COMMISSIONER OF INCOME TAX Vs. G VENKATARAMAN

JUDGEMENT

(1.) FOR the assessment year 1960-61, the Income-tax Officer treated a sum of Rs. 3, 21, 173 as dividend within the meaning of section 2(6A)(e) of the Indian Income-tax Act, 1922, hereinafter called "the Act", and included the same in the assessee's total income. The assessee is the karta of a Hindu undivided family. One Rudrappan was the karta of the Hindu undivided family prior to the present assessee. He was the managing partner in a firm called R. Guruswamy Naidu & Co. with six annas share. This firm was the managing agent of a public limited company called Vijayakumar Mills Ltd., hereinafter called "the company". The company had a share capital of Rs. 20 lakhs divided into 8, 000 preference shares of Rs. 100 each and 12, 000 equity shares of Rs. 100 each. According to one of the articles of association of the company, the regulations contained in Table "A" of the First Schedule of the Companies Act governed the company. According to regulation 60 of Table "A" every member has one vote for every share held by him, no distinction being kept between preference and equity shares. The accounting year of the company is the calendar year. During the year 1959, out of the 12, 000 equity shares 6, 834 were held as under

(2.) THE main business of the company was manufacture and sale of yarn, but in the year 1959, it sold besides yarn, cotton worth Rs. 17 lakhs. THE cotton that was sold was not required for its immediate use in the mills and was sold after obtaining the permission of the Textile Commissioner. THE board of directors of the company consisted of six persons of which four were the father and three sonsTHE balance sheet of the company as on January 31, 1959, showed the following reserves" *Reserve for redemption of preference shares ... Rs. 3, 20, 000Development rebate reserve ... Rs. 1, 50, 600Rs. 4, 70, 600 "THEre was net loss of Rs. 1, 49, 427 brought forward from the previous year. In the balance-sheet as on December 31, 1959, the statutory auditor made an observation that from the current books he found large sums of money received in the current year were paid and debited to suspense account for want of information and that such sums amounted to Rs. 5, 90, 705.30. THE board of directors explained stating that late Rudrappan was handling the company's cash balance and, due to his sudden and unexpected death, they were not able to collect the relevant information and hence such amounts pending clarification had been debited to suspense account. THE board of directors corresponded with the assessee herein and got a reply from the assessee that in late Rudrappan's account a sum of Rs. 4, 50, 000 had been advanced to various parties without corresponding credit in his account books and that it was possible that Rudrappan might have utilised the company's money in his possession for making such advances. In order to set the matter at rest, the assessee further added that he did not propose to question the liability of the estate to pay the sum of Rs. 4, 50, 000THE Income-tax Officer considered that the company was one in which the public were not substantially interested, that the whole sum of Rs. 4, 50, 000 represented a payment by way of loan or advance by the company to the assessee. He then went into the question of availability of profits. He determined that the balance of Rs. 3, 21, 173 arrived at after deducting Rs. 1, 49, 427, the brought forward loss from the two reserve amounts amounting to Rs. 4, 70, 000 represented the accumulated profits in the hands of the company.

(3.) THE position of a mortgagee or a pledgee of shares is clearly explained in the following passage in Gower's Principles of Modern Company Law at page 411 "Shares, being items of property can, of course, be disposed of by way of security for a loan as well as sold outright. It follows from what has already been said that the security can be a legal mortgage only if the mortgagee is entered on the register, and that this can only be done if there is an outright transfer to him. Hence, a legal mortgage involves a registered transfer which, for the protection of the borrower, should be coupled with a written agreement setting out the terms and containing an undertaking by the lender to retransfer when the borrower redeems by repaying the principal, interest and costs." *When once the share is registered in the name of the mortgagee, it is the mortgagee who can exercise the vote. THE mortgagor or the pledger had no right either to vote or control or direct the voting by the mortgagee. Even in cases where the name of the pledger of the share continued to be the holder of the pledged shares in the books of the company, the pledger is bound to vote according to the directions of the pledgee bank. This position is also supported from the following passage in the Hand Book on Formation, Management and Winding up of Joint Stock Companies by Sir Francis Gore-Browne (29th edition) at page 425"Where an agreement, for the sale of shares has been made, or where, shares are mortgaged but the vendor's or mortgagor's name remains on the register of members, he alone can vote, but he must do so in accordance with the dictation of those entitled to the beneficial interest in the shares unless it is otherwise agreed." *We are, therefore, of the view that the 1, 328 shares held by the bank shall be deemed to have been allotted unconditionally to or acquired unconditionally and held beneficially by the publicTHE learned counsel for the assessee also contended that the company's business consists wholly in the manufacture or processing of goods and that, therefore, it is enough if the percentage of equity shares required to be held by the public is 40 per cent. If this contention is correct, then even if 1, 328 shares standing in the name of the bank were to be taken as held by the controlling group, still the second condition for holding that the company is a company in which the public are substantially interested is satisfied. THE main business of the company was manufacture and sale of yarn. In 1959 it sold besides yarn, cotton worth Rs. 17 lakhs, as being not required for its immediate use after obtaining the permission of the Textile Commissioner. It is contended by the assessee that it was not the business of the company to sell cotton and it was not dealing in cotton except for the purpose of its own consumption and whatever cotton that was not required for the purpose of the company only was sold. On the other hand, the learned counsel for the revenue laid strong emphasis on the word "wholly" and contended that unless the business of the company consists wholly in the manufacture or processing of goods, it could not be said to be a company within the meaning of that condition. We are of the opinion that too much emphasis should not be placed on the word "wholly" though the significance of that word also should not be ignored. It may also be mentioned that in the definition of "company in which the public are substantially interested" in section 2(18) of the Income-tax Act, 1961, the word "wholly" is replaced by the word "mainly". In all businesses, at certain times, part of the raw materials purchased may have to be sold as being not suitable or of inferior quality or on the ground that they could not be used for immediate purposes of the company.