1. Pursuant to the order dated November 8, 1978, passed by this court in T.C.P Nos. 160 to 165 of 1978, the Income-tax Appellate Tribunal, Madras, has referred the following three questions of law for our consideration:
“1. Whether, on the facts and in the circumstances of the case and having regard to the provisions of clause 5 of the articles of association and the provisions of section 2(18)(b)(B)(ii) of the Income-tax Act, 1961, the Appellate Tribunal was right in holding that the company should be treated as one in which the public are substantially interested?
2. Whether the Appellate Tribunal's finding that the shares of the assessee-company are capable of possessing the character of the transferability under sub-clause (n) of clause 5 of the articles of association and, therefore, the shares are freely transferable is sustainable in law and is a reasonable view to take on the facts of the case?
3. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that all the shares of the company need not possess the character of transferability in order to fulfil the provisions of section 2(18)(b)(B)(ii)?”
2. These questions relate to the assessment years 1967-68 to 1973-74. Since the questions are common and based on identical facts, all these cases are decided by this common order. The assessee-company has during these years claimed that it should be treated as a company in which the public are substantially interested. The Income-tax Officer noticed that the assessee-company has technical collaboration with Messrs. Joseph Lucas Industries Limited of the United Kingdom and the said foreign company holds 60 per cent. of the share capital of the assessee-company and also 60 per cent. of the voting rights. The Income-tax Officer, however, held that even though the foreign company is not a private company, the shareholdings of the said company have not been analysed to show that they have not been controlled by five or less persons.
3. Unless this was proved, the question of treating the assessee-company as a company in which public are substantially interested as per section 2(18) of the Income-tax Act would not arise. The Income-tax Officer also held that the shares of the assessee-company are not freely transferable and in fact no transfers have been made so far. It also held that the shareholders of the assessee-company are closely related and, therefore, the question of free transferability of the shares does not arise. The claim of the assessee-company was, therefore, negatived by the Income-tax Officer.
4. The assessee-company preferred an appeal against the aforesaid order before the Appellate Assistant Commissioner of Income-tax, ‘A’ Range, Madras, and claimed the said status again. The appellate authority, on perusal of the collaboration agreement between the assessee-company and the foreign company, held that the foreign company was holding 60 per cent. shares of the assessee-company and consequently 60 per cent. of the voting power as well. Referring to various clauses of article 5 of the articles of association, the appellate authority came to the conclusion that the right of pre-emption vested in the other shareholders of the company as per the directions of the board of directors does not affect the free transferability of shares of the assessee-company. The authority, therefore, held that all the requirements of section 2(18) of the Act have been satisfied. The assessee-company was, therefore, held to be a company in which the public have substantial interest. The Income-tax Officer was accordingly directed to modify the assessment. The Department preferred an appeal before the Income-tax Appellate Tribunal against the aforesaid order. The impugned order held that because of clause (h) of article 5 of the articles of association which permits the board of directors to remove all obstacles to free transferability of the shares, this condition of free transferability under section 2(18) of the Act were fully satisfied. Accordingly, the order of the Appellate Assistant Commissioner was affirmed. It appears that since the Tribunal refused to make a reference the matter was brought to this court in T.C.P Nos. 160 to 165 of 1978 and a reference has now been made as directed.
5. It is common ground that the company is registered as a private limited company and this fact is clearly and specifically mentioned in article 2 of the articles of association. Article 2(a) provides that: “the right to transfer shares is restricted in the manner hereafter prescribed”. Article 2(c) further provides that “any invitation to the public to subscribe for any share in or debentures of the company is prohibited”. Article 5(b) provides that “except as hereinafter provided no shares in the company shall be transferred unless and until the rights of pre-emption hereinafter conferred shall have been exhausted”. Clauses (c), (d), (e), (f) and (g) of this article confer this right of pre-emption on existing members, authorises the board of directors to fix the price of the shares to be transferred and after obtaining consent of the members interested in purchase and allocate the shares to or among the members. It is only when the members do not exercise the right of purchase as aforesaid, the transfer of shares to any other person is permitted. Even such transfer has to be approved in writing by the company. Clause (g) puts a further rider on the right of transfer and vests right of approving transfer by both Joseph Lucas Industries Company of United Kingdom and T.V Sundaram Iyengar Private Limited. Clause (g) of this article provides that the board of directors may, in their absolute discretion, annul the operation of clauses (b) to (g) of this article either temporarily or permanently. Since this clause (h) has been the focus of our attention, it may be reproduced for ready reference:
“The Board may, in its absolute discretion, annul the operation of the provisions of clauses (b), (c), (d), (e), (f) and (g) of this article, either temporarily or permanently, and either generally or in respect of a specific class or number of shares and on such annulment the provisions of the said clause shall become inoperative and of no effect.”
6. A bare reading of this provision would indicate that the discretion is vested in the board of directors to annul the operation of clauses (b) to (g) of this article in the manner aforesaid. Once the board exercises this discretion, the clause dealing with the right of pre-emption of existing members become inoperative. This clause, however, does not affect the operation of article 2(a) and (c) which provide that right to transfer shares is restricted and invitation to the public to subscribe to any share is prohibited. The mere existence of the power under article 5(h) ensures according to the Tribunal free transferability of shares and specifies requirements of section 2(18) of the Act.
7. Section 2(18) as it stood at the relevant time permitted a company which is not a private company to be treated as a company in which public are substantially interested, the conditions being that either the share of such a company be shown to be listed in a recognised stock exchange in India or the shares may be freely transferable by the holder of the share to other members of the public. It is admitted that the shares of the assessee-company are not listed in any stock exchange and hence the assessee can get only the aforesaid status by showing that its shares are freely transferable. The provisions as it stood at the relevant time read as under:
“‘Company in which the public are substantially interested’ — A company is said to be a company in which the public are substantially interested—…
(b) if it is a company which is not a private company as defined in the Companies Act, 1956 (1 of 1956), and the conditions specified either in item (A) or in item (B) are fulfilled, namely:—
(A) shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) were, as on the last day of the relevant previous year, listed in a recognised stock exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and any rules made thereunder;
(B)(i) shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than fifty per cent. of the voting power have been allotted unconditionally to, or acquired unconditionally by, and were throughout the relevant previous year beneficially held by—
(a) the Government; or
(b) a corporation established by a Central, State or Provincial Act; or
(c) any company to which this clause applies or any subsidiary company of such company where such subsidiary company fulfils the conditions laid down in clause (b) of section 108 (hereafter in this clause referred to as the subsidiary company); or
(d) the public (not being a director, or a company to which this clause does not apply);
(ii) the said shares were, during the relevant previous year, freely transferable by the holder to the other members of the public; and
(iii) the affairs of the company, or the shares carrying more than fifty per cent. of its total voting power were at no time, during the relevant previous year, controlled or held by five or less persons,—
Explanation 1.— In computing the number of five or less persons aforesaid,—
(i) the Government or any corporation established by a Central, State or Provincial Act or a company to which this clause applies or the subsidiary company of such company shall not be taken into account; and
(ii) persons who are relatives of one another, and persons who are nominees of any other person together with that other person, shall be treated as a single person.
Explanation 2.— In its application to an Indian company whose business consists mainly in the construction of ships or in the manufacture or processing of goods or in mining or in the generation or distribution of electricity or any other form of power, item (B) shall have effect as if for the words ‘not less than fifty per cent.’ and ‘more than fifty per cent.’, the words ‘not less than forty per cent.’ and ‘more than sixty per cent.’, had, respectively, been substituted.”
8. A bare reading of the aforesaid would indicate that the respondent-assessee is first required to show that (1) it is not a private company as defined under the Companies Act, and (2) its shares were during the year previous to the assessment year freely transferable. It is common ground that as long as these conditions are not satisfied the assessee-company would not be entitled to claim the status aforesaid.
9. The submission of learned counsel for the respondents is that the assessee-company though registered as a private limited company has changed its status because of the applicability of section 43A of the Companies Act and is for that reason no longer a private company. The submission in particular is that since the foreign collaborators of the assessee, namely, Joseph Lucas Industries Limited of United Kingdom, hold not less than 25 per cent. of the paid-up share capital of the assessee-company it has become a public company under this provision. Section 43A(a)(i) of the Companies Act, reads as under:
“Private company to becom, e public company in certain cases.— (1) Save as otherwise provided in this section, where not less than twenty-five per cent. of the paid-up share capital of a private company having a share capital, is held by one or more bodies corporate, the private company shall,—
(a) on and from the date on which the aforesaid percentage is first held by such body or bodies corporate, or
(b) where the aforesaid percentage has been first so held before the commencement of the Companies (Amendment) Act, 1960, on and from the expiry of the period of three months from the date of such commencement unless within that period the aforesaid percentage is reduced below twenty-five per cent. of the paid-up share capital of the private company,
become by virtue of this section a public company:
Provided that even after the private company has so become a public company, its articles of association may include provisions relating to the matters specified in clause (iii) of sub-section (1) of section 3 and the number of its members may be, or may at any time be reduced, below seven:
Provided further that in computing the aforesaid percentage, account shall not be taken of any share in the private company held by a banking company, if, but only if, the following conditions are satisfied in respect of such share, namely:
(a) that the share—
(i) forms part of the subject-matter of a trust;
(ii) has not been set apart for the benefit of any body corporate; and
(iii) is held by the banking company either as a trustee of that trust or in its own name on behalf of a trustee of that trust, or
(b) that the share—
(i) forms part of the estate of a deceased person,
(ii) has not been bequeathed by the deceased person by his will to any body corporate, and
(iii) is held by the banking company either as an executor or administrator of the deceased person or in its own name on behalf of an executor or administrator of the deceased person;
and the Registrar may, for the purpose of satisfying himself that any share is held in the private company by a banking company as aforesaid, call for at any time from the banking company such books and papers as he considers necessary.
Explanation.— For the purposes of this sub-section, ‘bodies corporate’ means public companies, or private companies which had become public companies by virtue of this section.”
10. A bare reading of this provision would indicate that a company satisfying the aforesaid requirement becomes by virtue of this section a public company. The word “public” used in this provision does not have the same meaning as in section 3(1) of the Companies Act. The distinction between a private company, a public company and a company treated as a public company under section 43A of the Companies Act has been clarified by the Supreme Court in Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd., [1981] 51 Comp Cas 743 : (1981) 3 SCC 333 : AIR 1981 SC 1298. In this case, it was submitted for acceptance of the Supreme Court that the company law recognises only two types of companies, viz., private companies and public companies, and they are mutually exclusive. The Supreme Court noticed section 43A of the Companies Act and rejected the said submission. According to the Supreme Court, section 43A has introduced a new category of company and, therefore, there are three distinct types of companies in the scheme of the Companies Act, 1956, viz., (1) private companies, (2) public companies, and (3) private companies which have become public companies by virtue of section 43A, but which continue to include or retain the three characteristics of a private company. This classification would, therefore, clarify that the assessee-company has not become a public company for all purposes. The question requiring consideration in such a case is whether it has ceased to be a private company? It is clear that as long as the company continues to be a private company as defined under Section 3(1)(iii) of the Companies Act, it would not be entitled to be declared as a company in which public are substantially interested. Section 3(1)(iii) of the Companies Act provides that a company which, by its articles, (a) restricts the right to transfer its shares, if any; (b) limits the number of its members to fifty; and (c) prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company, would be a private company. As long as these three characteristics are found existing, the company will not be able to shake off its characteristics as a private company. Can it, therefore, be said that a company having these characteristics but acquiring the status of public company under section 43A of the Companies Act ceases to be a private company? The first proviso to section 43A of the Companies Act gives discretion to the company to retain its private character even after acquiring the new status. In the instant case, the assessee-company has chosen to retain its private company character and learned (sic) effected any change in its articles can in such a factual situation it be accepted that the company has ceased to be a private company? Having given our anxious consideration to the facts and circumstances of the case, we are not able to hold that the company has ceased to be a private company. In this connection, we are not unmindful of the fact that we are dealing with section 2(18) of the Income tax Act and not the provisions of the Companies Act. The aforesaid provision of the Income-tax Act deals with a situation where the company is either a private company or is not a private company. The said Act does not take into consideration whether a company ceasing to be a private company would be a public company or a company under section 43A of the Companies Act. Since the three characteristics of a private company exist in the instant case, there is no reason to hold that the assessee-company has ceased to be a private company. In this connection, it is also important to remember that the company was incorporated in 1961, when section 43A was already on the statute book. In spite of it, the subscribers to the memorandum and the articles of association got the company registered as a private company. This would clearly indicate the intention of the subscribers and would strengthen the aforesaid conclusion. In this connection, the decision of the Supreme Court in M. Rajamoni Amma v. Dy. CIT, [1992] 195 ITR 873 may also be looked into. This is a case where the company was originally registered as a private company. But, later on, action under section 43A was taken and the Registrar declared the said company to be a public company with effect from October 1, 1975. It would, therefore, appear that in this case there was not only an affidavit, but also a communication from the Registrar dated February 26, 1977, declaring the company as a public company. There is no such material placed for consideration of this court. Indeed, there is nothing except the statement that the foreign company owns 60 per cent. shares of the assessee-company. This bald statement is not in our opinion sufficient to hold that the company has given up its private character and has, therefore, ceased to be a private company. It was obligation of the respondent-assessee to place material on record particularly the action taken by them to get their private character changed to a public character. This judgment would, therefore, be of no help to the respondent-assessee.
11. Though the aforesaid is in our opinion sufficient to hold that the respondent-assessee is not entitled to the benefit of section 2(18) of the Income-tax Act, it may be examined whether the shares of the company were freely transferable. Article 2 of the articles of association which had been reproduced earlier clearly and specifically mentions that it is a private company and invitation to the public to subscribe for any shares in the company is prohibited. It is also clear that the number of members of the company cannot exceed 50. Under the circumstances, all the three basic requirements of a private company remain fulfilled. In Needle Industries (India) Ltd.'s case, [1981] 51 Comp Cas 743, the Supreme Court has held that the right to renounce shares in favour of any person as provided by section 81(1)(c) of the Companies Act cannot apply to a deemed public company under section 43A of the Act as exercise of this power in favour of a non-member would result violation of the restrictions contained in section 3(1)(iii) of the Act. This decision, therefore, is the authority for the proposition that in spite of the company acquiring a public character under section 43A of the Companies Act the restriction on the right of a member to transfer shares would continue. Under the circumstances, article 2 of the association would by itself be sufficient to hold that the shares of the assessee-company are not free transferable.
12. The Tribunal has, however, relied on article 5(h) of the articles of association to hold that the ability of the board of directors to waive the restrictions is by itself proof of free transferability. The decision, however, ignores the specific provisions of article 2 of the articles of association and cannot for that reason be accepted. Even otherwise, clause (h) of article 5 is in itself the evidence of restricted transferability. Transferability would remain restricted as long as the restriction was not removed. If the word “transferability” only had been used in the provision, it may have been possible to accept the decision of the Tribunal, but, the word “freely” is used as an adjective for the word “transferability” and hence transferability must be free from all possible restriction. In the instant case, restrictions exist in fact simply because those restrictions can be removed, it would not mean that free transferability is not affected. It is, therefore, not possible for this court to accept the view taken by the Tribunal and hold that the requirements of free transferability are fully satisfied. In this connection, the decision of the Supreme Court in CIT v. East West Import and Export Pvt. Ltd., [1989] 176 ITR 155 may also be looked into.
13. In this case, the Supreme Court emphasised/that it will not be proper to take two words only, i.e, free transferability, from the provision and give them the meaning and the proper course would be to interpret the entire provision. Though it was a case dealing with the Explanation to section 23A(1) of the 1922 Act more or less similar provisions exist in the present Act and hence it will be obligatory on the part of the authorities to interpret the entire provisions rather than two words thereof. If the words “were” during the previous year are also considered along with the words “freely transferable”, it would require a consideration of facts existing during the year previous to the assessment year and not the mere possibility. The fact in the instant case is that restrictions continue to operate as no decision under clause (h) of article 5 had been taken by the board of directors. Hence, it is not possible to hold that the shares were freely transferable during the year under consideration. It is, therefore, not possible for this court to accept the view taken by the Tribunal. The aforesaid would be sufficient to answer questions Nos. 1 and 2 of the reference. As regards the third question, learned counsel for the respondent-assessee has stated before us that the question is only academic as in the instant case all shares of the assessee-company possess the similar character of transfer. Since the company is registered as a private company and the legal provisions concerning it do not justify having shares with different characters of transferability, the statement of learned counsel finds full legal support. The view taken by the Tribunal that only more than 25 per cent. of the shares should be transferable is not a correct reading of the provision. The free transferability clause has relevance to the word “share” appearing in the beginning of the provision and has no relation whatsoever with the shares held by another body or company to attract the application of the provision. Under the circumstances, the view taken by the Tribunal is patently wrong and cannot be accepted.
14. In view of the discussion aforesaid, our answer to question No. 1 is in the negative and against the assessee. Similarly, our answer to question No. 2 is also in the negative. Our answer to question No. 3 is also in the negative. No costs. Counsel's fee is Rs. 1,000.