A company is a separate legal entity with a perpetual succession and an identity distinct from its members. Members may come and go but a company continues to exist independent of its members. This is a principle of law which has been laid down since the time the very first statute dealing with companies came into existence. However, there are times when the Courts decide to look behind the company, i.e., lift or pierce the corporate veil and ascertain who are the real beneficiaries behind the entity. Such scenarios are very few and far between but they do exist and are resorted to by the Courts in the rarest or rare cases.
Recently, the Supreme Court in the case of Estate Officer UT Chandigarh vs. M/s. Esys Information Technologies P Ltd, CA No 3765/2016 (“Esys’s case”) had an occasion to deal with the circumstances when the corporate veil may be lifted.
Corporate Identity
Section 9 of the Companies Act, 2013 provides that from the date of incorporation of a company, all its members shall be a body corporate by the name under which it is formed and the company shall be capable of owning property and shall have a perpetual succession. Thus, this section lays down the corporate identity of a company which is distinct and separate from its members.
Factual Matrix of Esys’s Case
Esys,a subsidiary of a Singapore company, was allotted a site at an Information Technology Park at Chandigarh under the Allotment of Small Campus Site in Chandigarh Information Services Park Rules, 2002. Esys was supposed to carry out construction of a campus site but before doing so, 98% of its shareholding was transferred by its Singapore-based holding company to a Dubai-based group company. The Dubai-based group company, in turn, transferred its controlling stake to another company, known as Teledata Informatics Ltd. In neither case was permission obtained for the transfer of shares. The Estate Officer concluded that since the shareholding changed hands after land allotment and that too without the prior permission of the Estate Officer, there was a violation of the terms of the allotment letter. The particular clause of the allotment letter being referred to by the Officer stated that the transfer of the site would not be allowed for 10 years from the date of allotment without the prior permission. It may be allowed in the event of merger or split of the allottee and that too after obtaining prior permission. Further, all cases of transfer were subject to payment of prescribed transfer charges.
As a result of the transfers, not only did the Dubai-based company became the owner of the land but it was further transferred to Teledata. This fact of transfer to Teledata was suppressed on oath by the Director of Esys but was discovered by the Estate Officer from an affidavit filed by the Director before the High Court of Singapore in another matter. In that affidavit the Director had very clearly conceded that Teledata was the new owner of Esys. The Estate Officer concluded that the manner in which the transfer was made was not permissible as per the Rules and terms of the allotment letter. The holding company and its subsidiaries were two distinct legal entities and hence, the corporate veil should be lifted so as to unearth the mala fide, dishonest and fraudulent design of the allottee. Accordingly, the Officer contended that this amounted to an illegal transfer of the land and also ordered that the allotted site be resumed. The Appellate Authority upheld this Order of the Estate Officer.
High Court’s verdict
The Punjab and Haryana High Court overruled the verdict of the Appellate Authority. It refused to lift the corporate veil in the case under discussion. It stated that there was neither a transfer of the allotted site nor a merger of the allottee. The allottee was a juristic entity and continued to remain as such. It relied upon an old decision of Saloman vs. Saloman, 1897 AC 22(1) which held that a company is separate and distinct legal entity. It also relied on the Supreme Court’s decision in the case of Bacha F. Guzdar vs. CIT, 27 ITR 1(SC) where the Court held that that a shareholderhas got no right in the property of the company. His only rights are the right to vote and right to dividend, if declared, but that does not, either individuallyor collectively, amount to more than a right to participate in the profits of the company. The company was a juristic person and was distinct from the shareholders. It was the company which owned the property and not the shareholders. It also discussed the judgment in the case of Andhra Pradesh State Road Transport Corporation vs. ITO, AIR 1964 SC 1486 which held that a shareholder does not own the property of the corporation or carries on the business with which the corporation is concerned. The High Court further held that the argument that the principle of lifting of the corporate veil should be applied, did not arise in the impugned case since the shareholders were distinct from the company and there was no change in the name of the allottee. The allotment continued in the name of the company. Change in shareholding could not be construed to be violative of the allotment letter as the company was a distinct and separate entity and composition of share holding did not change the nature of the company. It accordingly set aside the Officer’s site resumption order.
Based on this the Estate Officer appealed to the Supreme Court where a pointed question was raised by the Supreme Court to the director as to whether the shares of Esys have been transferred to Teledata? The director stated on oath that they have not been which was in fact, contrary to the truth.
When can the Veil be Lifted?
The Supreme Court held that in Juggilal Kamlapat vs. CIT 73 ITR 702 (SC), it has been laid down that it is true that from juristic point of view a company is a legal personality entirely distinct from its members and it is capable of enjoying rights and being subjected to rights and 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 or to perpetrate fraud. It further discussed the decisions of Jai Narain Parasrampuria vs. Pushpa Devi Saraf, 2006 (7) SCC 756;State of U.P vs. Renusagar Power Co., AIR 1988 SC 1737 wherein the Supreme Court held that it was well settled that the corporate veil could in certain situations can be pierced or lifted. In the expanding horizon of modern jurisprudence, lifting of corporate veil was permissible. Its frontiers were unlimited. It must, however, depend primarily on the realities of the situation. The aim of legislation was to do justice to all the parties. The principle behind the doctrine was a changing concept and it was expanding its horizon Whenever a corporate entity was abused for an unjust and inequitable purpose, the court would not hesitate to lift the veil and look into the realities so as to identify the persons who are guilty and liable therefor. The Apex Court observed that the corporate veil even though not lifted was becoming more and more transparent in modern company jurisprudence. It held that the case of Saloman vs. Saloman, 1897 AC 22(1) was still popular but the veil has been pierced in many cases. The lifting of the veil has been held to be permissible in Life Insurance Corporation of India vs. Escorts Ltd. AIR 1986 SC 1370 which held that it may be lifted where a statute itself contemplates lifting the veil, or 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.
Though not considered in this decision but the Supreme Court in Vodafone International Holdings BV vs. UOI, 341 ITR 1 (SC) had also dealt with this issue by stating that lifting of the corporate veil is readily applied in the cases coming within the Company Law, Law of Contract, and Law of Taxation. Once the transaction is shown to be fraudulent, sham, circuitous or a device designed to defeat the interests of the shareholders, investors, parties to the contract and also for tax evasion, the Court can always lift the corporate veil and examine the substance of the transaction. The Court is entitled to lift the veil of the corporate entity and pay regard to the economic realities behind the legal facade meaning that the court has the power to disregard the corporate entity if it is used for tax evasion. This principle is also applied in cases of a holding company – subsidiary relationship- where in spite of being separate legal personalities, if the facts reveal that they have indulged in dubious methods for tax evasion. This decision examined the concept of whether a transaction should be “looked at” or “looked through”. The amendments made by the Finance Act, 2012 to section 9 and section 2(47) of the Income-tax Act, 1961, which introduced the concept of taxation of Indirect Transfers, are nothing but an extension of the doctrine of lifting of the corporate veil.
Apex Court’s Decision
After considering various factors, the Supreme Court overruled the decision of the High Court in Esys’s case. It also held that prima facie from the affidavit of the director filed in Singapore, there was a transfer in favour of Teledata. Inspite of a direction to disclose the facts, there was a concealment of material facts. Esys was guilty of concealing the truth and thus, it held that the provisions of the allotment letter have been clearly violated and the Estate Officer was within his rights to resume possession of the land.
Fallout of this Decision
This decision raises several unanswered questions. Was this view taken by the Supreme Court merely because the director lied on on oath or would the doctrine of lifting the veil be applied in all cases where shares of a company are transferred? It appears that the Court was driven towards this view because of the concealment by the director. However, if there was no concealment, would the decision of the Supreme Court been different? It is relevant to note that the allotment letter contained no restriction on the transfer of shares of the allottee! All that it prohibited was a transfer of the site.
This question is relevant in several other situations. In case of transfer of shares of a company owning a valuable piece of land at Mumbai would stamp duty be levied @ 0.25% as on a transfer of shares or 5% as on conveyance of property? The Mumbai ITAT in the case of Irfan Abdul Kader Fazlani, ITA No. 8831/Mum/11 has held that section 50C cannot be applied to the sale of shares of a property owning company. The veil cannot be pierced in such a case to contend that what is being sold is actually land and building.
Similar questions also arise in flats where collector’s charges are to be paid. These charges are currently being avoided because what is being sold are shares of the company and not the property per se.
Further, if shares of such a company are long-term capital assets but the land held by the company is short-term capital asset, then would the gain on sale of shares be treated as short-term capital gain? A similar question was placed before the Karnataka High Court in Bhoruka Engineering Industries Ltd vs. DCIT, 356 ITR 25 (Kar). In that case, shares of a listed company were sold through the exchange and capital gains exemption was claimed u/s. 10(38). The only asset of the company was land. The AO contended that the veil should be lifted since what had been sold was virtually land and hence, the exemption should be denied.
The High Court denied this plea of the Department and held that the transaction was real, valuable consideration was paid, all legal formalities were complied with and what was transferred was the shares and not the immovable property. The finding of the assessing authority that it was a transfer of immovable property was contrary to the law and contrary to the material on record. It held that they committed a serious error in proceeding on the assumption that the effect of transfer of share was transfer of immovable property and therefore, if the veil of the company was lifted what appeared to them was transfer of immovable property. According to the High Court, such a finding was impermissible in law.
Conclusion
One can only hope that the lifting of the veil is resorted to in select cases, such as, those where there are instances of fraud or deceit. A wrong use of this decision could open up a Pandora’s box and it could be like Vodafone’s case being revisited all over again – one only hopes this purdah is not lifted easily!! _
