(Delivered by Ramachandra Iyer, J.)

This petition under Art. 226 of the Constitution praying for the issue of a writ of certiorari to call for records in G.I No. 7-1/55-56 dated 28th February 1957, and to qush the order of the Additional Income-tax Officer, Special Circle, Madras, assessing the petitioner to tax under S. 34 of the Indian Income-tax Act.

The petitioner, an assesseee, was assessed to an income of Rs. 3362 for the year 1955-56 (the corresponding year of account being 13th April 1954 to 12th April 1955) on the basis of his return; no taxt was levied thereon, as it was below the taxable limit. Some time thereafter, the Additional Incometax-Officer, Special Circle, Madras, obtained information which revealed that the assessee had failed to disclose fully and truly his real income for the year. The officer initiated proceedings under S. 34 of the Act, and after enquiry, found that, during the year of account, the assessee should be held as deemed to have received by way of dividend a sum of Rs. 1,01,695. On that finding the petitioner was assessed to tax on his total income, of Rs. 1,05,057, the tax levied thereon being Rs. 31,830-8-0. The petitioner has filed, before the Appellate Assistant Commissioner, an appeal against the order of assessment under S. 30 of the Act. He has also applied under Art. 226 of the Constitution for quashing the same on the ground that the provisions of the Indian Income-tax Act, namely, S. 26A(e) and 12(1B), under which he was deemed to have received the dividends, were ultra vires of the Union Legislature.

The facts necessary to appreciate the question raised are these. The assessee is a shareholder, owning one share of Rs. 100 in a private company, K.M.S.S Lakshmana Iyer and Sons Ltd. The company has its registered office at Madurai, and carries on business as dealears in yarn, it being one of the distributors of the yarn produced by Madura Mills, Ltd. The year of account adopted by the company is the year ending with 15th of September each year. The paid up capital of the company is Rs. 5,00,000 divided into 500 shares of Rs. 1000 each. During the relevant period, the other shareholders in the company were the four sons of the petitioner, the first three holding 125 shares each and the fourth 124 shares. On 31st August, 1955, the assessee transferred even the one share held by him in favour of his fourth son. There is no dispute that the company is a “controlled company” coming within S. 23-A of the Income-tax Act, and that, during the relevant period, the petitioner was a shareholder therein.

The company earned considerable profits; a sum of Rs. 25,000 of the undistributed profits was set apart on 16th September, 1953, as a ressrve. In the following year, that is, on 16-9-1954, there was a similar reserve of Rs. 75,000. Those amounts, which could have been distributed to the share holders as dividends, were not so distributed. But the petitioner was drawing monies from the company as loans. During the year of account, a sum of Rs. 70,429-9-11 was granted to him as a loan. On 27-4-1955, the liability of the petitioner to the company for amounts granted to him by way of loans was Rs. 87,596-0-8. On the latter date, the company, by a resolution made in that behalf, wrote off the entire amount due by the petitioner as irrecoverable. To effect the loss resulting from the writing off the petitioner's liability, the company transferred the reserve fund of one lakh of rupees (representing the undistributed profits) to its profit and loss account. In effect, the undistributed profits wiped off the liability of the petitioner in respect of his drawings.

The Income-tax Officer held that the loans advanced by the company to the assessee would be dividends, as defined in S. 2(6-A)(e) of the Act, and would be assessable to tax under S. 12(1-B), being loans to shareholders prior to 1-4-1955. The amount of loan was, therefore, held liable to be included in the assessment for the following year.

The correctness or otherwise of the assessment would ordinarily be a matter to be agitated in the appeal. On the facts stated above, there is no doubt that, while there were accumulated profits in the company, advances or loans were made by it to the petitioner during the year of account. It is, however, unnecessary to decide at this stage the precise amount of profits available or the extent of the advances made. S. 12(1-B) read with S. 2(6-A)(e) of the Act, which brings to charge such advances upto the limit of undistributed profits of the company would apply. Arguments in this petition were restricted to the constitutional validity of those provisions, it being agreed that the question relating to the propriety of the assessment should be left to be agitated in the appeal.

S. 2(6-A)(e) and S. 12(1-B) were introduced by way of amendment in the Indian Income-tax Act, by the Finance Act of 1955. and they came into operation from 1st April, 1955. The former section brought into the definition of the term “dividend” three types of payments made by a controlled company (which had accumulated profits) to or on behalf of its shareholders, namely (1) payment by way of loan or advance made to a shareholder, (2) payment to a third party on behalf of a share holder, and (3) payment made for the benefit of a shareholder. The payments mentioned above, to the extent to which the company had accumulated profits, were regarded as dividends, received by the assessee in the year in which the company made the payment to the shareholder by way of loan or advance. S. 12(1-B) related to loans to share holders of controlled companies made during the earlier years, that is, earlier than the relevant year of account of the assessee, corresponding to the assessment year, 1955-1956. All such loans outstanding on the first day in the year of account, corresponding to the assessment year, 1955-1956, were treated as dividends and made chargeable in that year of assessment. The effect of the two sections is to create a fiction, and treat the loans received by a shareholder in a controlled company to the extent of the undistributed profits of the company, as dividends received though factually no such dividends were received. The fiction created by S. 2(6-A)(e) is so comprehensive, that a shareholder who borrows from the company will have to pay tax on an amount which might be far in excess of what he would obtain by way of dividend, if dividends had been duly declared. To explain this by an illustration; suppose a member of a controlled company owning one share borrows from the company the entire accumulated profits available, the entire amount taken by way of loan would be treated as dividend and taxed, though his share of the dividend, if declared, would only be a fraction thereof, corresponding to his one share. The reason for such a drastic provision is not far to seek. It is a familiar device of the tax evaders to take shelter under the corporate personality which law confers on a company. No company is bound to declare dividends; profits earned by the company could therefore be accumulated and the persons who would get the share, if dividends were declared in the normal course, adopt devices to get the benefit of such profits indirectly e.g, a loan is taken from the company which is never repaid; the company meets an obligation of the shareholder or makes a payment for his benefit. Thus the shareholder would get the benefit of the dividend, though in form the process of obtaining such benefit would be otherwise than by way of a declaration of dividend. Such receipts (prior to the amendment) would not be liable to tax, as it could not be said that any dividend was either declared or received. Such or similar subterfuges would be possible only in the controlled companies and not in those where the public have a substantial interest. It can be expected that in the latter category of companies the public would see to it that they get their dividends properly and in time. In the controlled companies, however, the persons controlling would decide what is to be done. Profits distributable to the shareholders could ostensibly be accumulated; the persons in control could nevertheless have the benefit of the money by taking it under the guise of a loan or advancing it to a shareholder who would make it over to them and thus avoid tax on dividends. It is to check this type of evasion that the Legislature introduced Sub-Clause (e) to S. 2(6-A) which contained definition of the term “dividend”. That stated:—

“Any payment by a company, not being a company in which the public are substantially interested within the meaning of S. 23-A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or any payment by any such company on behalf of or for the individual benefit of a shareholder, to the extent to which the company in either case possesses accumulated profits. But “dividend” does not include

(i)…………

(ii) any advance or loan made to a shareholder by a company in the ordinary course of its business where the lending of money is a substantial part of the business of the company;

(iii) any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of Clause (e) to the extent to which it is so set off;”

(Rest of the section omitted as unnecessary).

The new definition of the term “dividend” as incorporated by the Finance Act of 1955, would by itself operate only from the assessment year 1955-1956. S. 12(1-B) brought to tax under the head ‘income from other sources’ earlier loans made by controlled company to its shareholder. It runs:

“Any payment by a company to a shareholder by way of advance or loan which would have been treated as a dividend within the meaning of Clause (c) of Sub-S. (6-A) of S. 2 in any previous year relevant to any assessment year prior to the assessment year ending on the 31st day of March 1956, had that Clause been in force in that year shall be treated as a dividend received by him in the previous year relevant to the assessment year ending on the 31st day of March, 1956, if such loan or advance remained outstanding on the first day of such previous year.”

It will be noticed that by virtue of the definition in S. 2 (6-A) (e) in regard to assessments beginning from 1955-1956, loans once advanced by a controlled company to its shareholder would attract tax liability, though such loans might be repaid subsequently even during that year. S. 12(1-B) which applies to loans made earlier, only brings to tax loans outstanding at the beginning of the year of account, corresponding to the assessment year, 1955-1956, thus relieving the shareholder of tax liability to the extent of repayment. Further S. 12(1-B) deals only with one of the three categories of payment mentioned in S. 2(6-A)(e), that is, loan advanced to shareholders. This difference in their respective operation of the two Sections was presumably intended for the benefit of the assessee. In cases of assessment for and subsequent to 1955-1956, an assessee would know that even if he took a loan from a controlled company in which he was a shareholder, he would be made liable to tax by treating the loan made to him as a dividend received by him. In regard to the earlier years, however, the borrowing shareholder could not have known that the loans themselves would attract tax; nor that he would be liable to pay tax on amounts paid by the company for his benefit. S. 12(1-B) therefore restricts the tax liability to the loans outstanding. It must be noticed that S. 2(6-A)(e) excludes the operation of the definition to the case of companies, a substantial part of whose business is money lending, for in such cases it cannot always be said for certain that the borrowing was a device to get the dividend.

The contention of the assessee is that the impugned Sections which bring to tax that which is not income, is beyond the constitutional competence of the Parliament, as under Art. 246 of the Constitution, it would only have a power to enact legislation in regard to the subjects mentioned in Lists 1 and 3 of the VII Schedule. Entry 82 in List 1 of the VII Schedule runs:

“Taxes on income other than agricultural income”. The learned Counsel for the petitioner contended that the enactment was part of the income-tax legislation, and unless the provisions come under the head of a tax on income, there would be no authority in the Parliament to enact the provisions referred to above and that the impugned Sections, which purported to tax a loan advanced by a company to its shareholder could not properly come under Entry 82. It is also contended that the impugned Sections being discriminatory in their operation, would contravene the provisions of Art. 14 of the Constitution.

The first of the two contentions raised rested on the assumption, that the Parliament had no power to legislate except on the matters specifically set out in Lists 1 and 3 to the VII Schedule to the Constitution. We shall consider later whether such an assumption is justified. Taking that assumption as correct, viz., that in order that Ss. 2(6-A)(e) and 12 (1-B) of the Income-tax Act may be valid they must be part of a legislation imposing a tax on income, the question for consideration would be whether those provisions in substance aimed at taxing the income. According to the learned Counsel for the petitioner, the term income is a well known concept, which implies that the person who gets it takes it for himself and would be under no obligation to repay. A loan, however, is one which has to be repaid. A liability of a shareholder under loan or advance made to him by the company, of which he is a shareholder, could not therof ore be characterised as income, as there would always subsist his liability to repay the same, and the company could always recover the amount from the shareholder. Therefore, what was brought to tax by the impugned Sections was not income but a loan which had to be repaid.

The question for consideration is not so much whether the term “income” would include the monies advanced as loan but whether the legislature was competent to enact legislation which would have the effect of bringing such amounts to tax. In Navinchadra Mafalal v. Commissioner of Income-tax, Bombay City(1), the Supreme Court held that, in construing an entry in a list conferring legislative powers, the widest possible construction according to their ordinary meaning must be put upon the words used therein, and that, where the question was whether a constitutional enactment conferred legislative power, a most liberal construction should be put upon the words, so that the same may have effect in their widest amplitude. In Azina Umma v. Income-tax Officer(2), the question was raised whether in enacting S. 16(3)(a)(ii) of the Indian Income-tax Act, the Legislature transgressed the powers conferred on it by Entry 54 of List 1 of the 7th Schedule in the Government of India Act, 1935 (which corresponds to Entry 82 of List I of the 7th Schedule to the Constitution). It was held that, although the impugned provisions purported to tax a person who did not receive the income, it was nevertheless only income that was assessed, and that the enactment of a legal fiction shifting the incidence of taxation from the person who received the income to another, would not take it out of the scope of Entry 54. A similar point arose in regard to the validity of S. 4(2) of the Indian Income-tax Act, where the incidence of taxation was shifted from the non-resident husband to the wife who was a resident within the taxable territories. In Jameelamma v. Income-tax Officer, it was held that the basis of taxation was income, and, therefore, within the competence of the legislature, and that the section did not violate the provisions of Art. 14 of the Constitution. Spencer v. Income-tax Officer, Madras, considered whether the provisions of S. 23-A under which the tax was levied in respect of undistributed portion of the profits, were ultra vires as they sought to bring to tax the undistributed profits of a controlled company as income, even though they did not become income of the shareholders until they were distributed. At page 119, it is observed:

“To focus attention on the incidence of the tax for which also S. 23-A provided, to the exclusion of the basis of taxation, can only tend to cloud the issue of legislative competence. What was it that was taxed; undisbursed profits. Undisbursed profits were undoubtedly income, a part thereof. True it was the income of the company and it remained as part of the assets of the company even after the Taxing Authorities had passed an order under S. 23-A. Except notionally and then only for the purposes of the incidence of the tax, undisbursed profits did not become the income of the shareholders. Nonetheless, the position remains, that what was taxed, undisbursed profits, was income. The net profits of the company were subject to tax. A provision for a further levy on undisbursed profits, which constituted a part of the net profits of the company would still be a statutory provision to tax income. Legislative power to provide for a further levy on the same income, the income of the company, could not be denied…So, what S. 23-A, did was, in essence, to tax income, the income of the company. Only, the incidence of that tax was not on the company in the first instance but on the shareholder, who had no doubt no legal right to get his share of the undisbursed profits of the company.”

In Navinchandra Mafatlal v. The Commissioner of Income-tax, Bombay City(3) the Supreme Court observed that the world “income” should be construed to extend to all ancillary or subsidiary matters, which can fairly and reasonably be said to be comprehended in it, and that the legislative measure to prevent evasion of tax on income would be within the scope of the legislative powers to tax the income. As stated already, Ss. 2(6-A)(e) and 12(1-B) were introduced, in order to prevent evasion of tax. Those sections deal only with controlled companies, and not with those in which the public have a substantial interest. The income itself in reality belongs to the persons who form the company, and the distribution of profits of the company depends entirely on the will of the persons who control the company. Evasion of tax was possible by keeping the dividends undistributed, and at the same time paying monies under the guise of loans. Having regard to the identity of the interest of the shareholders in a controlled company with that of the company, the assumption that the loans advanced are mere camouflages for payment of profits to the shareholders, is one based in reality on a number of cases. If the essence of the transaction were to be looked into, it will be seen that the tax sought to be levied is only on the occasion of the loan, the loan being only a semblance for the payment of the profits. The learned Counsel for the petitioner posed a number of possibilities in which the provisions of the Act would work hardship. One illustration mentioned was this: If a particular sum is advanced to a shareholder A and he repays the same, and the same amount is advanced to another shareholder B, both A and B would be liable to pay the tax. We do not consider that the assumption that both A and B would be liable to tax, is correct. Another illustration was that if a shareholder A borrows, pays back and again borrows, the fiction would entitle the Income-tax Department to levy tax twice over. That is also incorrect. As soon as the first advance is made to A, the statute would deem that as payment of dividend, and even if A pays back the money, it could not be held that there was undistributed profit, as the very fiction would show that the undistributed profits was paid as dividend in the first advance and that the same profits could not exist for the second advance. That one shareholder who borrows money first would be taxed, and that the others who take loans later escape such taxation would (subject to the consideration of the question under Art. 14) have no relevance in considering the legislative competence.

It is no doubt true that if a shareholder in a controlled company becomes, indebted, it may not necessarily follow that there has been a distribution of dividend to him. A debt, notwithstanding that it is advanced to the shareholder, would be an asset of the company and not income in the hands of the shareholder. But it is this very principle which is taken advantage of for the various subterfuges adopted to avoid taxation. There can be no doubt that, where a shareholder in a controlled company possessing accumulated profits, takes money with no idea of repayments it would be open to the legislature to tax such drawings as income as by so doing it legislates having regard to the reality of the transaction. Having regard to the devious ways which the ingenuity of man can adopt, if the legislature raises an irrebuttable presumption, that in all cases where loans are advanced to a shareholder in a controlled company having undisbursed profits, the advances should be deemed to be income, the legislation would still be one relating to income-tax, though it may be that it operates harshly in certain cases. It may also be that in the operation of such a presumption or of a statutory fiction like the one contained in S. 2(6-A)(e) certain loans are taxed as income. But that is only incidental in the operation of the statute, whose pith and substance is taxation of income. It must be remembered that S. 2 (6-A)(e) only applies to controlled companies which have, accumulated profits, the substantial part of whose business is not money lending. If a shareholder in that company wants money, he could as well take it out of the profits by declaring a dividend, for ex concessi the persons who decide to grant the loan, that is, the controlling directors can themselves declare the dividend.

Competence to legislate regarding income-tax would include a power to legislate in order to check evasion. That power should obviously extend also to subsidiary matters like taxing a loan where the loans are taken as a means of evading tax liability of income. Similar legislation has been made in other countries. S. 108 of the Commonwealth Income-Tax Act states;

“1. If amounts are paid or assets distributed by a private company to any of its shareholders by way of advances or loans, or payments are made by the company on behalf of, or for the individual benefit of, any of its shareholders, so much, if any, of the amount or value of those advances, loans, or payments, as in the opinion of the Commissioner, represents distributions of income shall, for all purposes of this Act, be deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or distribution is made.

(2) Where the amount or value of an advance, loan or payment is deemed, under the last preceding Sub-Section, to be a dividend paid by a company to a shareholder, and the company subsequently sets off the whole or a part of a dividend distributed by it in satisfaction in whole or in part of that advance, loan or payment, that dividend shall, to the extent to which it is so set off, be deemed not to be a dividend for any purpose of this Act.”

It will be seen that the application of S. 108 of the Commonwealth Income-Tax Act depends upon a finding given by the Commissioner that the payment represents distribution of profits. But the Indian Income-tax Act does not treat it as a matter to be adjudged judicially by the Income-tax Officer but creates a fiction which would bring all advances (if other conditions are satisfied) made to a shareholder by a controlled company. Notwithstanding the fact that the Indian Income-tax Act vests no power in any authority to decide whether particular loan was in reality a loan or the drawing of profits, the subject matter of legislation is a tax on income. Whether the Australian model is to be adopted or the enactment should be made more stringent, is for the legislature to decide. The purport of Ss. 2(6-A)(e) and 12(1-B) is to tax income, and the impugned legislation would come within Entry 82 of Sch. VII, List I.

Even if it were to be held that the impugned Sections would not come under Entry 82, the Union Legislature would have authority under Entry 97 in List I to the VII Schedule. That confers residuary powers of legislation on the Parliament to enact legislation on all matters not mentioned in Lists II and III. The principle that where a subject of legislation is not enumerated it must belong to Parliament is embodied in Art. 248. Therefore, even if the impugned sections of the Income-tax Act are held to impose a tax not on the income, but on a loan and thus outside the ambit of Entry 82 in List I of Sch. VII to the Constitution, the legislative authority therefor could be derived under Entry 97 of the List or Art. 248. In Mithanlal v. State of Delhi, a question arose as to the validity of a taxing enactment imposing tax on building contracts. The Bengal Finance (Sales-tax), Act, 1941, imposed such a tax. Parliament enacted Part C States (Laws) Act, 1950, under which the Central Government may by notification (within restrictions or modifications) extend any enactment in force in Part A State to Part C State. Acting under that provision, the Central Government extended the provisions of the Bengal Finance (Sales-tax) Act, 1941, to Delhi, a Part C State. It was held in State Of Madras v. Gannon Dunkerley & Co., (Madras) Ltd that a State law imposing a tax on works contract was ultra vires. It would follow that the Bengal Act in so far as it purported to do so would be invalid. Did that invalidity extend also to the Sales-tax law operating in Delhi? The Supreme Court answered the question in the negative. The reason for the conclusion was that the Sales-tax Act operating in Delhi was not one enacted by a State legislature but by Parliament (viz., the authority being under Part C State Laws Act, 1950) and that the Parliament's authority was extensive enough to impose a tax on building contracts even though there was no sale there involved therein. The decision of the Supreme Court upholds the residuary power of a Parliament on all subjects except those that are mentioned in List 2.

It is next contended that the impugned sections, in their operation, would contravene the provisions of Art. 14 of the Constitution, in that there has been denial of equality before the law or the equal protection of the laws, guaranteed by the Article, to all the shareholders, the first shareholder who obtains loan being the only person made liable to tax. The argument however fails to take notice of the fact, that the impugned sections are expressly made inapplicable to companies a substantial part of whose business is money lending. Money lending not being a normal feature of the companies to which the provision applies, the occasion of the loan is taken for imposing the tax by creating a fiction that it is a dividend. That in such companies another shareholder might take a loan when there are no accumulated profits is only a possibility, and question of discrimination cannot be judged with reference to hypothetical cases. The classification attempted is between controlled companies whose main business is not money lending and other companies. That a classification between controlled and other companies is a real one has been recognised in Spencer's case. Art. 14 provides that all persons in similar circumstances shall be treated alike both in regard to privileges conferred and liabilities incurred [State Of West Bengal v. Anwar Ali Sarkar,(4)]. The provision of Ss. 2(6-A)(e) and 12(1-B) undoubtedly treats alike all those shareholders of a company who borrow from whom there are accumulated profits. Further a legislation embodying a system of taxation on the basis of a rational distinction even between individuals would be proper and valid. There is a substantial distinction between a person who draws monies in a controlled company whether by himself or his nominee while undistributed profits are available and a person who draws monies therefrom when there are no undistributed profits. Taxing the former on the basis of the fiction enacted, takes note of the fact that even on that day he having the control of the company could declare the dividend and draw the money; while in the other case it cannot be so done. There is, therefore, no substance in the argument that the enactment is in any way discriminatory.

The petition fails and rule nisi is discharged. The petitioner will pay the costs of the respondent. Counsel's fee, Rs. 250.

V.C.S