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Petitioner: COMMISSIONER OF INCOME-TAX, WEST BENGAL VS Respondent: TONA JUTE Co. LTD.Honorable Justice G. K. MITTERS. Aiyangar and S. B. Sen,E. R. Meyer and B. L. Pal
1969 P T D 563
1969 P T D 563
[Calcutta (India)]
Before G. K. Mitter and A. N. Ray, JJ
COMMISSIONER OF INCOME‑TAX, WEST BENGAL
Versus
TONA JUTE Co. LTD.
Income‑tax Reference No. 46 of 1957, decided on 6th Feb ruary 1962.
Company------
----‑Undistributed profits‑Distribution order‑Exception‑‑Shares freely transferable to other members of the public-- Public company‑Directors having absolute discretion to refuse to register transfer to undesirable person‑Directors not bound to give any reason for refuse‑Indian Income‑tax Act, 1922. S. 23‑A.
A public company whose directors have absolute discretion to refuse to register the transfer of any share to any person whom it shall in their opinion be undesirable in the interest of the company to admit to membership, and are not obliged to give any reason for refusal to register, is not a company the shares of which are freely transferable to other members of the public within the meaning of section 23‑A of the Income‑tax Act and section 23‑A (1) can be applied to such a company, even if the board of directors have not objected to any transfer placed before them.
[Case‑Law referred].
STATEMENT OF CASE
By this application presented on 15th March 1957, the Commissioner of Income‑tax, West Bengal, Calcutta, has applied to the Appellate Tribunal to refer to the High Court certain questions of law said to arise out of the Appellate Tribunal's Order in I. T. A. No. 3805 of 1955‑56 dated 3rd January 1957. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order, we hereby draw up a statement of case and refer it to the High Court of Judicature at Calcutta under section 66(1) of the Indian Income‑tax Act.
2. The assessee is a public limited company. The assessment year in question is 1949‑50, the relevant previous year having ended on 7th July 1948. The total income finally determined as revised under section 31(3)(a) on 11th November 1954, was Rs. 1,12,132. The tax thereon amounted to Rs. 49,058, leav ing a balance of Rs.63,074 available for distribution among the shareholders of the company. In the annual general meeting held on 9th July 1949, the accounts for the year were adopted but no dividends were declared.
3. The Income‑tax Officer issued a notice that he proposed to make an order under section 23‑A. The assessee objected to it saying that it is a public limited company in which the public are substantially interested as all the shares carrying voting powers were allotted unconditionally to the members of the public and that the shares were, in fact, freely transferable by the holders to the other members of the public as per the articles of association of the company and that there was no restriction whatsoever on the right of any shareholder to sell the shares to any other member of the public.
4. As per the provisions of section 23‑A, a company shall be deemed to be a public company if its shares are freely transferable by the holders to other members of the public. The relevant portion of section 23‑A runs as follows:
"23‑A. For the purposes of this section, a company shall be deemed to be a company in which the public are substantially interested ‑
(ii) the said shares were at any time during the previous year the subject of dealings in any recognised stock exchange in India or were freely transferable by the holder to other members of the public; and . . . ."
5. Article 39 of the articles of association of the assessee company runs as follows:
"The directors may decline to register any transfer of shares upon which the company has a lien and in case of shares not fully paid up may refuse to register transfer to a transferee of whom they do not approve. The directors may also in their absolute discretion refuse to register transfer of any share to any person whom ii shall in their opinion be undesirable in the interest of the company to admit to membership. The directors shall not be bound to give any reason for refusal of transfer as aforesaid. No transfer shall be made to an infant or person of unsound mind."
The Income‑tax Officer was of opinion that, according to the above-said article, the directors may in their absolute discretion refuse to register transfer of any share to any person whom it shall, in their opinion, be undesirable in the interests of the company to admit to membership and that the directors shall not be bound to give any reason for refusal to transfer as aforesaid. It is clearly indicated that shares were not freely transferable and, as such, the assessee‑company could not be deemed to be a public limited company within the meaning of section 23‑A. He also noted that shares of the company were not quoted in any official stock exchange or sold in stock market. He held that the assessee‑company cannot be treated as a public limited company within the meaning of section 23‑A and ordered that the entire undistributed profits of Rs. 63,074 shall be deemed to have been distributed as dividends as on 9th July 1949, at the date of, the general meeting. A copy of his order is annexed hereto marked Exh. "A" and forms part of the statement of case.
6. Before the Appellate Assistant Commissioner, inter alia, it was contended that the Income‑tax Officer was wrong in holding that Article 39 of the articles of association restricted the free transferability of shares and that the said article had been incorporated only to safeguard the interest of the company against the competitors. It was also submitted that, as a matter of fact, the directors had not exercised their discretionary power and that from the date of incep tion of the company, 41 transfers had been effected during the period from 1946 to 1953. From the register of transfer of shares, the Appellate Assistant Commissioner found that the transfers were always to family members and the close associates of the directors, that the directors held 9,200 shares out of the total number of 1,00,000 shares of the company and most of the other shares were held by the close relatives and associates. He concluded that there was reason to presume that shares carrying more than 25% of the voting power had not been allotted or acquired unconditionally or held by the public and the shares were also not freely transferable by the holders to the members of the public. A copy of his order is annexed hereto marked Exh. "B" and forms part of the statement of case.
7. The assessee preferred a second appal to the Appellate Tribunal and contended that the restriction contained in Article 39 was a mere reserve power conferred on the directors, that the right to transfer is different from the transfer being recognise, that at the stage of transfer of shares, what may happen subsequently was irrelevant, that for the transfer as such there was no restriction, that the owners of shares were not in need of any permission from the directors to effect a transfer, that the article in question was innocuous and in spite of that article, the directors were not entitled to refuse registration without any reasonable cause and that, therefore, the shares were freely transferable.
8. The assessee‑company drew the attention of the Appellate Tribunal to Article 20 of Table A of the Indian Companies Act where similar power was given to the directors. The relevant portion of the said article runs as follows:
"20. The directors may decline to register any transfer of shares, not being fully paid shares, to a person of whom they do riot approve, and may also decline to register any transfer of shares on which the company has a lien. The directors may also suspend the registration of transfers during the fourteen days immediately preceding the ordinary general meeting in each year ... ... ...
If the directors refuse to register a transfer of any shares, they shall within two months after the date on which the transfer was lodged with the company send to the transferee and the transferor notice of the refusal."
9. Section 2 of the Indian Companies Act defines a "private company" and a "public company" as follows:
"(3) `private company' means a company which by its articles‑
(a) restricts the right to transfer the shares, if any ; and
(b) limits the number of its members to fifty not including persons who are in the employment of the company ; and
(c) prohibits any invitation to the public to subscribe for the shares, if any, or debentures of the company:
Provided that where two or more persons hold one or more shares in a company jointly they shall, for the purposes of this definition, be treated as a single member.
(13‑A) `public company' means a company incorporated under this Act or under the Indian Companies Act, 1882 (VI of 1882), or under the Indian Companies Act, 1866 (X of 1866), or under any Act, repealed thereby, which is not a private company."
10. Section 28 of the Indian Companies Act runs as fol lows:
"28. (1) The shares or other interests of any member in a company shall be movable property, transferable in manner provided by the articles of the company.
(2) Each share in a company having a share capital shall be distinguished by its appropriate number."
11. Section 34 of the Indian Companies Act runs as fol lows:
"34. (1) An application for the registration of the transfer of shares in a company may be made either by the transferor or the transferee, provided that where such application is made by the transferor no registration shall, in the case of partly paid shares, be effected unless the company gives notice of the application to the transferee and subject to the provisions of subsection (7) the company shall, unless objection is made by the transferee within two weeks from the date of receipt of the notice, enter in its register of members the name of the transferee in the same manner and subject to the same condi tions as if the application for registration was made by the transferee .........
(4) If a company refuses to register the transfer of any shares or debentures, the company shall, within two months from the date on which the instrument of transfer was lodged with the company, send to the transferee and the transferor notice of the refusal.
(5) if default is made in complying with subsection (4) of this section, the company and every director, manager, secretary or other officer of the company who is knowingly a party to the default shall be liable to a fine not exceeding fifty rupees for every day during which the default continues . . . .
(7) Nothing in this section shall prejudice any power of the company under its articles to refuse to register the transfer of any shares."
12. The Accountant Member held that most public companies retain the right of refusal to register transfer of shares when they find the transfer to be undesirable in the interest of the company and that the existence of such provi sions is not held in the commercial circles as restricting the free transferability of shares and that, in his opinion, the shares of the assessee‑company were, in fact, freely transferable. A copy of his order is annexed hereto marked Exh. "C" and forms part of the statement of case.
13. The Judicial Member held that in considering the Explanation to section 23‑A, consideration of section 34 of the Companies Act and Article 20 of Table A of the Companies Act and the decisions under those provisions were quite irrelevant as the words "freely transferable" which occur in the Explanation to section 23‑A, do not occur in any of those provisions and, further, the restrictions imposed by Article 39 were much wider than Article 20 of fable A of the Companies Act and that Article 39 offends the words "freely transferable" contained in the Explanation to section 23‑A. A copy of his order is annexed hereto marked Exh. "D" and forms part of the statement of case.
14. In view of the difference of opinion between the two Members under section 5‑A (7), they referred the following point of difference to the President:
"Whether on the facts and circumstances of this case and by a true construction of Article 39 of the articles of association, the assessee‑company was one in which the shares were freely transferable as envisaged by the provisions of section 23‑A of the Indian Income‑tax Act, and as a consequence the provisions of section 23‑A were not applicable to this company ?"
15. The President agreed with the Accountant Member and held that Article 39 did not in fact restrict the free transfer of shares and that, as such, section 23-A could not be invoked. A copy of this order is annexed hereto marked Exh. "E" and forms part of the statement of case.
16. On the facts stated above, the following question of law is referred to the High Court:
"Whether on the facts and in the circumstances of the case and on a proper construction of Article 39 of the articles of association, the assessee‑company was one in which the shares were freely transferable within the meaning of section 23‑A of the Indian Income‑tax Act and, accordingly, the provisions of sec tion 23‑A were not applicable to the assessee ?"
17. Copies of the draft statement of case were sent to both parties. The applicant had no suggestions to offer. The respon dent‑company made certain suggestions but none of them could be accepted. The draft statement is finalised.
E. R. Meyer and B. L. Pal for the Commissioner:
S. Aiyangar and S. B. Sen for the Assessee.
JUDGMENT
G. K. MITTER, J.‑This is a reference at the instance of the revenue for consideration of the question as to whether the shares of the assessee‑company were freely transferable within the meaning of section 23‑A of the Indian Income‑tax Act in view of the provisions of Article 39 of its articles of associa tion.
The assessee is a "public company" within the meaning of the expression used in the Indian Companies Act of 1913. The assessment year in question is 1949‑50, the relevant previous year having terminated on July 7, 1948. The total income of the assessee as finally determined under section 31 (3)(a) on November 11, 1954, was Rs. 1,12,132. The tax thereon amounted to Rs. 49,058 leaving a balance of Rs. 63,074 available for distribution amongst the shareholders of the company. No dividends were declared at the annual general meeting held on July 9, 1949.
For the purpose of the Indian Income‑tax Act, however, and specially under section 23‑A of the Act so far as is relevant to this case, a company can only be deemed to be a company in which the public are substantially interested if its shares were at any time during the previous year the subject of dealing in any recognised stock exchange in India or were freely transferable by the shareholders to other members of the public.
The Income‑tax Officer held that Article 39 of the articles of association of the company stood in the way of the assessee being considered "a company in which the public were subs tantially interested". The said article provides as follows:
"The directors may decline to register any transfer of share upon which the company has a lien and in case of shares not fully paid up may refuse to register transfer to a transferee of whom they do not approve. The directors may also in their absolute discretion refuse to register transfer of any share to any person whom' it shall in their opinion be undesirable in the interest of the company to admit to membership. The directors shall not be bound to give any reason for refusal of transfer as aforesaid. No transfer shall be made to an infant or person of unsound mind."
According to the Income‑tax Officer this provision prevented the free transfer of shares, inasmuch as it was open to the directors to refuse to recognise any transferee whom they did not approve of and as they were not bound to give any reasons for their refusal the power of refusal was unrestricted. There being no dispute that shares of the company were not quoted in any official stock exchange the Income‑tax Officer made an order that the entire undistributed profits of Rs. 63,074 should be deemed to have been distributed as dividends as on July 9, 1949.
The attention of the Appellate Assistant Commissioner was drawn to the fact that, since the inception of the company in 1946, no less than 41 transfers had been effected up to 1953 when the matter came up before the income‑tax authorities and that there had been no occasion for the directors to refuse registration of any transfer. The Appellate Assistant Commissioner, however, found that the transfers effected had always been to members of the same family or close associates of the directors. The assessee preferred an appeal to the Appellate Tribunal and the Tribunal has by 'a majority found that there was no restriction on the free transfer of shares imposed by Article 39 and hence section 23‑A Could not be invoked. The Accountant Member was in favour of the appeal being allowed while the Judicial Member took a different view. The President of the Tribunal, however, was of the same opinion as the Accountant Member and in the result the appeal was allowed.
Under section 28 of the Indian Companies Act, 1913, the shares in a company are movable property transferable in manner provided by the articles of association of the company.
Unless the articles provide otherwise, the shareholder has a free right to transfer his shares to whomsoever he wills. In the case of a private company the articles must restrict the right of a member to transfer his shares and must also limit the number of members to 50 and must contain a restriction prohibit invita tion to the public for subscription to the shares. Regulation 20 of Table A which is a model article provides that "the directors may decline to register any transfer of shares not being fully paid shares to a person whom they do not approve of, and may also decline to register any transfer of shares on which the company has a lien". Article 39 of the articles of association of the assessee‑company goes a little further than that. Under this article it is open to the directors of the company to refuse to register transfer of shares to any person if they consider that it would be undesirable in the interest of the company to admit the transferee to membership and it was argued that this showed that the right of free transfer was being cut down by the article. Regulation 20 itself shows that the Legislature thought that the company should have the power to refuse registration when the shares were not fully paid or when the company had a lien on the shares. This is because it was thought right that a person whose solvency was not beyond controversy should not be thrust upon a company. The question is does the power of refusal of the directors to recognise a transfer in favour of a solvent person on other grounds restrict the right of free transfer.
Where articles contain such a power the directors must before rejecting a proposed transferee fairly consider the question at a board meeting. If they do so they are not bound to disclose their reasons and in the absence of evidence to the contrary the Court will assume that they have acted reasonably and bona fide. The Court can examine the reasons if they are given but the Court will not overrule the decisions of the directors merely because it would not have come to the same conclusion itself. Ordinarily a member contracting to sell his shares to another merely undertakes to deliver genuine share scripts and transfer deeds duly signed and not to do anything which might prevent the transferee from having the full benefit of the transfer. If the directors refuse to recognise the transferee the purchaser cannot recover the price from the seller but the latter must hold the shares as trustee for the purchaser and vote in the way the transferee directs him to and make over any benefits received by way of dividends, etc., from the company to the transferee. A transfer of a share does not take place as soon as a member whose name is registered in the books of the company executes a proper deed of transfer which is accepted by the transferee who in his turn fills up the transfer deed and sends it on to the company for registration of his name. It was pointed out as early as 1885 in Societe General De Paris and G. Colladon v. Janet Walker ((1886) 11 App. Cas. 20), by the Earl of Selborne that a complete legal title . . . could not be acquired without registration". From this it follows that there is no complete divesting of title until registration of the transferee's name.
On behalf of the revenue our attention was drawn to section 28 of the English Companies Act of 1948 which is practically identical with section 2(13) of the Indian Companies Act, 1913, as amended up to 1936. A private company must by its articles of association restrict the right to transfer its shares and according to Palmers's Company Precedents, 17th Edition, page 687, "the restrictions on the right to transfer every share‑to comply with the section‑must be general; some shares must not be exempt from the restriction. It is sufficient for the purpose of the section to provide‑in the terms of the common clause‑that the directors may refuse to register any transfer of shares, but frequently the clause is supplemented".
It was contended that a power given to the directors by the articles of association to refuse to register any transfer of shares without anything more was restrictive of the right of free transfer of shares which the members would otherwise have had. It was argued that there could be no question when such power was coupled with the right of refusal to give the reasons therefore.
In my opinion, the contention of the revenue is sound. The point of time as to when a transfer is complete was discussed at length by Eve, J. in In re: Copal Varnish Co. Ltd. ((1917) 2 Ch. 349). In this case the company was at first a public company. Article 17 of its articles of association provided that "the directors may decline to register any transfer of shares made by any person who is indebted to the company for any money then due and payable or who may be solely or jointly liable to it for any call whether payable or not or any interest thereon or in respect of any debt notwithstanding that the same may not then be due, or where the proposed transferee is a person engaged in business of a similar character to the business of the company or who may otherwise be a competitor in trade with the company, or in any case where the directors shall consider the proposed transfer will not be conducive to the interest of the company."
When the company was turned into a private com pany the following words were added to Article 17 by a special resolution:
"No share shall be transferred to any person who is not already a member of the company without the consent of the directors."
There were only two directors, Ernest Randall and Percy Randall, and the quorum of directors was two. Ernest Randall was the chairman of the directors. He executed transfers of twelve of his shares to twelve persons who were not members of the company without first obtaining the consent of the board of directors. These were sent for registration and a meeting of the directors was summoned by a notice containing among the agenda, "transfer of shares". Parry Randall persistently refused to attend at board meetings. The transferees took out a summons under section 32 of the Companies (Consolidation) Act, 1908, for rectification of the register of members by inserting their names as holders of the shares in the place of the name of Ernest Randall.' In the course of his judgment the learned Judge observed:
"The operation of legally transferring a share is indeed one of some complexity. In the first place there is the contract of sale followed by the execution of an instrument of transfer containing an agreement by the purchaser to accept the shares subject to the several conditions on which the vendor held the same immediately prior to the execution of the transfer‑that is to say, subject, amongst other things, to the conditions imposing restrictions on the vendor's right to transfer to that particular purchaser. Up to this point all that has been done is to pass an equitable interest in the shares to the transferee. There has been no legal assignment completed; indeed, the most crucial point in the transaction has not been reached‑the acceptance of the transfer by the board of directors and the passing of it for registration; and even then the matter is not completed, because until the actual entry of the name of the transferee on the register the transferor remains the legal holder of the share."
In my view, the above clearly shows that a transfer of shares is not complete until registration of the name of the transferee if such registration cannot be insisted on as a matter of right and does not follow as a matter of course when a transfer deed duly completed is sent along with the…
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