MANU/SC/0236/1985

Equivalent Citation: [1985(51)FLR478], [1986]157ITR77(SC ), (1986)ILLJ142SC , 1985(2)SC ALE321, (1985)4SC C 114, 1986(1)SLJ218(SC ),
1986(1)UJ235

IN THE SUPREME COURT OF INDIA

Civil Appeal No. 1429 (NL) of 1975
Decided On: 19.08.1985
Appellants: Workmen Employed in Associated Rubber Industry Ltd.,
Bhavnagar
Vs.
Respondent: Associated Rubber Industry Ltd., Bhavnagar and Ors.
Hon'ble Judges/Coram:
O. Chinnappa Reddy and V. Khalid, JJ.
JUDGMENT
O. Chinnappa Reddy, J.
1 . The Workmen of The Associated Rubber Industry Ltd., Bhavnagar are the
appellants in this appeal filed pursuant to a certificate under Article 133(1) of the
Constitution granted by the High Court of Gujarat.
2 . The Associated Rubber Industry Ltd. had purchased, some years back, shares of
INARCO Ltd. by investing a sum of Rs. 4,50,000/-. They were getting annual
dividends in respect of these shares and the amount so received was shown in the
Profit and Loss Account of the company year after year. It was taken into account for
the purpose of calculating the bonus payable to the workmen of the company. Some
time in the course of the year 1968, the company transferred the shares of INARCO
Ltd. held by it to Aril Bhavnagar Ltd. (subsequently changed to the Aril Holdings
Ltd.), a subsidiary company wholly owned by The Associated Rubber Industry Ltd.
Aril Holdings Ltd. "had no other capital except the shares of INARCO Ltd. transferred
to it by the Associated Rubber Industry Ltd. It had no other business or source of
income whatsoever except receiving the dividend on the shares of INARCO Ltd. The
dividend income from the shares of INARCO Ltd. was not transferred to The
Associated Rubber Industry Ltd. and therefore, it did not find place in profit and Loss
Account of the company with the result that the available surplus for the purposes of
payment of bonus to the workmen of the company became reduced. The net result of
the exercise was that bonus at the rate of 4% only was paid to the workers for the
year 1969 instead of at the rate of 16% to which they would have otherwise been
entitled. We may mention here that Aril Holdings Ltd. was itself wound up in the year
1971 and amalgamated with The Associated Rubber Industry Ltd.
3 . The workmen of the Associated Rubber Industry Ltd., Bhavnagar raised an
industrial dispute claiming that they were entitled to be paid bonus at the rate of 16%
for the year 1969. According to them, the transfer of the shares of INARCO Ltd. to
Aril Holdings Ltd. was no more than a device to avoid payment of higher bonus to the
workmen. Industrial Tribunal and thereafter the High Court of Gujarat under Article
226 of the Constitution, held that The Associated Rubber Industry Ltd. and Aril
Holdings Ltd. were two independent companies with separate legal existence and

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 therefore, the profits made by Aril Holdings Ltd. could not be treated as profits of The
Associated Rubber Industry Ltd. for the purpose of computing to gross profits earned
by the Associated Rubber Industry Ltd. It was further held that there was no evidence
to show that the transfer of shares to Aril Holdings Ltd. was only a device to avoid
payment of bonus to the workmen.
4 . It is true that in law The Associated Rubber Industry Ltd. and Aril Holdings Ltd.
were distinct legal entities having separate existence. But, in our view, that was not
an end of the matter. It is the duty of the court, in every case where ingenuity is
expended to avoid taxing and welfare legislations, to get behind the smoke-screen
and discover the true state of affairs. The court is not to be satisfied with form and
leave well alone the substance of a transaction. In The Commissioner of Income-Tax,
Madras v. Sri Meenakshi Mills Ltd. and Ors. MANU/SC/0138/1966 :
[1967]63ITR609(SC) , the judicial approach to such problems was stated as follows :
It is true that from the juristic point of view the company is a legal
personality entirely distinct from its members and the company is capable of
enjoying rights and being subjected to duties which are not the same as
those enjoyed or borne by its members. But in certain exceptional cases the
Court is entitled to lift the veil of corporate entity and to pay regard to the
economic realities behind the legal facade. For example, the Court has power
to disregard the corporate entity if it is used for tax evasion or to circumvent
tax obligation. For instance, in Apthorpe v. Peter Schoenhofen Brewing Co. 4
T.C. 41 the Income lax Commissioners had found as a fact that all the
property of the New York company, except its land, had been transferred to
an English company, and that the New York company had only been kept in
being to hold the land, since aliens were not allowed to do so under New
York law. All but three of the New York Company's shares were held by the
English company, and as the Commissioner also found, if the business was
technically that on the New York company, the latter was merely the agent of
the English company. In the light of these findings the Court of Appeal,
despite the argument based on Salomon's case. (1897) A.C. 22 held that the
New York business was that of the English company which was liable for
English income tax accordingly. In another case-Fire stone Tyre and Rubber
Co. v. Llewellin (1957) 1 W.L.R. 464. an American company had an
arrangement with its distributors on the Continent of Europe whereby they
obtained supplies from the English manufacturers, its wholly owned
subsidiary. The English company credited the American with the price
received after deducting the costs plus 5 per cent. It was conceded that the
subsidiary was a separate legal entity and not a mere emanation of the
American parent, and that it was selling its own goods as principal and not
its parent's goods as agent. Nevertheless, these sales were a means whereby
the American company carried on its European business, and it was held that
the substance of the arrangement was that the American company traded in
England through the agency of its subsidiary. We therefore, reject the
argument of Mr. Venkataraman on this aspect of the case.
More recently we have pointed out in Mc Dowell and Company Limited v. Commercial
Tax Officer MANU/SC/0154/1985 : (1985) 3 SCC 230 :
It is up to the Court to take stock to determine the nature of the new and
sophisticated legal devices to avoid tax and consider whether the situation
created by the devices could be related to the existing legislation with the aid

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 of 'emerging techniques of interpretation as was done in Ramsay, Burmah Oil
and Dawson, to expose the devises for what they really are and to refuse to
give judicial benediction.
In that case, the court also had occasion to refer to the following observations of
Lord Brightman in Furniss v. Dawson (1984) 1 All ER 530 :
The fact that the court accepted that each step in a transaction was a genuine
step producing its intended legal result did not confine the court to
considering each step in isolation for the purpose of assessing the fiscal
results.
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.
5 . If we now look at the facts of the case, what do we find.? A new company is
created wholly owned by the principal company, with no assets of its own except
those transferred to it by the principal company, with no business or income of its
own except receiving dividends from shares transferred to it by the principal company
and serving no purpose whatsoever except to reduce the gross profits of the principal
company. These facts speak for themselves. There cannot be direct evidence that the
second company was formed as a device to reduce the gross profits of the Principal
company for whatever purpose. An obvious purpose that is served and which stares
one in the face is to reduce the amount to be paid by way of bonus to workmen. It is
such an obvious device that no further evidence, direct or circumstantial, is
necessary. It was argued that in 1971, the Aril. Holdings Ltd. was wound up and
amalgamated with The Associated Rubber Industry Ltd. and that this circumstance
showed that the initial creation of Aril Holdings Ltd. was not a device of avoidance.
But the learned counsel for the company was unable to explain why in the first
instance Aril Holdings Ltd. was created and why later it was wound up. Probably,
after Aril Holdings Ltd. was created, some unforeseen difficulties arose which have
not been brought to light before us and it became necessary to wind it up
amalgamate it with The Associated Rubber Industry Ltd. We are therefore, satisfied
that the amount of dividend from INARCO Ltd. received by the Aril Holdings Ltd.
should be taken into account in assessing the gross profit of The Associated Rubber
Industry Ltd. for the purpose of calculating the rate of bonus payable to the workmen
of the Associated Rubber Industry Ltd. The appeal is allowed with costs and it is
declared that workmen of The Associated Rubber Industry Ltd. Bhavnagar are entitled
to be paid bonus at the rate of 16% for the year 1969.

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