In the ultimate analysis, some human beings are the real beneficiaries of the corporate advantages, “for while, by fiction of law, a corporation is a distinct entity yet in reality, it is an association of persons who are in fact the beneficiaries of the corporate property.⁷” It may, therefore, happen that the corporate personality of the company is used to commit frauds or improper or illegal acts like tax evasion. Since an artificial person is not capable of doing anything illegal or fraudulent, the façade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as ‘piercing the corporate veil’⁸.

“The doctrine of disregarding a corporation’s separate and independent existence is commonly referred to as ‘piercing the corporate veil”⁹. Piercing the corporate veil describes a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders or directors. When the debt is due, the corporation does not have enough assets to repay it, and the controlling shareholder relies on the concept of limited liability to avoid personal liability. The result is that the third party ends up bearing the risk of the non-payment of the debt. In such situations, the court or tribunal may intervene to prevent such injustice and pierce the corporate veil by holding the controlling shareholder liable¹⁰.

TAX EVASION AND PIERCING OF THE CORPORATE VEIL

The corporate device is very often used as a means of avoiding forms of tax. It is very difficult for the legislation to plug all the gaps in the law and thus judiciary has to step in. The courts very often resort to pierce the veil in order to find out the true purpose/intent behind the activities of the company¹¹. In certain cases the court is entitled to pierce the veil of corporate entity and pay regard to the economic realities behind the legal façade. For example the court has power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation¹², which is the main part of this discussion.

A corporate entity otherwise qualified should not be disregarded as a façade merely because it was purposely created and operated to gain tax benefits¹³. We should not ignore the form in which transaction is entered. A complete disregard of the form is inconsistent with the existing fiscal jurisprudence. The Doctrine of perusing the substance and not the form of the transaction, applies when there is a colourable or illegal transaction.¹⁴

Thus this approach of the courts in piercing the veil in matters of tax evasion may be gauged by looking at the various judicial decisions that have emanated from world and India.

As C.H. Tan rightly notes that¹⁵:

“Corporate veil can be seen as attempts to use the corporate vehicle not for a bona fide transaction but to achieve an improper purpose that will often involve some degree of dishonestly or lack of moral probity.” Further to this point, ‘bad faith’ was relevant issue of piercing the corporate veil that was noted in passing by the judge in The Grande Properties Management Ltd v. Sun Wah Ornament Manufactory Ltd¹⁶. In Hong Kong, the idea of ‘good faith’ also influences whether to pierce the corporate veil. As Tax explains, the only major means in common law of piercing the corporate veil is where ‘the corporate form has been abused to further an improper purpose and not a bona fide, usually commercial, transaction.¹⁷

Later the case of China Ocean Shipping Co v. Mitrans Shipping Co Ltd¹⁸ accurately defines this area of law concisely: - “Using a corporate structure to evade legal obligations such as Tax evasion is objectionable. The court’s power to lift the corporate veil may be exercised to overcome such evasion so as to preserve legal obligations.”

Hence acting capriciously for an extraneous purpose (high profits) without a legitimate commercial interest based on the life of the contract can be sufficient mala fides combined with control to pierce the corporate veil.

Way back in 1936, the appellate court in IRC v. Duke of Westminster¹⁹ held that a citizen has the legal right to dispose of his capital and income so as to attract upon himself the least amount of tax. Avoidance of tax is not evasion and carries no ignominy. It was observed that “given a document of transaction is genuine the court cannot go behind it to some supposed underlying substance.”²⁰

The Westminster principle is followed in India.²¹ The five judge bench judgment of the Supreme Court in McDowell v. CTO²² is perceived to have changed this fiscal jurisprudence of the country. It is perceived that any tax planning which results in tax avoidance is invalid in the light of McDowell.

But in Union of India v. Azadi Bachao Andolan²³ (Azadi Bachao Andolan), it was argued that any tax planning which results in avoidance must be struck down in the light of McDowell. Rejecting this argument, the court upheld the legitimacy of tax planning. The court observed that the McDowell judgement was nothing exceptional but only an exception to the well-settled law.

The following conclusions can be drawn from this discussion:

a. Tax planning is an entitlement of the assessee within the contours of law.

b. Any genuine attempt to plan the financial and economic affairs should not be discouraged merely by taking shelter under McDowell’s judgement.

c. Tax incentives availed of by an assessee should be within the ambit of legitimate tax planning.

d. Tax planning should not involve use of colourable devices for reducing tax liability.

Accordingly, use of corporate entity in tax planning is legally valid provided its use within the contours of the above mentioned conclusions and should not be used for tax evasion. But even after giving legitimacy to the tax planning for avoidance of tax the natural persons in the façade of corporate entities try to evade taxes and earn illegal money. So because of this the judiciary had played a definite role in the prevention of tax evasion by “piercing the corporate veil” and punishing the real culprits.

The main test in tax avoidance is whether the purpose of an arrangement or transaction is to avoid the payment of tax, or whether it is used for a legitimate business purpose. Brennan J (as he then was), when speaking of tax avoidance in the case of Federal Commissioner of Taxation v. Gilland²⁴ nicely summarized the approach adopted in taxation law:

“If it can be predicated of an arrangement that among the purposes for which it was made is the purpose of avoiding tax then, provided that purpose is a substantial, not merely incidental, purpose of the arrangement, it is an arrangement on which s 260 operates.²⁵ To predicate of an arrangement that a purpose for which it was made is the avoidance of tax, something more is needed than a purpose to achieve what the arrangement is apt to effect if the arrangement is apt to effect a variety of consequences only one or some of which is the avoidance of tax.”²⁶

Hence the case nicely admits that if the there is some tax evasion by any company in consequences to fulfill the purpose of its establishment then lifting of corporate veil shouldn’t be done until and unless the evasion is massive.

In Newton v Federal Commissioner of Taxation²⁷, Lord Denning delivering the judgment of the privy Council said: ‘In order to bring the arrangement within the section you must be able to predicate – by looking at the overt acts by which it was implemented –that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessary being labeled as a means to avoid tax, then the arrangement does not come within the section of piercing the corporate veil’²⁸.

So the explanation given by Denning LJ is particularly useful because, of its insistence that conduct that makes up ordinary business dealings, without the dominant purpose of avoiding tax, cannot be tax avoidance²⁹.

PIERCING THE CORPORATE VEIL IN TAXATION MATTERS IN INDIA, UNITED KINGDOM AND UNITED STATES

· INDIA

A potent weapon for the Revenue is to lift the corporate veil, ignoring the special purpose vehicle, which held legal ownership of shares in the Indian company and look at the beneficial owner. There are several decisions on “piercing the corporate veil” in situations of fraudulent conduct of business, liquidation process etc³⁰. The court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligation³¹. In the case of India Waste Energy Development Ltd. v. Govt of NCT of Delhi³², it was held that lifting the corporate veil is permissible in cases of tax evasion even in the absence of any statutory provisions.

A clear illustration is In Re: Dinshaw Maneckjee Petit Bart³³: The total income of the assessee for the financial year 1925-26 was calculated at Rs. 11,35,102, and super-tax was assessed on it by the Income Tax authorities. The assessee disputed two items-one of Rs. 2,76,800 on account of interest arising from Government Securities and Bonds etc., and the other of Rs, 1,14,004 on account of dividends on shares in limited companies-on the ground that they formed income of four private companies formed by him and that therefore those companies were liable to super-tax in respect of them. By an agreement the assessee purported to sell a particular block of investments belonging to him to each company in return for the allotment of the company's shares. When interest and dividends on the securities and shares were received by the assessee, book entries were made in the books of each company crediting that company with the amount and on the same day a debit entry was made debiting the assessee with the same amount. Thus the interest and dividends received were treated as loans given to the assessee by the companies. The Income Tax Commissioner was of opinion that the companies were not genuine. Therefore, on a reference by the Commissioner under Section 66(2) of the Indian Income Tax Act, 1922, a case was filed.

It was held that the mere fact that the companies had paid tax on the interest credited to them by the assessee in respect of the alleged loans did not involve the conclusion that the loans were genuine, nor estop the Crown from showing that the loans were illusory. And that it was really a business carried on by the assessee himself for the purposes of avoiding payment of super-tax.

However, with respect to tax avoidance, the most celebrated decision of the Supreme Court is in the case of CIT v. Shri Meenakshi Mills Ltd.³⁴ The court held that Revenue authorities are entitled to pierce the veil of corporate entity and look at the reality of the transaction to examine if the corporate entity is used for tax evasion. Of course, such right could be examined under exceptional circumstances.

Members, themselves, however, are not allowed to claim that they should be regarded as economically identical with the company, particularly when this is not in the interest of revenue. In Bacha F. Guzdar v. CIT. Bombay³⁵, under the Income Tax Act, then in force, agricultural income was exempt from tax. The income of a tea company was exempt up to 60% as agricultural income and 40% was taxed as income from manufacture and sale of tea. The plaintiff was a member of a tea company. She received a certain amount as dividend in respect of shares held by her in the company and claimed that this dividend income should be regarded as agricultural income up to 60%. But it was held that although the income in the hands of the company was partly agricultural, yet the same income when received by the shareholders as dividends could not be regarded as agricultural income.

Another attempt by the members of a company to treat themselves at par with the company was frustrated by the Calcutta High Court in CIT v. Associated Clothiers Ltd.³⁶ The assessees, Associated Clothiers, formed a Company holding all its shares. They sold certain premises to the new company. The difference between the selling price and the cost of the property in the hands of the assessees was assessed as their income. They contended that this could not be done as there was no commercial sale, but only a transfer from self to self. The court rejected this and held that it was sale from one entity to another and not a trading with oneself.

From this point of view, incorporation sometimes becomes too dear. Shareholders are virtually compelled to pay the price for the advantages of incorporation. Those shareholders who become directors have then to owe duties of fiduciary nature to their own company and they cannot use the assets of the company as if they were their own. In a way they become strangers to their own enterprise.³⁷ This is one of those situations which go to prove the truth in Prof. Kahn-Freund’s statement that “sometimes corporate entity works like a boomerang and hits the man who was trying to use it.”³⁸

In the recent case Commissioner of Internal Revenue v. Menguito³⁹, the Supreme Court disregarded the separate and distinct corporate identities of a sole proprietorship and a corporation. The Supreme Court held that the doctrine of piercing the veil of corporate fiction would apply when the separate juridical personality of a corporation is utilized to practice fraud on our internal-revenue laws. In such case, the entities are treated as one taxable person, subject to assessment for the same taxable transaction.

In the Menguito case, the Supreme Court stated that it considers the following as substantial evidence that two entities are actually one juridical taxable person: (1) when the owner of one directs and controls the operations of the other, and the payments effected or received by one are for the accounts due from or payable to the other; or (2) when the properties or products of one are all sold to the other, which, in turn, immediately sells them to the public. In this case, the sole proprietor was held liable for tax liabilities of the corporation after finding overwhelming evidence supporting the piercing of the corporate veil. Such evidence consists of several admissions by the sole proprietor and his wife, and documents presented in evidence showing that the identities of the sole proprietorship and the corporation are interchangeable. Aside from the general guidelines set down by the Supreme Court, no hard-and-fast rule can be laid down to cover all cases where corporate entity theory cannot be availed of. Each case is decided on its own merits. At this point, we could just rely that the court’s objective, or, as one respected commentator says at least it should be, is not to use the piercing doctrine as a ram to break down the ramparts of the main doctrine of separate juridical personality, but for the piercing doctrine to act as a regulating valve by which to preserve the powerful engine that is the main doctrine of separate juridical personality. It is also worth noting that corporate fiction is pierced not only on the basis of fraud but also in alter-ego cases where a dummy corporation serves no business purpose other than as a blind. In at least two cases, the Supreme Court disregarded the veils of corporate fiction after finding that while the organization of a separate corporation was not to perpetuate fraud, the clear intention was to minimize taxes. However, the Supreme Court clearly stated that in such cases, no surcharge by virtue of fraud is imposable by the Bureau of Internal Revenue (BIR).

It must also be emphasized that in these cases, the Supreme Court found that the corporations are merely “dummies,” actually owned and controlled by the same personalities. Here, the distinction between tax avoidance and tax evasion comes in. A taxpayer has the legal right to decrease, by means which the law permits, the amount of what otherwise would be his taxes or altogether avoid them. The use of a corporate entity by a taxpayer to gain advantage of doing business through a corporation is not, by itself, a fraudulent scheme. The separate corporate entity will be disregarded only where it serves as a shield for tax evasion.

In Sophia Finance Ltd v. Income-Tax Officer Delhi⁴⁰, it was stated that the ITO should pierce the corporate veil and bring to tax the unaccounted money without taking into account the artificial distinction between the company and the shareholders. In my opinion, this is not a sound proposition. The distinction between the company and the shareholders is nothing artificial. It is real legal distinction. It is not possible with the law as it is now to treat the company and the shareholders as one and the same party. Piercing the corporate veil is to avail the Taxation Department in certain circumstances but surely in the case of a company which has just then been floated and that has hardly done any trade activity; there is no question of piercing the corporate veil for any purpose. The same was also discussed in the case of Shyam Kunj Traders and Agencies Ltd.⁴¹.

The judgment of the Bombay High Court rendered last year in the Vodafone Case⁴² favours the revenue when it comes to imposition of tax by the Indian authorities on sale of shares in an offshore company that has a substantial stake in an Indian company. While an appeal in the Vodafone Case is pending before the Supreme Court, the Karnataka High Court recently had the opportunity to pronounce a judgment in Richter Holding v. The Assistant Director of Income Tax⁴³ on a similar fact situation. Although the Karnataka High Court too sided the revenue, the reasoning substantially deviates from Vodafone.

Richter Holding (a Cyprus company) and West Globe Limited acquired 100% shares in Finsider International Company Limited (registered in the UK). Finsider in turn held 51% shares in Sesa Goa Limited, an Indian company. The Indian tax authorities sought to tax the transaction under the head of capital gains, and sought further information from the parties. In turn, Richter Holding filed a writ petition before the Karnataka High Court.

Richter Holding relied on the Vodafone Case to argue that acquisition of shares in an offshore company does not amount to acquisition of immovable property or control of management in an Indian company, and “it is only an incident of ownership of the shares in a company which flows out of holding of shares”. Moreover, it was argued that controlling interest in a company is not identifiable as a distinct asset capable of being held. The tax authorities, on the other hand, argued that the transaction resulted in an indirect transfer of 51% interest held by Finsider in Sesa Goa, which is subject to Indian taxation.

In its judgment, the Karnataka High Court refused to be drawn into the merits of the taxation dispute. The court left it to Richter Holding to urge contentions on the merit of taxation before the authorities. It also found that the agreement produced before the court was insufficient to determine the exact nature of the transaction.

Most importantly, the court allowed the tax authority to lift the corporate veil to ascertain the true transaction:

“It may be necessary for the fact finding authority to lift the corporate veil to look into the real nature of [the] transaction to ascertain virtual facts. It is also to be ascertained whether [the] petitioner, as a majority share holder, enjoys the power by way of interest and capital gains in the assets of the company and whether transfer of shares in the case on hand includes indirect transfer of assets and interest in the company.”

There has been a great amount of discussion regarding the Richter judgment by commentators. The aspect that deserves greater attention is that the Karnataka High Court demonstrates a keen interest in lifting the corporate veil. This has a number of implications. First, the Richter Holding Case extends even further the scope of the principles laid down in the Vodafone Case. For example, in Vodafone the Bombay High Court did not consider lifting the corporate veil to impose taxation in case of indirect transfers, as we have previously noted. In that sense, the Richter Holding Case arguably provides an additional ground to the tax authorities to tax indirect transfers. Second, it is not clear from the judgment itself whether the tax authorities advanced the argument regarding lifting the corporate veil and, if so, how it was countered by Richter Holding. Third, the Karnataka High Court appears to have readily permitted lifting the corporate veil without at all alluding to the jurisprudence on the subject-matter. Generally, courts defer to the sanctity of the corporate form as a separate legal personality and are slow to lift the corporate veil, unless one of the established grounds exists.⁴⁴

Although there are some statutes to prevent the evasion of taxes but then also the minds behind the corporation are sometimes successful in dodging the statutes and so again the judiciary has to interfere for filling of the loopholes in the statutes. Some of those instances are as follows.

Income Tax Act, 1961

Section 34⁴⁵ of the Act, discusses about the effect of registration of company. Where any private company is wound up and if the tax arrears of the company in respect of any income of any previous years cannot be recovered, every person who was director of that company at any time during that relevant previous year shall be jointly and severally liable for payment of tax.

In Life Insurance Corporation of India v. Escorts Ltd⁴⁶, it was held that the corporate veil may be pierced where a statute itself contemplates piercing the veil, of fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern.

Also in Juggilala Kamlapat v. Commissioner of Income Tax⁴⁷, the court is entitled to pierce the mask of corporate entity if the conception is used for tax evasion or to circumvent tax obligation.

Under FEMA, 1999

The directors and individuals may be proceeding individually or jointly for violations of this act in order to evade their tax liability.

Under Central Excises and Salt Act, 1944

In case of Shantanu Ray v. Union of India⁴⁸, it was alleged that company had violated section 11(a) of the central Excises and Salt Act, 1944. The court held that in case of economic offences like evasion of excise duty, a court is entitled to pierce the veil of corporate entity and pay regard to the economic realities behind the legal facade.

In Rollatainers Ltd v. Commissioner of Central Excise⁴⁹, the company won the appeal against the decision of the Customs, Excise and Gold (Control) Appellate Tribunal (CEGAT), whereas in the commissioner’s appeal against Modi Alkalies & Chemicals Ltd⁵⁰, the company received severe drubbing for floating three dummy units to evade tax duty.

In the first case, the companies had several units out of which one produced paper board and another manufactured speciality paper. They were separately registered for central excise. The government issued a notification in 2000 regarding paper, paper board and related articles. The company claimed concessions under the notification for each of the factories. The department, however, issued show cause notices to the company for demanding the benefit for each unit.

It maintained that both the factories were in the common premises, the balance sheet was common and the owners were the same. CEGAT dismissed the company’s petition and upheld the contention of the department. So the company appealed to the Supreme Court.

Allowing the appeal, the Supreme Court said: “Simply because both the factories are in the same premises, that does not lead to the inference that both the factories are one and the same. In the present case, from the facts it is apparent that there is no commonality of purpose, both factories have separate entrance, they are not complimentary to each other nor are they subsidiary to each other. The end product is also different, one manufactures duplex board and the other manufactures paper. They are separately registered with the department. There is no commonality between the two factories, both are separate establishment run by separate managers, though at the apex level, it is maintained by the appellant company.”

The case of Modi Alkalies (MACL) was in contrast to this. It was engaged in producing caustic soda of which hydrogen is a by-product. The authorities noticed that in reality MACL was engaged in the manufacture of hydrogen.

But with a view to evade payment of excise, and get the benefit given to small-scale industries, it floated three front companies near the main factory. Gas was sent to the dummy companies through pipelines and they compressed and bottled it. On inspection, it was found that all the three bottling units were located in one single shed and were separated from each other by a small brick wall.

The directors of the three companies were employees of the Modi group. MACL arranged unsecured loans for the dummies that had only Rs 200 as share capital. These factors prompted the department to send show cause notice to MACL.

The company maintained that the three companies were separate entities. However, the department imposed duty and penalty. The company moved CEGAT, which quashed the order. So the commissioner appealed to the Supreme Court. It accepted the contention of the department.

“When the corporate veil is lifted, what comes into focus is only the shadow and not any substance about the existence of the three companies independently,” the judgment observed, adding that “suppression of material features and factors has been clearly established.”

The statements of the directors showed that the whole show was controlled, both on financial and management aspects by MACL. “If these are not sufficient to show interdependence, probably nothing better would show the same,” the Supreme Court remarked, describing the CEGAT judgment indefensible.

The task of lifting the corporate veil is an exercise the court had been actively called upon to undertake since the Constitution bench judgment in Telco v. State of Bihar in 1965. The ordeal has become more onerous with the liberalization and growing complexity of laws.

The above cases dealt with excise matters. But it is a common theme in several aspects of business. Therefore, the regulators in each field have to be vigilant about the tricks of the trade.⁵¹

Income Tax Act, 1961

Section 34⁴⁵ of the Act, discusses about the effect of registration of company.

Where any private company is wound up and if the tax arrears of the company in respect of any income of any previous years cannot be recovered, every person who was director of that company at any time during that relevant previous year shall be jointly and severally liable for payment of tax.

Under FEMA, 1999

The directors and individuals may be proceeding individually or jointly for violations of this act in order to evade their tax liability.

Under Central Excises and Salt Act, 1944

The above cases dealt with excise matters. But it is a common theme in several aspects of business. Therefore, the regulators in each field have to be vigilant about the tricks of the trade.⁵¹

· UNITED KINGDOM

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.⁵² For instance, in Apthorpe v. Peter Schoenhofen Brewing Co.⁵³ the Income Tax 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 Commissioners also found, if the business was technically that of 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 Solomon's case, held that the New York business was that of the English company which was liable for English income tax accordingly.

In another case, Firestone Tyre & Rubber Co. v. Llewellin⁵⁴, 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 evade the taxes, and it was held that the substance of the arrangement was that the American company traded in England through the agency of its subsidiary. In this case, the corporate veil of the company was lifted.

· UNITED STATES

In recent years, the Internal Revenue Service in the United States has made use of corporate veil piercing arguments and logic as a means of recapturing income, estate, or gift tax revenue, particularly from business entities created primarily for estate planning purposes. A number of US Tax Court cases involving family limited partnerships (FLPs), such as Strangi, Hackl, Shepherd, and Bongard, show the IRS's use of veil piercing arguments. Since owners of US business entities created for asset protection and estate purposes often fail to maintain proper corporate compliance, the IRS has achieved multiple high-profile court victories.⁵⁵

In Federal Coke Co. Ltd. v. FCT⁵⁶ as noted by Bowen C.J.:

In taxation matters, the court is obliged to have regard to the actual facts and not to their equivalents where there is no statutory warrant for doing so, the court cannot disregard certain of the facts or re-arrange the facts or decide the case according to its view of the substance of the matter. It is not legitimate to disregard the separateness of different corporate entities or to decide liability to tax upon the basis of the substantial economic or business character of what was done.

Although the Asprey Report (Taxation Review Committee Full Report) has recommended that “it is in principle necessary to go behind the veil of separate legal personality which the company enjoys and translate the tax into a set of individual tax ‘burdens’.⁵⁷ This approach had earlier been implemented in Harold Holdsworth & Co. (Wakefield) Ltd. v. Caddies⁵⁸ Section 6(1) of the Income Tax Assessment Act provides that a company is to be recognized as a separate person for the purposes of the assessment of income tax under the Act. However, this general principle is subject to the following statutory exceptions designed to ensure that the corporate form cannot be employed to avoid “legitimate” tax liabilities.

Generally speaking, section 8Y of the Taxation Administration Act, 1953 imposes liability upon directors if their corporation commits an offence. More specifically, section 252 (1) (f ) of the Income Tax Assessment Act provides that in the event of default by a company under the Act, the public officer shall be answerable for that company's default. This liability extends to directors pursuant to section 252(1)( j). In Reynolds v. Deputy Commissioner of Taxation⁵⁹ a director of a company that had ceased to trade had failed to remit to the Commissioner (contrary to ITAA sections 221 F (5) and 221 F (11), pay installments that had been deducted from the wages of its employees. The prosecution relied on section 252 (1) (f ) and (j ) to impose personal liability on Reynolds. On appeal, the Federal Court held that as no notice had been served on Reynolds, the intention of section 252 (1) (j ) was not to impose personal liability on him upon default by the company.⁶⁰

Shareholders may also be held personally liable in cases of tax avoidance under the Income Tax Assessment Act, the Taxation (Unpaid Company Tax) Assessment Act, 1982 and the Crimes (Taxation Offences) Act, 1980.⁶¹ See further, for example, Insomnia (No. 2) Pty. Ltd. v. FCT¹ and FCT v. Gulland⁶³, Watson v. FCT⁶⁴, and Pincus v. FCT⁶⁵ in this regard.

Barwick C.J. in Slutzkin v. FCT⁶⁶ held that taxation is one area where the courts have been most amenable to lifting the veil, although they have not been consistent in their approach.⁶⁷

A Revenue authority is an obvious third party who stands to lose as a result of agreements reached by the taxpayer and who therefore has an interest, in seeking to apply revenue law, in ascertaining whether the agreements that have been entered into give effect to the parties' real intentions or are shams.

In both Ramsay case⁶⁸ and Furniss case⁶⁹, the Inland Revenue sought to persuade the Commissioners that the taxpayer's arrangements were a sham. This is apparent from the inspector's contentions before the Commissioners in Furniss, that:

(i) The entire transaction looked at as a whole was so invaded by fiscal considerations as to lose its character, and because of the fiscal considerations the corporate identity of Greenjacket should be pierced and Greenjacket recognized as the alter ego of the Dawson family;

(ii) Any representation of Greenjacket as an independent entity with an independent will discharging an active independent role was no more than a sham. Being a sham it should be ignored and the tax position determined as if Greenjacket did not exist;

(iii) The contractual relationship between the Dawson family shareholders and Greenjacket was such that Greenjacket must be taken to have acquired the shares as nominee or bare trustee for the Dawson family shareholders. Consequently Greenjacket never had more than bare legal ownership and therefore did not have control of the operating companies within the meaning of paragraph 6 of Schedule 7 to the FA 1965;

(iv) In the alternative, there were understandings between the Dawson family shareholders and Greenjacket, being understandings which were intended to be effective but had no binding force in law, the effect of which was such that Greenjacket's apparent beneficial ownership of the shares was no more than bare legal ownership. Consequently Greenjacket never had control of the operating companies within the meaning of paragraph 6, Schedule 7 to the FA 1965.⁷⁰

These different contentions illustrate the variety of challenges that can be made to the legal characterization of what a person has done, ranging from occasions on which a court may be prepared to pierce the corporate veil⁷¹ to questions as to what the parties have really agreed amongst themselves.

However, Lord Diplock's observation in the case of Burmah⁷² is of relevance. He noted:

“The kinds of tax avoidance schemes that have occupied the attention of the courts in recent years, however, involve inter-connected transactions between artificial persons, limited companies, without minds of their own but directed by a single master-mind. In Ramsay the master-mind was the deviser and vendor of the tax avoidance scheme; in the instant case it was Burmah, the parent company of the wholly-owned subsidiary companies between which the pre-ordained series of transactions took place.”⁷³

This does not involve piercing the corporate veil. Instead, it recognizes that the intentions of the parties (whether currently on the scene or not) may be capable of being determined by the person directing or in control of the transactions.⁷⁴

The courts will also lift the veil where a company is reorganized to enable it to avoid taxation liabilities. An example of such a reorganization is found in Gregory v. Helvering⁷⁵ where a company was incorporated solely for the purpose of transferring shares to the taxpayer and avoiding tax that would have otherwise been payable. The corporation carried on no business, and was dissolved on completion of the transfer. The United States courts have subsequently developed the “business activity” test, which considers whether a corporation was formed for a legitimate business purpose other than for the minimization of taxation.⁷⁶

DIRECT TAX CODE AND THE SCOPE OF PIERCING THE CORPORATE VEIL

Moving towards the Direct Tax Code (DTC), one of the stated objectives of it is to establish an economically efficient, effective and equitable direct tax system which shall facilitate voluntary compliance and raise the tax-GDP ratio. The objective is to bring assessor and assessee at ad item on the provisions of law.⁷⁷

The legislature was in need for a well defined anti-tax avoidance which can increase the power of tax authorities and can provide new contours to judiciary in piercing the corporate veil. Hence following measures are being pondered over to defeat tax planning and tax evasion under the DTC –

1. The section 123 of DTC proposing Anti-tax avoidance measures

Under section 123 of DTC, commissioner can declare any arrangement an impermissible avoidance arrangement (IAA). IAA as per section 124 (15) means, an arrangement, whose main purpose is to obtain a tax benefit and it:

i. Results, directly or indirectly, in the misuse, or abuse, of the provisions of DTC

ii. Lacks commercial substance, in whole or in part

iii. Creates rights, or obligations, which would not normally be created between persons dealing at arm’s length; or

iv. Is entered into, or carried out, by means, or in a manner, which would not normally be employed for bona fide purposes.

GAAR would apply to those transactions which the commissioner presumes to be motivated by tax avoidance. The concerned commercial transactions shall be deemed to be for the main purpose of obtaining tax benefit.

Effectively, the commissioner can pierce the corporate veil to ascertain the ‘substance’ of the transactions as and when desired. Thus, the GAAR in broad words allow the department to perceive a subsidiary as an agent or asset of the holding company at its will. This is clear departure from the existing legal principles which have set a threshold for piercing the corporate veil. DTC provides that a transaction would fall outside the rule if it was carried out for economic and commercial reasons.

2. The new notion of residence in case of company incorporated outside India

Under section 6 (3) of the Income Tax Act, a foreign company shall be considered to be resident in India only if the whole of the control and management of its affairs are located in India.⁷⁸ The DTC has widened the concept of residence. According to the Revised Discussion Paper, a company incorporated outside India will be treated as a resident in India and subjected to tax if its ‘place of effective management’ is situated in India.

The term shall have same meaning as currently laid down in section 314 (192), that is –

i. The place where Board of Directors (BoD) of the company or its executive directors, as the case may be make their decisions; or

ii. In case where BoD routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.

The first condition should be clarified, else, the test of effective management shall not only broaden the ambit of taxability of companies, but also make the application of the test uncertain and be subject to interpretation by courts at a subsequent stage, thereby making tax planning more difficult.

3. Strict Controlled foreign corporations provisions

Revised Discussion Paper had proposed for Controlled foreign corporations (CFC) provisions in DTC. CFC is a corporate entity which conducts business in one jurisdiction but is owned or controlled primarily by the resident taxpayers of another jurisdiction. CFC’s deliberately route their investments through tax havens (i.e. where corporate rate of tax is lower as compared to India) to avoid payment of taxes on income at home. As income from foreign source is taxed usually after it is accrued or received as income in the country of residence of the taxpayer, the mechanism enable the shareholders to defer the payments of taxes. Passive income earned by a foreign company which is controlled directly or indirectly by a resident in India, and where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received from the foreign company.

4. Agreement for ‘Double Taxation Avoidance’

Double taxation avoidance agreements (DTAAs) are commonly opt by multinational companies (MNCs) for enjoying tax benefits. It is a common practice among them to establish Special Purpose vehicles (SPVs) in tax havens such as Mauritius or Cayman Islands for holding shares in downstream Indian companies.⁷⁹ According to Revised Discussion Paper, an assessee will be free to opt for either DTAA provisions or DTC, whichever is more beneficial. Although RDP attempted to address the concerns raised by DTAA provisions in DTC, uncertainty still remains. DTAA, according to RDP, shall not inter alia enjoy preferential status when the revenue Department invokes GAAR or CFC provisions. Thus under the changed approach of the legislature and proposed direct tax code, tax planning will be difficult to be used for tax evasion.

CONCLUSION:

The above measures are going to increase the power of the tax authorities to pierce the veil anytime they felt that there is tax evasion. Also the new provisions of DTC will definitely be going to reduce the scope and power of the judiciary in ‘piercing of the corporate veil’ on the traditional grounds, but surely the judiciary will empower itself by availing new contours to ‘pierce the corporate veil’ on new grounds as we have seen in the Vodafone and Richter Holdings Case. Thus there is a much scope that this exceptional rule of ‘piercing of corporate veil’ can transform into a general rule. Tax risks are increasingly being discussed at the time of concluding deals and are a cause of great concern. In the meantime, as usual, deal makers will come out with other possible mechanisms to conclude transactions already in pipeline, for e.g. escrow accounts, insurance policy etc. Thus we can see that tax evasion can be avoided but can’t be conclusively stopped. Corporations will surely find different means and so judiciary as well as other authorities will invent more new grounds to ‘pierce the corporate veil’.

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4. For instance, the Court of Appeal in Adams v. IndustriesPlc [[1990] 2 W.L.R. 786, HL.], refused to lift the veil as against the defendant company on the ground that the right to use a corporate structure can be denied only in case of illegality and not immorality.

5. See, Palmer, ‘Company Law’, 2223 (1992). See also, C.I.T, Madras v. Meenakshi Mills Ltd., (1967) 63 ITR 609 (SC).

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12. See, Young v. David Payne & Co., Ltd [1904] 2 Ch. D. 608.

13. See, Barber-Greene Americans Inc. v. Commissioner of Internal Revenue, (1960) 35 TC 365.

14. See, McDowell v. CTO, AIR 1986 SC 649.

15. See, C. H. Tan, ‘Piercing the Separate Personality of the Company: A Matter of Policy?’ [1999] Singapore Journal of Legal Studies 531 at 536.

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20. See, W. T. Ramsay v. Inland Revenue Commissioners [[1982] AC 300] was a significant departure from the Westminster principle. In the instant case, the House of Lords considered a tax avoidance scheme which consisted of a series or a combination of transactions each of which was individually genuine but all of which as a whole resulted in tax avoidance. The House laid the principle that the fiscal consequences of a preordained series of transactions, intended to operate as such, are generally to be ascertained by considering the result of the series as a whole. It is not to be ascertained by dissecting the scheme and considering each individual transaction separately.

21. See, CIT v. A. Raman & Co. [(1986) 67 ITR 11] the Supreme Court held that the avoidance of tax liability is not prohibited. Legislative injunction in taxation statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.

22. See, Bank of Chettinad Ltd v. CIT, [ (1940) 8 ITR 522 PC]

23. (2003) 263 ITR 707 (SC).

24. (1985) 62 ALR 545; (1985) HCA 83 (Three Doctors Case).

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58. [1955] 1 W.L.R. 352

59. (1984) 9 A.C.L.R. 102

60. Gower, ‘Principles of Modern Company Law’ (3rd ed., 1969), p. 216.

61. Ibid. at p. 860.

62. [1982] Q.B. 84

63. (1986) A.T.C. 4145.

64. [1983] F.S.R. 54.

65. (1985) A.T.C. 4765.

66. (1977) 140 C.L.R. 314.

67. Peter Ziegler & Lynn Gallagher, ‘Lifting the corporate veil in the pursuit of justice. Journal of Business Law’, 1990.

68. WT Ramsay Ltd v. Inland Revenue Commissioners, [1982] A.C. 300 (HL)

69. Furniss v Dawson, (1984) 55 TC 324.

70. (1984) 55 TC 324 at 331.

71. Jones v Lipman [1962] 1 WLR 832.

72. IRC v. Burmah Oil Co Ltd., (1981) 54 TC 200.

73. Ibid at p. 215.

74. Malcolm Gammie, ‘Sham and reality: the taxation of composite transactions’, British Tax Review, 2006.

75. 293 U.S. 465 (1935).

76. Nelson v. Commissioner, 281 F.2d 1 (1960).

77. See, Discussion Paper on Direct Tax Code, August 2010, Chapter-II, A-9

78. “Control and management signifies contolling and directive power, the head and brain as it is sometimes called and also means de facto control and management”;, See, Dr. Girish Ahuja and Dr. Ravi gupta, ‘Direct Taxes and Practices’, Bharat Law House Pvt. Ltd., New Delhi, p. 45 , 2011; Also see, CIT v. Nandlal Gandalal, (1960) 40 ITR 1 SC

79. See, Arnold Brian J., ‘Tax Treaties & Tax avoidance’, (2004) 58 BIFD 244.

Received on 27.11.2012

Modified on 13.01.2013

Accepted on 20.01.2013

Research J. Humanities and Social Sciences. 4(3): July-September, 2013, 380-391