriment or prejudice to

the national interests, as perceived by the respondents”. The court in this case has also

attempted to make a distinction between tax planning and tax avoidance. However, this

distinction has very little relevance in the present era because of the varying and conflicting

court views. Thus we can summarize that Colourable Devices are sin qua non.

8.2 International Context: Where the justice of the case does not warrant the lifting the

corporate veil, the courts have shown a reluctance to do so, irrespective of the degree of

control exerted over the company by a third party.46

There is one well recognized exception to the rule prohibiting the piercing of the ‘corporate

veil’. This exception today is generally expressed as permitting disregard of the company

when the corporate structure is a “mere façade concealing the true facts” – “façade” or

43 (2004) 58 CL 217 (Delhi)

44 SAE (India) Ltd v. EID Parry (India) Ltd (1998) 18 SCL 481(Mad.)

45 (2003) 263 ITR 706 (SC)

46 Berna Collier Common Law Principles applicable to lifting- The Corporate veil Malaysia and Singapore, (1998) Canta L

R at 58.

20

“sham” having replaced an assortment of epithets47 which judges have employed in earlier

cases. The difficulty is to know what precisely may make a company a “mere façade”.

In general the court felt that it was “left with rather sparse guidance as to the principles which

should guide the court in determining whether or not the arrangement of the corporate group

involve a façade….” but, unfortunately, it declined to “attempt a comprehensive definition of

those principles”.

9. Piercing the Corporate Veil under Taxation Laws:

Tax planning may be legitimate if it is within the framework of law. Colorable devices cannot

be part of tax planning and it is wrong to encourage or entertain the believe that it is

honorable to avoid payment of tax by resorting to dubious methods. It is the obligation of

every citizen to pay the taxes honestly without resorting to subterfuges. It is up to the court to

take stock to determine the nature of the new and sophisticated legal devices to avoid tax and

to expose the devices for what they really are and to refuse to give judicial benediction.48The

court has the power to disregard the corporate entity if used for tax evasion or to circumvent

tax obligation.49

9.1 Lifting or Piercing of Corporate Veil in Taxation Matters: India

A recent ruling, dated 24th March 2011, of the High Court of Karnataka50 in the case of

Richer Holding Ltd. (RHL). The issue before the High Court was whether RHL was obliged

to withhold tax on the consideration paid for acquisition of 60% of the shares in a UK

company that held a majority stake in an Indian Company. The High Court rejected the

petition filed by RHL against the show cause notice by the Tax Authority since it was

premature it was premature at this stage to arrive at a conclusion that there is no avoidance of

tax obligations and RHL was not liable to tax on capital gains. Hence, RHL would need to

appear before the tax authority, which was directed to consider the case and pass appropriate

orders in accordance with law. The High Court also observed that it may be necessary for the

Tax Authority to lift the Corporate Veil as well as examine the extent of powers the majority 47 Bugle Press, Re[1961] Ch. 270 at 288, CA.

48 Supra Note. 31.

49 Deputy Commissioner v. Chetan Transport Corp. Ltd., (1992) 74 Comp.Cas. 563 (Mad.)(DB).

50 Writ Petition No. 7716/2011.

21

shareholder had in the interest/assets of the Indian Company to look into the real nature of the

transaction.

In Vodafone International Holdings BV v. UOI51 Hutchinson International (non-resident

company) held 100% shares of CGP Investments Holdings Ltd. (non-resident

company) which in turn held 67% shares in the Indian company Hutchinson-Essar.

Hutchinson-Essar was a joint venture between Hutchinson International and Essar. Vodafone

International Holdings BV (non-resident company) acquired the entire share capital of CGP

Investments Holdings Ltd. from Hutchison International. This resulted in an indirect transfer

of 67% shareholding in Hutchinson-Essar to Vodafone.

The question which arose was, whether the income accruing to Hutchinson as a

result of the transaction could be deemed to accrue or arise in India by virtue of Sec. 9 of the

Income Tax Act. The Income Tax Department issued Vodafone a show cause notice asking

why action should not be taken against it for failing to deduct tax at source under Sec. 195 of

the IT Act while making payment of the consideration to Hutch. The validity of the

show-cause notice was challenged by Vodafone in a writ petition before the Bombay High

Court. The High Court held that the writ petition challenging the show-cause notice was

premature as an alternative remedy was available to the petitioner. Vodafone appealed in the

Supreme Court. The petition was dismissed with a direction to re- agitate the jurisdictional

issue before the assessing officer.52

In Vodafone, the High Court answered all issues against Vodafone. However, final and

concrete conclusions cannot be drawn as the judgment was not dealing with the taxability of

the transaction. The court was only considering the validity of the show-cause notice issued

by the Department. Thus the judgment is more of an academic than of practical interest.

In Santanu Ray v. UOI53it was held that in case of economic offences the court is entitled to

lift the corporate veil and pay regard to the economic realities behind the legal façade. In this

case it was alleged that the company had violated Sec.11(a) of the Central Excises &Salt Act,

51 Vodafone International Holdings BV v. UOI, Ministry of Finance and Asst. Director of Income Tax(International

Taxation),[2009] 311 ITR 46 (Bom.)

52 Vodafone International Holdings BV v. Union of India, [2009] 179 TAXMAN 129 (SC).

53 (1989) 65 Comp.Cas. 196 (Delhi).

22

1944. The court held that the veil of corporate entity could be lifted by the adjudicating

authorities so as to determine as to which of the directors were concerned with the evasion of

excise duty by reason of fraud, concealment or willful misstatement or contravention of the

provisions of the Act.

9.2 Piercing of Corporate Veil in Tax Matters: International Context.

Judicial Pronouncement on Piercing the Corporate Veil: A corporation is a separate entity

from its shareholders and is subject to taxation separate and apart from its shareholders.54

Similarly, separate corporations are generally treated as separate entities for tax purposes, no

matter how closely they may be affiliated, as in the case of a parent and wholly owned

subsidiary.55 Only in exceptional circumstances will courts ignore the separate existence of

Corporations.56 If a corporation was formed for a valid business reason or conducted

substantial business activities after its formation, it will be recognized for tax purposes.57

While the Supreme Court has intimated that and otherwise separate taxable corporate entity

may, in some circumstances, qualify as a non taxable agent of a principal,58 two perquisites

must be satisfied: relations with the corporation`s principal must not be dependent on the fact

that it is owned by the principal, and its business purpose must be carried on of normal duties

of an agent.59 Where a corporation qualifies as a nontaxable agent, shareholders may be

entitled to deduct loses sustained in transaction engaged in through the agent.60

The principal exceptions to the general rule of recognition are when the corporation is a sham

and when the corporation has been created for the purpose of tax avoidance.61it has been

considered, however, that whether or not a corporation a separate entity form the individual

54 Ganter v. C.I.R.,905 F.2d 241, 90-2 U.S. Tax Cas. (CCH) P 50335, 66 A.F.T.R. 2d 90-5163 (8th Cir. 1990).

55 King v. C.I.R.,458 F.2d 245, 72-1 U.S. Tax Cas. (CCH) P 9341, 29 A.F.T.R. 2d 72-869 (6th Cir. 1972).

56 Britt v. US, 431 F.2d 227, 70-1 U.S. Tax Cas. (CCH) P 9400, 25 A.F.T.R. 2d 70-1212 (5th Cir. 1970)

57 Evans v. C.I.R., 557 F.2d 1095, 77-2 U.S. Tax Cas. (CCH) P 9596, 40 A.F.T.R. 2d 77-5602 (5th Cir 1977)

58 National Carbide Corp. v. C.I.R, 1949-1 C.B 165, 336 US. 422, 69 S.C.t. 726, 93 L.Ed. 779, 49-1 U.S. Tax Cas. (CCH) P

9223, 37 A.F.T.R. (P-H) P 834, 10 A.L.R. 2d 566(1949).

59 Vaughn v. U.S., 740 F.2d 941, 84-2 U.S. Tax Cas. (CCH) P 9706, 54A.F.T.R.2d 84-5664(Fed. Cir. 1984).

60 C.I.R. v. Bollinger, 485 U.S.340,180 S. Ct. 1173, 99 L. Ed. 2d 357, 88-1 U.S. Tax Cas. (CCH) P 9233, 61 A.F.T.R. 2d 88-

793 (1988).

61 Britt v. U.S., 431 F.2d 227, 70-1 U.S. Tax Cas. (CCH) P 9400, 25 A.F.T.R.2d 70-1212 (5th Cir. 1970).

23

who created the corporation is not the same question as whether it was an alter ego for the

purpose of piercing the corporate veil and holding the individual liable for its taxes; and a

finding of separate taxable entity does not preclude personal assessment against the

individual.62

A corporation is subject to federal corporate income tax liability as long as it continues to do

business in the corporate manner, despite the fact that its recognized legal status under state

law is voluntarily or involuntarily terminated;63 and a valid corporation will be disregarded

for federal tax purposes only after the state has revoked its charter.64A liquidating corporation

continues its federal tax existence so long as it retains valuable assets.65

A stark illustration in a recent case is the court’s pointing to the defendant’s tax fraud as

among the facts leading to piercing.66The problem, of course, is that the defendant’s tax fraud

in this case had absolutely nothing to do with the plaintiff’s (who was a private creditor)

claim.67We might all agree that tax or other fraud is wrong, but to allow recovery by parties

who were not the victims creates a windfall.

10. Piercing of Corporate Veil under Direct Tax Code:

The new Direct Tax Code (hereafter DTC) is all set to replace the Income-tax Act, 1961 with

effect from 1st April, 2012, the basic objective behind its enactment being simplification of

the language so as to enable better comprehension thereby reducing the number of law suits.

Significant among the provisions that it introduces are the provisions aimed at tackling the

problem of tax avoidance since this has been resulting in a major loss of revenue for the

government. Certain legislative amendments68 had been made earlier to counter this

particular problem but did not prove very effective since the tax payers found sophisticated

methods to get passed them thereby necessitating further changes.

62 Harris v. U.S., 764 F.2d 1126, 85-2 U.S. Tax. Cas. (CCH) P 9511 ,56 A.F.T.R.2d 85-5471 (5th Cir. 1985).

63 Messer v. C.I.R., 438 F.2d 774, 71-1 U.S. Tax Cas. (CCH) P 9214, 27 A.F.T.R.2d 71-621 (3d Cir. 1971).

64 U.S. v. Young, 604 F. Supp. 164, 85-2 U.S. Tax Cas. (CCH) P 9643, 56 A.F.T.R.2d 85-5196 (N.D. Okla. 1984).

65 Supra Note 43.

66 Sea-Land Servs., Inc. v. Pepper Source, 1993 F.2d 1309 (7th Cir. 1993)

67 Ibid. at 1312-13.

68 These legislative amendments also resulted in making the Act more complex thereby resulting in an increase in tax suits.

24

The current Income Tax Act 1961 marks a difference between ‘Tax avoidance’ and ‘tax

evasion’. Tax evasion refers to a situation where a person tries to reduce his tax liability by

deliberately suppressing the income or by inflating the expenditure. An assessee guilty of tax

evasion is punishable under the relevant laws. On the other hand tax avoidance refers to any

planning, though done strictly according to legal requirements but destroys the basic intention

of the statute, the assessee will be punishable under such circumstances only in the event of

colorable device69. The new GAAR provisions perceives all form of tax planning resulting in

tax avoidance as inequitable and undesirable. It echoes the above principle in the following

words:

“Tax avoidance, like tax evasion, seriously undermines the achievements of the public

finance objective of collecting revenues in an efficient, equitable and effective

manner.…Therefore, there is a strong general presumption in the literature on tax policy

that all tax avoidance, like tax evasion, is economically undesirable and inequitable. On

considerations of economic efficiency and fiscal justice, a taxpayer should not be

allowed to use legal constructions or transactions to violate horizontal equity.”

10.1 Reasons for Introducing GAAR:

Since the liberalization of the Indian economy, increasingly sophisticated forms of tax

avoidance are being adopted by the tax players and their advisers. The problem has been

further compounded by tax avoidance agreements spanning across several tax jurisdictions.

This has led to severe erosion of tax base. Further, appellate authorities and courts have being

placing a heavy onus on the revenue when dealing with matters of tax avoidance even though

the relevant facts are in the exclusive knowledge of the tax payer and he chooses not to reveal

them.70

In view of the above, it was necessary and desirable to introduce a general anti avoidance rule

which will serve as a deterrent against such practices. This is also consistent with the

international trend.

10.2 Provisions of General Anti Avoidance Rule: The DTC proposes to introduce General

Anti Avoidance Rule (GAAR) in the Indian tax legislation. The GAAR is a broad set of 69 Supra Note 50.

70 Discussion Paper on Direct Tax Code Bill 2009, Chap. XXIV (Para. 24.2)

25

provisions which can invalidate an arrangement that has been entered into by a tax payer with

the main objective of obtaining tax benefit.

GAAR is an explicit anti avoidance measure for the revenue authorities of a jurisdiction to

recognise aggressive tax planning by tax payers. GAAR provisions in domestic tax

legislations of the respective jurisdiction enable the authorities to re-assess the tax

consequences of a transaction, or a series of transactions where they have been entered into

with a primary purpose of tax avoidance.

10.3 Conditions under which GAAR may be invoked:

The DTC contains the following provisions under which these rules can be invoked:

a. It is required that the tax payer must have entered into an arrangement.

b. The basic purpose for which the arrangement has been entered into must be to obtain tax

benefit provided.

i. The arrangement is such which is not normally applied for bona fide business purposes.

ii. The transaction is in conflict with the code.

iii. The transaction lacks commercial substance either in whole or in part.

iv. The transaction creates an obligation which is not normally created between people at

arm’s length71.

v. A threshold limit will be prescribed and if the tax avoidance in an arrangement is above

this threshold limit, only then will the rules be applicable.

vi. A Dispute Panel Resolution22 will be set up under which the aggrieved parties can

approach the panel.

71 Arms’ length may be defined as a deal between two interrelated or enterprise associates parties. That is behaviour as if

they were not related, so that there is no query of a disagreement of attention. In simple way we can describe this as “a deal

between two unconnected or associate parties

26

vii. The Central Board of Direct Taxes has also been given the power to issue guidelines

under which these rules could be invoked.

10.4 Comparative Study (In International Context)

10.4.1 Canadian GAAR:

The GAAR provisions of Canada which is incorporated under S. 245 of the Canadian Income

Tax Act (“Act). S. 245 of the Act was introduced with effect from 13 Sep 1988 as a response

to the decision of the Canadian Supreme Court in Stubart Investments Limited v. The

Queen.72 S. 245(3) stipulates the transactions which are deemed to be avoidance transactions

for which consequences would follow as u/s 254(2) read with 245(5) [ Sec. 245(5) is not

quoted above]. A Conjunctive reading of Sec. 245(3) (a) and 245(3) (b) suggests that an anti-

avoidance transaction is one which is made “only” to obtain a tax benefit. More importantly,

a literal interpretation of Sec. 245(4) would suggest that the other provisions of the Act have

to be looked into before the GAAR provisions are invoked. In contrast DTC, categorizes any

transaction whose ‘main purpose’ is to obtain tax benefit as impermissible avoidance

arrangement. Evidently, in this regard the GAAR provisions under the DTC are of wider

import than Sec. 245 of the Canadian Income Tax Act. Further, DTC stipulates that a

transaction which “lacks commercial substance” in any manner may be deemed as

impermissible avoidance arrangement. If one peruses DTC which defines the term “lacks

Commercial substance” it would leave no iota of doubt that GAAR provisions under the DTC

are far wider than its Canadian counterpart. It is also worth noticing that the Canadian IT Act

does not presume any transaction to be for the “main purpose” of obtaining a tax benefit

unlike.

The GAAR, which began to be considered by the lower level courts a few years ago,

generally resulted in judgments in favour of the taxpayer, and seemed to put significant

limitations on its use.73 Recently, however, the GAAR environment has undergone a

significant change since it was first considered by Supreme Court in the The Queen v.

Canada Trustco Mortgage Company case.74

72 [1984] CTC 294

73 http://www.bdo.ca/library/publications/tax/taxfactors/2006-03c.cfm (last visited 26th September 2011)

74 2005 SCR 601.

27

In fact recent judgments have created confusion. A good example of this confusion comes

from two recent decisions- the Overs v. The Queen75 and Lipson v. The Queen76.the decision

in overs serves as a stark contrast to the decision reached in Lipson where the court

concluded that the GAAR did apply.

10.4.2 UK GAAR:

Doctrines in the UK and other Commonwealth countries usually commences with the seminal

Duke of Westminster case.77 He cites the case not only for the obvious point that the House

of Lords affirmed the right of taxpayers to arrange their affairs to minimise tax, but also for

the more subtle and arguably more influential point that the courts cannot tax on the basis of

economic substance but must respect the legal rights and obligations created by the parties:

The doctrine emerging from the Westminster case is that taxpayers and the Revenue are

bound by the legal results which the parties have achieved –even though this may be

inconvenient for the Revenue. The court cannot disregard those facts just because of the tax

avoidance purpose which may have led the parties to create those facts in the first place.

However, the Duke of Westminster principle does not mean, as some have suggested, that the

legal form of a transaction is conclusive. A court is not bound by the labels that the parties

have attached to their transactions; it is entitled to examine all of the facts ‘to discover the

true character in tax law of the transaction entered into’. This fundamental principle emerging

from the Duke of Westminster case is not just trotted out in the interests of tradition.

Moreover, the Duke of Westminster case is still ‘absolutely correct’ based on a rigorous legal

analysis of the contractual relations between the Duke and his gardener. Only by applying an

economic substance approach such as the US business purpose test, is it possible to conclude

that the gardener continued to receive his full wages after the Duke executed the deed to

provide the gardener with an annuity equal to a portion of his wages.78

75 2006 DTC 2192

76 2006 DTC 2687

77 IRC v. Duke of Westminster[1936] AC 1 (H).

78 An alternate possibility would be to treat the annuity as a sham because it was never intended that the contractual

arrangement between the Duke and his Gardener would be acted upon. It was understood that the gardener would not sue the

28

10.6 Criticism of GAAR:

The GAAR invoked a lot of criticism. Some of the Criticisms have been summarised below:

The Income Tax Act permitted minimisation of taxes. However the Direct Tax Code

withdraws this benefit and now describes tax minimisation as an offence. This provision will

now be in conflict with the decision given by the Supreme Court under Union of India v.

Azadi Bacho Andolan.79

The sweeping reach of GAAR might have application, even if a transaction does not result in

the misuse or abuse of provisions of the code as long as the transaction lacks commercial

substance. Clearly, the subjective intent manifested in Indian GAAR needs deeper thinking

and alignment with global standards. While, agreeably most anti-avoidance rules may seem

to require some level of subjective intent to avoid taxes, in the Indian context this analogy

assumes significance given the pro-revenue record of tax disputes in India. Even where the

subjective intent to avoid taxes is required, the question arises whether or not this must be the

sole intent of the transaction.

Another pertinent aspect in the implementation of GAAR provisions is how the

administration would go about determining the intent of the taxpayers; whether the intent of

transaction should be determined on a subjective basis or rather objectively. In the first

instance, it is a determination based on evidence of the state of mind of taxpayers; while in

the latter instance, it is a legal question of drawing consequences from objective

circumstances surrounding the transaction.

The applicability of DTAA is subject to GAAR and CFC provisions. As the contours of

GAAR and CFC provisions are highly ambiguous, the applicability of DTAA has

become unpredictable. Further, a company is a “resident” if BoD of the company or

its executive directors take decisions in India.

Accordingly, a company may be treated as a resident even when the BoD takes an ordinary

decision in India. This can have far-reaching adverse tax implications. Thus the provision

Duke to obtain his full wages. And it is significant in this regard that the Duke entered into these arrangements only with

long- term loyal employees.

79 Supra Note 33

29

needs further statutory elucidation to mean that the place of effective management is the

place where key management and commercial decisions that are necessary for

the conduct of the entity’s business are, in substance, made.

10.7 Recommendations:

International best practices, such as Canadian GAAR, which specifically provides misuse of

domestic tax law as a pre-condition for invoking GAAR along with the condition of

commercial substance. Also, the onus to prove that the transaction does not involve the

misuse of provisions of the DTC being on taxpayer is against the spirit of natural justice and

not aligned with international practices (Canadian GAAR requires the revenue authorities to

prove the misuse of domestic legislation; if such misuse cannot be decisively determined,

benefit of doubt goes to taxpayer).80

Swedish rules consider it sufficient that the revenue authorities can demonstrate that

based on circumstances, it can be assumed that obtaining a tax advantage was the sole motive

underlying the transaction, and hence, GAAR should be applied. On the other hand, Australia

perhaps has the most elaborate objective rules for deciding whether the intent of a particular

transaction was to avoid tax or not.

There are varied international precedents when it comes to the interaction between the

general and special anti- abuse provisions, with some jurisdictions ruling out applicability of

general anti-avoidance measures in cases were more specific anti-abuse provisions have been

applied (eg. Germany)

11. Conclusion: We advise a cautious approach in using a corporate entity in tax planning

especially considering the common practice among MNCs in establishing Special Purpose

Vehicles (SPVs) in tax havens for holding shares in downstream Indian companies. It is

advisable to obtain a nil withholding tax order from the tax authority before proceeding with

any use of the corporation as a vehicle for tax planning. DTC condemns tax avoidance on

moral, ideological and economic grounds. However, payment of taxes may not be as

sacrosanct as it is considered, which is well articulated in the observation of Sabyasachi

Mukharji, J. in Commissioner of Wealth Tax, Gujarat-II, Ahmedabad v. Arvind Narottam81:

80 See Section245 of Canadian Income Tax Act (R.S.C., 1985, c.1(5th Supp.))

81 Commissioner of Wealth Tax, Gujrat-II,Ahmedabad v. Arvind Narottam, AIR 1988 SC 824

30

“It is true that tax avoidance in an under-developed developing economy should not be

encouraged on practical as well as ideological grounds. One would wish, as noted by Reddy,

J. that one could get the enthusiasm of Justice Holmes that taxes are the price of civilization

and one would like to pay that price to buy civilization. But the question which many

ordinary tax-payers very often in a country of shortages with ostentious consumption and

deprivation for the large masses ask, is does he with taxes buy civilization or does he

facilitate the wastes and ostentiousness of the few. Unless wastes and ostentiousness in

Government’s spending are avoided or eschewed, no amount of moral sermons would change

people’s attitude to tax avoidance.”

31

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8. Vipul Jhaveri, Lifting the Corporate Veil for Checking Tax Avoidance

www.moneycontrol.com/news/features/lift-the-corporate-veil-says-karnataka-hc-

537688.html (last visited on 26th August 2011).

Books:

1. Gower and Davies, Principles of Modern Company Law, Sweet & Maxwell (8Th

Edition,2008.)

2. A.K. Majumdar & Dr. G.K Kapoor, Company Law Taxmann`s (3rd ed. 2009).

3. Avtar Singh, Company Law Eastern Book Company`s (14th ed. 2005).

4. C.R Datta, Company Law Lexis-Nexis, Butterworths, Wadhwa, Nagpur (6th Edition

2008).

5. Dr. Vinod. K. Singhania & Dr. Kapil Singhania, direct tax laws & practice, Taxmann’s

(43rd Edition, 2010-11).

32

6. Dr. Vinod. K. Singhania & Dr. Kapil Singhania Income Tax Rules, Taxmann’s (47th

Edition, 2010-11).

7. J.F Northey, Introduction to Company Law, Butterworths (8th Edition 1980).

8. Paul L. Davies, Principles of Company Law, Sweet & Maxwell (8th Edition 2008).

9. N.A. Palkhivala, We, the People, (Strand Book Stall, 1984).

e- sources

1. www.manupatra.com

2. www.westlaw.com

3. www.indlaw.com

4. www.lexisnexis.com

5. www.legalserviceindia.com

6. www.itatonline.com

7. www.taxindia.com

8. www.caclubindia.com

9. www.corporatelaw.com

10. www.taxman.com

11. www.clalawonline.com

12. www.scconline.com

13. www.heinonline.com

14. www.jstor.org

15. www.mca.gov.in