In re Sir Dinshaw Maneckjee Petit (1927)

Salomon holds that a registered company is a person distinct from its members and that the motive for forming it is irrelevant. The obvious next question is whether that principle protects a man who forms companies for no purpose except to shelter his own income from tax. Dinshaw Petit is the Indian answer, and it is the leading Indian authority on evasion of taxation as a ground for lifting the veil.

The reasoning is subtler than the textbook label suggests. Marten CJ does not say that the companies were not companies. He accepts that they were validly incorporated and were separate entities. What he refuses to accept is that the transactions between the assessee and those entities were real. Read the case that way and it becomes a case about proof and sham documents rather than a case about corporate personality — which is exactly why it survives Salomon.

For the financial year 1925-26 the assessee, Sir Dinshaw Petit, was assessed to super-tax on an aggregate income of Rs. 11,35,302 arising in the previous year. He objected to Rs. 3,90,804 of that figure, made up of two sums of Rs. 2,76,800 and Rs. 1,14,004, the first arising from Government and other fixed interest bearing funds and the second from dividends in companies. Marten CJ treated the distinction as immaterial.

Three things were admitted. The assessee was the legal owner of most of the funds, in the sense that they stood in his name and the interest and dividends were paid to him direct. As to the rest, the apparent legal owners were his nominees and he received the interest and dividends. And he had retained all the interest and dividends and applied the same to his own use.

His answer was that he was only a trustee for certain family companies he had formed; that the income was theirs and not his; that he had credited them in account; and that although he had the benefit of the money in specie, that was because the family companies had lent him these moneys at interest which he credited to them in account without actually paying it in cash. A company, he said, is under no obligation to declare a dividend and may lend out its income, even if over a series of years the fixed preference dividends go unpaid and a large sum of back income accumulates in his hands.

The four family companies

In 1921 the assessee formed four private companies — described in the judgment as family companies for convenience, although in fact no other member of his family took any direct benefit thereunder. They were Petit Limited, The Bombay Investment Company Limited, The Miscellaneous Investment Company and the Safe Securities Limited. Each took over a particular block of the assessee's investments. Because the modus operandi was substantially the same in each case, the Court followed the fortunes of Petit Limited alone.

The modus operandi, worked through Petit Limited

Petit Limited was incorporated on or about 12 April 1921 with a nominal capital of rupees ten millions, divided ultimately into 9,99,900 ordinary shares of Rs. 10 each and one hundred preference shares of Rs. 10 each carrying a fixed cumulative preferential dividend of six per cent. Its issued and subscribed capital was 3,48,604 fully paid ordinary shares, all held by the assessee, and three fully paid preference shares held by three persons alleged to be his subordinates and entirely under his control — the Secretary of the Petit Charities, the Secretary of the four family companies, and a clerk in the same companies. Kemp J records that the only cash the company ever received was Rs. 70, the price of the three preference and four ordinary shares paid for in cash.

The primary object in clause 3(1) of the memorandum was to enter into an agreement of 12 April 1921 under which the assessee sold the company 498 shares in Maneckji Petit Manufacturing Company Limited for Rs. 34,86,000, at Rs. 7,000 per share, in consideration of an allotment to him of 3,48,600 fully paid shares of Rs. 10 each.

By a contemporaneous indenture of the same date the assessee executed a declaration of trust. It recited an agreement that the 498 shares should not be transferred until the company called for a transfer, and that meanwhile the assessee and his nominees would hold them as agents and trustees for the company. Of the 498 shares, 254 stood in his name and 200 in the name of his wife, the rest in the names of some thirteen nominees. No formal transfers were ever called for, so the formation of the company made no difference at all to the names on the register of the Maneckji Petit Manufacturing Company.

The accounts told the rest of the story. On 10 September 1924 the cash book showed a receipt of Rs. 24,900 for a half year's dividend, immediately debited to the current account of the assessee, which also carried a debit of Rs. 40,549 for interest due by him and a total debit balance against him of Rs. 7,14,103. The company had not even paid the preference dividend of Rs. 30 a year in all on the three preference shares, though it purported to set aside rupees six lacs to a depreciation and reserve fund. Marten CJ summed the accounts up in a sentence: the dividends on the 498 shares "remained in fact with the assessee from first to last", and "All the rest represented book entries which might represent the truth or might not."

As for the company itself, "its activities were of the most modest description, despite the thirty-eight objects mentioned in its memorandum." There had been no additional buying or selling. "The company has been too timid to indulge in any active business. It has been content to be a holding company, and as counsel for the assessee truly points out, there is no general law against that." The articles gave the assessee complete control as governing director, and there was no other director.

For the Crown it was contended that the alleged disposition in favour of each family company was a sham, as was the declaration of trust; that "the transactions are all paper transactions and not real"; that if the family company carried on any business it did so solely as the agent of the assessee; and that in any event "the alleged loans are not genuine loans." The disputed sums were therefore the taxable income of the assessee.

The Commissioner stated four questions of law. Question (4) went to the genuineness of the alleged loans, and although in one sense a question of fact, the Commissioner explained in the case the basis on which he submitted it. In substance the Court had to decide:

1. Whether the Crown may go behind a registered transfer and a registered company's own documents to show that the transaction was a sham.
2. Whether there was evidence in law on which the Commissioner could find that there was no genuine transfer or declaration of trust in favour of the family company.
3. Whether the alleged loans were genuine loans or withdrawals of income under another name.

The reference was answered against the assessee. Question No. 1 was answered in the affirmative; Questions Nos. 2 and 3 in the negative; and Question No. 4 by holding "that the loans in question were not genuine loans but were merely withdrawals of income disguised as loans." That is the order recorded per curiam for the Court.

A company duly registered is a separate entity, but it does not follow that every alleged transaction between the company and its controller is real. Where the Crown proves that the transfer to the company and the loans back to the controller were sham book entries, the income is assessed as the controller's own.

Marten CJ puts the two halves together explicitly. Start "clearly with this that there was here a company duly incorporated under the Indian Companies Act and that this company was a separate entity from the assessee Sir Dinshaw Petit, just as much as, say, his secretary or any other third party might be." But because there is such an entity, "it does not necessarily follow that every alleged transaction between the assessee and X was valid or that it represented a real transaction."

The onus is on the Crown. The Chief Justice was emphatic that although it is permissible in law for the Crown to inquire into the genuineness of these transactions, "it would be quite wrong to start with the presumption that those transactions are sham ones. On the contrary one should start with the presumption that they are genuine, and throw the onus on the Crown to prove the contrary." He reinforced the point with Younger LJ's warning in Inland Revenue Commissioners v. Sansom against "the too indiscriminate use of such words as simulacrum, sham, or cloak" in connexion with one-man companies, which "exist under the sanction, even with the encouragement of the Legislature".

What discharged the onus. The evidence was circumstantial and cumulative. "one striking element is that the company has never yet obtained sole legal possession and control of the property which it purported to buy. Nor can one point to clear and definite evidence that the Company is carrying on a genuine business as a separate entity." Why, the Court asked, should an ordinary contract for the sale of shares be followed by an unregistered document of the same date depriving the buyer of the ordinary rights of a purchaser, and why conceal it from anyone searching the register? The concealed declaration of trust brought the company nothing but disadvantage: it could not begin the business contemplated by its memorandum until it actually acquired the shares, a lawsuit might be needed to compel transfers, and the nominees could have given good title to third parties ignorant of the trust. No substantial argument was offered to explain the device.

The loans. The dividends were received in the first instance by the assessee; the Maneckji Company was never instructed to pay them to the family company; the rest was book entries. And "beyond the accounts we have nothing in writing whatever to establish the alleged agreement for loan by the family company" — no minute, no resolution, nothing, "And none the less so because the governing director with his wide powers was purporting to lend the company's money to himself." By that alleged agreement "the family company practically bound itself hand and foot to do no business, for its cash immediately on receipt was to be handed back to its vendor and promoter at a fixed rate of interest."

The distinction from Salomon. Marten CJ states it in terms: "we have a case which is the exact opposite of Salomon v. Salomon & Co., in the essential facts which I am now considering." In Salomon there was a genuine and prosperous boot and shoe manufacture, it was genuinely transferred, the company genuinely carried it on, and there was no concealment; the creditors were driven to argue that the statute created no separate entity at all, and that contention the House of Lords demolished. The same distinction disposes of Sansom, where there was a real timber business and the Commissioners, having seen the man cross-examined, believed him; here "The assessee has not ventured to give any evidence and the finding of the Commissioner is against the truth of his story. Nor have any of the alleged loans been repaid."

Kemp J's concurrence puts the tax point at its bluntest. Limited companies were liable to super-tax at a much lower rate than individuals, so it was plainly to the assessee's interest that the income be treated as the company's. The facts "suggest that the company in this case was formed by the assessee purely and simply as a means of avoiding super-tax and that the company was nothing more than the assessee himself. It did no business but was created purely and simply as a legal entity to ostensibly receive the dividends and interest and hand them over to the assessee as pretended loans." On the trust he held that the burden lay on the assessee to show he was a trustee, and that "the evidence establishes that as a matter of fact he really held the shares on his own behalf and for his own benefit whilst professing to hold them as trustee for a genuine and bonafide company."

Two further arguments were rejected. That the revenue was estopped because the family company had paid tax on the credited interest: paying tax on the alleged interest "was much cheaper for the assessee than paying super-tax on the dividends themselves." And that only legislation could defeat a device of accumulating profits: "that argument does not touch a sham transfer nor a sham loan."