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LIFTING OF CORPORATE VEIL FOR TAX REVENUE AND ANALYSIS OF THE
PROS AND CONS OF LIFTING OF CORPORATE VEIL
* SWECHHA MALIK
Introduction: In Solomon vs Solomon &Co., it was observed by the Court that existence of
company is distinct and separate from its members. 1 Another main benefit of company is the
principle of limited liability which means the liability of members is limited up to the nominal
value of shares or amount guaranteed by them. 2 But there are certain situations like fraud, for
benefit of revenue, agency etc. where the Court will lift the veil of incorporation in order to
examine the realities which lay behind 3.So, the corporate veil is said to be lifted when the Court
ignores the separate legal entity and limited liability of the Company and concerns itself directly
with managers or members. This paper deals with lifting of corporate veil for protection of tax
revenue and analyses the pros and cons of lifting of corporate veil.
Lifting of Corporate Veil for Tax Revenue:
At times tax legislations warrant the lifting of the corporate veil and the courts disregard the
separate legal personality of companies in case of tax evasions or liberal schemes of tax
avoidance without any necessary legislative authority.4 In the Dinshaw Maneckjee Petit, Re5 the
Court ordered the lifting of corporate veil since the company was formed by the assessee purely
as a means for avoiding super tax and the company was nothing more than the assessee himself.
In Life Insurance Corporation of India v Escorts Ltd., the Supreme Court observed that: “the
corporate veil may be lifted where a taxing statute or a beneficent statute is sought to be evaded
or where associated companies are inextricably connected as to be in reality, part of one
concern and also for the protection of public interest.”6 In Juggilal Kamlapt v. CIT, the
Supreme Court held that it is well established that the Income Tax authorities are allowed to lift
the veil of corporate entity and look at the reality of the transaction. 7 The Court has the power to
disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation or to
1
Solomon v Solomon &Co., [1897] AC 22.
AVTAR SINGH,COMPANY LAW 7 (2007).
3
John P.Lowry,Lifting the Corporate Veil,Journal of Business Law 41(1993)..
4
Harshit Saxena, Lifting the Corporate Veil, available at
<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1725433>
5
Dinshaw Maneckjee Petit, Re,(1927) 29 BOMLR 447.
6
Life Insurance Corporation of India v Escorts Ltd, 1986 AIR 1370, 1985 SCR Supl. (3) 909.
7
Juggilal Kamlapt v. CIT, (1969) 73 ITR 702 (SC)
2
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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 matter8. Then,
in Jindal v CIT, the Calcutta High Court pierced the corporate veil and found that there was an
attempt to avoid the taxation of deemed dividend and refused to give effect to the separate legal
identity.9
The author CS Nivedita Shankar feels that, “while English courts are moving towards a
principled approach whereby mere apprehension of deceit or mis-representation shall not
suffice, Indian courts are still emphasizing on larger public interest for lifting of corporate veil
which has led to an exhaustible list of circumstances, when the corporate veil can be pierced.”10
In my opinion, tax authorities are demanding the lifting of corporate veil as a routine matter now
and they are justifying their action on the basis of tax revenue and compelling public interest
which is contrary to the judgment of Juggilal Kamlapt case.
Analysis of Recent Cases involving Piercing of Corporate Veil:
In Vodafone International Holdings B.V vs. Union of India, Supreme Court denied the lifting
of corporate veil and held that the tax Authority may invoke the ‘piercing the corporate veil’
test only after it is able to establish that the impugned transaction is sham or tax avoidant. 11 So,
lifting of corporate veil is permissible only if the controlling foreign enterprise makes an indirect
transfer through abuse of organization form without any reasonable business purpose resulting
in tax avoidance or avoidance of withholding tax. 12 Further, the tax authority must apply the
‘look at’ principle wherein the entire transaction as a whole needs to be looked at, without
dissecting it.13 While deciding whether or not to lift the corporate veil, following factors need to
be considered: a) Participation in investment b) Duration of time period for which the
holding structure exists c) The period of business operation in India d) Generation of
taxable revenues in India e) Timing of exit and continuity of business. 14 In my opinion, the
Supreme Court has
rightly supported the ‘holistic approach’ for
looking the transaction as a
whole instead of looking it in parts to ascertain the lifting of corporate veil. Moreover, the
8
Id
M.D Jindal v CIT, 1987 164 ITR 28 Cal.
10
CS Nivedita Shankar, Piercing corporate veil- moving towards a principled approach, available at https://indiafinancing.com/piercing_corporate_veil_moving_towards_a_principled_approach.pdf (June 20, 2013).
11
Vodafone International Holdings B.V vs. Union of India,[2012] 107 CLA 63 (SC)
12
Id
13
Id
14
Id
9
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judgment is in consonance with Creasey v. Breachwood Motors Limited, where the reason for
the denial of the piercing of veil was the timing of incorporation of the company and since the
company was carrying business for so many years, fraud exception was rejected. It was observed
that, “the Vodafone judgment re‐ignited the substance vs. form debate because Vodafone argued
that the business arrangement did not result in a sham transaction and was perfectly legal in
form whereas revenue authorities contended that the structure put into place by Vodafone was
calculated to avoid tax liability.”15
The corporate veil was lifted in the recent case of Richter Holdings Ltd. v The Assistant
Director of Income Tax, where Karnataka High Court observed:
“It may be necessary for the fact finding authority to lift the corporate veil to look into the real
nature of transaction to ascertain virtual facts.”16 According to Advocate Raj Kumar, “the
Karnataka High Court appears to have readily permitted lifting the corporate veil without at all
alluding to the jurisprudence on the subject-matter and the Court wrongly provides an
additional ground to the tax authorities to lift corporate veil to ascertain facts and tax indirect
transfer.17 I agree with the opinion of author because the Court is interpreting this doctrine very
widely and thereby causing more uncertainty and doubts in the minds of general public by
adding more grounds to this doctrine.
In a recent case of Kotak Mahindra Bank Limited v Subhiksha Trading Services Limited,18
Kotak Mahindra Bank was asking for winding up of Subhiksha after it failed to repay a loan of
Rs 35 crore with interest. Since Subhiksha failed to prove how it suffered losses of Rs 800
crores due to the global financial crunch, Kotak's counsel, Mr. H. Karthik Seshadri, submitted
that, the conduct of Mr. R. Subramanian (Managing Director of Subhiksha) required a detailed
investigation by lifting the corporate veil as there was a reasonable grounds to believe that he has
“willfully” transferred the company's assets to entities such as Cash and Carry Wholesale
Traders Pvt. Ltd., Custodial Services India, Pentagon Trading Services, Shevaroy Holiday
Resorts and Triad Trading Services, which are controlled by Mr. Subramanian(59%) along with
15
Adhitya Srinivasan & Vipul Agrawal, Taxing International Transactions By Lifting The Corporate Veil, available
at http://www.itatonline.org/articles_new/index.php/taxing-international-transactions-by-lifting-the-corporate-veil/
16
Richter Holdings Ltd v The Assistant Director of Income Tax, (High Court of Karnataka, 24 March 2011).
17
Raj Kumar(Associate Singhania and Partners),A view point on Richter Holdings Ltd. v The Assistant Director of
Income Tax, available at http://www.singhania.net/wp-content/uploads/15-RICHTER-HOLDINGS-LTD-vs.ASSISTANT-DIRECTOR-OF-INCOME-TAX.pdf
18
Kotak Mahindra Bank Limited v Subhiksha Trading Services Limited, (Madras High Court,29 February 2012).
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a few others.19 The Court in this case rightly upheld the winding up request made by Kodak and
in my opinion; it is a fit case of lifting of corporate veil because of fraudulent conduct of
Mr.Subramaniam which was deliberately done with knowledge with an intention to defraud
creditors by not paying borrowings and loans.
Lifting of Corporate veil-Boon or Bane?
While there are occasions where the courts will “pierce the corporate veil," those occasions are
still the exception and not the rule. 20 So, the Judiciary is unwilling to lift the corporate veil of
companies and it will do so only in exceptional circumstances. It can be argued that lifting of
corporate veil is rightly described as “incoherent and unprincipled concept” because it depends
on the judges concerned and they exercise strong discretion in such cases which only triggers
lack of predictability. 21 The author Stephen M. Bainbridge is in favor of abolishing the doctrine
of piercing of veil because it is vague and it functions as a tax on entrepreneurs because
shareholders with competent counsel will spend time, effort, and resources to ensure that their
business is conducted in ways that limit veil piercing risk and it will increase their business
costs.22 Further it can be argued that the nominal tests used by Courts while lifting Corporate
Veil-whether a corporation has a "separate mind of its own," whether it is a "mere
instrumentality," and so forth-are singularly unhelpful and arbitrary. 23 Since the tests applied by
the Courts are arbitrary, this raises serious questions on the utility of piercing of corporate veil.
Louis Velaphi Mthembu also criticizes the doctrine of lifting of corporate veil due to lack of
clarity since the courts would only pierce the corporate veil where it is convenient to do so and
secondly overlapping between certain categories is only aggravating the problem 24.
On the other hand it can be argued that it is possible to make sense out of the area of piercing by
carefully integrating broad policy concerns with specific grounds for piercing. 25 It can also be
argued that an individualist society with developed market needs lifting the corporate veil to
19
Id
Larry S. Bryant, Piercing the Corporate Veil, 87 Com. L.J. 302 (1982).
21
Shweta Sahu,Piercing the Corporate Veil: A Necessity today in India and abroad, available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2352489
22
Stephen M. Bainbridge, Abolishing Veil Piercing, 26 J. Corp. L. 535 (2001).
23
Frank H. Easterbrookt &Daniel R. Fischeltt, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 109
(1985).
24
Louis Velaphi Mthembu ,To lift or not to lift the corporate veil - the unfinished story, available at
http://researchspace.ukzn.ac.za/xmlui/bitstream/handle/10413/5302/Mthembu_Velaphi_Louis_2002.pdf?sequence=
1
25
Franklin A. Gevurtz,Piercing Piercing: An Attempt to Lift the Veil of Confusion Surrounding the Doctrine of
Piercing the Corporate Veil, 76 Or. L. Rev.907 (1997).
20
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control economic relations; it allows them to restrain illegal and dishonest use of limited liability
principle working for legal entities 26.Moreover, in the absence of piercing of corporate veil
business owners with dishonest reasons, shall have advantage over other market players by using
immunity principle for limited liability of a legal entity and this is in clear violation of the
principle of equity. According to Marion A. Hecht, “a corporation can avoid the lifting of
corporate veil by maintaining an active board of directors; documenting and maintaining the
board of directors minutes; ensuring active, functioning, and responsible officers; consistently
filing all required state paperwork associated with being incorporated, by producing an annual
report and by holding an annual meeting, complete with documented votes.”27
Conclusion
Supreme Court has rightly denied the lifting of corporate veil in Vodafone case by observing that
the tax Authority may invoke the ‘piercing the corporate veil’ test only after it is able to
establish that the impugned transaction is sham or tax avoidant.28 The doctrine of lifting of
Corporate Veil which is based on principle of equity is required to control economic relations
and to restrain illegal and dishonest use of limited liability principle working for legal entities.
However there is need for reform in this doctrine to remove the arbitrariness of nominal tests, to
remove lack of predictability and to prevent the unnecessary costs incurred by the shareholders
to minimize the risk of lifting of Corporate Veil. Further, Courts should not interpret this
doctrine too widely to ensure clarity in the l
26
Dmitry Kafanov, Lifting the Corporate Veil is Necessary for a Developed Market, available at
http://www.inmarlegal.ru/en/filemanager/download/486
27
Marion A. Hecht, Piercing the Corporate Veil, AIRA Journal Vol 25 No. 5, 14(2012).
28
Vodafone International Holdings B.V vs. Union of India,[2012] 107 CLA 63 (SC)
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