Legal Briefing

Recovery of tax by lifting the corporate veil

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India | 26 February 2013

The concept of an incorporated company having a separate existence and the law recognising it as a legal person separate and distinct from its members/shareholders was first recognised in the case of Saloman v Saloman & Co Ltd [1897]. Consequently, the legal framework pertaining to a company’s operations and obligations acknowledges separate legal existence as a key feature of the company structure. Lifting or piercing the veil of corporate personality means that the company is no longer viewed as a distinct entity. On the other hand, the company is seen as being no different from the persons who own the shareholding of the company. Simply stated, by applying the doctrine of ‘piercing the corporate veil’, courts disregard the separate corporate existence of the company and fix liability on the directors or other officers of the company as the case may be.


In the past, the Indian Courts, including the Apex Court, have applied the doctrine of lifting of corporate veil. A few judicial precedents have been recapitulated for the ease of reference.

  • In Sunil Siddharthbhai v CIT, Ahemedabad [1985] the Honourable Supreme Court held that in the task of determining whether a transaction is a sham or illusory transaction or a device or ruse, tax authorities are entitled to penetrate the veil covering it and ascertain the truth.
  • In CIT v Sri Meenakshi Mills Ltd & ors [1967], the Supreme Court, while applying the doctrine, observed that from the juristic point of view, the company is a legal personality entirely distinct from its members. But in certain exceptional cases, the Court is entitled to lift the veil of the corporate entity and to pay regard to the economic realities behind the legal façade.
  • In Life Insurance Corporation of India v Escorts Ltd [1986], the Honourable Supreme Court asserted that the veil may be lifted in cases where the aim is to avoid a taxation statute or to evade obligations imposed by the law or for the protection of public interest.
  • In McDowell & Co Ltd v CTO [1985], it has been held clearly that the taxpayer cannot be allowed to get away with any colourable device or artificial sham transaction. Therefore, it becomes an important function of the income tax authorities to look into the devices and natures of transactions used by the assessee, and decide upon the character and nature of such devices and transactions.
  • In Juggilal Kamlapt v CIT [1969], the Honourable Supreme Court held that it is well established that the income tax authorities are entitled to pierce the veil of corporate entity and look at the reality of the transaction. The Court has the power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation or to perpetrate fraud. However, the Court also observed that the doctrine of lifting the corporate veil ought to be applied only in exceptional circumstances and not as routine matter.

It thus becomes clear that the courts have consistently emphasised that the standard for lifting the corporate veil is to uncover a sham or illusory transaction that seeks to avoid tax liability or to evade any obligations imposed by the law. In such cases, the courts will explore the economic realities of the transaction to determine whether any of these transgresses have actually transpired. However such doctrine can be applied only in exceptional circumstances and not as routine matter.

RECENT JDGMENT: RECOVERY OF 
TAX BY LIFTING THE CORPORATE VEIL

In a recent ruling (Pravinbhai M Kheni v ACIT [2012]), the Honourable Gujarat High Court, while applying the principle of lifting of corporate veil, has held that even a director of public limited company can be held liable for recovery of tax dues of the company, whereas under s179 of the Income Tax 
Act (ITA) 1961, the recovery of tax can only be done against the directors of private limited company.

In this case search proceedings were conducted against the company, pursuant to which block assessment was framed. The tax authorities started recovery proceedings against the company; however the taxes could not be recovered from the company. Accordingly the authorities initiated proceedings under s179 to recover taxes of the company from the director (petitioner) of the company.

The petitioner opposed any recovery from him on the ground that he said company was a public limited company duly incorporated under the Companies Act, 1956 and the provisions of s179 of the ITA 1961 would be applicable only where tax is due from a private company.

However the assessing officer, while lifting the corporate veil of the company, held 
that the tax dues of a public company can be recovered from its directors on the following grounds:

  • It was apparent from the financial statements that unaccounted income of the company had been misappropriated by the directors and shareholders of the company.
  • It was evident from the Memorandum of Understanding that the company was formed to run a family business of its promoters.
  • Directors of the company had created huge assets in their own names. It was, therefore, evident that unaccounted income of the company was utilised for acquiring such properties by the directors.

The assessing officer, therefore, concluded that the evidence showed that the company was used as a conduit for generating unaccounted wealth. Aggrieved with the above order, the petitioner filed the present writ petition in the High Court to quash the recovery proceedings against the petitioner.

Rejecting the above stated contention of the petitioner, the Honourable High Court made following observations.

Lifting the corporate veil
  • The concept of lifting or piercing the corporate veil (sometimes referred to as cracking the corporate shell), is applied by courts sparingly and cautiously. However the boundaries of such principle have not yet been defined and the areas where the principle may have to be applied may expand.
  • The concept of piercing of corporate veil is applied by the courts in various situations. Two situations where such principle is consistently applied are, one where the statute itself so permits or provides for and second where, due to glaring facts established on record, it is found that a complex web has been created only with a view to defraud the revenue interest of the state.
  • If it is found that incorporation of an entity is only to create a smoke screen to defraud the revenue and shield the individuals who behind the corporate veil are the real operators of the company and beneficiaries of the fraud, the courts have not hesitated in ignoring the corporate status and striking at the real beneficiaries of such complex design.
Recovery of taxes from the director 
of a public limited company
  • In the present case, the revenue wanted to apply the principle of lifting the corporate veil to the case of a public company and sought to resort to provisions contained in s179 of the 
ITA 1961.
  • If facts are established that a company is used as conduit to defraud revenue, even a director of public limited company can be held liable for recovery of the tax demanded of the company.

CONCLUSION

There are several circumstances under which the corporate veil can be lifted or pierced and shareholders/members may be directly held responsible. These include misrepresentation, fraud, misfeasance or negligence by the members; failure to maintain clear and distinct division between assets of the company and personal assets of the members; siphoning of corporate funds; using the corporate shell for carrying out unlawful activities by the dominant shareholders; tax evasion, etc.

The judgment of the Honourable Gujarat High Court has basically reiterated the fact that the concept that incorporated companies’ separate existence, distinct from its members, can be pierced by the tax authorities by applying the principle of lifting of corporate veil, particularly in cases where companies are used as conduits to escape tax liabilities. The High Court in this case even placed the liability to pay taxes upon the directors of public limited companies.

However, the judgment may be loosely used by the tax authorities and could be used to recover taxes from the directors of public limited companies. Therefore the need of the hour is to use the aforesaid principles only in exceptional circumstances.