1994 (9) TMI 30 - HC - Income Tax

Summary

Issues Involved:
1. Whether the company should be treated as one in which the public are substantially interested.
2. Whether the shares of the assessee-company are freely transferable.
3. Whether all the shares of the company need to possess the character of transferability to fulfill the provisions of section 2(18)(b)(B)(ii).

Issue-wise Detailed Analysis:

1. Public Interest in the Company:
The primary issue was whether the assessee-company could be treated as a company in which the public are substantially interested under section 2(18) of the Income-tax Act, 1961. The Income-tax Officer (ITO) observed that the foreign collaborator, Joseph Lucas Industries Limited, held 60% of the shares and voting rights. However, the ITO contended that the shareholdings were not analyzed to prove they were not controlled by five or fewer persons, thus negating the public interest claim. The appellate authorities, including the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal, disagreed, stating that the right of pre-emption did not affect the free transferability of shares, thus satisfying section 2(18). The High Court, however, emphasized that the company retained its private character as per section 3(1)(iii) of the Companies Act, despite the foreign shareholding, and thus could not be treated as a company in which the public are substantially interested.

2. Free Transferability of Shares:
The second issue revolved around whether the shares of the assessee-company were freely transferable. The ITO argued that the shares were not freely transferable due to the pre-emption rights and the lack of actual transfers. The Tribunal, however, held that clause (h) of article 5, which allowed the board to annul restrictions on transferability, indicated free transferability. The High Court disagreed, stating that the mere potential to annul restrictions did not equate to actual free transferability. The Court emphasized that the restrictions in article 2 of the articles of association, which limited the number of members and prohibited public invitations for shares, meant the shares were not freely transferable.

3. Character of Transferability of All Shares:
The third issue was whether all shares needed to possess the character of transferability to meet section 2(18)(b)(B)(ii) requirements. The Tribunal had suggested that only more than 25% of the shares needed to be transferable. The High Court found this interpretation incorrect, asserting that the free transferability clause applies to all shares, not just a portion. The Court noted that the company's registration as a private company inherently meant all shares had similar transfer restrictions.

Conclusion:
The High Court answered all three questions in the negative, ruling against the assessee. The Court held that the company retained its private character, the shares were not freely transferable, and all shares needed to possess the character of transferability to satisfy section 2(18)(b)(B)(ii). The Tribunal's view was deemed incorrect, and the assessee was not entitled to the status of a company in which the public are substantially interested. No costs were awarded, and counsel's fee was set at Rs. 1,000.