Case Comment: The Associated Rubber Industry Ltd. v. Workmen

By Harish Khan 9 Minutes Read

“While a company is a separate legal entity from its shareholders, courts can “lift the corporate veil” to look at the true nature of transactions in cases of tax evasion or avoidance.”

Citation: (1985) 4 SCC 114

Court: Supreme Court of India

Date of Judgement: 19^th August, 1985

Bench: O. Chinnappa Reddy, V. Khalid

Facts

• The Associated Rubber Industry Ltd. had initially invested Rs 4,50,000 in shares of INARCO Ltd. and regularly received dividends from these shares, which were included in the company’s profit and loss account. These dividends contributed to the calculation of bonuses payable to the company’s workmen.
• In 1968, The Associated Rubber Industry Ltd. transferred its shares in INARCO Ltd. to its wholly owned subsidiary, Aril Bhavnagar Ltd. (later renamed Aril Holdings Ltd.). Aril Holdings Ltd. had no capital or business other than owning these shares and receiving dividends from them. This transfer meant that the dividend income from INARCO Ltd. shares was now received by Aril Holdings Ltd. instead of The Associated Rubber Industry Ltd.
• Since the dividend income from the INARCO Ltd. shares was no longer included in The Associated Rubber Industry Ltd.’s profit and loss account, the company’s available surplus for calculating bonuses was reduced. Consequently, the workers received a bonus of only 4% for the year 1969, instead of the 16% they would have received if the dividend income had been included in the profit and loss account.
• In 1971, Aril Holdings Ltd. was wound up and amalgamated back into The Associated Rubber Industry Ltd.

Legal Questions

1. Device to Avoid Higher Bonus: Was the transfer of INARCO Ltd. shares to Aril Holdings Ltd. a device to reduce the gross profits of The Associated Rubber Industry Ltd. and thereby reduce the bonus payable to its workmen?

2. Independent Legal Entities: Should the profits of Aril Holdings Ltd. be treated as the profits of The Associated Rubber Industry Ltd. for the purpose of calculating bonuses?

Contentions by the Parties

• Workmen

1. Bonus Entitlement: The workmen contended that they were entitled to a 16% bonus for the year 1969 based on the historical profitability of the company, which included dividends from INARCO Ltd.
2. Device to Avoid Bonus: They argued that the transfer of shares to Aril Holdings Ltd. was a strategic maneuver by The Associated Rubber Industry Ltd. to reduce the company’s gross profits, thereby lowering the available surplus for bonus distribution to the workmen.
3. Economic Reality: The workmen emphasized that Aril Holdings Ltd. had no substantial business activity other than holding the INARCO shares, indicating that its creation was merely a device to avoid higher bonus payments.

• The Associated Rubber Industry Ltd.

1. Separate Legal Entities: The company argued that both The Associated Rubber Industry Ltd. and Aril Holdings Ltd. were distinct legal entities, each with separate legal existence. Hence, the profits of Aril Holdings Ltd. could not be treated as part of The Associated Rubber Industry Ltd.’s gross profits.
2. Legitimate Business Decision: The company maintained that the transfer of shares was a legitimate business decision, and there was no intention to deprive the workmen of their rightful bonus.
3. No Evidence of Device: They asserted that there was no concrete evidence to show that the transfer of shares to Aril Holdings Ltd. was intended as a device to avoid paying a higher bonus to the workmen.

Judgments

• Industrial Tribunal and High Court of Gujarat:

• Held that The Associated Rubber Industry Ltd. and Aril Holdings Ltd. were distinct legal entities with separate legal existences.
• Ruled that the profits of Aril Holdings Ltd. could not be counted towards The Associated Rubber Industry Ltd.’s gross profits for bonus calculations.
• Found no evidence to support the contention that the transfer of shares was a device to avoid higher bonus payments.

• Supreme Court of India

• Substance Over Form: Emphasized the importance of looking beyond legal formalities to the actual substance of transactions, especially when legal structures are used to avoid welfare legislation. The court referred to the judgement of CIT v. Sri Meenakshi Mills Ltd. to support lifting the corporate veil to reveal economic realities.
• In this case, the Supreme Court dealt with a situation where corporate structures were used to evade tax liabilities. The court emphasized that while a company is a separate legal entity from its shareholders, courts can “lift the corporate veil” to look at the true nature of transactions in cases of tax evasion or avoidance.
• The court held that it is within its power to disregard the separate legal entity of a corporation if it is used to evade taxes or circumvent tax obligations, focusing on the substance over form.
• The Supreme Court in this case applied the principle from CIT v. Sri Meenakshi Mills Ltd., emphasizing that courts can and should look beyond the legal form of corporate structures to their economic reality, especially when used to circumvent legal obligations.
• In this case, the court determined that the transfer of shares to Aril Holdings Ltd. was a device to reduce the apparent profits of Associated Rubber Industry Ltd. to avoid paying higher bonuses to its workmen. By lifting the corporate veil, the court revealed the true nature of the transaction, ensuring that Associated Rubber Industry Ltd. could not evade its obligations by merely creating a subsidiary.

• Device to Reduce Profits: Concluded that the creation of Aril Holdings Ltd., the transfer of shares to it, and the retention of dividends within it served no business purpose other than to reduce The Associated Rubber Industry Ltd.’s gross profits, thereby reducing the bonus payable to workers. This was considered a clear device for avoidance.
• Decision: Ruled that the dividends received by Aril Holdings Ltd. from INARCO Ltd. should be included in assessing the gross profit of The Associated Rubber Industry Ltd. for calculating the bonus rate. The workmen were entitled to a 16% bonus for the year 1969.

Harish Khan

This is Harish Khan, Enrolled as an Advocate with the Bar Council of Delhi. Currently, working as Corporate Legal Associate at Blackbull Law House. Pursued B.B.A. LL.B (Hons) Specialised in Business Laws from Himachal Pradesh National Law University, Shimla [H.P]. completed LL.M Specialised in Business Laws from Amity University, Lucknow [U.P].