Workmen v. Associated Rubber Industry Ltd. (1985)

This is the Indian veil-lifting case that students should reach for first, for three reasons. It is a Supreme Court decision, so it binds; it lifts the veil in favour of workmen, not revenue authorities, which shows the doctrine is not confined to tax; and it states the test in a sentence that can be reproduced exactly. It also does something unusual and worth noticing: it holds that on facts of this shape no evidence of intention is needed at all, because the structure speaks for itself.

The Associated Rubber Industry Ltd. had some years earlier bought shares of INARCO Ltd. by investing Rs 4,50,000. It received annual dividends on those shares, and the amount was shown in its profit and loss account year after year and taken into account in calculating the bonus payable to its workmen.

Some time in the course of 1968 the company transferred its INARCO shares to Aril Bhavnagar Ltd., later renamed Aril Holdings Ltd., a subsidiary wholly owned by Associated Rubber. The judgment lists the features of that subsidiary with deliberate flatness:

• it had no capital except the INARCO shares transferred to it by the parent;
• it had no other business or source of income whatsoever except receiving the dividend on those shares;
• the dividend income was not transferred to the parent, and therefore did not appear in the parent's profit and loss account.

The consequence was arithmetical. The available surplus for the payment of bonus fell, and the workmen received bonus at 4 per cent for the year 1969 instead of the 16 per cent to which they would otherwise have been entitled.

In 1971 Aril Holdings Ltd. was itself wound up and amalgamated back into Associated Rubber.

The workmen at Bhavnagar raised an industrial dispute claiming 16 per cent for 1969, saying that the transfer of the INARCO shares was no more than a device to avoid the higher bonus. The Industrial Tribunal and then the High Court of Gujarat under Article 226 held against them: the two companies were independent companies with separate legal existence, so the subsidiary's profits could not be treated as the parent's for the purpose of computing gross profits; and there was no evidence that the transfer was a device.

Could the dividend income received by the wholly owned subsidiary be taken into account in assessing the gross profit of the parent for the purpose of calculating the rate of bonus, notwithstanding that the two were distinct legal entities?

Appeal allowed. The dividend from INARCO received by Aril Holdings was to be taken into account in assessing the gross profit of Associated Rubber, and it was declared that the workmen at Bhavnagar were entitled to bonus at 16 per cent for the year 1969.

Where a company creates a subsidiary that has no assets, no business and no income of its own beyond what the parent has passed to it, and that serves no purpose except to reduce the parent's gross profits, the court will disregard the separate existence of the subsidiary and treat its income as the parent's. Where the structure itself discloses the device, no further evidence of intention, direct or circumstantial, is required.

Separate personality is conceded, and then set aside

Chinnappa Reddy J begins by conceding the whole of the respondent's law: "It is true that in law The Associated Rubber Industry Ltd. and Aril Holdings Ltd. were distinct legal entities having separate existence." The concession is the point — this is not a case about whether the subsidiary was properly incorporated. What follows is the duty of the court:

It is the duty of the court, in every case where ingenuity is expended to avoid taxing and welfare legislations, to get behind the smoke-screen and discover the true state of affairs. The court is not to be satisfied with form and leave well alone the substance of a transaction.

Two things in that sentence carry marks. First, welfare legislation stands alongside taxing legislation: the doctrine is not a revenue doctrine. Second, the test is substance against form, and the court's task is described as a duty, not a discretion.

The authority relied on

The judgment adopts the statement of judicial approach from CIT v. Sri Meenakshi Mills Ltd., AIR 1967 SC 819. From the juristic point of view the company is a legal personality entirely distinct from its members, "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." The court has power to disregard the corporate entity "if it is used for tax evasion or to circumvent tax obligation."

Meenakshi Mills itself illustrated the point from two English decisions: Apthorpe v. Peter Schoenhofen Brewing Co., where a New York company was kept in being only to hold land that aliens could not hold, and the business was held to be that of the English company despite the argument based on Salomon; and Firestone Tyre and Rubber Co. v. Llewellin, where an English subsidiary selling its own goods as principal was nevertheless the means by which the American parent carried on its European business.

The judgment adds the more recent statement in McDowell & Co. Ltd. v. CTO: it is for the court "to determine the nature of the new and sophisticated legal devices to avoid tax", to expose them for what they really are "and to refuse to give judicial benediction."

Why no evidence of purpose was needed

This is the part of the reasoning most worth memorising, because it answers the High Court's finding that there was no evidence of a device.

A new company is created wholly owned by the principal company, with no assets of its own except those transferred to it by the principal company, with no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the gross profits of the principal company. These facts speak for themselves.

The judge accepts that "There cannot be direct evidence that the second company was formed as a device", and holds that none is needed: the obvious purpose served, and which "stares one in the face", is the reduction of bonus. "It is such an obvious device that no further evidence, direct or circumstantial, is necessary."

The argument from the later amalgamation

Counsel argued that the winding up and amalgamation of Aril Holdings in 1971 showed that its creation had not been a device of avoidance. The court rejected the inference: probably, after Aril Holdings was created, some unforeseen difficulties arose, not brought to light, which made it necessary to wind it up. A structure that is a device when created does not cease to have been one because it is later dismantled.

| Case | What was behind the veil | What the court did | |---|---|---| | Salomon | A solvent business lawfully incorporated | Refused to lift; separate personality upheld | | Dinshaw Petit | An individual's income routed through companies he controlled | Lifted, for income tax | | Gilford Motor | A pre-existing covenant | Lifted, and the injunction went against the company too | | Associated Rubber | A subsidiary with no function but to shrink the parent's profits | Lifted, and the subsidiary's income treated as the parent's |

Associated Rubber is the case that extends the group of exceptions from revenue to welfare and labour legislation, and the phrase to quote for that extension is "taxing and welfare legislations".