Although a company is an artificial juristic personality having separate legal entity, in reality the business is carried on by its member shareholders and key managerial personnel. The doctrine of lifting the corporate veil refers to the scenario when the court completely disregards the company and actually concerns itself with the natural persons running its day-to-day operations. However, the court lifts the corporate veil only in exceptional scenarios which are well settled. Let us take a look at these scenarios one by one:
Statutory Provisions
The Companies Act, 2013 itself contains statutory provisions which enjoin the court to lift or pierce the corporate veil to reach the real persons concerned. These provisions are reproduced, below:
Section 7(7) – Lifting of Corporate Veil to reach the real forces of action
According to this Section, where a company is incorporated by furnishing any false or incorrect information or by suppressing any material fact or by any fraud, the NCLT may:
(a) pass orders for regulation of the management of the company including changes in its memorandum and articles, in public interest or in the interest of the company and its members and creditors; or
(b) direct that liability of the members shall be unlimited; or
(c) direct removal of the name of the company from the register of companies; or
(d) pass an order for the winding up of the company; or
(e) pass any other order:
Section 251 (1) – Punishment of incorporation of company by furnishing false information
According to this Section, where it is found that an application by a company for removing the name of the Company from the register of companies has been made with the object of evading the liabilities of the company or with the intention to deceive the creditors or to defraud any other persons, the persons in charge of the management of the company shall, notwithstanding that the company has been notified as dissolved—
(a) be jointly and severally liable to any person or persons who had incurred loss or damage as a result of the company being notified as dissolved; and
(b) be punishable for fraud in the manner as provided in section 447.
Section 339 – Liability for fraudulent conduct of the business during the course of winding up
This Section says that if, during the course of winding up of the company, the business of the company has been carried on with the intent to defraud creditors of the company or any other persons, the NCLT may declare that any person, who is or has been a director, manager, or officer of the company or any persons who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct. In addition, every person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be liable for action under section 447.
Grounds of Judicial Intervention
The following are the grounds of judicial intervention when the courts shall disregard the corporate veil:
(a) Where the Corporate Veil has been used for commission of fraud or improper conduct: In Jones v Lipman [(1962) All ER 342] L agreed to sell a certain land to J for 5250 pounds. He subsequently changed his mind and to avoid the specific performance of contract, he sold it to a company formed especially for the purpose. The company had L and a clerk of his solicitors as the only members. J brought an action for the specific performance against L and the company. The court looked at the reality of the situation, ignored the transfer and ordered that the company should transfer the land to J.
(b) Where a corporate façade is really only an agency instrumentality: In Re FG Films Ltd. [(1953) 1 WLR 483] an American company produced a film called “Monsson” in India technically in the name of a company incorporated in England. The English company had a capital of 100 Pounds in 1 Pound shares, 90 of which were held by an American director. The production was financed by the American company. In these circumstances, the Board of Trade refused to register it as a British film and their decision was upheld by the court. It would be a mere travesty of the facts to say or to believe that this insignificant company undertook the arrangements for the making of the film. They acted, insofar as they acted at all in the matter, merely as the nominee of, and agent for the American company.
In Smith, Stone & Knight Ltd. V. Birmingham Corpn. [(1939) 4 All ER 116 KB], the parent company held all the shares except a few, treated the subsidiary company’s profits as its own, appointed managers and exercised effectual and constant control. The court concluded that if ever one company could be said to be the agent or employee, or tool or simulacrum of another, that was the case here. Thus, exclusive control in all respects and without any person having any voice in the affairs is the surest indication of agency or trust. As in that case the subsidiary company could not be said to be operative on its own behalf but on behalf of the parent company.
(c) Where the conduct conflicts with public policy: In Daimler Co Ltd. V. Continental Tyre & Rubber Co. Ltd. [(1916) 2 AC 307] the House of Lords laid down that a company incorporated in the UK may assume an enemy character when persons in de facto control of its affairs are residents in any enemy country or, wherever resident, are acting under the control of enemies. Accordingly the company was not allowed to proceed with the action to recover trade debt. If the action had been allowed the company would have been used as a machinery by which the purpose of giving money to the enemy would be accomplished. That would be monstrous and against public policy.
(d) Tax Evasion: In Apthorpe v Peter Schoenhofen Brewing Co Ltd. [(1899) 4 TC 41] In New York, aliens were not permitted to own property. An English corporation bought a New York company's operations and assets. The American firm, on the other hand, was maintained on foot to preserve control of the area. The English corporation was in charge of financing and running the business. It was decided that because the American firm had become the agent of the English company, all of its profits were subject to be taxed as the English company's income.
In Re Sir Dinshaw Maneckjee Petit (AIR 1927 Bombay 371) the assessee was a wealthy man enjoying large dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the accounts of the company. The company handed back the amounts to him as pretended loans. This way he divided his income into four parts in order to reduce his tax liability.
The Court held: “the company was formed by the assessee purely and simply as a means of avoiding supertax and the company is nothing more than the assessee himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee as pretended loans.” The court decided to disregard the corporate entity as it was being used for tax evasion.
In CIT v Associated Clothiers Ltd. (AIR 1963 Cal 629) the assessee (Associated Clothiers) formed a company holding all its shares. They sold certain premises to the new company. The difference between the selling price and the cost of the property in the hands of assessees was assessed as their income. They contended that this could not be done as there was no commercial sale, but only a transfer from self to self. The court rejected this and held that it was sale from one entity to another and not a trading with oneself.
In CIT v Sri Meenakshi Mills Ltd. (AIR 1967 SC 819) the assessee companies borrowed moneys from the Madurai Branch of the bank on the security of the fixed deposits made by their branches with the Pudukottai branch of the bank. The loans granted to the company were far in excess to the available profits at Pudukottai. The Income Tax officer included the entire profits of the assessee companies including the interest receipts from the Pudukottai branch in the assessment of the assessee companies, since the overdraft availed of by the assessee companies far exceeded the available profits. The question arose: “Whether on the facts and in the circumstances of the case, the taxing of the entire interest earned on the fixed deposits made out of the profits earned in Pudukottai by the assessee’s branches in Pudukottai branch of the Bank of Madurai is correct?”
The Tribunal concluded that the Bank itself was started at Madurai and a branch was opened at Padukottai only with a view to helping the financial operations of the Director and the mills in which he was vitally interested. The Tribunal found that the Padukottai branch of the Bank had transmitted funds deposited by the assessee companies for enabling the Madurai branch to advance loans at interest to the assessee companies and the transmission of the funds was made with the knowledge of the assessee companies who were the major shareholders in the Bank. Thus, it disregarded the corporate façade of the assessee companies.
In Vodafone International Holdings B.V. v. Union of India & Anr. [SLP (C) No. 26529 of 2010] the Court recognised the fundamental principle of the corporate veil by noting that, “The approach of both the corporate and tax laws, particularly in the matter of corporate taxation, generally is founded on the abovementioned separate entity principle, i.e., treat a company as a separate person. The Indian Income Tax Act, 1961, in the matter of corporate taxation, is founded on the principle of the independence of companies and other entities subject to income-tax.” It observed in the context of parent / subsidiary relationships, that it is generally accepted that the group parent company would give guidance to group subsidiaries, but that by itself would not justify piercing the veil or imply that the subsidiaries are to be deemed residents of the State in which the parent company resides, and that “a subsidiary and its parent are totally distinct tax payers”.
The court listed the following six factors which might be considered to determine whether the transaction is a bogus and whether in a specific case, the corporate veil may be lifted: “(i) the concept of participation in investment, (ii) the duration of time during which the Holding Structure exists; (iii) the period of business operations in India; (iv) the generation of taxable revenues in India; (v) the timing of the exit; and (vi) the continuity of business on such exit.”
In the final analysis, the Supreme Court decided against lifting the corporate veil in Vodafone, as the tax authorities failed to establish that the transaction was a bogus or tax avoidance scheme.
(e) Avoidance of Welfare Legislation: In Workmen of Associated Rubber Industry v. Associated Rubber Industry Ltd. [(1985) 4 SCC 114] a company created a subsidiary and transferred its investment holdings to it in a bid to reduce its liability to pay bonus to its workers. The court brushed aside the separate existence of the subsidiary company and held that it is the duty of the court in every case where ingenuity is expended to avoid taxing and welfare legislations, to get behind the smoke screens and discover the true state of affairs.
In National Dock Labour Board v Pinn & Wheeler Ltd. [1989 BCLC 647 QBD] a group of three companies working in the same geographical location of a dock were not allowed to claim that they should be treated as three different companies when their purpose was to avoid the effect of the Dock Labour Scheme.
Conclusion
Lifting or piercing of the corporate veil of the company is resorted to in exceptional circumstances and generally, the courts refrain from doing so. However, even though the real persons behind the company might be liable for the wrongdoings under the garb of the corporate personality, certain criminal charges cannot be levelled against the company itself. For instance, a company cannot be prosecuted for cheating and conspiracy because such offences require mens rea. [A. K. Khosla v. T.S. Venketesan (1994) 80 Comp Cas 81 Cal]. Similarly, a company cannot be imprisoned for evasion of taxes or any other crime. But penalties can be imposed. [Maniam Transports v. S. K. Moorthy (1993) 1 Comp LJ 153 Mad].
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