Lifting the Corporate Veil: A Practical Overview
P r oject oject Sub S ubm mi tte tted By B y : Prakhar Bhandari Semester V Roll No. 114
Project Submitted To: Dr. Deepak Das Faculty: Corporate Law-I
Hidayatullah National Law University, New Raipur
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ACKNOWLEDGEMENTS:
First and foremost, I would like to thank my Corporate Law teacher, Dr. Deepak Das for offering this subject and for his valuable guidance and advice. He inspired me greatly to work on this project. His willingness to motivate me contributed tremendously to my project. Besides, I would like to thank the Hidayatullah National Law University for providing me with a good environment and facilities to complete this project. Last but not least, I would like to thank all m y friends who helped me do this project by sharing their ideas when we combined and discussed together.
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Prakhar Bhandari ROLL NO. 114 SECTION: C
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Contents ........................................................................................................................................ 4 Table of Cases. ........................................................................................................................................ ........................................................................................................... 5 RESEARCH METHODOLOGY. ........................................................................................................... .................................................................................................................................. ............................................................ 6 INTRODUCTION ......................................................................
COMPANY AS SEPARATE LEGAL ENTITY .................................................................................... 7 ............................................................................................... ...................................... 9 LIFTING OF THE CORPORATE VEIL .........................................................
JUDICIAL PROVISIONS OR GROUNDS FOR LIFTING THE VEIL ............................................. 13 STATUTORY PROVISIONS FOR LIFTING THE VEIL .................................................................. 16 ...................................................................................................................................... ..................................................................... 18 Vodafone Case .................................................................
Facts leading to the Dispute .............................................................................................................. 18 ........................................................................................................ ............................................... 19 Issue before the Supreme Court .........................................................
Arguments of Revenue ........................................................... ..................................................................................................................... .......................................................... 19 ....................................................................................... 19 Observations made by the Supreme Court ........................................................................................ .................................................................................................................................... 20 CONCLUSION ..................................................................................................................................... ..................................................................................................................................... ...................................................................... 21 REFERENCES ...............................................................
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Table of Cases Daimler Co.Ltd V. Continental Tyre And Rubber Co.Ltd D.H.N. Food products Ltd. v. Tower Hamlets London Borough Council Gas Lighting Improvement Improvement Co. Ltd. v. IRC Gilford Motor Company Ltd v. Horne H.L. Bolton (Engineering) v. T.J. Graham & Sons Ltd. Hobart Bridge Co. Ltd. v. FCT Industrial Equity v. Blackburn Jones v. Lipman Kapila Hingorani V/s State of Bihar Lee v. Lee’s Air Farming Littlewoods Mail Order Stores Ltd. v. IRC Macaura v. Northern Assurance Co. Ltd New Horizons v. Union of India India Novartis v. Adarsh Adarsh Pharma Odyssey (London) Ltd. v. OIC Run Off Ltd. Re F.G.Films ltd Salomon v. Salomon & Co. Ltd. State of UP v. Renusagar Tata Engineering Locomotive Locomotive Co v. State of Bihar Vodafone International International Holding (VIH) v. Union of India
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RESEARCH METHODOLOGY Research Problem/ Rationale:
This project seeks to examine the concept of Corporate Veil, its significance, idea behind a separate legal entity, a legal fiction--all from a practical viewpoint.
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INTRODUCTION Corporate personality has been described as the ‘most pervading of the fundamental principles of company law” 1. It constitutes the bedrock principle upon which company is regarded as an entity distinct from the shareholders constituting it. When a company is incorporated it is treated as a separate legal entity distinct from its promoters, directors, members, and employees; and hence the concept of the corporate veil, separating those parties from the corporate body, has arisen. The issue of “lifting the corporate veil” has been considered by courts and commentators for many years and there are instances in which the courts have negated from the strict application of this doctrine. This doctrine has been established for business efficacy, necessity and as a matter of convenience.2
In the doctrine of ‘Lifting the Corporate Veil’, the law goes behind the mask or veil of incorporation in order to determine the real person behind the mask for the purpose of holding them liable. 3 But for clarity as to ‘Lifting of the Corporate Veil’, an understanding of the corpora te personality of a company is required, along with study of the provisions of Indian law that pave the way for courts to pierce the corporate veil. Various grounds for piercing of the corporate veil and elements of lifting of corporate veil analyzed through the lens of leading case laws and judgements form the crux of this project report.
1
http://corporatelawreporter.com/2013/06/12/lifting-of-corporate-veil-with-reference-to-leadingcases/#_ftn1 2 Ibid 3 http://www.lslaw.in/Uploads/MediaTypes/Documents/TOP_DISCUSSION_TAX_Direct%20Tax_Corporate_veil _nikhil.pdf, as assessed on 29th September 2015
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COMPANY AS SEPARATE LEGAL ENTITY The company as a separate entity was firmly fir mly established in the landmark decision in Salo Salom mon
v. Sa S alomo lomon & C o. Ltd L td .4 Salomon, a sole trader, sold his manufacturing business to Salomon & Co. Ltd. (a company he incorporated) in consideration for all but six shares in the company, and received debentures worth 10 thousand pounds. The other subscribers to the memorandum were his wife and five children who each took up one share. The business subsequently collapsed, and Salomon made a claim, on the basis of the debentures held, as a secured creditor. The liquidator argued that Salomon could not rank ahead of other creditors because, in fact, the company and Mr. Salomon were one and the th e same – same – or or alternatively, that the company carried on business on Salomon’s behalf.
On appeal, the House of Lords held that Salomon & Co. Ltd. was not a sham; that the debts of the corporation were not the debts of Mr. Salomon because they were two separate legal entities; and that once the artificial person has been created, “it must be treated like any other independent person with its rights and liabilities appropriate to it self.” 5
In Maca Macaura v. Northe Northerr n Assura Assuranc nce e Co. Ltd the House of Lords decided that insurers were not liable under a contract of insurance on property that was insured by the plaintiff but owned by a company in which the plaintiff held all the fully-paid shares. The House of Lords held that only the company as the separate legal owner of the property, and not the plaintiff, had the required insurable interest. The plaintiff, being a shareholder, did not have any legal or beneficial interest in that property merely because of his shareholding. In Lee v.
Lee’s Air
F arming rming 6, the Privy Council held that Lee, as a separ ate and distinct entity from the company which he controlled, could be an employee of that company so that Lee’s wife could claim workers’ compensation following her husband’s death. In H obar t B r i dge Co. Lt L td. v. F C T 7 relying on the judgment by Lord Sumner in G as Light Li ghtii ng
I mpr ovem vement C o. Ltd L td.. v. I R C 8, Kitto .J summarizes the position in the following manner:
4
[1897] A.C. 22 [1925] A.C. 619 6 [1925] A.C. 619 7 (1951) 82 C.L.R. 372, 385 8 1923] A.C. 723, 741 5
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“Between the investor, who participates as a shareholder, and the and the undertaking carried on, the law imposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham …” 9
More recently, the High Court in I ndust ndustrr i al E quity v. Bla B lackb ckbur urn n has held that the principle operates to prevent a holding company from treating a wholly-owned subsidiary’s profits as its own. Therefore, it can be seen that there has been, and still is, the highest authority for the separate entity concept.
However, consideration has to be given to the limitations of the separate entity principle which completely denies the efficacy of the corporate entity as a legal person separate from its founders, shareholders or management. Judgements as early as the Salomon case have indicated the recognition of exceptions to the principle of separate entity by the courts. Recognition of the separate entity entit y is possible provided there is “no fraud and no agency and if the company was a real one and not a fiction or myth.” According to Lord Denning 10
in L i ttlew “ca st a veil over tlewoods Ma M ai l Or der Stor Stor es Lt L td. v. I R C , incorporation does not fully “cast the personality of a limited company through which the courts cannot see. The courts can, and often do, pull off the mask. They look to see what really lies behind.” “A corporation will be looked upon as a legal entity as a general rule but when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime the law will regard the corporation as an association of persons.”
The two significant reasons as to why exceptions to the separate entity principle exist is that firstly, although a corporation is a legal person, it cannot always “be treated like any other independent person.” For example, a corporation is not capable of committing a tort or a crime requiring proof of mens rea unless courts disregard the separate entity and determine the intention held by the directors and/or shareholders of the corporation 11. Secondly, strict recognition of the principle may lead to an unjust or misleading outcome if interested parties can “hide” behind the shield s hield of limited liability. Judicial discretion and also legislative action allows the separate entity principle to be disregarded where some injustice is intended, or 9
(1977) 52 A.L.J.R. 8 [1969] 1 W.L.R. 1241, 1254 11 H.L. Bolton (Engineering) v. T.J. Graham & Sons Ltd. [1956] 3 All E.R. 624 10
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would result, to a third party (either internal or external to the company) with whom the company is dealing.
LIFTING OF THE CORPORATE VEIL
Lifting or piercing the veil is corporate law’s most widely used doctrine to decide when a shareholder or shareholders will be held liable for obligations of the corporation. Lifting the veil doctrine exists as a check on the principle that, in general, investor shareholders should not be held liable for the debts of their corporation beyond the value of their investment. The corporate evil is said to be lifted when the court ignores the company and concerns itself directly with the members or the managers. “It is impossible to ascertain the factors which operate to break down the corporate insulation.” The matter is largely in the discretion of the courts and will depend upon “the underlying social, econo mic and moral factors as they operate in and through the corporation corporation.” .” 12 It can be said “that adherence to the Solomon principle will not be doggedly followed where this would cause an unjust result”. 13 One of the grounds for lifting of the corporate veil is fraud. The courts have pierced the corporate veil when it feels that fraud is or could be perpetrated behind the veil. The courts will not allow the Solomon principal to be used as an engine of fraud. The two classic cases of the fraud exception are G i lford lford Moto Motor C ompany Ltd L td v. Ho H or ne14 in which Mr. Horne was an exemployee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne. Horne. “In this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud.” Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings.
In the second case of J ones nes v. L ipma ipman
15
a man contracted to sell his land and thereafter
changed his mind in order to avoid an order of specific performance he transferred his
12
Tata Engineering Locomotive Co v. State of Bihar AIR 1965 SC 40 Odyssey (London) Ltd. v. OIC Run Off Ltd. (2000) TLR 201 CA 14 [1933] Ch. 935 (CA) 15 [1962] l WLR 832 13
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property to a company. Russel J specifically referred to the judgments in Gilford v. Horne and held that the company here was “a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity” he awarded specific performance both against Mr. Lipman and the company. Under no circumstances will the court allow any form of abuse of the corporate form and when such abuse occurs the courts will step in.
The second ground for piercing of corporate veil covers group enterprises. Sometimes in the case of group of enterprises the Solomon principal may not be adhered to and the court may lift the veil in order to look at the economic realities of the group itself. In the case of D.H.N.
F ood products products L td. td. v. To T ower wer H amlets lets Lo L ondon ndon Boroug B orough h Counc C ouncii l 16 it has been said that the courts may disregard Solomon’s case whenever it is just and equitable to do so. The court of appeal thought that the present case where it was one suitable for lifting the corporate veil. Here the three subsidiary companies were treated as a part of the same economic entity or group and were entitled to compensation. Lord Denning has remarked that we know that in “many respects a group of companies are treated together for the purpose of accounts, balance sheet, and profit and loss accounts”. The nature of shareholding and control would be indicators whether the court would pierce the corporate veil. In the case of Woolfsan 17 the House of Lords held that there was “no basis consonant with the principle upon which on the facts of this case the corporate veil can be pierced to the effect of holding Woolfson to be the true owner of Campbell’s business or the assets of Solfred, “the two subsidiary companies that were jointly claiming compensation for the value of the land and disturbance of business.
The House of Lords in the above mentioned case had remarked “properly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere facade concealing the true facts” In the figurative sense facade denotes outward appearance especially one that is false or deceptive and imports pretence and concealment. That the corporator has complete control of the company is not enough to constitute the company as a mere facade rathe r that term suggests in the context the deliberate concealment of the identity and activities of the corporator. The separate legal personality of the company, although a “technical point” is not a matter of form it is a matter of substance and reality and the corporator ought not, on every occasion, to be relieved of the disadvantageous consequences of an arrangement voluntarily entered into by the corporator 16 17
[1976] 1 WLR 852 (1978) SC (HL) 90
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for reasons considered by the corporator to be of advantage to him. In particular “the group enterprise” concept must obviously be carefully limited so that companies who seek the advantages of separate corporate personality must generally accept the corresponding burdens and limitations.
The third ground for piercing the corporate veil is agency. In the case of Solo Solom mon v.
Solo Solom mon Justice Vaughan Williams expressed that the company was nothing but an agent of Solomon. “That this business was Mr. Solomon’s business and no one else’s; that he chose to employ as agent a limited company; that he is bound to indemnify that agent the company and that this agent, the company has lien on the assets………” However on appeal to the House of Lords it was held that a company did not automatically become an agent of the shareholder even if it was a one man company and the other shareholders were dummies. A company having power to act as an agent may do so as an agent for its parent company or indeed for all or any of the individual members if it or they authorize it to do so. If so the parent company or the members will be bound by the acts of its agent so long as those acts are within actual or apparent scope of the authority. But there is no presumption of any such relationship in the absence of an express agreement between the parties it will be difficult to establish one. In Cape case attempt to do so failed. In cases where the agency agreement holds good and the parties concerned have expressly agreed to such an agreement them the corporate veil shall be lifted and the principal shall be liable for the acts of the agent. The courts may pierce the corporate veil to look at the characteristics of the shareholders. In the case of Abbey and Planning the court lifted the corporate veil. In this case a school was run like a company but the shares were held by trustees on educational charitable trusts. They pierced the veil in order to look into the terms on which which the trustee held the shares. Sometimes tax legislations warrant the lifting of the corporate veil. The courts are prepared to disregard the separate legal personality of companies in case of tax evasions or liberal schemes of tax avoidance without any necessary legislative authority. There are three components that the complainant must prove in order to pierce the corporate veil. Those elements are as follows
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1.
Control and domination: Control and determination part of the test determines the
relationship between the shareholder and the corporation. 18 Generally, mere majority stock ownership will be insufficient to satisfy this element. Instead, one must show “complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction has no separate mind, will or existence of its own.” To determine the existence of “complete domination”, courts usually require the plaintiff to produce evidence of inadequate capitalization or undercapitalization, failure to follow corporate formalities, commingling of funds, diversion of funds or assets for non-corporate purposes 19, etc.
2.
Improper purpose or use : This test requires the plaintiff to show that the control
exercised by the parent company compan y or dominant stockholder was “used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of plaintiff’s legal right.” Thus, this second inquiry focuses on the relationship between the plaintiff and the corporation. It is an explicit recognition that some improper conduct must have occurred beyond establishing that the corporation was controlled and dominated.
3.
Resulting damage or harm [21]: In this test the plaintiff must show that the
defendant’s control, exerted in a fraudulent, illegal or otherwise unfair manner toward it, caused the harm suffered. In other words, the plaintiff must prove that, unless the corporate veil is pierced, it will have have been treated unjustly by the defendant’s exercise of control and improper use of the corporate form and, thereby, suffer damages.
Therefore, the most important thing for the courts to remember while lifting the corporate veil is to exercise care to balance the competing goals of incorporation and protecting creditors.
18 19
White v. Jorgenson, Jorgenson , 322 N.W.2d 607, 608 (Minn. 1982) Miller Brewing Co. v. Best Beers of Bloomington, Inc. , 579 N.E.2d 626, 641 (Ind. Ct. App. 1991)
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JUDICIAL PROVISIONS OR GROUNDS FOR LIFTING THE VEIL
Fraud or improper conduct- The Courts have been more that prepared to pierce the corporate veil when it fells that fraud is or could be perpetrated behind the veil. The Courts will not allow the Salomon principal to be used as an engine of fraud. The two classic cases of the fraud exception are Gilford Motor Company Ltd v. Horne and Jones v. Lipman. In the first case, Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this, he incorporated a limited company in his wife's name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that "the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne" in this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud. Thus the Court of appeal regarded it as a mere sham to cloak his wrongdoings. In the second case of Jones v. Lipman, a man contracted to sell his land and thereafter changed his mind in order to avoid an order of specific performance he transferred his property to a company. Russel judge specifically referred to the judgments in Gilford v. Horne and held that the company here was "a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity" .Therefore he awarded specific performance both against Mr.Lipman and the the company. For benefit of revenue- “The Court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligations. A clear illustration is Dinshaw Maneckjee Petit, Re; The assesse was a wealthy man enjoying huge dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. 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 into four parts in a bid to reduce his tax liability. But it was held that, “the company was formed by the assessee purely 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, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee asse ssee as pretended loans”. Page | 13
Enemy character- A company may assume an enemy character when persons in de facto control of its affairs are residents in an enemy enem y country. In such a case, the Court may examine the character of persons in real control of the company, and declare the company to be an enemy company. In Daimler Co.Ltd V. Continental Tyre And Rubber Co.Ltd. 20 A company was incorporated in England for the purpose of selling in England, tyres made in i n Germany by a German company which held the bulk of shares in the English company. The holders of the remaining shares, except one, and all the directors were Germans, residing in Germany. During the First World War, the English company commenced action for recovery of a trade debt. Held, the company was an alien company and the payment of debt to it would amount to trading with the enemy, and therefore, the company was not allowed to proceed with the action. Where the company is a sham- The Courts also lift the veil where a company is a mere cloak or sham (hoax). Company avoiding legal obligations- Where the use of an incorporated company is being made to avoid legal obligations, the Court may disregard the legal personality of the company and proceed on the assumption as if no company existed. Single economic entity- Sometimes in the case of group of enterprises the Salomon principal may not be adhered to and the Court may lift the veil in order to look at the economic realities of the group itself. In the case of D.H.N.food products Ltd. V. Tower Hamlets 21, it has been said that the Courts may disregard Salomon's case whenever it is just and equitable to do so. In the above-mentioned case the Court of appeal thought that the present case was one which was suitable for lifting the corporate veil. Here the three subsidiary companies were treated as a part of the same economic entity or group and were entitled to compensation. Lord Denning has remarked that 'we know that in many respects a group of companies are treated together for the purpose of accounts, balance sheet, and profit and loss accounts. Gower too in his book says, "There is evidence of a general tendency to ignore the separate legal group". However, whether the Court will pierce the corporate veil depends on the facts of the case. The nature of shareholding and control would be indicators whether the Court would pierce the corporate veil. The Indian Courts have held that a ‘single economic unit’
20
Ltd [1916] 2 AC 307 [1976] 1 WLR 852
21
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argument could work in certain circumstances. These circumstances would depend on the factual control exercised. This view is strengthened by the Supreme Court decision (cited in Novartis v. Adarsh Pharma 22 ) in New Horizons v. Union of India. 23 State of UP v. Renusagar 24 was decided in 1988. Back in the year 1988 also, in Renusagar case, the Court proceeded, on the basis of prior English law which had accepted the ‘single economic unit’ argument. Thus, Renusagar case seems to support the conclusion that a ‘single economic entity’ argument would succeed in India for lifting the corporate veil.
Agency or trust- Where a company is acting as agent for its shareholder, the shareholders will be liable for the acts of the company. It is a question of fact in each case whether the company is acting as an agent for its shareholders. There may be an Express agreement to this effect or an agreement may be implied from the circumstances of each particular case. In the case of F.G.Films ltd25, An American company financed the production of a film in India in the name of a British company. The president of the American company held 90 per cent of the capital of the British company. The Board of trade of Great Britain refused to register the film as a British film. Held, the decision was valid in view of the fact that British company acted merely as he nominee of the American Company. Avoidance of welfare legislation- Avoidance of welfare legislation is as common as avoidance of taxation and the approach of the Courts in considering problems arising out of such avoidance is generally the same as avoidance of taxation. It is the duty of the Courts in every case where ingenuity is expended to avoid welfare legislation to get behind the smokescreen and discover the true state of affairs. Public interest- The Courts may lift the veil to protect public policy and prevent transactions contrary to public policy. The Courts will rely on this ground when lifting the veil is the most ‘just’ result, but there are no specific grounds grou nds for lifting the veil. Thus, where there is a conflict with public policy, the Courts ignore the form and take into account the substance.
22
[2004 (29) PTC 108 (Mad)] 1995 SCC (1) 478 24 1988 AIR 1737 25 1953) All ER 615 23
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STATUTORY PROVISIONS FOR LIFTING THE VEIL Reduction Of Number Of Members- Under Section 45 of The Indian Companies Act, 1956, if a company carries on business for more than six months after the number of its members has been reduced to seven in case of a public company and two in case of a private company, every person who knows this fact and is a member during the time that the company so carries on business after the six months, becomes liable jointly and severally with the company for the payment of debts contracted after six months. It is only that member who remains after six months who can be sued. Fraudulent Trading- Under Section 542 of The Indian Companies Act, 1956, if any business of a company is carried on with the intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, who was knowingly a party to the carrying car rying on of the business in that manner is liable to imprisonment or fine or both. This applies whether or not the company has been or is in the course of being wound up. This was upheld in Delhi Development Authority v. Skipper Constructions Co. Ltd. (1997). Misdescription Of The Company- Section 147 (4) of The Indian Companies Act, 1956, provides that if any officer of the company or other person acting on its behalf signs or authorizes to be signed on behalf of the company any bill of exchange, promissory note, endorsement, cheque or order for money or goods in which the companies name is not mentioned in legible letters, he is liable to fine and he is personally liable to the holder of the instrument unless the company has already paid the amount. Premature Trading- Another example of personal liability is mentioned in Section 117 (8) of The English Companies Act. Under this section secti on a public limited company newly incorporated as such must not "do business or exercise any borrowing power" until it has obtained from the registrar of companies a certificate that has complied with the provisions of the act relating to the raising of the prescribed share capital or until it has re-registered as a private company. If it enters into any transaction contrary to this provision not only are the company and its officers in default , liable to pay fines but if the company fails to comply with its obligations in that connection within 21 days of being called upon to do so, the directors of the company are jointly and severally liable to indemnify the other party in respect of any loss or damage suffered by reason of the company's fail ure.
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Failure To Refund Application Money- According to Section 69(5) of The Indian Companies Act, 1956, the directors of a company are jointly and severally liable to repay the application money with interest if the company fails to refund the money within 130 days of the date of issue of prospectus. Holding And Subsidiary Companies- In the eyes of law, the holding company and its subsidiaries are separate legal entities. But in the following two cases the subsidiary may lose its separate entityWhere at the end of its financial year, the company has subsidiaries, it must lay before its members in general meeting not only its own accounts, but also attach therewith annual accounts of each of its subsidiaries along with copy of the board’s and auditor’s report and a statement of the holding company’s interest in the subsidiary. The Court may, on the facts of a case, treat a subsidiary as merely a branch or department of one large undertaking owned by the holding company. The Indian Supreme Court in Kapila Hingorani V/s State of Bihar 26 held that the corporate veil which separates an entity vis-à-vis its shareholders could be lifted when the corporate personality was found to be ‘opposed to justice, convenience and interest of the revenue or workman or against public interest’. The apex court in State of Uttar Pradesh V/s. Renusagar Power Company, in observing the difficulty of confining the scope and applicability of this doctrine within predetermined boundaries, stated that it was neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible, since that would necessarily depend on a host of disparate factors including the relevant provisions of the applicable statute/ regulation, the object sought to be achieved, the impugned conduct of the company, the involvement of public interest and its effect on parties. Although this doctrine has been invoked across a wide spectrum of legal fields spanning tortious liability, contractual, criminal and even constitutional law, it is most frequently cited in the realm of taxation. While the Income Tax Act, 1961 does not contain any statutory provision for lifting the corporate veil, Indian courts have in the past permitted revenue authorities to look through the legal structure adopted by an assessee company to reveal whether the economic reality of such a facade amounts to tax evasion.
26
Writ Petition (civil) 488 of 2002
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Vodafone Case The Supreme Court of India pronounced the landmark judgment in Vodafone International Holding (VIH) v. Union of India (UOI). 27 The Bench consisting of Chief Justice Just ice S.H Kapadia, K. S. Radha krishnan and Swatanter Kumar quashed the order of High Court of demand of Rs 12000 crores as capital gain tax and absolved VIH from liability of payment of Rs 12000 crores as capital gain tax in the transaction dated 11.2.2007 between VIH and Hutchinson Telecommunication International Limited or HTIL (non-resident company for tax purposes).
The court held that in Indian revenue authorities do not have jurisdiction to impose tax on an offshore transaction between two non-residents companies where in controlling interest in a (Indian) resident company is acquired by the non-resident company in the transaction.
Facts leading to the Dispute
Vodafone International Holding (VIH) and Hutchison telecommunication international limited or HTIL are two non-resident companies. These companies entered into transaction by which HTIL transferred the share capital of its subsidiary company based in Cayman Island i.e. CGP international or CGP to VIH. VIH or Vodafone by virtue of this transaction acquired a controlling interest of 67 percent in Hutch is on Essar Limited or HEL that was an Indian Joint venture company (between Hutchinson and Essar) because CGP was holding the above 67 percent interest prior to the above deal. The Indian Revenue authorities issued a show cause notice to VIH as to why it should not be considered as “assesse in default” and thereby sought an explanation as to why the tax was not deducted on the sale consideration of this transaction.
The Indian revenue authorities thereby through this sought to tax capital gain arising from sale of share capital of CGP on the ground that CGP had underlying Indian Assets.
VIH filed a writ petition in the High Court challenging the jurisdiction of Indian revenue authorities. This writ petition was dismissed by the High Court and VIH appealed to the Supreme Court which sent the matter to Revenue authorities to decide whether the revenue had the jurisdiction over the matter. The revenue authorities decided that it had the 27
[S.L.P. (C) No. 26529 of 2010, dated 20 January 2012]
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jurisdiction over the matter and then matter went to High Court which was also decided in favour of Revenue and then finally Special Leave petition was fil ed in the Supreme Court.
Issue before the Supreme Court The issue before the Apex court was whether the Indian revenue authorities had the jurisdiction to tax an offshore transaction of transfer of shares between two non-resident companies whereby the controlling interest of an Indian resident company is acquired by virtue of this transaction.
Arguments of Revenue The revenue submitted that this entire transaction of sale of CGP by HTIL to VIH was in substance transfer of capital assets in India and thus attracted capital gain taxes transaction led to transferring of all direct/indirect rights in HEL to VIH and this entire sale of CGP was a tax avoidance scheme and the court must use a dissecting approach and look into the substance substance and not at “look at” form of transaction as a whole.
Observations made by the Supreme Court
The principle of lifting of corporate veil can also be applied in relationship of Holding and subsidiary company in spite of their separate legal personalities if facts reveal that dubious methods were adopted to evade tax.
The revenue authorities should look at transaction in a holistic manner and should not start with the question that the impugned transaction is tax deferment/saving device.
The revenue authorities may invoke the principle of piecing of the corporate veil only after it is able to establish on the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant.
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CONCLUSION
Thus it is abundantly clear that incorporation does not cut off personal liability at all times and in all circumstances. “Honest enterprise, by means of companies is allowed; but the public are protected against kitting and humbuggery”. The sanctity of a separate entity is upheld only in so far as the entity is consonant with the underlying policies which give it life. Thus those who enjoy the benefits of the machinery of incorporation have to assure a capital structure adequate to the size of the enterprise. They must not withdraw the corporate assets or mingle their own individual accounts with those of the corporation. The Courts have at times seized upon these facts as evidence to justify the imposition of liability upon the shareholders. The act of piercing the corporate veil until now remains one of the most controversial subjects in corporate law. There are categories such as fraud, agency, sham or facade, unfairness and group enterprises, which are believed to be the most peculiar basis under which the Law Courts would pierce the corporate veil. But these categories are just guidelines and by no means far from being exhaustive.
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REFERENCES
1. Txmann’s Company Law 2. Txmann's Business Laws 3. http://www.legalserviceindia.com/articles/corporate.htm 4. http://www.slideshare.net/amandeepkaurnaib/lifting-of-corporate-veil 5. http://www.lawteacher.net/free-law-essays/business-law/article-on-lifting-of-the-lawessays.php 6. http://indiacorplaw.blogspot.in/2014/09/the-indian-supreme-court-on-lifting.html 7. http://artismc.com/index.php/blogs/view/55/221/ 8. http://www.legalservicesindia.com/article/article/lifting-of-corporate-veil-indianscenario-1876-1.html 9. http://www.lakshmisri.com/Uploads/MediaTypes/Documents/TOP_DISCUSSION_T AX_Direct%20Tax_Corporate_veil_nikhil.pdf 10. http://www.legalindia.com/lifting-the-corporate-veil-the-english-and-indian-laws/
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