Forex

THE doctrine of lifting the corporate veil has been discussed from the time the corporate entity was first conceived. A company is a separate legal entity even if there is only one director holding a majority of its shares. Two companies which are incorporated with the same set of shareholders are nevertheless distinct and separate entities (Pattinson v. Bindhya Debi; AIR 1933 Pat 196).

The doctrine of lifting of the veil has been applied, in the words of Palmer, in five categories of cases:

# where companies are in relationship of holding and subsidiary (or sub-subsidiary) companies;

# where a shareholder has lost the privilege of limited liability and has become directly liable to certain creditors of the company on the ground that, with his knowledge, the company continued to carry on business six months after the number of its members was reduced below the legal minimum;

# in certain matters pertaining to the law of taxes, death duties and stamps;

# particularly where the question of the "controlling interest" is in issue;

# in the law relating to exchange controls, and in the law relating to trading with the enemy where the test of control is adopted (Palmer's Company Law; page 215, 24th Edn., 1987). In some of these cases, judicial decisions have lifted the veil and considered the substance of the matter.

On the question of legal status of a company and the circumstances in which a corporate entity can be disregarded by lifting the veil, the most important judgment is of the Supreme Court in Tata Engineering and Locomotive Co. Ltd v. State of Bihar (AIR 1965 SC 40). In this case, the apex court held that a corporation in law is equal to a natural person and has a legal entity of its own.

The entity of a corporation is entirely separate from that of its shareholders; it bears its own name and has a seal of its own; its assets are separate and distinct from those of its member; it can sue and be sued exclusively for its own purpose; its creditors cannot obtain satisfaction from the assets of its members; the liability of the members or shareholders is limited to the capital invested by them; similarly the creditors or the members have no right to the assets of the corporation.

This position is well established since the decision in the case of Salomon v. Salomon & Co. (1897 AC 22) and it has been a well-recognised principle of common law.

However, in course of time, the doctrine that a corporation or company has legal and separate entity of its own has been subjected to certain exceptions by the application of the fiction that the veil of the corporation can be lifted. The doctrine of lifting of the veil marks a change in the attitude that law had originally adopted towards the concept of separate entity or personality of the corporation. As a result of the impact of the complexity of economic factors, judicial decisions have sometimes recognised exceptions to the rule, about the juristic personality of the corporation.

Gower has similarly summarised this position. According to Gower, courts have only construed statutes as "cracking open the corporate shell" when compelled to do so by the clear words of the statute; indeed they have gone out of their way to avoid this construction whenever possible. Thus, the judicial approach in cracking open the corporate shell is somewhat cautious and circumspect. It is only where the legislative provision justifies the adoption of such a course that the veil has been lifted. In exceptional cases where courts have felt "themselves able to ignore the corporate entity and to treat the individual shareholder as liable for its acts" the same course has been adopted.

It would not be possible to evolve a rational, consistent and inflexible principle which can be invoked for determining the question as to whether the veil of a corporation should be lifted or not. Broadly, where fraud is intended to be prevented, the veil of a corporation is lifted by judicial decisions and the shareholders are held to be "persons who actually work for the corporation."

In Polly Peck International Plc. (In Administration; No. 3; Re 1996 1 BCLC 428 Ch D), a company registered in England created a subsidiary in a foreign country to save itself from the listing rules of London Stock Exchange and also for obtaining certain tax advantages. The subsidiary company issued bonds to a group of financing banks and the holding company gave a guarantee for the obligations of the subsidiary.

There are many cases in which it has been held, on facts, that a company has acted as an agent or nominee, either for its principal shareholder or for some other party (Firestone Tyre and Rubber Co. Ltd. v. Lewellin — Inspector of Taxes; 1957; 1 A11 ER 561). However, neither agency nor nomineeship — still less, sham or something akin to sham — is to be inferred simply because a subsidiary company has a small paid-up capital and a board of directors, all or most of whom are also directors or senior executives of its holding company.

A subsidiary cannot always be considered as the agent of the holding company (Kodak Ltd. v. Clark, 1903, 1 KB 505 CA; or I.R.C. v. Samsom, 1921, 2 KB 492 CA). In another case, the court refused to allow the holding company to force its subsidiaries to produce documents for the proceedings (Lonrho Ltd. v. Shell Petroleum Co. Ltd., 1982 AC 173, HL).

There is no general principle that all companies in a group should be regarded as a single economic unit and, on the contrary, each company in a group of companies is an independent entity. The fact that a subsidiary is set up to reduce the potential tortuous liability of the parent company constitutes a legitimate use of the corporate form and does not constitute a ground for piercing the corporate veil of the subsidiary so as to treat its activities as being those of the parent.

In C.I.T. v. Meenakshi Mills Ltd. (AIR 1967 SC 819), the court held that the income-tax authorities were entitled to pierce the veil of corporate entity and to look at the reality of the transaction to examine whether the corporate entity was being used for tax evasion. In this case, a separate corporate entity was brought into existence outside the taxable territory with the ulterior motive of evading the tax obligation by the assessee mills.

The Supreme Court observed: "It is true that from the juristic point of view, the company is a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or borne by its members.

But 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. For example, the Court has power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation."

In Juggi Lal Kamalapat v. C.I.T. (AIR 1969 SC 932), the apex court reiterated that the income-tax authorities were entitled to lift the veil of the corporate entity, for looking at the substance of the transaction.

To conclude, a sham, bogus or contrived transaction would, in appropriate circumstances, justify the tearing of the corporate veil. However, the tax authorities must act with great circumspection while challenging the corporate status of an entity.