Piercing the Corporate Veil in Taxation Matters

(India & International Transactions with special reference to

Direct Tax Codes)

A Code to Decode Greed

Table of Content
Sr No.

Title

Pg No.

I.

Abstract

Scope

III.

Research Object

1.

Introduction

2.

Method of Research

3.

Theories of Corporation

3.1.

Fiction Theory

3.2.

Realist Theory

3.3.

Bracket Theory

3.4.

Concession Theory

3.5

Purpose Theory

Concept of Separate Legal Personality

4.1.

Principle of Separate Legal Entity

4.2.

Characteristic of a Body Corporate

4.2.1.

Limited liability

4.2.2.

Perpetual Succession

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
2

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

Where the Court refused to lift the Veil of Corporation

18

8.1

Indian Context

19

8.2

International Context

19

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

22

International Context.
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

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.
4

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

Wanchoo Committee Report, P. 6

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

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.

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

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

Miraglia: Comparative Legal Philosophy. p.371.

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.

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

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

Edition,2008.) Pg. no.193.

9

[1895-99]All ER Rep 33

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

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.

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 companys 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 members 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

15

Gramophone& Typewriter Co. V. Stanley, (1906) 2 K.B. 856 at p. 869.

(1955) 25 Comp Case. 1 (SC)

16

(1925) AC 619

17

Supra Note Gower Pg No. 44

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.
18

10

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

11

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 Lees 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.

12

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:

Limited Liability

Piercing the Corporate Veil

General Rule

Exception to the Rule

Motive: encourage investment by

Motive: to deter private interest under

general public.

the cover of public interest.

Bestows right.

Limits those rights.

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)

13

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

14

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 entity31.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)

15

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.

16

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.

17

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)

18

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 faade concealing the true facts faade 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.

19

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 faade.
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 faade. 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.

20

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
company)

held

100%

shares

of

International

(non-resident

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 faade. 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).

21

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).

22

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 courts pointing to the defendants tax fraud as
among the facts leading to piercing.66The problem, of course, is that the defendants tax fraud
in this case had absolutely nothing to do with the plaintiffs (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.

23

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

70

Supra Note 50.

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

24

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
arms 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

25

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 antiavoidance 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.

26

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

27

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

28

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 entitys 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

29

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
Governments spending are avoided or eschewed, no amount of moral sermons would change
peoples attitude to tax avoidance.

30

Bibliography
Articles:
1. Brain Arnold, A Comparison of Statutory General Anti Avoidance Rules and Judicial
General Anti Avoidance Doctrines as a means of Controlling Tax Avoidance; which is
better? Comparitive Perspectives on Revenue Law; Essays in honour of John Tiley
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