Case Note & Summary
The appeal arose from a reference under Section 66(2) of the Indian Income-tax Act, 1922 concerning the applicability of Section 23A to the assessee company, a public limited company, for the assessment year 1943-44. The Income-tax Officer had applied Section 23A on the ground that the company was not one in which the public were substantially interested, as the dividend declared fell short of the statutory requirement. The company contended that the public held more than 25% of the voting power and therefore Section 23A should not apply. The Bombay High Court, after initially remitting the case for a supplementary statement, ultimately answered the reframed question against the assessee, holding that shares held by three sons of a director were not held by members of the public because they were under the de facto control of their father. The assessee appealed by special leave to the Supreme Court. The material facts showed that the company’s issued capital was Rs. 10,00,000 divided into 10,000 shares. One director, Maganlal Parbhudas, originally held 6,344 shares, but had gifted 1,000 shares to each of his five sons. During the relevant accounting period, the company had eight directors who together held 4,695 shares. Relatives of directors held 4,754 shares, including the three sons Bipinchandra, Harishchandra and Krishnakumar, each holding 1,000 shares. The remaining 551 shares were held by members of the public unrelated to directors. The Managing Agents were Ravindra Maganlal & Co. Ltd., and the five sons of Maganlal Parbhudas had subscribed its capital equally. Three sons, Ravindra, Surendra and Bipinchandra, were directors of the Managing Company. The core legal issue was the meaning of the expression “held by the public” in the Explanation to the third proviso to Section 23A. The Revenue contended that the shares of directors and those of relatives under the control of directors should be excluded from public holding, leaving less than 25% with the public. The assessee argued that directors as a class could not be automatically excluded from the public, and that mere relationship did not deprive relatives’ shares of public character unless actual control was proved. The Supreme Court held that the word “public” is used in contradistinction to one or more persons who act in unison and among whom the voting power constitutes a block. If such a block possesses more than seventy-five per cent of the voting power, the company cannot be said to be one in which the public are substantially interested. The test is to identify whether an individual or group controls the voting power as a block; only shares held unconditionally and beneficially by the public uncontrolled by the controlling group can be counted. Directors are not automatically outside the public; they must hold shares unconditionally and beneficially for themselves. Mere relationship is insufficient; there must be proof that one relative controls the voting power of another. In the present case, the Tribunal had found that Maganlal Parbhudas exercised de facto control over his three sons, and this finding was supported by evidence. Accordingly, the shares held by those sons could not be treated as held by the public. Excluding the directors’ 4,695 shares and the three sons’ 3,000 shares left the public holding below the required 25%. The Supreme Court dismissed the appeal and answered the reframed question in the negative, holding that Section 23A was applicable.
Headnote
A) Income Tax - Company in which public are substantially interested - Scope of 'public' - The word 'public' in the Explanation to third proviso to Section 23A is used in contradistinction to a controlling block; shares held by such block are not held by public - Indian Income-tax Act, 1922 (11 of 1922), Section 23A Third Proviso Explanation - The assessee company had directors holding 4,695 shares and relatives holding 4,754 shares; only 551 shares were held by unrelated public. The Income-tax Officer applied Section 23A because the dividend declared was less than statutory requirement. The court held that the test is to identify whether an individual or group controls voting power as a block; if such block possesses more than 75% voting power, the company cannot be said to be one in which the public are substantially interested. Held that shares held by a controlling block cannot be treated as held unconditionally or beneficially by public (Paras 16-18). B) Income Tax - Directors as Members of Public - Directors not automatically outside 'public' - Directors can be part of public if they hold shares unconditionally and beneficially for themselves, without being controlled by a group - Indian Income-tax Act, 1922, Section 23A Third Proviso Explanation - The High Court initially treated directors' shares as automatically not held by public, but the Supreme Court held this view erroneous, following Commissioner of Income-tax v. H. Bjordal. A director is outside public only if he does not hold shares unconditionally and beneficially for himself. Held that mere status as director does not exclude shares from public (Paras 16-18). C) Income Tax - Relatives and De Facto Control - Mere relationship insufficient - Actual control over voting power required to exclude relative's shares from public - Indian Income-tax Act, 1922, Section 23A Third Proviso Explanation - The three sons of a director held 1,000 shares each; the Tribunal found they were under de facto control of their father, who was a director. The court held that mere relationship is of no consequence unless it is proved that voting power of one relative is controlled by another; here there was evidence of de facto control. Held that shares so controlled cannot be counted as held by public (Paras 14-15). D) Income Tax - Application of Section 23A - De Facto Control Block Disqualifies Company - Since the controlling block included directors and three de facto controlled sons, total public holding fell below 25%, so Section 23A applicable - Indian Income-tax Act, 1922, Section 23A(1) - The company had 10,000 shares; public needed at least 2,500 shares to avoid Section 23A. After excluding directors' 4,695 shares and the three de facto controlled sons' 3,000 shares, remaining public holding was less than 25%. Held that the assessee company was not one in which the public are substantially interested and Section 23A applied (Paras 17-18).
Issue of Consideration
Whether shares held by directors must always be regarded as not held by the public under the Explanation to the third proviso to Section 23A of the Income-tax Act, 1922; What is the proper meaning of 'held by the public' in the Explanation, particularly whether shares held by relatives of directors can be considered held by the public if they are under de facto control of a director; Whether Section 23A was applicable to the assessee company for assessment year 1943-44 given the shareholding pattern
Final Decision
Appeal dismissed; Supreme Court held that the High Court correctly answered the reframed question in the negative; the shares held by Bipinchandra, Harishchandra and Krishnakumar could not be considered shares held by members of the public within the meaning of Explanation to third proviso to Section 23A, because they were under de facto control of their father Maganlal Parbhudas; Section 23A applicable.
Law Points
- The word 'public' in the Explanation to the third proviso to Section 23A of the Income-tax Act
- 1922 is used in contradistinction to one or more persons who act in unison and among whom the voting power constitutes a block
- If such a block exists and possesses more than seventy-five per cent of the voting power
- the company cannot be said to be one in which the public are substantially interested
- The test is first to find out whether there is an individual or a group which controls the voting power as a block
- Only those shares which are unconditionally and beneficially held by the public uncontrolled by the controlling group can be treated as shares held by the public under the Explanation
- Directors merely by reason of their being Directors do not stand outside the 'public'
- Mere relationship is of no consequence unless it is proved that the voting power of one relative is controlled by another relative
- De facto control over voting power
- not just legal relationship
- determines whether shares are held by the public
