Private company director held liable for tax defaults by lifting corporate veil us 179 of Income-tax if in true sense company not acted as public limited company
ABCAUS Case Law Citation:
ABCAUS 1149 (2017) (02) HC
The Grievance:
The petitioner, had challenged the legality, validity and propriety of the order issued under Section 179 of the Income-tax Act,1961 (‘the Act’) whereby, the corporate veil of a company was lifted and the directors were held to be defaulters within the meaning of Section 179.
Important Case Laws Cited/relied upon:
Pravinbhai M. Khemi V/s. Assistant Commissioner of Income-tax
Narayanan V/s. Adjudicating Officer, SEBI
Ajay S. Patel Vs. Income Tax Officer
Dr. A. Lakshmanaswami Mudaliar & Ors. vs. Life Insurance Corporation of India & Anr.
Juggilal Kamlapat V/s. Commissioner of Income Tax
Commissioner of Income-tax V/s. Sri Meenakshi Mills
VS Ramaswamy Iyer V/s. Brahmayya and Anr.
Brief Facts of the Case:
A limited company was incorporated under the provisions of the Companies Act, 1956 initially with promoter directors. Shortly, within two months of the incorporation, the petitioner was introduced as director of the company and he continued to be a director for approx six months before resigning from the company.
However, after the passing of eight years from his resignation, the petitioner received a notice from the Income tax Department (‘the Department’) under Section 179 of the Act. Later he was issued a show cause notice to explain as to why he should not be held responsible to pay the dues of the company.
Later, in pursuance of the order of the Hon’ble High Court of Gujarat which quashed the notice u/s 179, the Income Tax Department issued a fresh show cause notice in detail giving all particulars and called upon the petitioner to explain as to why steps should not be taken as contemplated under Section 179 of the Act.
After considering the communication from the Petitioners, the Department passed an order in exercise of power u/s 179 and concluding that petitioner had failed to prove his gross negligence, misfeasance or breach of duty in relation to the affairs of the company and by lifting the corporate veil of the public limited company in question, all the three directors including the petitioner were held to be defaulters within the meaning of Section 179 of the Act.
Against the above said order, the Petitioner had filed the present Special Civil Application before the Hon’ble Gujarat High Court.
Major Contentions of the Appellant:
It was submitted by the petitioner that though he was appointed as a director, in reality he had not acted as such; neither he had made any signature in any affairs of the company nor on any financial statements, banks, income tax documents and except remaining as a director he was not in charge of the affairs of the company. It was submitted that there was adequate material available on the file of the Department to show that some other person was managing the affairs of the company and not the petitioner who merely brought the capital in the form of shares and except remaining as director on the board of the company, he in reality had not acted as such.
It was also contended that Section 179 of the Act ex-facie was not applicable to a public limited company and therefore invocation of Section 179 was impermissible and therefore, the action tantamount to be without authority of law.
It was also contended that concept of vicarious liability could not be inferred by the Department more particularly when the petitioner had never participated as a director. Unless a fraud is practiced or the petitioner was shown to be a beneficiary out of it then only, it could be said that corporate veil deserved to be lifted or pierced.
It was pointed out that corporate veil can be lifted or pierced if either statute permits the same or any extraordinary circumstances prevailing and compelling the authority to lift the veil.
Major Contention of the Respondent Department:
It was submitted that during the span the petitioner was a director of the company, his share holding in the share capital of the company was to the extent of 98.33%. The attention of the Court was drawn to the fact that before the induction of the petitioner as director, the share capital of the company was only Rs. 5 lacs and thereafter, upon induction of petitioner as a director, the share capital strength had increased to Rs. 7 crores and mostly the equity shares were held by him.
It was pointed out that when such kind of huge share capital was in the hands of the petitioner, as a natural consequence he would be active in the affairs of the company. But though he was major shareholder, the petitioner had never raised any voice against functioning of either company or any person alleged to be actually running the company and rather provided full support which appears to be a serious dereliction of duty on the part of petitioner being the director holding a major share capital.
It was submitted that the record sufficiently established that the Company was formed with a view to provide accommodation entries in the form of bogus share capital and share premium and therefore, when such a situation of extraordinary nature was prevailing or emerging from the record, the authority was thoroughly justified in passing the order.
It was submitted that though the company was incorporated as public limited company, the company had not involved public in any substantive form and the characteristic of the affairs of the company were found to be akin to the private limited company and therefore, the authority rightly come to the conclusion that company in question was treated as defacto private limited company and therefore, the petitioner was rightly held to be responsible.
It was submitted that the total liability accrued to tax dues of the company was to the extent of Rs.240.08 lacs including penalty and subject to chargeability of interest under Section 220(2) of the Act and therefore, when such a huge claim of the department had remained outstanding for the relevant year in which the petitioner was a director, though silent was equally responsible for the ultimate outcome of the company and therefore, the Department had rightly passed an order under Section 179 of the Act and therefore, in this view of the matter, no extraordinary jurisdiction be exercised in favour of the petitioner.
Observations made by the High Court:
The Hon’ble High Court noticed the following facts which support the lifting the corporate veil:
(1) The Company was faced with evasion of tax demand and penalties under Income Tax Act, 1961.
(2) There was a sizable increase in the share capital of the company within 2 and ½ months and the Petitioner came to be holding 29,50,000 shares in the Company which were 98.33% of the total shareholdings.
(3) No public issue was advertised and no shares were issued to the public and there was no remote involvement of public in the Company though the Company appeared to be a Limited Company.
(4) The assets of the company in the form of fixed assets, sundry debtors, loans and advances and bank balances which were approx 1090 lakhs when the petitioner was director, became practically zero when the attachment proceedings were initiated.
(5) The commencement of business of the company under Section 149(3) of the Companies Act actually took place only after the petitioner came to be introduced as an additional director.
(6) When the Department initiated recovery process, land of the company was disposed off and bank accounts were also closed before the resignation of the petitioner.
(7) The Company though a Limited company had acted practically as a Private Limited Company altogether and the Directors appeared to have acted in such a detrimental way which falls within the purview of section 179 of the Income Tax Act.
(8) Directors of the company did not cooperated in the Income tax proceedings.
(9) It was alleged that substantial accommodation entries had been made during the course of time when the petitioner was a director.
(10) As per object clause of the MOA of the company it was set up for different purpose than those pursuing as was reflecting from the assessment. Therefore, the inference raised by the department that company was set up essentially for the purpose of accommodation entries might not be ignored.
The Court noted that while taking step against the petitioner, the department had initiated action and made all possible efforts to recover huge revenue demand as crystallized from the company but, all efforts went in vain and surprisingly none of the Directors cooperated with the department nor had presented themselves in the course of the recovery proceedings. It further revealed that the demand substantially was related to the period in which the petitioner for a short time but was a Director.
It was also noted that after the resignation of the petitioner, there was no substantial business of the company and after that only which was left there was huge accrual of debts of the company and for recovery of that, even the properties have been auctioned and sold away under the steps of Securitization Act and therefore, after resignation of the petitioner what has been left with the company is huge liabilities only which compelled the department to initiate action u/s 179.
The Hon’ble Court opined that the entire factual matrix clearly indicated that the company was in a gradual process to a virtual closure on account of gross neglect, misfeasance or beach of duty on the part of directors in relation to the affairs of the company and therefore, the conditions which were contained in Section 179 of the Act before its invocation were appearing on the face of it which rightly visualized by the department for passing the order.
The Court stated that there are series of cases in which it has been held that the position of a director of a company is fiduciary relationship with the company and director is supposed to or under a legal obligation to observe the utmost good faith towards the company in any transaction with it or in its behalf and therefore, looking to this obligation of the petitioner towards the company, he cannot plead ignorance completely about the affairs of the company which has practically led virtually a company to a closure. This fiduciary obligation does not cease with the resignation. As said earlier, sub-section (3) of Section 166 of the Companies Act which spelled out that director shall exercise his duties with due and reasonable care.
The Court stated that the well recognized principle of corporate veil could be lifted if the company is used as a means to evade tax or to circumvent the tax obligation and in that case, an individual shareholder may also be liable to pay the income-tax. The Supreme Court in case of Juggilal Kamlapat held that the Court is entitled to lift the mask of corporate entity if it is used for tax evasion or to circumvent the tax obligations and therefore, in such a situation, the person concerned can be held to be liable for income-tax. In case of Sri Meenakshi Mills the Supreme Court also spelt out the proposition that the Court is empowered to lift the corporate veil if the company is used as a means to circumvent the obligation.
Further with regard to the question whether the Department was justified to treat the public limited company akin to a private limited company while passing the order, the Court opined that though the words ‘private limited’ was not mentioned in the certificate of incorporation but on close look at the affairs of the company, the manner in which the affairs proceeded with, all indicated that in actual terms the company has not acted as a public limited company in true sense. On the contrary, practically the company appeared to have systematically operated as if it was a private concern.
The Hon’ble Court explained the position of a director in the company and stated that the directors of the company have got a specific legal position in the company. The legal position of the directors may be that definitely it could not be crystallized but, these directors were akin to trustees.
According to the Court, in the overall situation if analyzed in its true perspective then only one conclusion which could be arrived at was that the corporate veil to be lifted and rightly so by the Department.
Held:
The Hon’ble Court opined that there was no irregularity and/or illegality of any nature which warrants exercise of extraordinary jurisdiction under Articles 226 or 227 of the Constitution of India. Accordingly, the petition was dismissed.
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