Startup guide to Digital Personal Data Protection Act (DPDPA)

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November 8, 2024

This article has been written by Rahena Anandraj pursuing a Personal Branding Program for Corporate Leaders from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Table of Contents

Who is a stakeholder

A ‘stakeholder’ is an individual or a group of individuals or an organisation with a financial/any other vested interest in the success of a business. In other words, stakeholders are defined as those who are likely to be affected directly or indirectly by or whose actions can affect/influence the operations of a company. The stakeholders include investors, owners, shareholders, employees, customers, clients, outsourcing partners/vendors, retainers, suppliers, the general public, local communities, governments, statutory/regulatory bodies and trade associations. However, a stakeholder is not always a shareholder. Hence, a stakeholder can be either within or outside an organisation.

A stakeholder has an interest in the performance of a company for reasons other than stock performance or appreciation and has a dire need and deep-rooted interest in the success and prosperity of the company. The stakeholders serve as the backbone and risk-takers of any company. It is through stakeholder engagement and active participation that a company tries to understand the expectations of all stakeholders regarding their concerns on governance, strategy, company processes, policies, and performance. Effective stakeholder engagement plays a critical and crucial role in the sustainable long-term growth of the company, developing strong relationships and building trust within the company. Furthermore, stakeholder involvement in the operations of the company enables them to make informed strategic and operational changes for the smooth functioning of the company.

Stakeholders could be internal or external to a company. While internal stakeholders are individuals directly related to the company through employment, ownership or investment, external stakeholders are individuals not directly related to the Company but nevertheless affected by the actions and outcomes of the business. Examples of internal Stakeholders are employees, shareholders, investors, etc., whereas examples of external stakeholders are suppliers, creditors, Public Interest Groups, statutory/regulatory bodies, etc.

What is governance and management and how are they different from each other

‘Governance’ as per Dictionary and in layman’s understanding is the action or manner of governing state, people, organisation, etc. Management, as per Dictionary and in layman’s understanding, is the process of dealing with or controlling things, people, etc.

Now, the terms ‘government’ and ‘management’ are often misinterpreted and, accordingly, used interchangeably in similar contexts or situations. However, there exists a difference in the sense that governance is the laying out of the processes, policies, rules, and regulations, whereas management is implementing these laid out processes, policies, rules, and regulations.

Corporate governance and management

There are many laws, rules, regulations, guidelines, notifications, precedence, and circulars, as amended from time to time (hereinafter referred to as ‘applicable requisites’), that are applicable to a company. Corporate governance and management is nothing but formulating, framing, and implementing or enforcing these applicable requisites into/through the standard operating process and policies of the company in its day-to-day affairs. It is through such corporate governance and management that the company is able to uphold its values, reputation/goodwill and well-being in a holistic way.

Corporate governance and its management can be effectively controlled only by the company’s board of directors. It is because the Board of Directors, being well-qualified, well-experienced, and well-informed, are capable of taking independent and objective decisions.

Having ever-evolving corporate governance in place is necessary for the growth of not only the company but also a society and, consequently, the nation. The unity of corporate governance and stakeholders has been recognised as a vital element of corporate social responsibility (‘CSR’). Together. It is a sure-shot way of achieving sustainability in the long run and on a long-term basis.

How did the concept of the Stakeholder Relationship Committee find place in the Indian Companies Act, 2013?

Before the Companies Act, 2013 came into force, companies were required to constitute shareholder grievance committees. This Committee only looked at and resolved the grievances of just one category of stakeholders, viz., shareholders, and these grievances were related to nothing more than non-receipt of dividends, non-receipt of annual reports, noting changes in address, etc., and often overlooked other grievances pertaining to operations, labour, environment sustainability, service quality, corporate social responsibility, and other day-to-day affairs of the company.

This is because the shareholders own part of the public company through shares of stock, and so the shareholders interest lies in the stock’s price movement and its value increment. The shareholders do not need to have a long-term perspective on the company and can sell the stock whenever they need to. Thereby, the shareholder can usually get out at any time and reduce their losses.

This, however, lead to non-alignment of interests of various Stakeholders other than shareholders, and there is a probability of conflict of interests as a Shareholder is looking to enhance and maximise the values of the shares held by such a Shareholder, and this could be at the labour costs, reduction or elimination of company’s services, etc.

The most efficient companies successfully manage the interests and expectations of all their stakeholders as against the general understanding that the companies are only required to maximise shareholder wealth. This is where the concept of ‘Stakeholder Capitalism’ was brought into motion. With its advent, the companies are now required to serve the interests of all their stakeholders, not only their shareholders.

Previously, Clause 49 of the Listing Agreement to the Indian Stock Exchange (with effect from 31st December 2005) was formulated for the improvement of corporate governance in all listed companies. Under the said Clause 49, a committee under the chairmanship of a non-executive director and such other members as may be decided by the board of the company would be formed to specifically address the redressal of the grievances of the security holders, i.e., shareholders, Debentureholders and other security holders. This committee looked into and resolved the grievances of security holders relating to the transfer of shares, non-receipt of the balance sheet, etc. This Clause 49 was later amended from time to time.

It is imperative to note that this provision was not replicated in the erstwhile Companies Act, 1956, although, under the Companies Act, 1956, it introduced the Shareholders Grievance Committee (SGC) to address the need of that time. As the name suggests, SGC only focused on shareholders. This perspective has since evolved on account of changes in the ground realities. The companies are now focussing on stakeholders instead of shareholders (i.e., stakeholder capitalism as opposed to shareholder capitalism); the committee was renamed the Stakeholders Relationship Committee (SRC) via Section 178(5) of the Companies Act, 2013 (hereinafter, referred to as ‘the Act’ for the sake of brevity). The Act has replaced the words ‘Shareholders’ and ‘Grievance’ in ‘SGC’ with ‘Stakeholders’ and ‘Relationship’ in ‘SRC’. Further, SRC has found its place in Regulation 20 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended from time to time (“SEBI LODR”).

Stakeholders relationship committee : governance and management

The Stakeholder’s Relationship Committee (SRC) has come into existence as one of the four mandatory Board Committees. The intention of Section 178 of the Act is to allow a company, be it public or private, to be able to constitute a SRC for better governance and management. SRC overlooks various aspects of Stakeholder’s interests.

SRC is formed at the board level of the company, and in lieu of the approval of the board of directors, SRC shall be constituted. The board of directors of a Company which consists of more than one thousand shareholders, debenture holders, deposit holders and any other security holders at any time during a financial year is to constitute a SRC. A Chairperson of such a committee shall be a non-executive director and be present at the Annual General Meeting to answer the queries of security holders (as per the provisions of the Companies Act, 2013). The minimum of three directors with at least 01 independent directors (in the case of a listed company having outstanding security receipt equity shares, a minimum of two-thirds of the SRC shall comprise independent directors) (as per the provisions of SEBI (LODR) Regulations, 2015). SRC shall meet at least once in a year.

The Act and SEBI LODR (hereinafter collectively referred to as ‘legislation’) focus on strengthening corporate governance and, thereby, enabling to maintain the internal management of the company. The legislation, by the inclusion of a separate committee (SRC), specifically addressed the grievances of all the stakeholders. The stakeholders now have a platform to voice their concerns and also suggest remedial/corrective measures to bring about improvisation in the management and the affairs of the Company. For example, SRC will seek for complaints and try to resolve those complaints, which range from transfer of shares, non-receipt of declared dividends, non-receipts of annual reports, non-receipt of interest, issuances of share certificates, general meetings, etc.

Lacunae

Although the legislation attempted for good corporate governance and management, the legislation does not provide for enabling provisions as to how this would be implemented. The attempt was made to the extent of replacement of words and not the scope of the SRC, as against the rising expectations of the stakeholders. The SRC is expected to deal with the grievances rather than building the relationship and trust. Even the composition of SRC has not been well thought of and the placing under the Act is not distinct and separate and is merely a sub-clause of Section 178 of the Act.

The SRC, being a committee, has to overlook the complaints and interests of all the stakeholders; it continues to pursue the complaints and interests of a particular set of stakeholders, i.e., shareholders. The rest of the stakeholders, like labour-related issues, client/customer servicing, SOPs/policies, etc., are often found to be neglected or given the least importance.

Conclusion

While the legislation has undoubtedly played a vital role in diligently bringing all the interests into one fold of “stakeholders,” there still remains a lot of room for improvisation.

There should be flexibility in the composition of the SRC. The roles, accountability and rights of the SRC are to be framed well, and SRC is to be made answerable on non-hearing of feedback and resolution of complaints from all Stakeholders (not restricting to a particular category, i.e., Shareholders) like the employees, vendors, clients, etc.

Of course, the change in thought process and framing of well-articulated roles, accountability, and rights of the SRC shall happen gradually and over time. Yet, this change has to begin for the health and wealth of the organisation as a whole.

Corporate governance and management, in its literal sense, cannot be made a reality in the absence of a well-balanced approach between operational transparency to stakeholders and maintaining confidentiality to facilitate effective and efficient decision-making. This is where the role of independent directors comes into play.

References

Minor’s capacity to contract

By

Sylvine

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November 8, 2024

This article is written by Shafaq Gupta. This article deals with the capacity of a minor to enter into a contract as per the Indian Contracts Act, 1872. It explores the nature and consequences of an agreement with a minor. It further looks over an important issue of the validity of such agreements along with providing a few examples of contracts that are beneficial to a minor.

Table of Contents

Introduction

In our day to day lives, we enter into several contracts. In India, the law of contracts is regulated by the provisions of the Indian Contracts Act, 1872 (hereinafter referred to as ‘the Act’). Section 2(h) of the Act defines a contract as an agreement which is enforceable by law. A contract is a combination of two elements i.e. an agreement and enforceability. But in today’s world we see a lot of minor children below the age of 18 years entering into a contract with other persons. They are doing so either for their own benefit or to enter into some kind of business or to fund their education or may be lured by any person to do so without knowing the consequences of their acts.

So, what would be the nature of their liability or are they even competent to enter into a contract? These are the questions that would arise in the minds of every reader. This article deals with the minor’s capacity to contract and the exceptions related to it. Let us dive deep into the understanding of the same and start by understanding the essential of being a competent party to contract under the Indian law followed by understanding the ambit of law related to a minor.

Capacity to contract under Indian Contract Act, 1872

Let us start by understanding who has the capacity to enter a contract as per the Indian Contract Act, 1872. For an agreement to be legally enforceable as a valid contract, Section 10 of the Indian Contract Act provides certain essential conditions which are as follows:

There must be an agreement.
There must be two or more parties to a contract.
The consent of the parties entering the contract must be free.
The parties must be competent enough to contract.
There should be a lawful consideration.
The agreement must be made for a lawful object.
It must not have been expressly declared void.

Therefore as per the law only those agreements which fulfill all the conditions specified under Section 10 of the Act can be said to be contracts. Therefore, all agreements are not contracts. Section 11 of the Act talks about the competent parties who can lawfully enter into a contract. The essentials of being a competent party to contract under the Indian law are as follows:

Age of majority i.e. above the age of 18 years;
Sound mind at the time of entering into a contract; and
Not disqualified under any law to which he/she is subjected.

The rationale behind keeping majority as an essential condition to be fulfilled before entering into a contract is that a child below 18 years of age is of a tender nature and unable to understand the nature and consequences of his act. Moreover, it is assumed that the minor is not in a position to fulfill his contractual obligations as he is not able to understand them. So, the bona fide interest of the minor was kept in mind while deciding the majority as a condition to a valid contract. A contract with a minor is void i.e. it has no legal effect.

Let us understand the same with the help of an example.

For example, a child who is 16 years of age wants to buy PlayStation games but his parents did not allow him. As a consequence, he mortgaged his mother’s gold ring to a moneylender and got Rs 40,000. After he attained the age of majority, he filed a suit against the moneylender that the contract was entered into while he was a minor and therefore, he is not under an obligation to fulfill it.

Since he was not of the age of majority, he was not capable of entering into a contract. He is not liable to execute his contract of mortgage because he was not mature enough to understand the legal implications of his actus reus. In order to understand the capacity of a minor to enter a contract, the need is to first of all, see who is considered to be a minor under the ambit of law.

Definition of a minor

So, who is a minor as per law? The word ‘minor’ has not been expressly defined under Section 2 of the Act. But Section 3 of the Indian Majority Act, 1875 expressly tells about the age of majority of a person domiciled in India. A person is considered to be a major if:

He possesses a domicile in India.
He has attained the age of 18 years.
In case, a guardian has been appointed for him or his property or he is under the superintendent of the Court of Wards, after attaining the age of 21 years.

Further, the date of birth of a person has to be counted as a full day in computing his age of majority. For example, X was born in India on 29 February,1852 and has an Indian domicile. The guardian was appointed for his property by the court. So, X would have attained majority at the first moment on 28th February, 1873.

From this, we can infer that a minor is a person who has not attained the age of 18 years and in case a guardian is appointed, a person who has not attained the age of 21 years. So what will happen if a minor enters a contract? Let us read further to understand the same.

Nature of minor’s agreement

Will a minor be eligible for a contract then? As we can see that Sections 10 and Section 11 of the Act do not expressly state whether a contract with a minor is void or voidable at the option of another party to a contract. This controversy was resolved in the landmark case of Mohori Bibee and Ors. vs. Dharmodas Ghosh (1903) which was delivered by the Privy Council. In this case, any contract with a minor was held to be void-ab-initio i.e. void from the very beginning. This thumb rule is generally followed. Though there may be some exceptions.

Mohori Bibee and Ors. vs. Dharmodas Ghosh (1903)

Facts of the case

In order to obtain a loan of Rs. 20,000, the plaintiff, Dharmodas Ghose, mortgaged his land in favour of the defendant, Brahmo Dutt, a moneylender. At that time the plaintiff was a minor but he concealed his age. The actual approved loan amount was less than Rs. 20,000. Mr. Kedar Nath, a lawyer, was representing Bhramo Dutt. He already had knowledge of the fact that the plaintiff was a minor at the time of entering into a contract with them.

When the mortgage was executed, the plaintiff filed a suit against the defendant and claimed the cancellation of the mortgage deed. He argued before the court that he was a minor at that time and thus the contract was null and void. Bhramo Dutt, the moneylender passed away and Mohori Bibee filed an appeal before the Privy Council as his representative.

On the other hand, the defendant contended that the plaintiff had misrepresented his age and took advantage of it by entering into a contract of mortgage. Consequently, he should not get further benefit of the cancellation of the contract. if he ought to get the benefit, he should at least be required to repay the advance sum of Rs. 10,500.

Judgement

The Privy Council laid down that the minors are not competent to contract as per Section 11 of the Act. Regarding the competency of parties, an express condition has been laid down in the Act which cannot be violated. Since a minor lacks the legal capacity to enter into a contract in the first place, any agreements made with them are void ab initio. Secondly, the lawyer representing Brahmo Dutt already knew about the minority of the plaintiff. So, the law of estoppel cannot be made applicable to this case as the true facts were already known beforehand and hence, no fraud was committed.

Thirdly, the court also stated that Section 64 (consequences of rescission of voidable contract) does not apply to this case because its applicability is limited to voidable contracts and not void contracts. It talks about the contracts which are voidable at the option of the person who later rescinds it, the other party to a contract is not under an obligation to perform it.

In the present case, the contract with a minor is void and the money advanced can’t be refunded. Moreover, Section 65 (obligation of a person who has received advantage under the void agreement, or contract that becomes void) of the Act is not applicable in the case of minors because these Sections presume that the contract was made between the competent parties at first hand. So, the minor was held not liable to return the amount of advance received. Now let us understand the topic in more depth to get a clearer picture of the capacity of minors to enter different contracts.

Other case of minor’s capacity to contract

In the case of Mir Sarwarjan vs. Fakhruddin Mahomed Chowdhuri (1911), a guardian, entered into an agreement on the behalf of his minor child to buy some real estate. The minor sued the other party for recovery of possession of that property and requested that the court order the other party to carry out the specific terms of the contract.

The claimed remedy was rejected by the Bombay High Court and the reason stated for this decision was that a minor cannot be bound by a contract that involves their property or by someone else managing their estate. A person holding managerial position of the property of the minor cannot enforce such a contract as there was no mutuality in the contract. Further, the minor cannot claim specific performance on attaining majority.

Contracts beneficial to a minor

In the Mohori Bibee case of 1903, the contract with a minor was held to be absolutely void. The scope of this judgement is limited to the situation where the parties try to enforce it against a minor and there arise some obligations which need to be fulfilled by the minor himself. However, a minor may be a promisee or a beneficiary.

He can accrue the benefits arising out of the contract entered into by him, if he has to fulfill no obligations regarding it and full consideration is already paid for it. There are some contracts which are substantially beneficial to the minor and they are enforceable in a court of law. Beneficial contracts are an exception to the thumb rule laid down in Mohori Bibee’s case. In the present era, an agreement with a minor is not always null and void. Some case laws related to it are as follows:

In the case of A.T. Raghava Chariar vs. O.A. Srinivasa Raghava Chariar (1916), Justice Abdur Rahim of the Madras High Court opined that “what is meant by the proposition that an infant is incompetent to contract or that his contract is void is that the law will not enforce any contractual obligation of an infant.” So, it can be inferred that a minor can be allowed to enforce an agreement which is beneficial to him.

In another case of The Great American Insurance Co. Ltd. vs. Madanlal Sonulal (1935), the guardian entered into a contract of insurance on behalf of the minor to protect his property from fire. In the meantime, the insured property got damaged. The minor went to the court to claim compensation for it. But the insurance company rejected his claim by saying that a contract with a minor is null and void and hence, he has no claim. The Bombay High Court delivered the judgement that the insurer must pay damages because this contract was beneficial to a minor and carries a binding value.

In the case of Sri Kakulam Subrahmanyam vs. Kurra Subba Rao (1948), the minor sold a plot of hindu undivided family property to the holders of the promissory note as payment for the obligation, which included the promissory note and the mortgage debt owed by his mother, father, and minor. Later on, the minor demanded the ownership of the sold property and argued before the court that the contract was unenforceable due to his minority.

However, the Bombay High Court delivered the judgement stating that such a contract was valid in the eyes of the law. It is because the contract was entered by the mother, on behalf of the minor and moreover, it was beneficial to the minor. As a result, it has a binding value and is enforceable.

Let us look at the case of Rajkumar vs. Nathi Devi (2015), wherein the respondent made a gift deed while he was a minor. The plaintiff argued about the non-validity of the gift deed as a minor is incompetent to enter into a contract. Nevertheless, the Rajasthan High Court delivered the judgement that the respondent had a legitimate claim to the property that their father had left behind. The gift deed was beneficial to the minor and even if he does not sign it, a minor may still claim it as long as his name appears on the gift deed.

Some instances of beneficial contracts for a minor are as follows:

Contract of marriage

A contract for marriage is prima facie considered to be beneficial to a minor and hence, can be enforced by the minor. As we see even today, in most Indian communities, the parents of minors arrange marriages for them among their children as these customs have been prevalent for a long time. If a marriage is solemnized between a major and a minor, then that marriage is not void as per law but voidable at the option of the minor. So, the law must adapt to the needs of the customs and conventions generally followed by a large set of people.

In the case of Khimji Kuverji Shah vs. Lalji Karamsi Raghavi (1941), the issue before the Bombay High Court was whether the contract entered into by the minor’s mother on her behalf for her marriage with a guy who was major could be enforced or not. The court held that the contract of marriage is for the benefit of the minor and hence, the minor can enforce it by filing a suit in case of its breach.

Contract of apprenticeship

The contract of apprenticeship is also considered beneficial to a minor. Under the Indian Apprentices Act, 1850, a minor receives training or education that will benefit him in the future. These types of contracts are made for the advantage of the minor. An essential that needs to be mandated is that the contract of apprenticeship should be entered by a guardian on behalf of the minor. Only then it will be of a binding nature. This act was formed with the objective of enabling the children, especially those who were orphans and poor children, to learn trades, crafts and employment. Through this, they will be able to make their future better by gaining a livelihood.

Contract of partnership

According to Section 30 of the Indian Partnership Act,1932, a minor can be admitted to the benefits of the partnership. It can be explained with the help of the following pointers:

A minor can be admitted to the benefits of the partnership if all the other partners in the firm consent to it. But a minor himself can’t be recognized as a partner.
The minor is entitled to a portion of the property and profits earned by the firm as may be agreed by all the partners.
The minor has the right to go through and inspect the copies of accounts of the firm.
The minor has no personal liability for the acts of the firm.
After the minor attains the age of majority, he is bound to give public notice regarding the fact that whether he represents himself as a partner in the firm. He may either become a partner or choose not to be a partner in the firm.
If he fails to give such public notice, he will be considered a partner in the firm after the expiry of six months from attaining the age of majority.

In the case of Shriram Sardarmal Didwani vs. Gourishankar Alias Rameshwar (1959), the Bombay High Court delivered the judgment that a minor is incompetent to contract as per Section 11 of the Indian Contracts Act, 1872 and therefore, a minor cannot be a partner in a firm or a company.

In another case of Bombay High Court in Commissioner Of Income-Tax vs. R. Dwarkadas And Co.(1968), it was held that a minor cannot become a full-fledged partner in any of the existing firms. Section 30 of the Act does not allow one to be a partner but to be admitted to the benefits of the partnership.

Exception to beneficial contracts

It’s time to dwell into the exceptions as well. Read below to understand them.

Ordinary trade contracts

The category of beneficial contracts does not expand to inclusion of ordinary trade contracts. In the case of Cowern vs. Nield (1912 2 KB 419), a minor was in control of the commercial business as a hay and straw merchant. The plaintiff delivered a check to the minor to supply clover and hay. The minor was only able to deliver clover which was rejected due to bad quality and failed to deliver hay. The plaintiff’s action for recovering back the amount of cheque failed because this contract was not particularly for the benefit of a minor but was an ordinary trade contract.

Effect of agreement with minor

You might be wondering what effect an agreement will have on a person who is a minor. So, the following are the effects of an agreement with a minor –

No liability arising out of either tort/contract

An agreement with a minor is null and void and it has no legal effect. It is because he/she is not capable of giving valid consent and if the consent is not valid, the status of the parties cannot be changed.

In England, in the case of Johnson vs. Pye (1665 1 Sid 258: 83 ER 1091), an infant obtained a loan of money by falsely representing his age. So, the court held that the infant cannot be held liable alternatively in the form of damages for deceit and does not have to repay the amount of the loan. It is because an agreement which cannot be enforced directly, cannot be enforced indirectly too.

In another case of Jennings vs. Rundall (1799 8 Term Rep 335: 101 ER 1419), Rundal, who was an infant, borrowed a horse for a short ride but took the horse for a longer ride and in that period, the horse got injured. So, the court did not hold the minor to be liable because in this case the cause of action arose in the law of contracts and it cannot be converted to torts. This general principle is also followed in India that if a minor cannot be sued under Contracts law, the same agreement cannot be enforced against him by changing the nature of the agreement into Torts.

In the case of Harimohan vs. Dulu Miya (1934), the Calcutta High Court did not hold the minor liable as per the law of torts for the amount of money lent on a bond. But if the tort committed by a minor is independent of the liability in contracts, he can be held liable.

For example, in the case of Burnard vs. Haggis (1863 4 CBNS 45: 8 LT 328), a minor borrowed a horse from his friend for the purpose of riding. But he further lent that horse to one of his friends, who jumped and ultimately the horse was killed in the incident. So, the minor was held liable for the tort committed.

No estoppel against a minor

Section 115 of the Indian Evidence Act, 1872 ( Section 121 of Bhartiya Sakshya Adhiniyam, 2023) basically defines the law of estoppel as the principle that forbids someone from providing misleading statements before the court by preventing them from making contradictory claims in court. They cannot contradict a statement made previously by them as it will amount to committing fraud against the other party. But when the facts of the case are already known beforehand, this law cannot be made applicable.

For example, the case of Mohori Bibee vs. Dharmodas Ghosh (1903). The general exception to this rule of estoppel is that it is not applicable to an agreement with a minor. So, a minor who misrepresents his age for the purpose of entering into a contract cannot be held liable by way of estoppel. In the case of Jagar Nath Singh & Ors vs. Lalta Prasad & Ors(1908), the Allahabad High Court held that the law of estoppel is not applicable to minors.

In a landmark case of Khan Gul vs. Lakha Singh (1928), the Lahore High Court opined that the Indian Evidence Act is a general law which is applicable to everyone. However, there is a specific provision regarding the competency of parties under Section 11 of the Indian Contracts Act,1972. It carries a specific objective and declares an agreement with a minor as void. Hence, the law of evidence cannot be made applicable to a minor as the special law prevails over the general law.

Doctrine of restitution

When an infant misrepresents his age and as a result of it, obtains goods or property from the other party, he can be forced to repay it if those goods or property is still there in his possession. This is called the equitable doctrine of restitution. But if that infant sold those goods or property or converted them into any other form, then he cannot be held liable as a void agreement can’t be enforced.

A landmark case related to the doctrine of restitution is Leslie vs. Sheill (1914 3 KB 607 CA). In this case, the plaintiff entered into a contract with the defendant to lend him a sum of £400 and misrepresented himself to be a major. As a result, the defendant lent him £400. The King’s Bench held this agreement to be void and the money lent can’t be restored.

The court stated further that a minor cannot be held liable as per the Infants Relief Act, 1874 even if he misrepresented his age, specifically the contracts involving financial transactions. The defendant tried to recover his amount by way of seeking relief for fraudulent misrepresentation but failed as what cannot be done directly, cannot be done indirectly.

Even in the case of Mohori Bibee vs. Dharmodas Ghosh (1903), the minor was not ordered to restore the original amount of money advanced to him. However, in the year 1928, in the famous case of Khan Gul vs. Lakha Singh (1928), the Lahore High Court directed the minor to repay an amount of Rs 17,500 which he took as an advance for the sale of the land.

The controversy arose between various High Courts as in the case of Ajudhia Prasad & Anr vs. Chandan Lal & Anr (1937), the Allahabad High Court refrained from following this principle of restitution against a minor and declared that a minor was not liable to repay the money that he took by mortgaging his house.

The law commission of India agreed to the view of the Hon’ble Lahore High Court and the principle of restitution was incorporated under Section 33 of the Specific Relief Act,1963. The provisions with regards to the power of the Court, to require restoration of benefits received and fair compensation which are supposed to be made when an instrument is canceled are provided under Section 33 In the Specific Relief Act, 1963.

Section 33 of Specific Relief Act

It states that when the court decides to cancel an Instrument either completely or partially, then the party towards whom such relief is granted is required to either restore/claim any benefits. These are those benefits which he/she may have received from the other party or to make the required amount of compensation for it. Such conditions are put forth by the act to deliver justice to the parties, as a court is a place that is responsible for delivering justice to the people who approach it.

This Section also provides for the conditions under which, a defendant in a suit for the performance of a contract may claim for the cancellation of such a contract. The conditions mentioned in Section 33 are as follows:

When a plaintiff files a suit to enforce a contract against a defendant and the defendant tries to resist the contract by claiming such a contract to be voidable. In such a case if the court is also of the opinion that the contract/instrument under consideration is voidable, then the court may order for the cancellation of such a contract.
When a plaintiff files a suit to enforce a contract against a defendant and the defendant tries to resist the contract by claiming such contract to be void because of the defendant not being competent to participate in a contract under Indian Laws. Competence to enter into a contract is defined under Section 11 in the Indian Contracts Act, 1872. Competence to enter into a contract can be judged by conditions such as age, soundness of mind, etc. In such a case the contract shall be canceled by the court.

In the recent case of Maniyan Nadar vs. Harikumar (2015), the Kerala High Court stated that if the buyer was aware of the minor’s age and the minor did not engage in fraud or deception, the minor who rejected the transfer of his assets by a guardian is not under an obligation to refund the benefits he received from the transaction. The buyer is left with no power to take legal action against the child or his property in such a situation.

Minor as an agent or principle

What about the cases when a minor is the agent? Let us read Section 183 of the Act which basically talks about the contract of the agency. In a contract of agency, there is an agent who mediates the things between the principal and the third party. Therefore, both the principal and the third party must be competent to contract. They should not be of minor age and have a sound mind.

A minor cannot be the principal because he is incompetent to contract as per Section 11 of the Act. Therefore, a minor is not allowed to employ an agent under him. But if we read the subsequent section i.e. Section 184 of the Act, a minor can become an agent if he is of sound mind. The condition attached to this section is that the minor won’t be personally liable for any of his acts. The principal will be vicariously liable for the acts of the minor.

Contract of necessity for a minor

As per Section 68 of the Act, if a minor receives goods of necessity by any other person, then the minor is under an obligation to recompensate the person who supplied the necessaries. The various essentials laid down in the Section are:

The person must be incapable of entering into a contract i.e. we can say a minor/unsound person or there is a legal obligation on other person to support him
Necessaries are supplied by some other person for the basic and reasonable existence of such an incapable person.
That incapable person must not be enjoying these necessaries beforehand or he does not have the means to have them.
The person who supplied the necessaries is entitled to get compensation for it out of the property of an incapable person.

Meaning of necessaries

Let us get an in-depth understanding of the term ‘necessaries’ to get a better understanding of the concept. The word ‘necessaries’ has not been defined anywhere in the statute. In basic terms, it can be said to be the goods which are necessary for the existence of a human being i.e. food, clothes and a place to live etc. But this may vary from person to person according to their needs and situation. What may be a necessity for one person, it may not be for another. But the condition is that the requirement of that good must be reasonable for that person.

In a famous case of England, Chapple vs. Anne Cooper (1844 13 M&W 252 ), the meaning of ‘necessaries’ was explained in the following words – “ Things necessary are those without which an individual cannot reasonably exist. In the first place, food, raiment, lodging and the like. About these there is no doubt. Again, as the proper cultivation of the mind is as expedient as the support of the body, instruction in art or trade, or intellectual, moral and religious education may be necessary also then the classes being established, the subject and extent of the contract may vary according to the state and condition of the infant himself.

His clothes may be fine or coarse according to his rank; his education may vary according to the station he is to fill, and the medicines will depend on the illness with which he is afflicted, and the extent of his probable means when of full age. But in all these cases it must first be made out that the class itself is one in which the things furnished are essential to the existence and of reasonable advantage and comfort of the infant contractor.

Thus, articles of mere luxury are always excluded, though luxurious articles of utility are in some cases allowed.” From this definition, we can understand that ‘necessaries’ are things without which the person cannot survive. It includes both physiological things like clothing, food , shelter and intellectual things like any other skills required or education etc. Let us take a look at a few examples to understand the same.

Examples

Beema is a lunatic and Anu supplied him with the necessary goods for his existence. So, Anu has the right to get compensated out of Beema’s property.
Bhuvi is a minor who is an apprentice and needs a cycle to travel to his place of work but does not have the means to buy it and is also incapable of entering into a contract. Arjun supplied him with a cycle. So, Arjun can get reimbursed out of the property of the minor.
Money paid for the performance of funeral rites of the minor’s father.
House provided to the minor on rent for the purpose of his living while pursuing the studies.
Money supplied for defending any criminal process.
Giving loan to a minor on mortgage in order to save minor’s estate from enforcement of Court’s decree.

Case laws for necessaries

In the case of England, named Peter vs. Fleming (1840 6 M & W 42: 9 LJ Ex 81), the Court held that purely ornamental things cannot be a requisite for anyone. So, it was unnecessary and unreasonable to give a watch and a watch chain to a child on credit who was an undergraduate at a college. There are two conditions that need to be followed to render an infant’s estate liable for necessaries – firstly, that good must be reasonably necessary for the support in his life and secondly, he must not have sufficient sources to afford it.

In another English case of Nash vs. Inman (1908 2 KB 1 CA), the undergraduate child at Cambridge University was already supplied with the clothes necessary for his position. But another set of 13 fancy waistcoats were provided to him which was found unreasonable by the King’s bench and hence, the cost of those waistcoats was held to be irrecoverable.

In the case of Kunwarlal Daryavsingh vs. Surajmal Makhanlal (1961), it was held by the Madhya Pradesh High Court that supplying a house to a minor to live in for the bonafide purpose of being able to continue his education is a supply of necessity. Therefore, the minor is liable to compensate that person out of his own property.

Nature of liability for necessaries

There are two views prevalent regarding the nature of liability of a minor with regards to contract for necessaries. The first view states that the contract of necessaries is a quasi-contract and therefore, the claim for compensation for necessaries is not based on the consent of the minor. It arises just because the goods necessary for the life of the minor were supplied to him.

The second view states that the contract for necessaries is a contract only between the minor and the other party. They make a settlement between them to supply those goods to the minor and the minor is free from all liabilities. This view is generally followed in England.

Conclusion

In India, Contract law serves as the fundamental framework for regulating all types of agreements and contractual duties. It is well-established that the rights and obligations that result from contracts are the main focus of the Act. Thus, the legislators try to shield young and mentally incompetent individuals from acting by prohibiting them from signing contracts. They act in this way because these people are unable to weigh the implications of such an agreement. In order to acknowledge the significance of contracts for the purposes of necessities and sustenance, a few exceptions have been added to the contracts. This enables the minors to sign contracts with a guardian’s consent.

The legal disqualifications are designed to keep a specific group of people from signing a contract in the interest of public policy, the state, or the maintenance of law and order. The clauses have been consistently read by the judiciary as offering a strong mechanism for competent parties to enter into contracts. In addition, lawmakers need to investigate the ambiguity that emerges in the digital sphere when it comes to smart contracts in order to set standards for minors’ capacity to enter into online transactions. Laws must adapt to the times, and the Indian Contract Act of 1872, a pre-independence statute, needs to be reviewed to include elements that are appropriate for the modern digital era.

Frequently Asked Questions ( FAQs)

Can a contract with a minor be ratified later by him on attaining the age of majority?

A contract by a minor is void-ab-initio i.e. void from the very beginning. As it has no value in the eyes of law, it is considered a dead letter which cannot be revived. Any consideration offered as a part of that contract is not valid. Moreover, it cannot become valid at a later stage when the minor attains the age of majority as he cannot ratify it later. Though they can enter into a new contract but the old one cannot be ratified by a subsequent contract. The new contract made as a result of it would require fresh consideration.

In case of Suraj Narain Dube vs. Sukhu Aheer & Anr. (1928), a minor borrowed a sum of money executing a simple bond for it, and after attaining a majority executed a second bond in respect of the original loan along with the interest. The Allahabad High Court held in a 2:1 majority that the suit upon the second bond was not maintainable, as that bond was without consideration and did not come under Section 25(2) of the Act.

What is the liability of a minor under the Negotiable Instruments Act, 1881?

As per Section 26 of the Negotiable Instruments Act, 1881, a minor has the right to draw, endorse, deliver and negotiate negotiable instruments and bind all the parties to it except himself. It is because only those parties who are competent to contract are bound by such instruments and minors are as such incompetent to contract.

What is the position regarding contract with a minor under English law?

According to the common law, the contract with a minor was considered voidable at the option of the minor. Later, the Infants Relief Act, 1874 was enacted and it declared three types of contracts with minors as absolutely void. They are contracts for repayment of money lent or to be lent, contracts for the supply of goods other than necessities, and contracts for accounts stated.

Can a minor be declared insolvent?

No, a minor cannot be declared insolvent. This is because he is not capable of incurring debts and has no personal liability. Though the debts may be paid out of his personal property.

What is the liability of a minor if a joint contract is made by an adult and a minor?

If a joint contract is made by an adult and a minor, then it can only be enforced against the adult party to the contract and not against the minor. The same principle was held to be appropriate in the case of Sain Das vs. Ram Chand (1923).

Can a minor be a shareholder in a company?

As we saw in the article above, a minor cannot be a partner in a firm or a company, so he cannot hold shares of the company. However, he can exercise such power through a lawful guardian by transferring his fully paid shares in the guardian’s name.

Can a minor be employed as a labourer in any factory or a mine?

A minor who is not below 14 years of age can be employed as a labourer in a factory or a mine or as a plantation worker under the various provisions of the Factories Act,1948; the Mines Act,1952; and the Plantations Labour Act,1951.

References

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Section 33 of Trade Marks Act, 1999

By

Rachit Garg

-

November 8, 2024

This article is written by Ashwani Dwivedi. In this article, the author has discussed the doctrine of acquiescence, its history along with its essentials, the use of this doctrine as defence to infringement, and landmark cases.

Introduction

Ever thought how a business could lose its trade mark just for waiting too long to prevent someone else from using it? Possibly you have read cases of businesses which forgot to safeguard their rights and then realised there was little they could do about it. These kinds of circumstances draw attention to a key legal concept in trade mark law known as acquiescence. It basically shows how delaying the defence of your brand, can make one lose the right to defend it forever.

Section 33 of the Trade Marks Act 1999 talks about acquiescence. It simply means that a trade mark owner may lose their right to prevent further use of their trade mark if they allow someone to use it for five years without opposition. It basically means holding off too long may result in losing your ability to act. But the issue goes beyond the delay; it also involves knowing that someone is using the trade mark and choosing to take no action.

This article will look at how acquiescence relates to other legal defences that are frequently raised in trade mark issues, such as estoppel and abandonment. By the moment you are done, you will know more about how these defences operate under Indian law, how they differ and where they could connect.

What is Section 33 of the Trade Marks Act, 1999

Section 33 of the Trade Marks Act of 1999 addresses acquiescence. This means that if a trade mark owner is aware of somebody else using their trade mark but decides not to take action, it may be taken as consent to that usage. The owner’s delay to act can be taken to mean as if he is passively consenting to the use of his trade mark.

Using a brand or logo without the consent and knowledge of the trade mark owner is in normal cases considered trade mark infringement. This may cause confusion in the minds of the customer about where a product or service is based, affecting the original brand’s goodwill. Trademark infringement is a serious issue as it reduces the value of the brand and has a negative impact on trade and commerce.

Still, in other cases, acquiescence can be used to benefit a person. However, this defence only applies if the person utilising the trade mark was honest and had no malicious purposes.

If they’re trying to pull a fast one on customers or exploit the trade mark’s reputation, they can’t just hide behind acquiescence as a reason. The courts will examine their actions to determine whether they were being honest or trying to pull a fast one.

Just because a trade mark owner doesn’t raise any objections doesn’t mean they are totally fine with the use of it. For acquiescence to occur, the trade mark owner needs to take some action—like giving passively consenting, verbally agreeing or demonstrating through their behaviour that they’re fine with the use.

Burden of proof under Section 33

The person using the trade mark needs to show that they honestly thought they weren’t doing anything wrong and that the owner’s actions led them to believe they can use the mark in question and that the owner of the trade mark does not have any objection to such use. Thus, the burden of proof to prove that the owner’s inaction falls within the ambit of acquiescence lies on the person who is using the trade mark, or the person against whom infringement action is brought by the owner of the trade mark.

Let’s go through other relevant provisions.

Exception to infringement under Section 32 of the Trade Marks Act, 1999

For an understanding of Section 33 of the Trade Marks Act 1999, we need to first understand the different defences and acts that don’t qualify as trade mark infringement under Section 32 of the Act.

One important defence is being honest and using it at the same time. Section 12 of the Act lets the Registrar give the green light for the registration of identical or similar trade marks for two different companies that provide the same or similar goods or services. This is possible as long as there’s honest concurrent use or any other special situation that the Registrar thinks is suitable. If that’s the case, this registration acts as a solid defence, meaning no one can file a lawsuit for damages due to infringement.

Other scenarios where trade mark use is allowed include:

Using the trade mark in a way that does not take unfair advantage of the original owner.
Using the trade mark solely to indicate the services being provided.
Using the trademark outside the original territory where it is registered.
Using the trademark on goods that are sold in retail but were bought in bulk from the trademark owner.
Using trademarks when selling spare parts or accessories, which is common in industries like automotive and engineering.
The use of a trade mark by an assignee after the trade mark has been assigned.
Prior use of the trade mark by someone else before the current claim.

Section 32 of the Trade Marks Act 1999 describes certain scenarios in which a trade mark owner is unable to pursue legal action for infringement. It’s all about the owner giving their silent nod to the use of their registered trademark, which the Act recognises.

History and evolution of the principle of acquiescence

The basic provision of acquiescence came under the Trade Marks Act of 1999 under Section 33. The Trade Marks Act of 1940 (TM Act) or the Trade and Merchandise Marks Act of 1958 didn’t have an explicit provision regarding acquiescence.

Legislative history

The defence of acquiescence was not present in any of the provisions of the Trade and Merchandise Marks Act of 1958 or any other law. This law basically said that if there is no action taken by the owner, it would act as a condition against him in the future.

Section 30 of the Trade and Merchandise Marks Act 1958 explains certain rules for using trade marks in business. These conditions help us understand when someone can use a trade mark without being on the wrong side of the law or the rights of the trade mark owner. The rules are as follows:

1. If someone from the business uses it: This rule says the person who works with the trade mark owner can use the trade mark. If someone works for the owner or is involved with the business they can use the trade mark. This rule is for persons who are working under the trade mark owner.

2. Permission given by the owner: The second rule says that a person can use the trade mark if the owner has given them permission. This means that the trade mark owner has allowed another person to use the trade mark. This permission can be given through a licence, an agreement or other formal approval so they can use the trade mark for goods or services.

3. Goods not removed by the owner: The third rule states that the trade mark owner shouldn’t have gotten rid of or destroyed the goods or services that feature the trade mark. If the owner of the trade mark does not take steps to remove the products from the market, it suggests that using the trade mark on those items is allowed.

4. Trade mark used on many products: The fourth rule states that the trade mark needs to be used on a wide range of products. This indicates that the trade mark has been used on a variety of products and those products have been available for sale or distribution in the market. When you use the trade mark like this, it means the owner has given their consent for use of the mark on those specific products.

These rules help explain when someone can use a trade mark without breaking the rights of the owner. If an individual related to the company has consent and the protected products are open in the market without being removed, then they are allowed to use the trade mark for business purposes.

Thus, the defence of acquiescence was not itself inculcated into the legislative acts of the country. But what we can find here is that there was a mention of passive consent and the acceptance of the fact that even through passive encouragement, a trade mark may have been used if it was done in good faith.

Judicial history

It is significant for us to note here that before the Trade Marks Act of 1940, India did not have an official law for trade marks. Instead, Indian courts followed rules set by English courts like those from the Reports of Patent Cases (RPC) and the Chancery Division of England. These courts decided that just ignoring trade mark infringement was not the same as acquiescence, which means allowing it without protest.

In India, before the introduction of legal trade mark laws, for proof of acquiescence in a trade mark dispute, an owner had to show two things:

They did not prevent the other person from using the trade mark for a long period of time, and
They additionally encouraged the other individual to invest in the business involving that trade mark.

This rule made sure that trade mark owners couldn’t later complain about infringement if they had allowed and encouraged someone else to use the mark.

Moolji Sikka & Co. vs. Ramjan Ali (1928)

The Calcutta High Court in Moolji Sicca & Co. vs. Ramjan Ali (1928) made it clear that for a defence under the heading of acquiescence against a trade mark owner, it needs to be shown that the owner was conscious of the use made by the other user of his mark and encouraged such use by failing to object to the same. The Calcutta High Court relied on the statement of Lord Justice Cotton in Proctor vs. Bennis and Ors (1887) (36 Ch. Div.) as regards the acquiescence defence thus:

“It is necessary that the person who alleges this laying by should have been acting in ignorance of the title of the other man and that the other man should have known that ignorance and not mentioned his own title.”

Indian Dental Works And Anr. vs K. Dhanakoti Naidu And Anr. on 24 February 1961

This case was about a mother and her son who took over a tooth powder business started by the husband in 1934. The product was called Pyorrhea Tooth Powder and had the number 1431 along with a picture of a face showing diseased gums. After the founder passed away someone else started using the same name and number for their own product. The mother and son argued that this confused customers, making them think the other product was theirs.

The plaintiffs mentioned another case Gasper and Co. vs. Leong Chey and Co. from 1934 where the court ruled that using someone else’s trade mark even by accident could still lead to trouble. This helped support their argument.

The court agreed with the mother and son. They had used their trade mark for a long time, which gave them the right to it. The court told the other person to stop using the name 1431 and copying the design because it misled customers.

The other party did not have to return all the items with the trade mark but they could no longer use it moving forward. The court said it was clear that the other party had tried to copy the plaintiffs product to confuse people and benefit from it.

Gasper & Co. vs. Leong Chey & Co. (1934)

This case was relied upon in the Indian Dental Works case. The court underlined in Gasper & Co. vs. Leong Chey & Co. (1934) that where the owner of a trade mark stands by and lets several other persons replicate his mark he loses his mark and loses his right in it by reason of the fact that mark has become common to the trade. On the other hand, the plaintiff was able to show that the other firms violating the image of a cruise ship or sailing ship used marks theory for no more than one year in the current case and that the plaintiffs were never aware of their usage.

Devi Doss and Co. Bangalore vs. Athur Abboyee Chetty (1941)

In Devidoss And Co., A Firm Of Cloth … vs. Alathur Abboyee Chetty And Co., A Firm Of … (1941) case, the Madras High Court gave its decision based on Romer J. ‘s 1896 remark in Rowland vs. Michell (1897) stated, if the individual uses their business to earn profits and build their reputation, despite criticism, they cannot then turn around and claim the business should be shut down. The actions should be in line with intent and success should also have accountability.

As decided by Indian courts before the country’s trade mark law was made official, a third party can use acquiescence as a defence in a lawsuit against the owner while using his trade mark without permission as long as the owner knew about the unapproved use and chose not to object even though he knew about it. Inaction by an owner who does not protest unlawful use of their trade mark might be seen as permission over time; acquiescence provides a defence to the same.

T.V. Venogopal vs. Ushodaya Enterprises Ltd. & Anr 2011

Facts of the case

The appellant owned a business called Ashika Incense incorporated in Bangalore, where they made incense sticks under the name ‘Eenadu’.
The respondent published a Telugu newspaper also called Eenadu and filed a lawsuit saying the appellant was copying their trade mark and copyright.
The appellant argued that Eenadu is a common word used in South Indian languages so the respondent can’t claim it as their own.
The appellant also said that the respondent allowed other businesses to use the name Eenadu in different fields, which weakens their claim. They referred to Section 33 of the Trade Marks Act 1999 which talks about allowing others to use a trade mark without objecting (acquiescence).

Issues:

Did the appellants use of the name ‘Eenadu’ violate the respondents trade mark and cause confusion even though they are in different types of businesses?
Did the respondent allowing others to use the name Eenadu affect their right to protect the trade mark in this case according to Section 33 of the Trade Marks Act 1999?

Judgement:

The court decided that the respondent’s name, Eenadu, had gained a lot of reputation and goodwill in Andhra Pradesh.
The court found that the appellant used the name Eenadu dishonestly, trying to take advantage of the respondent’s reputation which could confuse people.
Because of this, the court ruled in favour of the respondent and said the appellant couldn’t use the name ‘Eenadu’ in Andhra Pradesh.
The court also said that just because the respondent allowed other businesses in different fields to use the name it didn’t mean they gave up their right to protect it where confusion could happen. Section 33 did not apply because the appellant acted dishonestly.

Principle of acquiescence under Section 33

Section 33 of the Trade Marks Act of 1999 covers the implications if the owner of a registered trade mark fails to take action when someone else uses their mark.

It is based on the maxim “Vigilantibus non dormientibus aequitas subvenit”, which means law helps the vigilant not the indolent.

Section 33(1) states that if someone uses a trade mark that is registered without permission and the original owner is conscious of it but does nothing for a period of five years, the owner is considered to have given passive consent for another person to keep using it. This is called passive consent.

If the owner does not take action in those five years, they lose certain rights. One of these rights is the ability to say the trade mark is still officially theirs under sub-section (1)(a).

The ability to stop another person from using the mark is another right. But for this to be a defence, the person who started using the trade mark must prove they were acting in good faith and believed they were covered under sub-section (1)(b). If they cannot prove this, they lose this defence.

Lastly sub-section (2) says that if both owners of the earlier and later trade marks do not take action they both lose the right to oppose each other. This means that neither of them can stop the other from using the trade mark anymore.

In simple terms, we can see that these provisions encourage trade mark owners to take action quickly if they see someone else using their trade mark without permission. Otherwise, it might be too late to do anything about it.

Essential ingredients of Section 33

There are three basic ingredients of Section 33 which talk about the defence of acquiescence. Ingredients for getting the defence of acquiescence are listed below:

The holder of the trade mark should be aware that an infringement has occurred.
The infringement has caused huge damage to the rights of the trade mark owner.
Also, if the proprietor has not been able to send a specific notice, it would be interpreted as an encouragement on the part of the proprietor.

In these kinds of circumstances, it becomes essential to keep in mind that the law must be followed while also keeping in mind the purpose of trade mark protection. It basically means that the basic purpose of a trade mark registration is that an average person can be able to understand the difference between two products or two services.

Taylor Fashions Ltd. vs. Liverpool Victoria Friendly Society. (1979) decision by Oliver L.J. served as the cornerstone for the Supreme Court’s decision in Dr Reddy’s Laboratories Pvt. Ltd. vs. Reddy Pharmaceuticals Limited (2013) stating-

“Estoppel by conduct is a legal idea that has grown a lot over the years. Basically, it means that one should be held responsible for their acts. It’s about making sure that everyone is treated fairly based on how they have behaved. If someone has done or said something that made others believe they wouldn’t act differently they shouldn’t be allowed to change their mind if it would hurt the other person.”

Therefore, the Supreme Court declared that in cases involving the doctrine of estoppel by acquiescence or waiver for infringement, the conduct of the parties has also been deemed to constitute a reason for raising the court’s attention. In Neel Electrical Techniques & 8 Ors. vs. Neelkanth Power Solution & Anr. (2016) it involved a case of two trade marks. The court observed that unless the owner of the trade mark does not object to the use of the same trade mark for a period of five years. Then the use of the trade mark by the other party would mean that there was positive consent on the part of the trade mark owner.

Judicial application of Section 33

At its outset, Section 33 basically permits to hold the proprietor accountable for his ignorance and actions following the knowledge of the marks some pertinent case laws can be used to clearly illustrate this principle:

Make My Trip (India) Private Limited vs. Make My Travel (India) Private Limited (2019)

Facts

In the case Make My Trip vs. Make My Travel (2019) the company Make My Trip went to court because they felt another company called Make My Travel was copying their name and logos.

The company Make My Trip asked the court to stop Make My Travel from using:

1. The name ‘Make My Travel’, the initials ‘MMT’, and the tagline ‘Dreams Unlimited’.

2. The logo of ‘Make My Travel’ also had the words ‘Dreams Unlimited’ and ‘MMT’.

3. The website name that ‘Make My Travel’ was using.

The Make My Trip company called these things the Impugned Marks (which means marks they felt were wrong to use).

Make My Trip said that these marks were too similar to their own marks which were:

1. The ‘MakeMyTrip’ word mark (their brand name).

2. The letters ‘MMT’.

3. Their taglines: ‘Memories Unlimited’ and ‘Hotels Unlimited’.

Together these were called the MakeMyTrip Marks.

Issues

Does Make My Travel (India) Private Limited’s name and logo violate Make My Trip (India) Private Limited’s trade mark?
Given the two businesses’ similar names and branding, is there a chance that the public will become confused?
Has acquiescence resulted from Make My Trip’s purported prior knowledge of Make My Travel’s branding?
Is it appropriate to issue a permanent injunction to stop Make My Travel from using comparable trade marks?

Judgement

The court decided that it seemed like Make My Travel was not being honest when they used the name and other things that were so similar to Make My Trip. The court said that Make My Travel didn’t give any good reason why they chose these names and logos.

The court also said that Make My Trip did not give permission to Make My Travel to use these marks even though a customer care worker from Make My Trip talked with Make My Travel. That worker didn’t know about the trade marks and it wasn’t enough proof that Make My Trip allowed the copying.

Therefore, the court decided that Make My Travel had to stop using these marks because it was confusing and unfair to Make My Trip and their customers.

Ramdev Food Products vs. Arvindbhai Rambhai Patel and Ors (2006)

Facts

In this case, Ramdev Food Products Pvt. Ltd. complained about Arvindbhai Rambhai Patel & Ors. using their masala products without permission. They claimed this was an unauthorised use of their trade mark.

Issues

Does Ramdev Food Products Pvt. Ltd.’s registered trade mark rights get in the way of the defendant’s use of the “Ramdev” trade mark?
Does the MOU between family members permit the defendants to utilise “Ramdev” legally?
Will the public become confused as a result of the defendant’s use of comparable labels and packaging?
Is it appropriate to prohibit the defendants from utilising “Ramdev” outside of approved outlets?

Judgement

The court explained that if someone allows others to use their trade mark while they spend money on it it is called acquiescence. It simply means that once the owner allows the use knowingly, they lose the right to stop it later. Just delaying action is not enough to refuse an injunction. Instead if someone accepts or ignores the infringement it may become unfair to give them legal help later.

Emcure Pharmaceuticals vs. Corona Remedies Pvt. Ltd. (2014)

Facts

In this case in 1996 Emcure Pharmaceuticals Ltd. registered the trade marks ‘OROFER’ and ‘OROFER-XT’ for medicines used to treat iron deficiency and anaemia. Between 1997 and 2012 the company sold products worth over Rs. 95 crores exporting them to 34 countries. Emcure claimed distinctive trade mark rights and common law rights.

Issues

Are the Plaintiff’s registered trade marks “OROFER” and “OROFER-XT” violated by the Defendant’s use of the trade marks “COROFER” and “COROFER-XT”?
Will customers become confused about the origin of the pharmaceutical products as a result of the marks’ similarity?
Is the Defendant trying to mistake its products for the Plaintiff’s?
Should the court designate a Court Receiver and issue an interim injunction to limit the defendant’s use of the disputed trade marks?

Judgement

The Bombay High Court held that the plaintiffs’ failure to take action did not mean that the defendant had received encouragement to use the trade marks. Simply not taking legal action cannot be seen as granting permission to the defendant.

Hindustan Pencils Pvt. Ltd. vs. M/s. India Stationery Products Co. Ltd. (1989)

Facts

In this case Hindustan Pencils Pvt. Ltd. discovered in 1985 that India Stationery Products Co. had secretly registered a copyright for a label similar to their own. The defendants used the name Nataraj and even included a dancing figure that looked identical to the one used by Hindustan Pencils for their trade marks.

Issues

Does the Plaintiff’s registered “Nataraj” trade mark get in the way of the Defendant’s use of a similar trade mark?
By using a similar brand and technology, is the Defendant trying to pass off its goods as the Plaintiff’s?
Will the plaintiff’s failure to file a lawsuit be considered “inordinate delay” or “acquiescence,” which would affect their ability to seek temporary relief?
Should the defendant be subject to an interim injunction from the court?

Judgement

The court held that if someone violates a trade mark holder’s rights the trade mark owner can get an injunction. If passive encouragement is proven the trade mark owner must return any profits gained from unauthorised use.

Hybo Hindustan vs. Sethia Hosiery Mills (1993)

Facts

In this case, the plaintiff, Hybo Hindustan alleged that the defendant Sethia Hosiery Mills had used their registered trade mark ‘VIP’ without permission. The plaintiff sought an injunction to prevent Sethia Hosiery Mills from using the mark for hosiery products.

Issues

Does the Plaintiff’s registered “VIP” trade mark rights go in the way of the Defendant’s use of the “VIP” trade mark for ready-made clothing and hosiery?
Can the Defendant defend its use of the “VIP” mark by claiming that the Plaintiff’s trade mark registration is no longer valid?
Has the plaintiff’s right to relief been impacted by the delay in bringing the lawsuit?
Should the court uphold the defendant’s temporary injunction?

Judgement

The Calcutta High Court ruled that if a defendant uses a trade mark knowing that it violates the rights of the original owner a delay in taking legal action should not prevent the granting of an injunction. The interim injunction was granted to the plaintiff preventing the defendant from using the mark until the final decision was made. This judgement emphasised that delay alone is not enough to allow unauthorised use of a trade mark to continue.

Hidesign vs. Hidesign Creations (1991)

Facts

In this case Mrs. Pampa Kapoor the owner of Hidesign had been making and selling feather garments, bags, belts and other leather products since 1977. She claimed to be the first to use the trade mark ‘Hidesign’ which was displayed on all products and business literature. In 1980 she found out that Hi-Design Creations was using a similar name for similar products.

Issues

Has Hidesign, the plaintiff, created proprietary rights in the “Hidesign” trade mark that would grant it the right to use the term exclusively?
Will customers be confused by the Defendant’s use of the similar mark “Hi-Design,” mistakenly associating it with the Plaintiff’s well-known brand?
Given its established market presence, may the plaintiff assert that the trade mark “Hidesign” has goodwill and reputation, making it eligible for protection under passing off principles?
Is it possible that the defendant’s acts qualify as dishonest mark adoption and need an injunction to stop future use?

Judgement

The Delhi High Court ruled that to claim acquiescence, the defendant must prove honest use of the mark without knowing the owner’s rights. A mere delay in action by the owner does not give the defendant the right to continue using the mark. The court emphasised that honest concurrent use is necessary for acquiescence to apply.

Cable News Network Lp Lllp (Cnn) vs. Cam News Network Limited 2008

Facts

In this case, ‘CNN’ the plaintiff, filed a temporary remedy from the court for alleged trade mark infringement, unfair competition, and passing off by the defendant. ‘CNN’ claimed that its brand name ‘CNN’ was known around the world due to its big broadcast network. It further stated that the trade mark has been officially registered in India in several categories, including printed items, media content, and software.

‘CNN’ also said that it had spent a lot of money developing the ‘CNN’ brand, which resulted in a respected position and praise in India and around the world. ‘CNN’ said that the defendant, while using ‘CNN’ in their magazine, ‘CAM News Network Today’, infringed on its trade mark and can confuse customers.

Issues

Does the usage of “CNN” by Cam News Network violate CNN’s registered trade mark?
Is it acceptable for Cam News Network to just use “CNN” as an acronym for its name?
Has CNN’s claim been undermined by its tardiness in bringing this lawsuit?
Should CNN be given temporary respite to stop Cam News Network from using it going forward?

Judgement

The court considered whether to grant temporary relief to CNN by looking at three key factors:

whether CNN had a strong case
whether the balance of convenience favoured CNN and
whether CNN would suffer serious harm if the relief was not granted.

The defendant argued that CNN had delayed too long in seeking relief but the court rejected this defence because the defendant could not prove they were honestly and concurrently using the CNN mark.

The court found that the defendants use of CNN alongside CAM News Network Today could mislead the public into thinking there was an affiliation with CNN. As a result the court granted temporary relief to CNN preventing the defendant from using the CNN trade mark in any way for publishing or providing news services.The court noted that these findings were preliminary and would not affect the final decision on the case.

Understanding laches and acquiescence in intellectual property law

These are two important rules used in intellectual property law to stop old claims from being brought up again but they work in different ways.

Acquiescence occurs when the trade mark owner does nothing to stop someone else from using their trade mark without consent. With time, this may seem if the owner has allowed its use passively. If the trade mark owner knew about this infringement and did nothing about it, the other person may take it as his consent. In India, courts have said that if a trade mark owner ignores the use of their mark, it becomes harder for them to make a claim later.

Under Section 33 of the Trade Marks Act 1999, if the trade mark owner allows someone else to use their mark for five years without taking action, they may lose the right to stop that use. The only exception is that there was malicious use and intentions of the third party.

Laches is when someone waits too long to take legal action to protect their rights. If a person delays too much they might lose the ability to get help from the courts because it would be unfair to the other party. In India this idea is based on fairness. Courts look at each case to decide if the delay was too long, why it happened and how it affected the other party. Laches often come up in civil cases like those related to property or intellectual property.

Indian courts, including the Supreme Court, have denied help to people who waited too long to take action especially if their delay caused harm to the other party.

Trade mark infringement cases: In India, both laches and acquiescence can be used as defences in trade mark cases. Courts will look at whether the trade mark owner knew about the unauthorised use and if their delay caused the other person to believe they would not face any legal issues. In the case of M/S Power Control Appliances & Ors. vs. Sumeet Machines Pvt. Ltd. (1994) the Supreme Court said that just being silent or not doing anything is not enough to prove acquiescence. It must be shown that the trade mark owner led the other person to believe they could use the trade mark without any objections.

The difference has been objectively explained in the table below:

Acquiescence	Latches
The owner of a trade mark appears to passively permit unauthorised usage by taking no action to prevent it.	Delay in filing a lawsuit, which could lead to the loss of the remedy.
The owner of the trade mark was aware of the illegal use but did nothing about it.	Unreasonable hold-up on the part of the rights holder to file a lawsuit.
Discovered in accordance with Trade Marks Act of 1999, Section 33.	Based on the fairness concept; each case is examined separately.

Passing off and acquiescence

The interchangeability of passing off and acquiescence leads to significant confusion. It is important to understand the difference between the two if one plans to defend their trade mark from infringement.

It is illegal for someone to claim their goods or services are the same as those of another. This practice is known as passing off. This may cause confusion and harm the reputation of the rightful owner. The court held that no one could make money by just copying another person or brand. This includes using that person’s reputation to promote products. This was established in the 1996 case N.R. Dongre & Ors vs. Whirlpool Corporation (1996). Using another person’s brand without permission was determined to be passing off in ICC Development (International) Ltd. vs. Arvee Enterprises (2003). Passing off is mentioned in Sections 27(2), 134(1)(c) and 135 of the Trade Marks Act, 1999. It is not defined in detail.

On the other hand, the Trade Marks Act’s Section 33 explains acquiescence. It happens when a trade mark holder is aware that another party is using their mark but they decide to allow it to continue nevertheless forfeiting their right to later stop it. Choosing to acquiesce conveys the idea that the owner of the trade mark has approved it on purpose, allowing the other party to use the mark without restriction. The reason is that the defendant might use acquiescence to show that the trade mark owner knew the mark existed and granted the defendant consent to use it without permission; acquiescence is important in passing off cases.

Importantly, acquiescence describes the trade mark owner’s conduct while passing off describes the intentional deception and confusion of others. In order for the defendant to use acquiescence as a defence, they must show that the trade mark owner was aware of the usage and misled them into thinking they wouldn’t pursue legal action. This is where acquiescence differs from just exhibiting dishonesty or fraud. To show acceptance in this scenario, the trade mark owner’s actions are essential.

Passing off has expanded throughout time to include a variety of situations such as unfair business tactics and trade mark infringement. The 1990 case Reckitt and Colman vs. Borden (1990) established that misrepresentation, damage, and goodwill are the three main elements needed to prove passing off. However, the defendant can say that if the trade mark owner gave their consent or permission to this fraud they have lost their rights.

Finally, in passing off cases, acquiescence is a powerful defence especially if the trade mark owner has given the defendant the impression that there won’t be an issue through their actions or inaction. This shows that in order to maintain their ability to stop others from using their mark, trade mark owners must move quickly to protect their rights.

The following table provides a better understanding of the concepts:

Passing off	Acquiescence
Illegal for one to claim their goods/services as those of another, causing confusion and potentially harming reputation.	The owner of a trade mark may lose their right to object if they willfully permit another party to use their mark.
Deliberate deception by the defendant to mislead customers.	Inaction on the part of the trade mark owner indicates their explicit or tacit consent.
Implied in the Trade Marks Act of 1999, Sections 27(2), 134(1)(c), and 135 respectively.	Defined in accordance with Trade Marks Act of 1999, Section 33.

Conclusion

In most trade mark infringement cases, a trade mark owner can get a court order to stop the illegal use. But if the owner knows about the infringement and doesn’t take action soon they might lose the right to sue. This is called acquiescence. Acquiescence can only be used as a defence if the person using the trade mark act honestly and in good faith.

Before the Trade Marks Act of 1999 courts needed these conditions to prove acquiescence:

The user didn’t know about the owners rights.
The owner knew about the infringement.
The owner didn’t try to stop the use.
The use continued for a long time.

Although trade mark law often grants complete rights to the owner, acquiescence means the situation where the person using the brand can remain using it with the owner. This will benefit companies since it allows them to retain using a trade mark if certain criteria are satisfied.

Frequently Asked Questions(FAQs)

What is the difference between consent and passive consent ?

Consent is the active, clear agreement to something. Passive consent, also referred to as acquiescence is the ability of someone to let something happen without taking action against it. Usually expressed by words or official paperwork, this is a clear voluntary action in which a person or entity knowingly agrees to a given act or use. Consent is deliberate, therefore the person or party directly expressing their agreement.

In legal terms, passive consent means not opposing or taking action despite knowledge of it. Silence or inaction instead of clear agreement amounts to implicit permission. The important point is that when given the chance assuming implicit consent, the person or entity does not show resistance.

Can a trade mark owner get monetary relief for damages after someone uses their mark without permission?

Once acquiescence is proven, the owner of the trade mark usually can’t go after damages or an injunction. The person who wasn’t supposed to be there can use the defence of acquiescence if they can show that they did so in good faith and that the owner passively agreed without objecting.

What are the most important things that need to be shown to prove consent to satisfy acquiescence in trade mark infringement cases?

The defendant has to show that:

the trade mark owner knew about the violation
the owner did nothing for five years
the defendant used the mark in good faith and
the trade mark owner showed support or failed to object.

What are the benefits of Section 33 of Trademarks Act 1999?

The principle of acquiescence under Section 33 of the Trade Marks Act, 1999, assists trademark owners in the following ways:

It prevents delayed objections and trademark owners cannot object to their use after a certain amount of time.
It promotes justice by ensuring that firms cannot utilise inaction to hurt another party.
It encourages consistency and revents avoidable disagreements and litigation.
It encourages reliance and protects those who have counted on the continued use of a trademark.

References

Text and commentary on the Trade Marks Act 1999 and the Geographical Indications of Goods (Registration and Protection) Act 1999 by K.C. Kailasam
Law Relating to Intellectual Property by V.K. Ahuja
Intellectual Property Rights-Infringement And Remedies by Ananth Padmanabhan
http://www.commonlii.org/in/journals/NALSARLawRw/2006/2.pdf
https://jlrjs.com/wp-content/uploads/2023/03/42.-Soumi-Lahiri.pdf

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Separate legal entity

By

Rachit Garg

-

November 7, 2024

This article is written by Tejaswini Kaushal and further updated by Ashwani Dwivedi. The article discusses the ‘concept of separate legal entity’. It talks about the history, implications, and cases that led to the development of the concept.

Table of Contents

Introduction

The legal personality of a company or its legal existence as a separate legal entity has been recognised since medieval times, and several judgements have been pronounced by various courts since the 17th century, acknowledging the notion of a corporation’s independent legal being.

The concept of a separate legal entity as it pertained to huge joint stock firms emerged throughout much of the nineteenth century, particularly between 1840 and 1880. This transformation was slow and entailed minor modifications on several fronts. The change in nature of shareholding and the refining of internal relationships inside a company were some of the legal innovations and improvements done under common law. These helped in distinguishing a company from its shareholders, and hence in distinguishing companies from partnerships.

Companies modified their capital structures and methods of raising capital to make themselves more appealing to investors at the same time. These methods also reflected the investing sector’s differentiation between joint stock companies and partnerships. Thus, it has grown significantly through judicial precedents and legislative interventions, making it an important concept with legal implications for businesses.

To truly understand why companies enjoy a distinct legal personality, we must delve into the concept of a ‘separate legal entity.

What is a separate legal entity

A separate legal entity is a ‘legal person’ i.e., a person recognised by law. Separate from persons who govern and/or own the company, the entity has its own legal rights and duties.

A separate legal entity has the following essential characteristics:

It can buy, sell, and own any type of property under its own name,
It can enter into contracts and
Sue in its own name and be sued in its own name.

As a result of these characteristics, independent legal entities can:

Owe money (which is created by a contractual relationship) by lending to others, they become creditors
Own assets, including

i. Tangible assets: Land, buildings, furniture, etc.

ii. Intangible assets: Intellectual property rights: designs, trademarks, trade secrets, etc.

Be responsible for paying taxes (a statutory obligation).

From a legal standpoint, all legal entities that can accomplish what a human can are classified as separate legal entities.

For instance, a company is a group of two or more people who work together to achieve a similar commercial goal. It is a ‘separate legal entity’ with a unique identity among its members. A company can possess property in its own name, sue and be sued in its own name, and enjoy everlasting succession as a legal entity, among other things.

However, because a company is an artificial person, it can only act via its agents, which are the Board of Directors. Also, they are responsible personally until the company is incorporated.

‘Incorporation of a company’ is the legal process of establishing a corporate company as a separate legal entity from its members. To start a company, a group of people must get a certificate of incorporation from the Registrar of Companies (ROC).

The Companies Act, 2013, which was adopted for the first time in 1913, governs companies in India. It has undergone amendments in 2015, 2017, 2019, and most recently in 2020.

Before diving into the concept of a separate legal entity, it’s essential to first understand what a ‘separate entity’ actually means.

What is a separate entity

“Separate legal entity” means a business or group that is legally separate from its proprietors or members. To put it differently, the entity has its own legal rights and responsibilities that are different from those of its owners, directors, or shareholders. It can own goods, sign contracts, get into debt, sue, and be sued in its own name.

A company is a legally distinct entity. The company registers with the state and uses transactions and ownership documentation to keep its operations distinct. Small companies, professional companies, and personal service companies are all different sorts of companies. To operate a business, all forms of businesses except sole proprietorships must register with the state. However, it is important to note that registration with the state does not imply that the company is a separate legal entity.

For instance, a Limited Liability Company (LLC) is likewise distinct since the LLC owners (called members) are only liable for their contributions to the firm.

Similarly, depending on the sort of partnership chosen, partnerships can be independent legal entities with limited responsibility. In a general partnership, each member is individually accountable for the partnership’s obligations and litigation. On the other hand, certain forms of partnerships, however, are classified as limited liability and independent companies.

Additionally, a limited partnership, or Limited Liability Partnership (LLP), can be formed as a distinct entity. A Professional Limited Liability Partnership is a distinct organisation created by a group of professionals (attorneys, CPAs, or architects, for example).

In contrast, a sole proprietorship is not a distinct legal entity. The sole proprietorship business is run by one individual, who is also the owner of the firm. Thus, corporate and individual debts and legal responsibilities are intertwined.

Ultimately, any sort of business can be legally established, but the fundamental reason for doing so is to segregate the firm’s obligations from the liabilities of the person who owns the business.

A company or a person can be held liable for debts as well as litigation arising from carelessness or criminal behaviour. Understanding how the law treats these liabilities helps us see why the concept of a ‘legal entity’ is so important.

What is a legal entity

A legal entity is a person or a group of people who have legal rights and responsibilities concerning contracts, agreements, transactions, payments, obligations, lawsuits, and penalties. It refers to any type of organisation that is legally established in accordance with the country’s laws.

An individual, an organisation, a business, a partnership, or any other social form permitted by the legal framework might be considered a legal entity. It is a body established at the time of legal incorporation with a distinct name and identity in the eyes of the legal system, as opposed to a natural person. There are several forms of legal entities, each with its own set of legal privileges and duties.

A sole proprietor, for example, is a type of legal structure that has the benefit of being low-cost and straightforward but provides no asset protection for the individual. This indicates that the sole proprietor becomes personally liable in such cases. Shareholders in companies, on the other hand, have minimal obligations and liability risk.

Divisions of legal entity

A ‘division’ of a company, generally coined with a distinct name, is used to refer to a business unit inside that certain company, which is a legal entity having a name different from that of the division. Therefore, the division corresponds to that legal entity’s name and does not create a new legal entity.

Sometimes the term ‘division’ refers to one or more legal entities as well. But is an exceptional scenario and has to be confirmed from legal documents and registrations of the company or the division in question. One can do so by conducting company searches to learn the genuine name of the company that is trading and claiming to be a ‘division.’

Branches of legal entity

Any business that wants to expand and relocate will need to find a new location. That’s why several companies have many branches or offices, each with its own physical address. In most cases, nothing is stopping a company from forming a subsidiary of the main company for each branch, with each branch owned by a single subsidiary. But this raises the question of how the new branch location may be lawfully integrated into the company’s structure.

This can be accomplished in one of three ways:

Establishing a subsidiary with its own legal identity, i.e., a subsidiary which has a separate existence from the main organisation
Establishing a dependent branch (operating facility), i.e., dependent on the headquarters in every manner and is not a separate legal entity.
Establishing a separate branch (branch establishment), i.e not a separate legal entity from the main organisation, and acts as a legal and organisational component of the main organisation.

Types of legal entities

Following are the types of legal entities:

Limited liability company

A private limited company is one that has no public shareholders. A private limited company can be founded with as few as 2 members and as many as 200. This kind of company cannot offer the prospectus in the market i..e., cannot take public funding. A private company’s shares are not readily transferable, for example, Google LLC. According to the Companies Act of 2013, a private limited company in India can be one of the following types:

Company limited by shares
Company limited by guarantee
Unlimited company

Public company

A public limited company is one whose shares are publicly traded on a stock market. A public limited company can be established with as few as 7 members. The interchangeability of shares is completely unrestricted. The government, as well as other agencies such as the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and others, need greater public disclosures and compliances from a public limited company, for example, Indian Oil Corporation Ltd.

Sole proprietorship

This is the most basic type of company that one may run. A sole proprietorship is not a legally recognised business entity. The owner of the firm is personally accountable for the company’s debts. For tax and legal purposes, the owner and the business are considered one entity, and the business is not taxed separately. Freelancers, for example, often operate as sole proprietors.

One person company (OPC)

The Companies Act of 2013 created the notion of a one person company, allowing a sole proprietorship to enter the corporate framework. This permits a single investor to incorporate a limited liability company. The form of a one-person company is identical to that of a proprietorship, but without the problems that owners typically confront. One of the most essential characteristics of a one person company is that the dangers are restricted to the value of the shares held by that person.

Partnership

Section 4 of the Indian Partnership Act of 1932 defines partnership as a “relationship between individuals who have consented to share the profits of a business carried on by all or any of them acting for all”. A partnership is an agreement between two or more people to split the earnings of a business they manage jointly.

This business may be conducted by all of them or by any of them acting on behalf of all. Individually, the owners of a partnership business are known as ‘partners,’ and together, they are known as ‘firm’ or ‘partnership firm’. ‘Firm Name’ is the name under which the business is conducted. In some ways, the firm is just an acronym for the partners, for example, Red Bull.

A partnership, unlike a company, is not a separate legal entity from its members. It is unable to possess property, incur debts, or file lawsuits in its own name. Furthermore, the partners of a partnership firm are jointly and severally accountable for the firm’s liabilities.

Limited liability partnership (LLP)

The Limited Liability Partnership Act of 2008 controls limited liability partnership concepts in India. It has characteristics of both LLP and a public company. Unlike a partnership, an LLP’s liability is restricted, and neither partner may be held accountable for the actions of the other. It is a separate legal entity having its own distinct entity independent from its members. The fundamental drawback of an LLP is that, unlike a company, it cannot raise cash from the public through an IPO, for example, law firms.

Creating a corporate legal entity entails more than just a name and a mission; it is a systematic procedure for defining the company’s legal identity, rights, and duties. From registration to compliance, we’ll look at how a business comes to life in the eyes of the law.

Means of formulating a corporate legal entity

A corporation’s legal personality can be formed in one of four ways:

Maintaining consistency

This means that a company can continue to do business, own property, and carry out contracts without interruption. The legal organisation can continue to exist over time even if the owner dies or withdraws the corporation’s assets. The life of a corporation is immortal, which means that the company continues to operate without interruption until it is wound up by a procedure. This principle was established in the landmark judgement of Trustees of Dartmouth College v. Woodward, (1819).

Creating an ‘identifiable persona’

The name by which the corporation is known is referred to as an ‘identifiable persona.’ The name of the corporation acts as a legally liable person who is liable for its actions and omissions during the carrying out of business activities. The names of the people involved in that corporation are well-known. The title or name of the company are the corporation’s intangible assets, such as a franchise, exclusive rights, reputation, image brand, and so on. Intangible assets are a lucrative source of revenue for businesses. This persona is utilised in all contracts, and in this persona, a corporation can sue and be sued.

Assets specification

There should be a mechanism in place to segregate the assets of the corporation from the assets of the shareholders, as well as a specification of which assets are allocated to the business. This asset separation makes it effortless for those who plan to invest or contribute to the business. It also ensures that, in the event of the corporation’s dissolution, a person will have to bear a defined amount of loss (principle of limited liability).

Self-governance

A corporation must have a system and capacity to control its internal affairs in order to be considered a legal entity. The corporation should have the authority to make internal governance decisions.

Before understanding the significance of a separate legal entity, it’s essential to look back at the origins of this concept and understand its historical roots.

Origin of separate legal entity

The evolution of corporate personhood has a long history, and research suggests that this concept was first created for religious and church purposes in the middle ages. Local lords and kings awarded charters to these institutions, which gave them authority. Charters were issued with the intent of holding property.

The ability of an institution to hold property in its own name ensured that the property held by that institution was solely owned by that institution and not by the individuals or legal heirs who governed it. These properties were also exempt from high taxes. They were also granted a royal charter after their creation.

The property owned by such institutions could not be changed back to the Lord’s estate after the royal charter was granted. Later in the 16th century, the range of institutions eligible for charters was expanded, and hospitals, universities, and colleges were among those granted charters.

The purpose of those incorporations was to ensure perpetual succession and the recognition of multiple individuals as a single legal entity. But till that period, the corporations were not used for commercial purposes. Individuals such as kings, bishops, and others were involved in certain types of corporations known as ‘Sole corporations’.

The goal of these corporations’ incorporation was to make it clear and obvious to the general public that the property they manage is not their own but held by them in the public interest, and the contracts made, if any, were not on personal behalf but instead in an official capacity. All of these businesses were referred to as ‘aggregate corporations’.

In 17th-century England, charters were initially issued to trading firms for commercial purposes. However, trading corporations were legally recognised contractual partnerships that did not require a charter. By the end of the 17th century, many such companies had been established. Over time, legislative interventions and judicial precedents have played a major role in the development of this concept.

Importance of a separate legal entity as a legal concept

Why is it important for a firm to have its own legal identity? Consider this: with a separate legal entity, the company, not its owners, bears the risk, debt, and responsibility. This separation protects personal assets, fosters investment, and allows the firm to thrive without placing individual stakeholders at risk. It’s a powerful principle that enables modern business!

The concept of a separate legal entity makes the company distinct from its owner. The most crucial justification is that the firm retains culpability for any offence, rather than the owner, shareholders, or directors. The company should be held responsible for the crime it has committed.

The company’s founders are solely accountable for the extent of their engagement in it. This implies that the company’s stockholders are not entirely liable for any commercial debts, and lenders cannot seize their personal property to satisfy financial obligations.

Similarly, investors must pay taxes on any earnings received as a result of the company’s profit. These earnings are in the form of salary, gratuity, or incentive, and the company must pay company tax on the earnings or any additional profits at a reduced corporate rate.

Also, the company does not collapse when one of the members or any of the directors resigns since it is an autonomous entity made up of members, directors, and shareholders. If a shareholder or an investor dies, the company may transfer its shareholdings in the same manner as any other asset, and the firm is not harmed. This provides the company with perpetual succession.

Why have a separate legal entity

Why go to the trouble of forming a separate legal organisation for your business? Imagine being able to secure personal assets, decrease liability, and allow your business to function independently. With a separate legal organisation, the firm can make its own decisions, incur debt, enter into contracts, and even be sued all without hurting the owners’ personal finances. It’s like giving the company its own ‘legal cloak’ that allows it to expand and take risks safely!

Companies are the most common form of undertaking in case of trade and business. Individuals engaged in the business are protected from personal liability that may develop as a result of doing business by the company, which is a separate legal entity. Therefore, the company:

creates money that belongs to the company;
incurs expenses that are paid by the company;
incurs a legal duty to pay taxes to tax authorities; and
pays tax at a lower rate than other individuals.

With the exception of a few, business owners and directors are immune to a legal responsibility (which essentially involves some sort of fraudulent conduct). The protection of shareholders and legal responsibility is frequently at the top of the list of reasons why it is vital. But what happens when a new business is formed out of collaboration of more than one company? In these cases joint ventures provide solutions.

Joint ventures

Joint venture corporations are a frequent mechanism for enabling different projects from current businesses. Two or more independent firms (i.e., separate legal entities) wish to join forces for a specific purpose; they often establish a joint venture. These joint ventures are frequently referred to as ‘special purpose vehicles’ because they were formed for a specific purpose. They:

are jointly owned by the founding companies;
may make profits that are owned by the joint venture company;
purchase and own assets;
buy and lease property, licence intellectual property rights, such as software;
have their own customers and suppliers;
pay expenses, taxes, employees and consultants;
return profits to the founding companies in agreed percentages;
are sold off when successful;
isolate the liabilities to the joint venture; and
be liquidated without impacting the parent companies

As a result, it can be noted that joint ventures provide an opportunity for companies and firms to cooperate and avoid direct involvement of the parent firms in taking direct responsibility. But what strategies do parent companies use to deal with multiple ventures or operations in different countries? This leads us to subsidiary businesses.

Subsidiary businesses

Some corporations operate as conglomerates, with a single parent company overseeing a large number of subsidiaries, each of which has its own set of subsidiaries. For a variety of reasons, subsidiary firms may be established beneath a parent company:

As a method of organising a company’s operations;
To shift risk away from the main firm and onto other legal entities;
Organise your operations;
Separate specific assets and liabilities from the rest of the portfolio;
Run an independent firm within a larger corporation;
Balance the income and losses of the group’s many companies;
To trade in a foreign jurisdiction in order to acquire benefits for a corporation within that country, such as the freedom to trade tariff-free (such as those found in the European Union), as well as reduced tax rates; and
Attract outside investment without relinquishing ownership of the complete set of companies or a parent company.

Whatever the reasons, subsidiaries have all of the advantages of other separate legal companies, including personal liability protection for the people who administer, work for, and own them. Therefore, this concept of a separate legal entity can be used to gain benefits in a variety of ways, such as:

Shielding a single company’s directors and owners from responsibility in larger firms;
separating new projects and joint ventures in the special purpose vehicles;
trade in different nations with subsidiaries incorporated under local law; and
holding parent firms not accountable for the debts of their subsidiaries (the subsidiary is responsible for all of its debts), and so on.

Regarding the last point, if the subsidiary has engaged in a pattern of mismanagement that draws legal culpability, such as sham firms, the parent company may be held accountable for the subsidiary’s obligations.

Benefits of a separate legal entity

As most people cannot afford the larger responsibility incurred by a firm, the concept of liability protection is critical. The term ‘corporate shield’ or ‘corporate veil’, illustrates the concept of a separate entity, implying that the company (or other separate entity) is protected from liability. That shield or veil cannot be pierced if the company is a separate entity. This principle can be used in a variety of circumstances, including:

Making shareholders personally responsible for the company’s decisions;
Creditors are unable to pursue firm owners who are different legal entities; and
Personal and commercial assets are mixed together.

The concept of independent legal personality has several legal implications for businesses, affirming the position that the company, its directors, and shareholders are distinct entities. The benefits also include the following features of this concept:

An independent legal entity results in limited responsibility in the sense that shareholders’ culpability for the company’s debt is limited to the amount paid for the company’s shares, and they cannot be held personally accountable for the company’s debts. This is confirmed by Section 19(2) of the Act, which states that a person is not liable for any liabilities or obligations of a company solely because he or she is an incorporator, shareholder, or director of the company, except to the extent that the Act or the Memorandum of Incorporation doesn’t provide otherwise.
The company’s property and assets belong to the company, not the shareholders or directors. Therefore, the company’s debts and liabilities are its own, and the shareholders cannot be forced to pay the company’s debts.
A separate legal personality also allows a company to enjoy perpetual succession, which means that the firm will preserve its legal identity and continue to exist even if its membership changes.

Legal implications of having a separate legal entity

There are several recurring legal issues which can be avoided by taking some precautions. Some of them are mentioned below:

Determining the legal entity correctly

There is no replacement for conducting a company search to discover the legal entity on the appropriate business registration. In India, the Registrar of Companies is the relevant office to approach. It functions under the Indian Ministry of Corporate Affairs and deals with the administration of the Companies Act, 2013, the Limited Liability Partnership Act, 2008, the Company Secretaries Act, 1980, and the Chartered Accountants Act, 1949. It keeps records of all registered companies, limited liability partnerships, and other incorporated legal organisations in the country.

Performing a quick and easy company search eliminates any ambiguity about:

The company’s perpetual presence and official address are determined by the company’s registration number.
Details of ownership and who is taking the routine care of the business,
whether the company has filed all of the required documents with the Registrar of Companies, and
company’s current state.

The company does not have legal existence if it is not listed in the ROC.

Signing of contracts before the company is formed

In anticipation of the formation of a company, some business people sign contracts before it is formed. Because the company does not exist as a separate legal entity, it is unable to enter into any contracts. This is because if the company didn’t exist at the time, contracts executed in its name aren’t enforceable against it. The fact that the company exists at a later period after the contract was signed does not make the contract legitimate.

The records will also show if the company has dissolved or is in liquidation. When a company is dissolved, it ceases to exist and can no longer enter into contracts. However, the contract may be enforceable against the person who signed it.

Identifying the contracting parties

When incorporated firms were first being formed over a century ago, they were required to include the word “Limited” or the abbreviation “Ltd.” to their name as a method of informing clients and suppliers that they were dealing with a company with limited liability. This criterion is still in place today, and it hasn’t changed. For example Mr. X owns and operates an online business. He has a website. However, he does not mention the company’s name in his:

Terms of business,
Privacy statement, or
On other pages on the website.

So, it becomes difficult to know what is the name of the legal entity that owns or hosts the website? Who owns the company? It can’t be the company that’s trading without knowing the whole name of the company for example: ‘Amarkanth’ and ‘Amarkanth Limited’ ’are wholly separate legal entities. Therefore, when a natural person signs a contract in their own name rather than the company’s, they become personally accountable.

When do you use your company’s entire name

If you’re doing business as a company, you must include the words ‘Limited.’ or ‘Ltd.’ The company is obligated by law to properly identify itself. In addition, failing to include the company’s entire name can result in personal culpability under the contract and it’ll aggravate ambiguity in contractual relations. It needs to be done on all documents, such as letters, business cards and invoices, email footers, orders for purchase or sale, filings required by law, any communication with parties, on the website, employment contracts etc. Once you’ve got yourself registered, it’s critical to use the complete registered name as it appears on the government records in order to make legally enforceable contracts.

What happens if one doesn’t utilise the firm name when it’s appropriate

A strong case can be made arguing that it’s not the company that’s trading. Trading is being done by someone other than the company. If that person is a company director, it’s an easy way to avoid the restricted responsibility that would otherwise apply to business directors and stockholders. That’s because the legal relationship isn’t with the company. It’s most likely the people in charge of the company’s operations.

Business entities that are not treated as a separate legal entity

There are two sorts of business entities that are distinct entities but are not treated as separate legal entities:

Sole proprietorships; and
Partnerships, in most scenarios

Sole proprietorships under the doctrine of separate legal entity

Sole proprietorships do not have their own legal entity. This implies that your commercial assets and obligations are not distinct from your personal ones. You may be held personally accountable for the company’s debts and obligations.

Partnerships under the doctrine of separate legal entity

There are various forms of partnerships, and the legal responsibilities of each are determined by the type your company chooses. The following are the different forms of partnerships and their associated liabilities:

General partnership

All partners bear equal legal and financial responsibility for the firm in a general partnership. The level of each partner’s duty may be determined via written agreements.

Limited liability partnership

Limits each member’s personal liability so that if one partner is sued, the other partners are not affected. Uninvolved participants in any issues are less likely to be involved in this form of collaboration.

Limited partnership

General and limited liability partnerships are combined in a limited partnership. At least one member is personally and legally responsible for the company’s debts. One or more members of the partnership are silent partners, with responsibility confined to their investment in the company. Silent partners are usually not involved in the day-to-day operations of the company.

LLC partnership

LLC partnerships are legally considered as LLCs since they are multi-member LLCs. As LLCs are a business structure for private companies, the owners are seen as entities separate from the firm.

What cannot be a separate legal entity

Despite its apparent looks, a separate legal entity cannot be:

Trademark

A trade mark is personal property that is owned by a legal entity, whether that entity is an individual, a business, or another type of legal body.

Domain name

A domain name is a name that is registered in the name of a business. It is not owned by the legal body that has the right to utilise it. The applicable domain name registrar rents it to the legal entity.

Brand or a trading name

A brand or a trading name is essentially an alias for a legal company. The only genuine connection to a corporation, like trademarks, is the usage of the suffix with the corporate name.

Group of companies

Each firm in the collection is a separate legal entity. Just because a group of businesses exists with subsidiaries and parent companies does not mean they all have the same legal status. They are all separate legal entities.

Business

A business can refer to a group of legal entities operating as one or a single legal entity operating independently of other legal entities. It all depends on how the term ‘business’ is defined.

Separate legal entity of a company

Separate legal personality has long been a concept in our legal system, and it is central to corporate law. A company is defined in Section 1 of the Companies Act, 2013 as a juristic entity incorporated under the Act, and a company is a legal person with a separate legal personality under Section 19(1)(b) of the Companies Act.

Therefore, the Act recognises that a company has its own legal personality, allowing it to acquire rights and incur liabilities separate from those of its directors and stockholders. Except to the degree that a legal person is inept in undertaking any such power or having any such authority, or to the extent that the Memorandum of Incorporation provides.

This concept of separate legal personality exists from the date and time that a company’s incorporation is registered, and the company will have all the legal powers and capacities of an individual from that point forward. Despite its importance, advances in common law and legislative developments have shown that this privilege is not absolute and will not be upheld in cases of misuse.

However, it will be claimed that the courts’ establishment of these exceptions has protected this cornerstone of company law from being destroyed, and it acts as an essential tool to ensure that the concept of separate legal personality is protected.

The firm must be properly incorporated and registered to be referred to as a separate legal entity. If the firm is correctly incorporated, it will have a distinct legal existence from its parent company. It must essentially consist of;

Directors: Because they oversee the company’s operations.
Members of the company: They are the company’s true owners.
Shareholders: Those who have purchased the company’s stock.

The Court of Appeal held in HL Bolton Engineering Co Ltd. vs. TJ Graham and Sons Ltd. (1956) that a company can be equated to a living creature in some circumstances. Similar to how a live person’s brain and the nervous system maintain the body’s functioning, a company’s brain and nervous system do as well. It even has hands for operation and operating in accordance with the company’s directors’ orders.

The majority of personnel in the organisation are employees and agents who are in the company’s hands, who execute the job, and who cannot be proved to reflect the company’s thoughts or intent. Others are executives and supervisors, who embody the company’s fundamental organisational ideas and oversee its operations. These executives’ ideas are the thoughts of the business, and the law treats them as such.

There are a few things that firms could have done if the notion of a separate legal entity had not existed, such as:

On account of the offence committed by anybody, the firm may have held anyone who owns or works for the company accountable.
They may have created agreements that made both the individual and the firm accountable.
If a firm is part of a group of companies, there would have been numerous agreements that were established incorrectly.
There would have been legal cases that neither the firm nor the person would have desired. Court hearings could have been held based on violation of fiduciary responsibility, criminal misappropriation, a claim for punitive damages, or any other cause of action involving a person or entity other than the legal party. If the claim was successful, it could have resulted in personal culpability.

Hence, a notion of a separate legal entity must exist in the current firm environment, otherwise, there will be numerous misappropriations, which may lead to court disputes.

Concept of the corporate veil

When you think of the corporate veil, does it seem fair that it can protect business owners from personal liability but only to a point?

The corporate veil theory is a legal notion that distinguishes the company’s identity from that of its individuals. Therefore, the members are protected from liability deriving from the company’s acts.

Therefore, if the firm incurs debts or breaks any laws, the members are not accountable for such mistakes and benefit from corporate immunity. Simply put, the shareholders are safeguarded against the company’s actions.

This raises several key questions:

Is it possible to lift or pierce the corporate veil?
If so, what are the possible circumstances and regulations for piercing the corporate veil?

Piercing the corporate veil entails going beyond the legal entity that is the corporation. Alternatively, ignore the business brand and focus on people.

In other circumstances, the courts disregard the corporation and deal directly with the company’s members or management. The process is known as piercing the corporate veil. When the dispute concerns a question of control rather than ownership, courts usually adopt this alternative.

Lifting the corporate veil

Ever wondered what happens when the protection of the corporate veil is removed? Lifting the corporate veil means that the courts disregard the separate legal identity of a company and hold its owners or directors personally responsible for its actions. This usually happens when there’s evidence of fraud or abuse, and it’s a way for the law to ensure that business owners can’t hide behind their company to escape accountability.

It is an exception to the separate legal entity doctrine since the doctrine may be abused and business members cannot be trusted blindly because they can conduct fraud and still profit. It deters employees from committing an illegal act on the company’s name. If the notion does not exist, the company’s members will attempt to abuse the doctrine, and the court will be forced to grant a benefit to members who utilise the doctrine of a separate legal entity as a defence.

Hence, the notion of corporate veil lifting is just as important as the doctrine of separate legal entities. There are times when the idea of a separate body might be viewed as arbitrary, and courts can rule against the concept of a separate legal entity for a variety of reasons. In order to confront the individual behind the veil and uncover the genuine nature of the company, the court also makes decisions that are hostile to the notion of a separate legal entity.

Piercing through the veil is the most widely utilised theory in company law, in which the court decides whether or not to hold a person accountable for an offence committed in the company’s name. This notion continues to be one of the most widely applied in today’s globe.

Piercing through the veil law exists presently as a sign of risk that the shareholders of a firm should not be held liable for the responsibilities of their company beyond the valuation of their investment. The basis for limiting individual financial professionals’ liability focuses on eliminating three types of transaction costs.

The first is the costs of loan bosses or individual investors watching the wealth of various investors, and the second is the costs and various problems of each investor or lessee assessing the risks of the executives’ activities. Third, limited investor risk makes it less expensive and easier for investors to increase their bets. Restricted duty both energises ventures and encourages market activity as a result of restricting these exchange charges.

Therefore, when the veil is raised, the court abandons the corporation and holds the member accountable for acts performed in the company’s name. It is impossible to determine the variables that cause the corporate insulation to crumble. The case is heavily reliant on the court’s discretion as well as underlying social, economic, and moral elements as they work in and through the organisation.

Scenarios in which the corporate veil can be lifted

The corporate veil provides a significant protection, but it is not impenetrable. However, in certain circumstances, the law allows courts to lift this veil to uncover the true nature of the actions of a company or the intentions behind its formation. Some of the scenarios in which the corporate veil can be lifted are mentioned below:

To determine the company’s character

In some circumstances, the courts must determine whether a firm is an adversary or a friend. In such circumstances, the courts use the control test. Unless the public interest is jeopardised, courts seldom pierce the corporate veil. However, the court may decide to investigate whether a corporation is an enemy company.

A question that arises is: How can a corporation be a foe? It can’t be a friend or adversary because it doesn’t have a mind or conscience, right? If a corporation’s affairs are in the hands of persons from an enemy country, the firm may become an adversary as well.

In such instances, the court may investigate the character of the persons in charge of the company’s operations, as was the case in Daimler Co., Ltd. vs. Continental Tyre and Rubber Co. (1916).

To safeguard revenue or tax

The court may overlook the business entity in cases involving tax evasion or circumvention, for example. Consider a firm that is being utilised to avoid paying taxes. In such circumstances, breaching the corporate veil permits the court to determine who is the true owner of the company’s earnings and hold them accountable for lawful taxes.

To prevent evasion of legal obligation

Members of a corporation can sometimes form a subsidiary company to avoid certain legal requirements. In such circumstances, breaching the corporate veil permits the courts to see what is going on behind the scenes.

Take, for instance, a corporation that is legally obligated to split a certain percentage of its income as a bonus with its employees. To circumvent this, the corporation establishes a fully owned subsidiary and transfers its investment interests to it. The newly established corporation has no assets and generates no revenue. It is entirely reliant on the main corporation.

Subsequently, the primary company’s incentive obligations to its employees were decreased. By piercing the corporate veil, the courts can gain insight into the major company’s true intentions and guarantee that it complies with its legal duties.

To establish subsidiaries as agents

The purpose of forming a corporation is sometimes to operate as a trustee or an agent for its members or another firm. In such circumstances, the company’s originality is sacrificed in favour of the principal. In addition, the principal is accountable for the company’s actions.

To address fraudulent or illegal corporate purposes

The corporate veil may be lifted or pierced in circumstances when a corporation is founded for illegal or inappropriate intentions, such as circumventing the law.

In most cases, each legal entity is independent, but some situations require the use of a single system when several companies are considered a single economic subject. This leads us to the ‘Single Economic Entity’ concept in which the financial interests of associated companies are taken as a unity.

Concept of ‘Single Economic Entity’

The Single Economic Entity rule is used in situations where there are individual legal entities that are controlled by different parent legal entities but in fact are grouped for economical purposes. This implies that all companies relative to their holding company possess the shared economic motive, hence, subsidiaries like sister companies do not compete because they can’t make their own decisions in the market.

In Copperweld Corp. vs. Independence Tube Corp.(1984), the US Supreme Court said that a parent company and its wholly owned subsidiary would be considered one entity. Similarly, in India, Section 2(h) of the Competition Act, 2002 defines ‘enterprise’ in a way that reflects the idea of a ‘Single Economic Entity’.

According to the said section, an ‘enterprise’ means a person or a department of the Government which is engaged in any activity, either directly or through one or more of its units or divisions or subsidiaries.

The Indian Antitrust Laws need to work on it to make it clearer. It needs to be decided if the idea of an enterprise is enough to get rid of the single economic entity doctrine. No matter what, it is clear that the idea of a single economic entity is part of India’s competition law.

Thus, it’s clear that the idea of a single economic entity comes from the idea of lifting the corporate veil. The subsidiaries legally exist separate from their parent company and act in their own names, but behind the corporate veil, there is still a single parent company. Because the parent company has a say in what its subsidiary does, it can be held legally responsible for what it does.

Landmark judgements on the concept of separate legal entity

Foss vs. Harbottle (1843)

This case is a key precedent in English company law. According to the ruling established in this case, if the company suffers a loss as a result of the negligent or fraudulent activities of its members or outsiders, the action can be initiated on behalf of the company or as a derivative action.

Facts of the case

Richard Foss and Edward Starkie Turton were two minority owners in the ‘Victoria Park Company,’ which was founded in September 1835 to purchase 180 acres (0.73 km per square kilometre) of property near Manchester and transform it into ‘Victoria Park, Manchester.’

The corporation was founded to set out and maintain the attractive park within the townships of Rusholme, Chorlton upon Med-lock, and Moss Side, in the county of Lancaster, by an Act approved by Parliament in 1837.

They claimed that the company’s property was plundered and wasted, as well as that numerous mortgages were provided improperly over the company’s property. Both shareholders decided to file a claim against the five directors, the solicitor, and architects, as well as against the various assignees of Byrom, Adshead, and West.

The following were the basis for their claim:

The primary reason was that the company’s assets were misappropriated through fraudulent activities.
The second ground was that the company lacked qualified directors who could make up the board, and the third ground was that the company lacked qualified directors who could truly make up the board.
As for the third ground, the corporation lacked a clerk and an office.

Due to these conditions, the shareholders had no option but to file legal action against the directors in order to wrest control of the company from them.

Issues involved in the case

Whether or not company members could file suit on behalf of the company?
Whether or not the guilty people could be held liable for their wrongdoings?

Judgement of the court

The Court of Chancery determined that the stockholders were not the proper plaintiffs and hence could not file a lawsuit. The corporation is a proper claimant, according to the court. As a corporation is a legal entity distinct from its members, a member cannot sue to correct the damage done to the company.

This is something that the company can handle on its own. Individual members are not permitted to sue in the name of the corporation. In the circumstances, nothing stood in the way of the corporation getting remedy in its corporate capacity for the issues raised.

In Re: The Kondoli Tea Co. Ld. vs Unknown (1886)

This case law is founded on the idea that a corporation is a different legal person or body from its members, capable of living beyond their lifetimes. It also established that regardless of whoever the shareholders in the Kondoli Tea Company Ltd. were, the company was a separate person and a separate body, and hence, the transfer of property to the company which was owned by certain stakeholders in their individual capacities was just as much of a transfer of property as if the shareholders in the company were completely different people.

Facts of the case

A group of eight persons who were the company’s sole shareholders transferred a tea estate to a corporation. This transferee-company’s only stockholders were these eight persons. The transaction was paid in transferee-company shares and debentures. It was argued that this was only a passing over of the property from one name to another under a different name, rather than a conveyance (legal transfer of ownership of the property) or sale. The exchange price was $43,320, with the money being paid in the company’s shares and debentures at par.

However, the company’s stockholders refused to pay the ad valorem duty due on every transaction of the land, resulting in this lawsuit. They attempted to dodge the ad valorem tax by claiming that they were the company’s sole shareholders. The shareholders claimed that because they were the sole shareholders in the company, the property was transferred from them to themselves under a different name, therefore they did not have to pay the tax.

Issue involved in the case

Is a document carrying out a specific transaction in the form of a conveyance, as defined in Clause 9 of Section 3 of the Stamp Act and as defined in Article 21 of Schedule I of that Act?

Judgement of the court

The High Court of Calcutta ruled that because the company is a separate legal entity and the property was transferred to the company’s name, the property should be recognised as transferred and the petitioners are not liable for any taxes.

The Calcutta High Court ruled that Kondoli Tea Company Ltd. was an independent legal entity or body from its individuals, capable of lasting beyond their lifetimes. Regardless of who the shareholders in the Kondoli Tea Company Ltd. were, the company was a separate person, a separate body, and a transfer of ownership of the property to the company that was the property of the sharers in their individual capacities was just as much of a conveyance as if the shareholders in the company were completely different people.

The contested document is a conveyance, and the appropriate stamp to use on it is the ad valorem stamp described in Article 21 of Schedule I of the Stamp Act, which must be determined on the amount of the consideration stated in the instrument.

Salomon vs. A Salomon Co. Ltd. (1897)

This is the primary case that established the concept of the corporate veil. It is a major decision in UK Company Law that firmly upholds the doctrine of corporate personality as a separate legal entity, implying that shareholders cannot be held personally accountable for the company’s insolvency.

Facts of the case

Mr. Aron Salomon was a very successful leather dealer in the nineteenth century, and his business was at its peak because he was the sole trader of leather at the time. There was no one else in the company who could compete with Mr. Salomon. Mr. Salomon then formed a corporation with 20007 shares, of which he purchased 20001, and his family members, namely his wife and five children, one each, purchased the remaining 6 shares. Mr. Salomon established a corporation and sold it to the company for 38,782 pounds.

The firm paid Mr. Salomon 20001 fully paid shares and 8,781 pounds in cash, bringing the total amount paid by the company to Mr. Salomon to 28,782 pounds (both in shares and cash), with 10,000 pounds remaining payable to Salomon by the company, which he secured with a debenture.

Mr. Salomon followed all of the necessary rules and regulations for forming a business. There were seven people in his company, but Salomon owned the majority of the shares. He was also the company’s principal creditor at the same time.

Issue involved in the case

When the firm was wound up because it had failed, an issue was presented in court to determine whether the secured loan of Mr. Salomon would take precedence over the unsecured debt of another creditor in the sum of 11,000 pounds. If the court awarded the secured loan priority over the unsecured loan, the non-secured creditor would be left with nothing because the company’s assets were so low. The company’s assets at the time of insolvency were only 7,000 pounds.

Arguments of the parties

Salomon moved the business to the firm on purpose, according to the liquidator assigned to wound up the corporation. The liquidator further claimed that the corporation worked as Salomon’s agent and that, as the principal, he is responsible for unsecured creditor debts.

Judgement of the court

After hearing the case and considering the arguments of the liquidator, the High Court determined that because the corporation was Mr. Salomon’s agent, he was held liable for all of the creditors’ obligations.

Appeal

Mr. Salomon exploited the rights of incorporation and limited liability; thus, his appeal against the lower court judgement was likewise denied. Only those who are loyal and fair stockholders are eligible for limited liability. Mr. Salomon did not use clear hands when forming the firm. He ran the firm as a sole trader.

House of Lords

The House of Lords overturned both the lower court’s and the court of appeal’s rulings, establishing a cornerstone basis for current business law. It was unanimously agreed in the House of Lords that a company is a different legal entity from its members and stockholders. All of the prerequisites for legitimate business incorporation were met.

The company’s memorandum of incorporation had been signed by seven members. All of the subscribers had shares, and there was no mention of independence. The House of Lords found that Salomon Company was properly constituted in conformity with the law, that the company’s obligations are its debts, and that the members are not accountable for the company’s debts.

Final result

The stockholders followed all of the provisions of company law to incorporate the firm as a legal entity. It makes no difference whether the firm is managed by a single individual or by all of the owners; consequently, Mr. Salomon’s debenture was given priority.

Daimler Co., Ltd. vs. Continental Tyre and Rubber Co. (1916)

When a company is formed for a specific purpose, it is expected to be neutral and distinct from its shareholders, but this is not the case during wartime, and the shareholders may exert influence over the company’s decisions. This case is about the same matter, and the ruling clarified several controversies, and it serves as a precedent for the same issue.

Facts of the case

A company was formed in England to sell tyres made in Germany by a German manufacturer in England. Except for one shareholder, who was born in Germany but had become a naturalised British citizen, the other stockholders were all German.

Following the commencement of the First World War between England and Germany, Continental Tire, a German business, refused to pay any money, stating that doing so would constitute trading with an enemy nation, thereby breaking the Trading with the Enemy Act (1914). The secretary took action against the offender. The same was decided in favour of the German firm, indicating that the firm was hostile.

Issues involved in the case

If the corporation was an alien company, would payment of the debt be considered trading with the enemy?
Is it possible to lift the corporate veil in an emergency?

Judgement of the court

The secretary of state appealed against the court of appeals’ verdict to the House of Lords. The House of Lords upheld the appeal, ruling that though the corporation is a separate artificial entity from its shareholders, if the shareholders or agents in charge of the company are from an enemy country, the company will take on a hostile character.

When everything is at peace or when it is not wartime, the court believed that the character of individual shareholders cannot affect the character of the company. However, when it is wartime, the agents or anyone who is taking orders from such shareholders who are from an enemy country is important to consider in determining the character of the company as a whole.

The court held that in this case, it is presumed that the company has an enemy character because the secretary owns only one share out of 25000, and the rest are from Germany. The court held that the company bears the burden of proving that the secretary wasn’t taking orders from other shareholders from an enemy country.

The Court found in this case that the actions and character of the shareholders can influence the activities of that particular firm and that the corporation can acquire enemy character if stockholders from an enemy country make decisions for the company.

Macaura vs. Northern Assurance Co. Ltd. (1925) AC 619

The House of Lords heard this case, which dealt with the issue of removing the corporate veil. In this scenario, the request came from the corporation’s owner, which is unusual.

Facts of the case

Mr. Macaura, the appellant, formerly held a wood estate in Northern Ireland, which he sold to a Canadian Milling Concern in exchange for payment in the company’s shares. The appellant was given 42,000 fully paid up £1 shares, giving him complete ownership. He was also a £19,000 unsecured creditor. The appellant purchased fire insurance coverage for the timber in his own name, and the fire caused damage shortly after. The appellant attempted to recover damages under such an insurance policy, but Northern Assurance Co. refused to pay since the corporation owned the timber and was a different legal entity.

Issue involved in the case

Is the insurance company responsible for Mr. Macaura’s fire-related damages?

Judgement of the court

The House of Lords ruled that insurers were not responsible under the contract because Mr. Macaura had no insurable interest in the timber because his relationship was with the corporation rather than the commodities. In this case, the application to lift the corporate veil was submitted by the corporation’s owner, who claimed to hold the greatest percentage of shares. The court, however, decided that the corporator, even if he owns all of the shares, is not the corporation and that neither he nor any of the company’s creditors have any legal or equitable property in the business’s assets.

Gilford Motor Co. vs. Horne (1933)

This is a case involving piercing the corporate veil in the United Kingdom. In a circumstance where a company is utilised as a fraud instrument, it shows how courts will see shareholders and a firm as one.

Facts of the case

Gilford was a merchant that operated under the name Gilford Motor Vehicles and sold assembled items over the internet. Gilford bought the motor parts from the manufacturers, put them together, and then sold them on the internet. The company also offered spare parts and performed maintenance on the motors that were purchased online.

Horne was then hired by Gilford as a managing director. The job was for six years on a contract basis. However, the contract contained a restriction on the employee’s trade, which stated that the employee was not allowed to seduce any of the employer’s customers while at the company or after the contract was terminated.

Unfortunately, Gilford and Horne’s work contract expired after two and a half years, and Horne left the company. However, immediately after leaving his job at Gilford Motor Vehicles, he established J.M. Horne & Co. Ltd. at his home. He also approached several clients that he had seduced through his encounters with them while working at Gilford Motor Vehicles.

Issues involved in the case

The court evaluated the following two major issues:

Can the court pierce J.M. Horne & Co. Ltd.’s veil?
Is Horne in violation of the trade restraint covenant in his previous employment contract?

Judgement of the court

The petitioner was unsuccessful in the initial action. The restriction attempted to be imposed on Horne by Gilford was found to be invalid for two reasons:

The restraint was part of the employment contract, and as such, it did not survive the termination of the job, which occurred without warning or reason, and
The restraint sought to be imposed was too broad, and it could no longer be enforced.

In light of these, the court originally declined to determine whether Horne’s company was fraud or not. Initially, the court held that the prohibition was prima facie unenforceable against Horne because it was too broad in scope.

On appeal, however, the situation was different. The Court of Appeals disagreed with the lower court’s decision. Horne’s established firm was treated as what it was, a sham devised by Horne to get around the conditions of the employment agreement and the restrictive covenants included therein.

Lee vs. Lee’s Air Farming Co. Ltd. (1960)

This case is of New Zealand, and it consists of a company law issue involving the corporate veil and distinct legal personality that is also relevant to UK company law and the Indian Companies Act, 2013. The Privy Council’s Judicial Committee reaffirmed that a corporation is a separate legal entity and that a director may still be employed by the company that he alone controlled.

Facts of the case

The appellant’s husband Lee created ‘Lee’s Air Farming Ltd.’ in 1954 intending to continue in the aerial top-dressing business, with 3000 thousand shares of one euro each being the company’s share capital, of which Lee possessed 2999 shares. Lee also served as the organisation’s director. He had complete authority over the company’s activities and was the only decision-maker on all contracts.

The company engaged in numerous contracts with insurance agencies for employee insurance, and a few premiums for personal policies taken out by Lee in its own name were paid through the company’s bank account, although they were debited in Lee’s account of the Company Book. Lee was a pilot in addition to being the company’s director.

Lee was murdered while flying the plane during aerial top-dressing in March 1956. Lee’s wife, the appellant, sought worker compensation under the New Zealand Workers’ Compensation Act, 1922, claiming that Lee was injured while working for the firm. The New Zealand Court of Appeal dismissed the appellant’s claim because it refused to recognise Lee as a worker, stating that a man cannot effectively employ himself.

Issues involved in the case

Is the Separate Entity Principle relevant or not?
Is Mrs. Lee (appellant) entitled to compensation under the 1922 Worker’s Compensation Act?

Judgement of the court

The matter was taken to the New Zealand Court of Appeal to determine whether the deceased was engaged as a worker by the respondent firm under the Worker’s Compensation Act, 1922.

The decision was negative, and the bench stated that the deceased was the sole governing director for life, with complete control over the company; however, while there can be an employment contract between the director and the company, in this case, the company only had one person with authority, and he could not be the one giving orders and obeying them.

Therefore, both offices cannot coexist with a single individual and are thus incompatible. The Court of Appeal further determined that because the deceased was a director, he was not an employee of the respondent corporation and so could not be a servant or worker.

The appellant then brought his case to the Privy Council, where the Lordships considered the precedent set by the Salomon vs. Salomon (1896) decision, which held that a person can operate in several roles while the firm and its single owner or shareholder remain legal entities.

Similarly, there existed a contractual relationship between Mr. Lee and the respondent firm as soon as it was established, and that relationship cannot be destroyed since the deceased was the largest shareholder and controlling power in the company. It is unknown what position he was in when he died while executing his responsibilities, but it was done at the request of the farmers who had contractual rights and obligations with the respondent firm.

The fact that a contractual connection may only be created between two independent legal entities that have already been proven cannot be discounted simply because of the deceased’s situation. Therefore, the appellant was able to obtain the compensation since there existed a contract of service between the worker and the company.

Conclusion

As a result of the preceding debate, it may be inferred that a company is a separate legal entity from its members and that a business receives legal standing following appropriate formation under corporate law. A company can do business through its representatives and agents, and any transaction carried out by a company member will be deemed a company transaction carried out by someone who is authorised to do so. The company can sell any property it has and can also purchase any type of property. Therefore, the company has the contractual capacity and can contract with anybody, even its own workers and stockholders.

If any party violates any of the contract’s conditions, both parties have the right to take the matter to the court. Hence, the company has the ability to sue and be sued.

Also,the concept of a ‘Single Economic Entity’ is crucial in understanding competition law within the European Union and India. It says that parent companies and their wholly owned subsidiaries operate as a single unit, allowing them to engage in agreements without breaching competition regulations. Ultimately, the recognition of this concept is integral to ensuring fair competition in the market.

Frequently Asked Questions (FAQs)

Does a new legal entity come into existence by changing a company’s name?

When a business is created in India, it is registered and allotted a distinct identification number called the Corporate Identification Number (CIN). It’s a registration number that uniquely identifies the company. That registration number remains constant and is a company’s permanent unique identifier.

A business’s name change does not result in the formation of a new company. The CIN remains the same, and all stakeholders’ rights and liabilities remain unaltered. Therefore, the CIN never changes, and the company’s name, on the other hand, is subject to change.

What are the problems that come with having a different legal entity?

There are several benefits of running as a separate legal entity, but there are also problems that come with it. The process can be complicated and time-consuming, and it can cost a lot for incorporation. There are also legal and financial duties, like following rules, making yearly reports, and more complicated tax duties that can be hard to handle without the right tools or knowledge.

How can one create an Indian separate legal entity?

Establishing a separate legal entity in India, say a Private Limited Company or LLP, requires following several steps:

Get directors a Digital Signature Certificate (DSC) and Director Identification Number (DIN).
Choose a distinctive company name using the Ministry of Corporate Affairs (MCA) portal.
With the Registrar of Companies (RoC), file incorporation documentation, including Articles of Association (AoA) and Memorandum of Association (MoA).
Pay the required registration fees and follow any extra legal guidelines, including GST registration.

Is a trust a separate legal entity?

A trust is not treated as a separate legal entity in the same way that a corporation or LLC are. A trust can possess property and enter into transactions, but it lacks its own legal personality. Instead, a trust is a legal framework in which a trustee controls and manages assets on behalf of the beneficiaries. The trustee operates on behalf of the trust, and it is the trustee who is legally responsible, not the trust itself. So, while a trust can function in certain ways like a separate company, it does not have the same legal status.

How does being a separate legal entity help the business owners?

Being a separate legal entity benefits business owners by limiting responsibility and shielding personal assets from corporate obligations and legal concerns. It assures corporate continuity regardless of ownership changes, facilitates ownership transfers through shares, and provides tax advantages. It also improves access to funds, streamlines legal operations, and separates personal and company matters, making it easier to manage finances and reduce risks.

References

https://www.researchgate.net/publication/291425524_Separate_Legal_Entity_of_Corporation_The_Corporate_Veil.

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Transitioning from Indian Accounting Standards to US GAAP : a practical approach

By

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November 7, 2024

This article has been written by Mohini Raval pursuing an Executive Certificate Course in US Accounting and Bookkeeping from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Table of Contents

Introduction

There are various reasons that necessitate Indian companies to transition from Indian Accounting Standards (Ind AS) to the United States Generally Accepted Accounting Principles (US GAAP). These reasons include companies seeking to raise capital in the United States, regulatory compliances, global expansion, legal and contractual requirements, mergers and acquisitions, etc. Let us understand the article topic in detail, covering these reasons, the key differences between India AS and US GAAP, challenges faced during the transition, strategies for ensuring a seamless conversion, and the benefits of such transitioning.

Understanding India AS and US GAAP

First, let us understand the meaning of the above terminologies and their background:

Ind AS

Indian Accounting Standards (Ind AS) are a comprehensive set of accounting principles and guidelines adopted by Indian companies and non-banking financial companies (NBFCs) to regulate and standardise their financial statement preparation and reporting practices. The primary objective of Ind AS is to enhance transparency, accuracy, and comparability of financial information across different entities in India and facilitate seamless integration with global financial markets.

Ind AS is largely harmonised with International Financial Reporting Standards (IFRS), which are widely accepted as the benchmark for high-quality financial reporting worldwide. However, there are certain carve-ins and carve-outs in Ind AS that are specific to the Indian business environment and regulatory framework. These modifications aim to address unique accounting challenges faced by Indian companies while maintaining alignment with the core principles of IFRS.

Ind AS was constituted by the Ministry of Corporate Affairs (MCA), Government of India, and notified in 2015 as an optional framework for early adoption. Subsequently, in 2016, the MCA mandated the compulsory adoption of Ind AS for listed companies and NBFCs with a net worth of 500 crore rupees or more. This move was aimed at enhancing the credibility and reliability of financial statements and boosting investor confidence in the Indian capital markets.

The adoption of Ind AS has several benefits for Indian companies. It enables them to align their financial reporting practices with international standards, making it easier for investors, analysts, and other stakeholders to understand and compare their financial performance with global peers. Furthermore, Ind AS promotes convergence with global accounting principles, facilitating cross-border transactions, capital raising, and foreign direct investment.

To ensure effective implementation and compliance with Ind AS, the Institute of Chartered Accountants of India (ICAI) has played a pivotal role. ICAI has developed detailed guidance notes, training programs, and certification courses to equip accountants and auditors with the necessary knowledge and skills to apply Ind AS in practice. Additionally, the National Financial Reporting Authority (NFRA), established by the MCA, oversees the enforcement of Ind AS and investigates any potential violations.

Overall, Ind AS has significantly improved the quality and consistency of financial reporting in India, contributing to greater transparency, investor protection, and global comparability. It has also supported India’s integration into the global financial ecosystem, enhancing its attractiveness as an investment destination and fostering economic growth.

US GAAP

Generally accepted accounting principles (US GAAP) are the standard accounting rules followed in the United States for the preparation, presentation, and reporting of financial statements. US GAAP is a comprehensive set of rules and guidelines that provide a framework for accountants to ensure that financial statements are accurate, transparent, and consistent.

The history of US GAAP dates back to 1939 when the American Institute of Certified Public Accountants (AICPA) established the Committee on Accounting Procedures (CAP). The CAP was responsible for developing and issuing accounting principles and procedures. In 1973, the Financial Accounting Standards Board (FASB) was formed to take over the responsibility for establishing and improving accounting principles in the United States.

US GAAP is applicable to a wide range of entities, including:

Public companies that are regulated by the Securities and Exchange Commission (SEC)
Private companies
Non-profit organisations
Foreign companies listed on the U.S. stock exchange
Government entities

US GAAP is important because it provides a common set of rules and guidelines for preparing financial statements. This helps to ensure that financial statements are accurate, transparent, and consistent, which makes it easier for investors, creditors, and other stakeholders to understand and compare the financial performance of different companies.

US GAAP is constantly evolving to reflect changes in the business environment and accounting practices. This process is overseen by the Financial Accounting Standards Board (FASB), which is responsible for issuing new accounting standards and amending existing standards.

US GAAP is an important part of the U.S. financial reporting system. It helps to ensure that financial statements are accurate, transparent, and consistent, which is essential for the efficient functioning of capital markets.

Exploring the need: transitioning from India AS to US GAAP

Below listed are a few reasons for transitioning from India AS to US GAAP:

Global expansion and access to capital market

The US is the largest capital market in the world. Access to such a larger market can lead to economies of scale, cost-effective production, and greater market access. Therefore, it is beneficial for companies to expand their business globally. As of March 2024, the New York Stock Exchange, located in the United States, is ranked as the largest stock exchange in the world, with an equity market capitalisation of over 28 trillion U.S. dollars. Hence, companies expanding globally or listing on US stock exchanges often need to adopt US GAAP to comply with regulatory requirements.

Cross-border operations or dual reporting

Indian companies having subsidiaries or operations in the United States must prepare financial statements in compliance with US GAAP to ensure consistency and comparability globally. Transitioning to US GAAP helps to streamline reporting processes and reduces complexities and costs associated with maintaining dual accounting systems.

Investor’s expectations and confidence

US GAAP is rule-based and strict; it ensures consistency and transparency and requires detailed disclosures. This results in enhancing credibility and building trust amongst the investors and financial institutions. Companies following US GAAP are often considered reliable and trustworthy.

Mergers and acquisition

In the case of mergers and acquisitions involving US companies and investors, financial statements prepared under US GAAP facilitate a standardised and clearer basis for due diligence and valuation. Following uniform accounting standards post-acquisition results in the ease of integration and consolidation process.

Key differences between India AS and US GAAP

Conceptual difference

Ind AS is more principle-based and is mostly aligned with IFRS. It focuses on fair value and substance over form, requiring professional judgement.

US GAAP is rule-based, and it emphasises more on detailed disclosures, rules, stringent guidelines, and provides industry-specific guidelines.

Hierarchy and nomenclature

The Ind AS standard begins with “Ind AS” adhering to the framework set by the Institute of Chartered Accountants of India (ICAI).

US GAAP standards begin with “ASC” (Accounting standards codification), structured under the Financial Accounting Standards Boards (FASB).

Financial statements, presentations, and disclosures

Ind AS	US GAAP
A financial statement consists of a balance sheet, a statement of profit and loss, a statement of changes in equity, a statement of cash flows, and notes to financial statements.	Financial statement consists of Balance sheet, Income statement, statement of comprehensive income, statement of changes in stockholder’s equity, statement of cash flows,
Notes to financial statements provide additional details and context for the numbers in financial statements, including significant accounting policies and other explanatory information.	Notes to financial statements provide detailed explanations and additional information to support figures in the financial statements.
Balance sheets are presented in the order of liquidity.Assets are listed first, followed by liabilities and then shareholder’s equity.It emphasises separation between current and non-current items more explicitly.Mandatory clear presentation of the classification within equity such as reserves and surplus.	Balance sheets are presented in the order of liquidity.Assets are listed first, followed by liabilities and then shareholder’s equity.Current assets and liabilities are separated from non-current items.
Uses terminology asEquity share capital and other equity	Uses terminology asCommon stock and retained earnings

Recognition and measurement

Revaluation Model

US GAAP predominantly uses historical cost measurement basis. Fair value measurement is used in certain cases, such as financial instruments and impairment testing.

Ind As allows for revaluation of Property Plant & Equipment (PPE). It also follows fair value measurement adoption for property plant & equipment (PPE), biological assets, financial instruments, share-based payments, etc.

Inventory valuation

Ind AS 2 permits FIFO and the weighted average cost method but does not allow the LIFO method.

US GAAP (ASC 330) permits FIFO, weighted average cost, and LIFO methods.

Deferred income tax

Under Ind AS 12, deferred tax assets and liabilities are classified as non-current. Whereas under US GAAP (ASC 740), assets and liabilities are classified as either current or non-current based on the classification of the related asset or liability.

Revenue recognition

US GAAP (ASC 606) and Ind AS 115 both follow a 5-step model for revenue recognition. However, US GAAP follows a detailed approach with specific criteria, such as whether delivery has occurred or services have been rendered and the collectability of the consideration is reasonably assured. Whereas Ind AS follows substance over form, it considers the transfer of risk and rewards for revenue recognition.

Financial instruments

Ind As 109, instruments are classified as either fair value through profit or loss, fair value through other comprehensive income, or as amortised cost. The classification depends upon the business model for management of such instruments and their contractual cash flow characteristics.

US GAAP ASC 320/ASC 815 uses different criteria for classification and measurement for different financial instruments.

ASC 320: Investments—Debt and Equity Securities: This topic focuses on the accounting and reporting treatment by an entity for investments in debt and equity securities.

ASC 815 (Derivatives and Hedging): This refers to the accounting to be followed by the derivative instruments and hedging activities in terms of fair value and hedge accounting requirements.

Impairment

US GAAP (ASC 350 & 360) provides for a 2-step impairment test process:

1. Recoverability test

2. Fair value test.

Ind As 36 follows a one step impairment test process.

Practical steps to ensure smooth transition

Identify the purpose

The first step is to determine why transitioning from India AS to US GAAP is necessary. For instance, if the reason for the transition is due to an Indian subsidiary operating in the US, then we need to conduct a thorough assessment of subsidiary financial statements in order to align accounting policies with US GAAP and prepare the consolidated financial statements for stakeholders as per US GAAP.

Analysis

Conduct a detailed analysis comparing accounting policies between Ind AS and US GAAP, identifying the key differences and areas needing adjustment. For instance, under US GAAP, revaluation of Property Plant & Equipment (PPE) is not permitted. Therefore, during the transition from Ind AS to US GAAP, if any of the PPE was revalued under Ind AS, it needs to be adjusted and restated at historical cost.

Seek a consultant or expert’s advice

Hire a consultant having extensive knowledge in US GAAP and Indian AS transitions, certified with practical experience, in order to ensure smooth and effective transitioning under the expert’s guidance.

Systems and processes

Check whether any internal control needs to be implemented, whether ERP systems need to be upgraded, or whether a new system needs to be implemented in order to ensure accuracy, consistency, and effective application of US GAAP.

Training & education

Conduct hands-on workshops to train and educate the finance and accounting team on ERP systems or accounting software emphasising US GAAP standards with practical examples and post-training support for application and adjustment challenges.

Financial reporting

Restate prior period financial statements to conform with US GAAP and ensure all the disclosures are made as per US GAAP. Make necessary adjustments and prepare a reconciliation for differences between Ind AS and US GAAP.

Documentation and continuous monitoring

Maintain detailed documentation for all adjustments made, including the rationale behind those adjustments. Conduct periodic reviews to determine whether training is conducted properly or not and whether employees and management are adhering to the provisions and complying with the US GAAP provisions.

Challenges faced during transition

Complexity of US GAAP: US GAAP is a complex accounting framework that requires detailed disclosures, contains complex guidelines, and is rule-based. This complexity can make it difficult for companies to understand and implement US GAAP, especially for those that are not familiar with the framework.
Costly compliance: Compliance with US GAAP can be costly due to its rigid nature, detailed disclosure requirements, and industry-specific standards. This cost can include the implementation of new systems or the upgrading of ERP systems, as well as the hiring of expert consultants for guidance.
Frequent updates and amendments: US GAAP is subject to frequent updates and amendments by the Financial Accounting Standards Board (FASB). This requires companies to be alert of changes and adjust their reporting practices accordingly, which can be time-consuming and costly.
Employee resistance: Employees may feel threatened towards job security due to concerns about coping up with the technical and practical advancements required by US GAAP. This resistance can make it difficult for companies to implement US GAAP successfully.

In addition to these challenges, companies may also face the following issues during the transition to US GAAP:

Lack of resources: Companies may not have the necessary resources, such as time, personnel, and expertise, to implement US GAAP effectively.
Cultural differences: Companies that are headquartered outside of the United States may find it difficult to adapt to the cultural differences associated with US GAAP.
Legal and regulatory issues: Companies may need to address legal and regulatory issues, such as tax implications, when transitioning to US GAAP.

Benefits of adopting US GAAP

Enhanced comparability and analysis: Adopting US GAAP provides a standardised framework for financial reporting, making it easier for investors and stakeholders to compare the financial statements of different companies within the United States. This comparability facilitates comprehensive analysis, allowing investors to make informed decisions based on consistent and reliable information.
Transparency and reliability: US GAAP emphasises transparency and reliability in financial reporting. By adhering to this framework, companies can ensure that their financial statements accurately reflect their financial position and performance. This transparency builds trust among investors, creditors, and other stakeholders, encouraging confidence in the company’s financial reporting practices.
Comprehensive guidance: US GAAP offers comprehensive guidance on various financial activities and accounting issues, including complex transactions. This guidance helps companies to consistently and accurately account for their financial activities, ensuring that their financial statements are prepared in accordance with established accounting principles. It also minimises the risk of misinterpretation and promotes consistent application of accounting treatments.
Global Influence: US GAAP is widely recognised and followed by many multinational corporations across the globe. Its influence extends beyond the United States, making it a preferred framework for financial reporting in various countries. Adopting US GAAP allows companies to align their financial reporting practices with international standards, enhancing their credibility and facilitating cross-border transactions and investments.

Case study: Transition from India AS to US GAAP: revenue recognition

Company overview

ABC Ltd. is a leading software development company operating mainly in software subscription business models and development IT consulting services and software products, which is based in India but is known for its global operations and customers. The company is among the companies that are listed on the Bombay Stock Exchange (BSE) and apart from this, it also has a proven position in the North American and European markets.

Background

The accounting method used by ABC Ltd. for reporting has always been Ind AS. After developing strategies that will pave the way for them to be on par with the global reporting requirements and be able to attract global investors, the company chooses to bring about the change through the transition to US Generally Accepted Accounting Principles (US GAAP).

Revenue recognition challenges

It was the result of the need to transfer from India AS to US GAAP that made ABC Ltd. to be heavily hit by revenue recognition the most. Under the Indian Accounting Standards (Ind AS), revenue is usually recognised through a method that calculates the percentage of the completion of the long-term contracts. US GAAP, however, sets more rigid criteria for revenue recognition over time, which might require the company to prepare more detailed information about the underlying projects and contracts to make sure they are in compliance with the relevant US GAAP standards. Previously, we have been using the method of revenue recognition specified for the revenue generated from the sale of contracts written in Ind AS, and it will be the same as before. Under the terms of the contracts, the work has been done using the method of percentage of completion, a method customarily applied. However, with respect to the same project terms, the allocation of the profits and losses at each stage of the project was going to be handled differently if US GAAP reporting was applied. Provisions for detailed checks and contracts with potential risks of noncompliance were the differences between the two methods, Ind AS and US GAAP.

Implementation strategy and outcome

One of the things the ABC Ltd. finance and accounting team did was to analyse how both the new and old revenue recognition frameworks are put into practice in light of the Indian Accounting Standards (Ind AS) and the International Financial Reporting requirements (US GAAP). The contracts were identified where, under U.S. GAAP, technical changes were required and those changes were made. An additional audit by financial experts was held and required in order to ascertain the accuracy of the provisions and the compliance with the principles put out by the US GAAP standardisation body.

The final story is that ABC Ltd. achieved its goal of moving the US revenue recognition practices to the new standard, which increased clarity and comparability observed in the financial sector. In addition, this alignment was more than just making sure they were compliant with not only the laws but also being on the international level. This way of doing business was reinforced by investor confidence and the new markets were entered successfully.

This is a good case of a company such as ABC Ltd. having to get through the labyrinth of revenue recognition during the transfer from Ind AS to the US GAAP, showing the importance of the deal with the strategic plan and the technical skills; it was a success in the financial report conversion.

Conclusion

This transition from Ind AS to US GAAP is, therefore, quite complex and requires in-depth knowledge about the dissimilarities between both standards. In that respect, companies may, however, effectively manage this transition by placing major emphasis on key areas of difference: revenue recognition, lease accounting, and changes in the reporting of financial instruments. Steps for compliance checking, training, and updating of related financial systems are therefore very important. It may not be impossible for companies to plan and execute the transition in a manner so that the financial statement can be presented both with Ind AS and under US GAAP.

References

Importance of creativity in innovation

By

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November 7, 2024

This article has been written by Steven Lyall, pursuing a Diploma in Content Marketing and Strategy from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Table of Contents

The decline of the diploma

Suited and Unrecruited

Is that you? Qualified, but on the sidelines? More and more, it seems, the credentials we worked so long and hard to achieve and paid so dearly to collect are rapidly weakening in value by the year. Sadly, this scenario is becoming more and more common, and all the while, HR teams complain that it’s getting tougher to recruit any suitable talent.

And yet this predicament is not the case for everyone, is it? We all have that fortunate friend who blossoms from job to job while we are still interview hopping with waning success and withering hope. It’s as if one piece of the puzzle always eludes us, no matter how hard we try. How can it be so difficult to land a position that you are perfectly suited for?

Welcome home to the bane of the suited and unrecruited.

The most important skill in the world

Marketplace evolution is rapidly accelerating. Every year our devices get smarter and our internet more available. The resulting opportunities for business make for a “smaller world”—a world with greater access to marketplaces but also greater competition—resulting in an unparalleled demand for innovation.

This demand for businesses to keep innovating translates into a demand for employees to be innovative. And, as it turns out, many candidates fail to demonstrate the ability to innovate. Recruiters say that creative problem solving is one of the skills that are hardest to find.

But what’s the link between creativity and innovation? After all, the positions that you are applying for may not require any artistic talent at all. And we can’t all be creative, right? Can’t we leave that fluffy stuff to the artists and the dreamers—the people who want to make the world a better place?

Innovation and creativity can seem similar to some people and very different to others. Let’s break it down.

Innovation is the stuff of practical solutions that alter the landscape of marketplaces. Innovation is why we book cabs on an app instead of hailing a taxi at the curb. Innovation strategies are what businesses desperately need. And innovation is what recruiters fervently seek.

But instead, they look for creativity.

Why is that?

Creativity is, in fact, a way of thinking that assists with problem-solving. And problem solving is the name of the game. All the amazing innovations that keep rocking the market are all incredible solutions to problems.

It helps to think of creativity as the spark that fuels the engine. It’s the engine employers want, but they’re looking for the spark. And rightfully so. Creativity makes a person more responsive to the ever-changing environment by enabling them to solve problems better, faster and more uniquely.

To put it differently, there is no innovation without creativity. That’s the importance of creativity.

Psychology Today states that 94% of hiring managers say it is important to consider creativity when hiring a job candidate. Creativity has become the most important skill in the world.

Just not creative enough

Numerous research reports have shown that creativity among college students in India is at a lower level on average compared to their counterparts in countries like the United States, Finland, and Canada. This is because creativity is not typically something that is developed much in our school system.

So where does that leave us?

Well, there’s actually some really great news in what you just read. Creativity is developed.

Creativity is not something you’re either born with or without. It can be developed. It’s never too late to start. And it’s fun and easy to do.

From now on, you’ll never miss out on an opportunity because you’re not creative enough.

You actually have it

So our environment and the way we go about engaging with it play a determining role in the development of creativity. And this plays out in the classroom as well as in life—including our adult lives.

Try incorporating at least some of these activities into your daily routine. If you do, you’ll be well on your way to developing more of that creative spark.

And we all know you actually have it.

Start moving

A little movement helps get the blood moving faster and can stimulate the brain. If you have a project coming up or an activity that requires some creative problem-solving, try doing a little exercise first. And don’t worry if you’re not the most ardent gym rat or marathon champ. You’ll be pleased to know that according to The Stanford Walking Study, simple walking is actually an incredible catalyst for creativity and might just be all you need. Walking provides a changing environment that can help to clear your mind, and once you get started with this habit, you will find that simply thinking or discussing the problem at hand while on a walk is an incredible tool for problem solving.

Take a big dump

Okay, not literally. Unless you need to. This dump is actually a little different.

Write out all of your thoughts and ideas on the topic and any related topics that occur to you. The idea is not to get everything to make sense right away, but rather to clear your mind of what is being processed by dumping everything out so you can generate new ideas and find new connections. They don’t need to be in any particular order. They don’t even need to make sense. And try not to judge yourself or assign any value to what you are writing as you are doing it.

Try to continue writing a bit after your thoughts on the topic have exhausted. You might find that the most interesting discoveries, ideas, and connections happen then.

Pro Tip: Set aside the gadgets and go old school with a nice pen and notebook for this one.

Pro Tip 2: Start a journal where you regularly write down your thoughts from that day or about any topic you feel like writing on at that moment. This activity would not need to be specific to a project, but will be just as beneficial all the same.

Indulge in the arts

Did you know that music and art help engage the imagination and develop problem-solving skills? No kidding. Art helps individuals engage in divergent thinking and consider multiple solutions rather than just settle for the most obvious solution. Music has been shown to significantly boost creativity and multidisciplinarity among students, particularly in computer science and software engineering courses.

You could experiment with listening to music while engaging in a task. If you find yourself getting distracted, try switching to instrumental music.

Change your space

Changing your environment every now and then creates fresh stimuli and can result in enhanced creative thinking. This could be as simple as rearranging your desk, a hobby area, or any portion of your home. You could find new environments to do certain activities in or vary the lighting or decor in certain spaces. Try to feel good in the space you’re creating. You want to be excited to be there. And don’t feel underwhelmed by the seeming simplicity of modifying your spaces—it is in reality extremely effective at boosting your creativity.

What is a space you can change this week?

Shutdown

Our phones have become like second brains for us, haven’t they? And while we boast of a massive advantage over previous generations (with all the information and entertainment that is readily available at our fingertips), our devices can also end up distracting and demotivating us, reducing our thinking and problem solving abilities.

On the other hand, technology is incredible at helping us to collaborate and develop ideas; it just may not be the best for the problem solving portions of your day.

Pro Tip: Start to recognise the portions of your work or daily tasks at home that require creative problem solving, so you can shut down or separate yourself from your devices at those moments.

Pursue a hobby

At the risk of triggering the debate of whether or not watching Netflix is a bonafide hobby, for the purpose of developing creativity in innovation, try a hobby that you are truly passionate about and that presents the opportunity to engage in a bit of creative problem solving. Ask yourself if your hobby evokes these types of questions:

What would it be like to grow fruit trees in containers? What would improve the quality of the fruit?

How can I solve this 2000-piece puzzle faster? What would improve my time?

What would it take for me to beat Dave at table tennis? What would make my smash tougher to return?

And yes, sports make excellent hobbies.

If you aren’t sure which hobby you might be interested in, don’t despair. Try thinking back on what used to interest you as a child, try out some introductory classes online, or join a friend who is passionate about a hobby and see if any of those topics spark your curiosity and imagination.

Pro Tip: Approach selecting a hobby as a problem solving exercise. Write ideas that come to mind and why you may or may not enjoy engaging in those hobbies. Or go for a walk? You get the picture. Just remember to enjoy the process.

Collaborate

Working with others can develop our creative problem solving skills in ways we wouldn’t otherwise have access to. Collaboration provides numerous opportunities to look at things differently. You may become aware of problems to solve that you weren’t aware of previously. You may be exposed to new methods of operating or dealing with challenges or even new ways of approaching obstacles.

Collaboration can also be fun and is a great career skill to continue developing at every stage. That’s a triple win.

Keep solving problems

It helps to start getting used to the idea that life is full of wonderful problems that need to be solved—that can be solved by you and that will be rewarding to solve.

Problem solving is a key to a successful career. More than a certified graduate, an employee who can solve a variety of problems without panicking is a valuable company asset, but it sure is nice to have a practice environment where the stakes aren’t quite so high, isn’t it? That’s where the daily exercises come in.

Practice talking with family and friends about problems you solved. Share what you dealt with, the solution you developed and what your thought process was. Write your favourites down to recall later when you’re preparing for an interview.

And remember, the competence developed through creative problem solving is not only going to benefit your career but every aspect of your life.

A life that will only become richer and more rewarding as you keep solving problems.

References

Adam Smith’s theory on canons of taxation

By

Amber Kotnala

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November 7, 2024

This article is written by Amber Kotnala and further updated by Moiz Akhtar. This article throws light on canons of taxation propounded by well known economist Adam smith and how these canons are even relevant today is discussed in detail.

Table of Contents

Introduction

In countries like India, taxes form the basis of infrastructures, developments and public benefit schemes run by the government as a whole. Taxes serve as the backbone of the national economy where public centric infrastructure like education, healthcare, roadways, food security etc. are powered and funded by the government. The government of India runs massive schemes in various sectors such as railways, transport corridors, freight corridors, energy infrastructure, indigenous pharma productions, indigenous manufacturing of various automobiles components, manufacturing of electronics and electricals etc. In all these developments, the Indian government has invested money collected through direct and indirect taxes.

The power of levying tax is conferred by Article 265 of the Indian Constitution. Article 265 states that only the authority of law has the power to levy and collect the tax. Therefore, it becomes the duty of every citizen to pay tax. The tax income collected goes to the consolidated fund of India i.e. Article 266 of Indian Constitution.

Payment of tax (Government’s Income) is not considered a burden to the citizens. As rightly said by Justice Homes of the US Supreme Court that “taxes are the price for civilization”. It is time that tax is no longer considered a burden but a price for civilization. For this, the government has to make tax collection so simple that citizens do not feel harassed or burdensome about it.

Let’s first understand what exactly does taxation mean before moving towards Adam Smith’s canons of taxation.

What is taxation

Taxation is an involuntary payment of levy that administration/government makes mandatory on its citizens. Generally, taxation doesn’t require any consent from the payer of tax, and there is also no direct service provided by the authority to taxpayers in exchange for the tax collected. Taxation or collecting a levy by the government/authority is legitimate, if the law of the land legitimises this collection. Governments have the control and power to levy, and collect different types of taxes from their citizens. From time immemorial, taxes have been levied on both physical assets such as land, housing as well as on the sales and transactions of goods.

After understanding the meaning of taxation let’s see why taxes are required to be levied all around the world!

Need for taxation

The 21st century is the era of technological advancements and financial upgrades leading to booming of various sectors of economies. The fiscal prudence and transparent tax policies adopted by a state reflects the economic philosophy of the government. In India, tax collection and levy is not a new idea, it’s been there for ages. Taxation is a fiscal tool used by the government since ages to run the administrative machinery of the state. To run administration smoothly the state requires resources and means. Tax collected from the citizens serves as a resource to the government.

Characteristics of canons of taxation

A good taxation system is the productive base of any economy. A good taxation system should reflect the view of a progressive economy. The framers of the taxation mechanism while framing the tax laws must keep in mind various needs of different sections of the society and frame laws accordingly. A good taxation system should be just and equitable to all so that the tax burden of the country is fairly distributed on all of its citizens. Fair distribution doesn’t mean equal distribution rather it means equitable distribution.

Although there are numbers of characteristics of canons of taxation, some among them are mentioned below-:

The most important characteristic of a taxation system is that it should charge each and every individual according to its capacity to earn and spend. A person earning lower income should be subjected to a lower level of tax rates.
Convenience to pay tax should be in an easy manner without much technical and procedural jargon should be made intrinsic to any tax framework.
Simple and easy computation of tax liability is very crucial for a tax system to function well. The easier the method of tax computation, the more aware people become about tax policy functioning.
A tax structure should be flexible enough to make exceptions for varied circumstances. The tax structure should be flexible to tackle situations like Covid-19 pandemic when the economy of the country hits a downline.
One of the most important characteristics of a good taxation system is the diverse ways it uses to collect taxes in the country. The more diversified the tax structure, the less the people will feel the burden of paying taxes.
The primary motive of a tax structure should be to frame such tax laws and policies which are not regressive towards the growth of the economy in general.
If taxes are levied on purchase and expenditure then the structure of tax would get more diversified and wide.
Taxing individuals on the basis of income they make is justified and is an advanced nuance in the sector of taxation. Most of the countries are charging income tax and have held that income tax should be the basis of a man’s ability to pay the tax.
A tax should be logical enough for the taxpayers because an arbitrary tax without any cause or reason must not qualify as a tax. A tax imposed arbitrarily without any expedient cause will face severe criticism from the taxpayers.
A good taxation system should be cost effective and the cost of collection should be meagre as compared to the amount of tax collected.

Now after getting a good idea on the meaning and need of taxation it would be easy for us to understand the other remaining part of the article.

Let’s now move towards the main topic of discussion which is the canons of taxation given by Adam Smith.

Adam Smith’s theory on canons of taxation

Before understanding the different types of canons of taxation let’s know who Adam Smith was.

Who was Adam Smith

Adam Smith was a Scottish philosopher whose views and ideas played a major role in the story of Scottish enlightenment. He was born in the year 1723 and was considered as one of the major proponents of classical liberalism. His views regarding economics and political philosophy took a hit worldwide when his book “The Wealth of Nations” was published in the year 1776. He was a student of both Glasgow University and Oxford’s Balliol College. The ideas he propounded were eventually accepted by almost all modern political systems.

His two main ideas were the free market economy and the invisible hand that regulates markets. According to him, the state’s intervention in the sphere of market and trade should be minimum so that the market could be able to function in an optimal manner where the growth is not limited by any of the policies of the state. He said that the economy of a country functions well when there is minimum or no interference by the political system of the country.

The crux of his theory of invisible hand was that, the market and sentiments of people are enough to determine the price of commodities and realisation of growth of the overall economy. People catering to their own needs and acting on self interest would lead to a situation in the market which would be beneficial for the economy and society as a whole. In his book ‘The Wealth of Nations’ he has also explained the canons of taxation which are integral for a modern taxation system and are inalienable features. These canons are adopted and implemented by many of the modern taxing economies including India.

Meaning of canon of taxation

Canons of taxation are the characteristics which a good system of taxation must possess. In order to be called a good taxation system, various characteristics such as equality in taxation, certainty in taxation, easy, and convenient taxation etc are much needed. While framing and carving out a detailed taxation system for its nation, a government should keep these canons of taxation in view.

After knowing about the person behind these canons of taxation, we will understand the four canons of taxation given by him.

Adam Smith’s canons of taxation

Canons of taxations are the guiding rules and principles to make the tax collection system effective and functional. The government has to build a structure that can make tax collection simple and effective. Therefore, certain rules and principles have to be followed in order to do the same. But any principle so framed or proposed would not be exhaustive. This is so, because of the dynamic nature of the society.

A progressive society is always subject to changes and these changes have to be adopted by the government in order to make the tax collection mechanism effective and efficient. Adam Smith gave four canons in his famous book named ‘Wealth of Nation’.

These four canons are also called Adam Smith’s canons of taxations. Following are the four canons of taxation:

Canon of equality
Canon of certainty
Canon of convenience
Canon of economy

Now let us deal with each canon in detail.

Canon of equality

Equality means treating everyone equal but here, the term equality is used with regard to the ability to pay. As considering everyone equal would result in payment of the large amount by the low-income group or payment of the same amount i.e. less, by the high-income group. While taxing the person, the government must know which person belongs to which income group and then the individual must be taxed.

Adam Smith argued that the taxes should be proportional to income, i.e. citizens should pay the taxes in proportion to the revenue which they respectively enjoy under the protection of the State. Adam Smith had rightly stated as this would reduce the gap between the rich and poor. If there would be no such principle, the gap between the rich and poor would only increase with time. In simple words, we can say that taxing the individual according to his ability to pay results in the equal distribution of wealth in the economy. Because of this principle of Adam Smith, the government has made the different tax slabs so that the sacrifice made by the individual in a monetary term shall be equal.

The purpose of the canon of equality is to provide a base for the taxation philosophy that a modern economy should reflect. Evolving economy should function on a taxation system which is just and rational to even the last person standing on the line of income. Equity in the taxation system promotes the overall socio-economic growth of a society as a whole. India is moving towards a nominal Gross Domestic Products (GDP) of 5 trillion dollars and it will achieve the numerical targets of GDP soon.

The future of a country depends upon the economic policies it adapts to make provision for the growth of different sectors of the economy and different classes of people. For the purpose of imposing and collecting taxes in India, taxpayers are categorised into different categories of annual income. Different categories of annual income have different tax slabs. Each tax slab represents a different percentage share of tax that one individual has to contribute according to the annual income they make. The higher the income, the higher the tax slab and tax percentage.

Categorisation of individuals into different tax brackets does justify the proportional taxation system that India follows but not having access to high end accounting services often leads to paying of more taxes by the lower income group of the country. Although purchasing power parity for two residents of India who belong to upper and lower tax slabs is the same , the disposable income they left with is disproportionate.

Types of taxes in India

In India taxes are categorised into two types -:

Direct tax

Direct taxes are the taxes levied by the government on the individuals and business entities whose burden and liability is on the assessee themselves. The person pays this tax by virtue of making an income in this country. This tax system is designed in such a way that the slabs of taxation are placed in a progressive manner due to which the share of tax increases as the income increases i.e. personal income tax. Direct taxes are collected by the central government directly and the Central Board of Direct Taxes (CBDT) is the regulating authority of this category of tax.

Examples of direct taxes include income tax, corporate tax, securities transaction tax, capital gains tax, gift tax and wealth tax. Rates of income tax in India are decided by the government for each upcoming year and are mentioned in the budget itself. The revision of tax rates compared to the preceding year is updated in the rules of income tax through making amendments to the Income Tax Act, 1961 and introduction of new finance legislations and circulars.

Updated and revised tax regimes as well as rebates are mentioned in the new Finance Act and the new Act replaces the previous Acts if any. Amendments to both Income Tax Act,1961 and related laws are being made throughout the year to make the tax model advanced and updated.

Following are the updated income tax rates applicable for Financial Year 2024-25 based on the Annual budget 2024-25 and Finance (No.2) Act 2024 -:

Income tax slab (in Rs.)	Income tax rate (%)
From 0 to 3,00,000	0%
From 3,00,001 to 7,00,000	5%
From 7,00,001 to 10,00,000	10%
From 10,00,001 to 12,00,000	15%
From 12,00,001 to 15,00,000	20%
From 15,00,001 and above	30%

It is clearly witnessed from the above table that as the income of an individual increases the rate of tax increases. Further these taxes are applicable to people who belong to the income generating age (from 18-60). People belonging to the senior citizen group i.e. age 60 and above and the super senior citizen group i.e. age 80 and above have different taxation rates and deductions.

Indirect tax

Indirect taxes are the taxes which are levied by the government on the sales and purchases of goods and services. This tax is transferable in nature as it could easily be transferred to the other person in the chain of taxation system. For example, Goods and Services Tax (GST) could be easily transferred to the end consumer of the product and the consumer is liable to pay the tax. GST is considered as one of the biggest bulwarks of indian taxation system and it additionally generated revenue worth of Rupees 1.50 lakh crore in August 2024 which is 6.5% higher than Rupees 1.41 lakh crore which was collected in the month of August in 2023.

Examples of indirect taxes in India are VAT, GST, excise and custom duty etc. Although India has varieties of indirect tax and GST being the prominent one among them. After the implementation of GST, it has replaced many central taxes like additional duties of excise, central excise duty, excise duty levied under Medicinal and Toilet Preparations (Excise duty) Act 1955, additional duties of excise levied under textiles and textile products, additional duties of customs, service tax, surcharge and cess as well as central sales tax.

Whereas taxes levied by states like state VAT/sales tax, purchase tax, entertainment tax, luxury tax, entry tax (all forms), taxes on lottery (gambling and betting included), surcharges/cess and taxes on advertisement were also replaced by GST.

As far as indirect taxes are concerned, collection of indirect tax increased by Rs. 216946 Cr (20%) during the financial year 2021-2022 as compared to its previous year’s collection. The annual growth of the indirect taxes year-on-year which constantly decreased from 5.8% in FY-2018 to 1.76% in FY-2020 witnessed an upward trend in FY-21 and FY-22.

The growth of indirect tax has contributed to an increase in collection of GST and custom duty respectively. GST collection in the year 2022 has increased by 27% and Custom duty was increased by 48% as compared to FY-21.

During the covid years indirect taxes indirect taxes as a percentage of GDP declined from 5.35% in FY-18 to 4.76% in FY-20. However during FY-21 and FY-22 there was an increase in indirect tax to GDP ratio when it was increased to 5. 47% during FY-21 and FY-22. Indirect taxes are consumption based and are dependent upon the capacity of consumption of an economy and market.

Consumption is dependent upon macro-economic factors such as the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) along with various other factors. After the Covid-19 pandemic growth of the Indian economy propelled and India witnessed a rapid recovery in the economic sphere. Strong economic recovery combined with better compliance efforts in taxation leads to the rise in indirect tax collection in FY-22.

Canon of certainty

Another important canon given by Adam Smith is the canon of certainty. According to him, ‘the tax which an individual is bound to pay ought to be certain and arbitrary’. The amount of tax, the manner of payment, and the person to whom it is to be paid shall be certain so that the individual shall be informed well in advance about the amount that is to be levied as a tax. If the tax system is not certain, it may lead to harassment of an individual.

This principle of certainty states that tax should not be arbitrarily fixed or imposed by the income tax authorities. Moreover, lack of certainty in the tax system, as pointed out by Smith, encourages corruption in the tax administration. Therefore in a good tax system, “individuals should be secure against unpredictable taxes levied on their wages or other incomes; the law should be clear and specific; tax collectors should have little discretion about how much to assess taxpayers; for this is a very great power and subject to abuse.”

The Indian taxation system is designed in such a way that each year’s tax slab, be it direct tax such as income tax or indirect tax such as GST is already being disclosed in the annual budget in the month of July. Although the final union budget is presented in the month of July in Parliament, the interim budget which contains the vision of the government for the upcoming financial year is presented in the month of February itself.

Budget is presented in the Parliament and broadcasted live to make the citizen aware of the financial planning programmed by the government and to gain insights on sector specific policies and investment planned to be executed. An aware citizen knows to which income bracket he/she belongs and could check as well as calculate the amount of tax he/she is liable to pay the government. The tax structure remains the same and constant for the whole year after declaration so that people could do business and financial planning according to the rates and slabs of the taxes declared by the government.

This eliminates all arbitrariness regarding the amount of tax one is liable to pay in the current financial year. Although the calculations and assessment of tax is simple in India, to claim deductions and rebates is quite complicated. Citizens often need the help of tax experts and professionals to claim them. Multiple heads of deductions and rebates motivate people to earn more and save tax on their income.

In other words, we can say, an individual who is paying tax, has to pay the same, in a complicated manner, shall restrain him in doing so because of the hardship and problems that he has to face while paying tax. Also, if an individual is unaware of the amount of tax to be deducted from his income in advance then he may get demotivated to do investment bearing high risk if he is a businessman. Therefore, the tax system must be certain and not arbitrary. Uncertainty along with arbitrariness would defeat the very purpose of the tax system.

Canon of convenience

Another important canon of taxation is the ‘canon of convenience’. As the word ‘convenience’ per se means to make it easy, simple, and comfortable. According to him, “every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it”. The payment and manner of payment of the taxable amount must be convenient to the person paying the same. If the tax collection mechanism is complex, it would lead to frustration and dissatisfaction to the contributor.

A good taxation system is one which is convenient to the contributor. Income tax is always collected in the preceding year of the assessment year. That means the tax is deducted only when the income is earned by the individual. If this would not be the case then the situation may arise, where the burden of paying the tax would be on the contributor, not having earned the income.

Income tax authority cannot tax the amount which is not earned. It may create an absurd situation, where tax is deducted on the amount, not in existence. Apart from this, another important aspect is, after earning income, how the tax collection must be done so as to make it convenient. The best example of this is Tax Deducted at Source (TDS). TDS means “deduction of tax from the source it has been generated”.

It is the obligation of the employer to deduct the tax before crediting the salary of the employee in his/her account and the tax so deducted shall be paid to the government, when due. This relieves the employee from paying the tax. Due to the rapid growth of technology, the internet has gained more popularity and is easily accessible nowadays. This gave rise to e-payment of direct taxes.

Income tax department assesses the amount of tax on the total amount of transactions made in a financial year on the assessee’s Permanent Account Number (PAN). Nowadays all the bank accounts are also linked to PAN and hence it is very easy for the income tax personnel to calculate the amount of total income and tax incurred on an individual or on any business in a financial year.

Individuals and businesses having more than one source of income might need the help of tax experts to file for their income tax return but computation of tax for salaried individuals is simpler and could be filed by the individuals themselves. If any extra amount of tax they had paid beyond their tax liability based on the income group they belong to in the previous year then, they could file for an income tax return. So, the convenience to pay tax and to file for tax return has become a lot simpler in India. Also payment of tax regularly reflects a clean and credible credit repayment capability of the individuals and businesses.

For making e-payment of taxes one should have only two things, an internet connection and a net banking enabled account in an authorised bank. If the taxpayer does not have a net banking enabled account, then he can make e-payment using a net banking enabled account of any other person but the tax should be paid in his name. What a contributor has to do is just to follow the procedure by logging onto the website of the Income tax department. All these things have made the tax collection mechanism convenient.

Further if any dispute arises between the taxpayer and the income tax department regarding the computation and calculation of tax then, one could visit the tax officer in the income tax office to resolve the matter. If the matter is not resolved under the tax officer then the taxpayer has the right to knock on the door of the tax commissioner and further appellate tribunal as well as the High Court also in the hierarchy of institutions. Hence, the claim of tax amount by the government on an individual or business is not final. There are institutions and courts where any aggrieved party can appeal for resolution of tax matters and seek relief.

Canon of economy

A good tax system is where the cost of collecting the tax is minuscule to that of the amount collected. The government shall always endeavour to lower down the expense incurred on the tax collection so as to have the larger amount to its treasury. The very purpose of tax collection is to generate revenue for the government but the same is defeated when the expense gets increased. To quote Adam Smith “every tax ought to be contrived as both to take out and keep out of pockets of the people as little as possible over and above what it brings, into the public treasury of the state.”

Therefore, this canon of taxation is significant in adopting the method of collection. As stated earlier, due to technological advancement payment of tax has become an easy task. From the point of view of the government, technology has reduced the expenses that would be incurred in case of absentia. Without technological advancement in a tax system, we cannot imagine how much a hefty amount the government may have incurred in the collection of tax.

Apart from Adam Smith’s canons of taxation, Charles F. Bastable the economist has also given us the modern canons of taxation. Adam Smith’s canons were the fundamental canons of taxation while these were added later in order to address the modern problems.

Modern canons of taxation

Canon of simplicity

A simple tax structure must fetch or generate more revenue for the government. Where the whole of the tax structure is simple, it doesn’t create confusion and is easy to understand. Tax rates must be simple. Where it is complex, it may lead to confusion and thereby the contributor may abstain from paying such tax.

The canon of simplicity along with the other canons plays a significant role in the effective and efficient functioning of the tax system. GST is one such example to encourage people to pay the tax without getting stuck into the technicalities of different taxes. GST has made the tax structure simple and productive.

Canon of productivity

Imposition of tax must not bypass the rule of productivity i.e. production in the economy. Tax amount shall not be arbitrarily fixed and imposed on the individuals, because this could discourage them to make further investment in the economy. But this does not mean the imposition of the tax in favour of the big shots of the country. The government shall impose the tax in such a way to make it productive i.e. yielding sufficient revenue.

A country only flourishes when the government allows the citizen to create private property for their personal benefits. Since India is a welfare democracy, it promotes the concept of welfare economy and welfare state. The Indian politico-economic system reflects a mix of capitalism and socialism. India aims for economic prosperity along with upliftment of society as a whole.

Canon of elasticity

Tax structure must be flexible enough that it moves along with the economic growth. When there is an increase in the people’s income, the revenue of the government shall increase. This is best applicable in case of indirect taxes. For example, the imposition of the high tax on high-end goods or luxury goods and services. Similarly, when there is a decrease in the income of people, the tax shall also be decreased accordingly.

The above explanation is best supported by an example of the Indian government’s move to put gambling, speculation and trading unregulated crypto currencies under 30% tax rate without any deductions. Luxury tax is also levied on the goods such as high end luxury cars, high end consumer electronics etc at 28% GST tax slab. Hence those who can afford luxury products are liable to pay higher tax amounts which are ultimately credited to the government treasury.

Canon of diversity

Canon of diversity states that there shall not be a single tax which has too high rates but shall have several taxes with lesser rates. This is so because an individual paying higher tax would lead to evasion of tax. The canon of diversity also encourages investments and leads to economic growth. Understanding better, in terms of human psychology, a person may abstain himself from paying a single high rated tax rather than from paying several lesser rated tax.

Another advantage of the rule of diversity is that imposing several low rated taxes will bring others, having low income, within the purview of the taxation system thereby leading to the contribution to the State treasury by a low-income group.

Canon of expediency

As per this canon the determination of the taxes should not be on the basis of political, social and economic expediency. There are some practical considerations which should be taken into account. The taxes have to be acceptable from all spheres like social, political and economic. This canon helps in winning the public acceptance and ensures that the taxes which are imposed are not unjust and do not burden the people of the country.

Are these canons of taxation given by Adam Smith still relevant in the modern tax system of India? Let’s move towards the next heading to know the answer for this.

Relevance of Adam Smith’s canons of taxation to modern tax system in India

There is no doubt that canons of taxation have helped the modern economy in many ways. Starting from the simplification of the taxation system so that more people would be willing to pay tax to the advancement in the technological sphere so that filings of tax returns should be hassle free and easy. Taxation system in India has changed significantly from the year 1991 when the Indian economy moved from a planned and domestic economy to an open market economy.

Adam Smith was a proponent of free market economy where the government has minimal interference. Taxation system in India was revolutionised so that it can cater to the growing needs of a market economy. In India, the taxation system was developed in such a way that it has many characteristics of the canons mentioned by Adam Smith. The planning and the finance commission always tried to make citizen centric tax laws so that it could be implemented without any complexities. Equitable taxation system, fair and certain amount of taxes to be paid, online payment of tax leading to easy payment are some of the characteristics of Smith’s canons which are adopted by Indian taxation mechanism.

Streamlining of indirect tax and implementation of GST lead to the elimination of cascading effects of tax and effective execution of Input Tax Credit (ITC). Effective implementation of tax rules and relevant laws are crucial for development of an economy. There are no countries in the world which satisfies all the canons of taxation, however the policymakers try to comply with the canons of taxation as much as possible. Good taxation system and transparency in collecting tax leads to more funds with the government.

With more funds the government easily caters to the needs of infrastructure and administration of the country. This makes it less likely to take debt or loan from other nations. This leads to lowering the debt portfolio of the government and makes the economy self-sufficient in the long run.

Although Adam Smith gave the canons of taxation nearly 200 years ago, it is fairly relevant in modern times too. Countries with modern economies incorporate these taxation principles given by Smith even today. These canons are relevant today and will be in future also because they are the fundamentals and classical features of a tax system.

Conclusion

These canons of taxation are the real secret of the successful tax system. Non- fulfilment of these may demolish the whole structure and would create problems having only one solution i.e. following these aforesaid canons. But, we have to keep in mind that these canons are not exhaustive. With the passage of time, there may be an evolution of new canons which would be best suited to the circumstances of that time. India has a growing economy, therefore, new canons are obvious to evolve.

As India is approaching the target of nominal GDP of $5 trillion, supporting business and income class people through various means and tax measures will not only create a positive sentiment among the citizens but also in the minds of foreign investors looking for investment opportunities in India. The whole world sees India as a potential dark horse in the realm of economy which could generate significant returns on investments.

Simplification of the taxation system and complying to the ideas of ease of doing business will only add up to the thrust that pushes the economy upward. Although the Indian taxation system has developed and upgraded to a much better level still, there remains a lot of progress to be made to cater to the high levels of financial transactions that are taking place every then and now.

Frequently Asked Questions (FAQs)

What is a tax incentive?

A tax incentive is a fiscal tool used by the government to reduce the tax rate or complete waiver of tax on a specific transaction or kind of business to promote and encourage it among the public. If a particular sector/business becomes tax free then, financial transactions under that sector would increase which will ultimately promote the business. Tax incentives and waivers are also provided by the government to specific industries if they are on the verge of collapse or showing a negative revenue for years.

What is GST?

Goods and Service Tax (GST) is an indirect tax reform which was introduced by the government of India through The Central Goods and Services Act, 2017. This was introduced to abolish and replace VAT (Value Added Tax) for the majority of the goods and commodities in India. GST simplifies the indirect taxation system for goods and services and the tax is computed at the end of the production when the consumer purchases the goods. GST has divided goods and commodities into five tax slabs i.e. 0%,5%,12%,18% and 28% respectively.

What is CBDT?

Central Board of Direct Taxes (CBDT) is a statutory body established in the year 1963 under The Central Boards of Revenue Act, 1963. The body is responsible for programming the structure of income tax department, framing of measures for collection and assessment of taxes, ensuring the implementation of policies to check tax evasion and tax avoidance, works related to grievance shell as well and inspection division etc.

What is an assessment year?

In India, for the purpose of tax collection convenience the time period from April 1st of current year to March 31st of next year is termed as assessment year. During this period whatever tax liability incurred upon the businesses and individuals are collected and their respective PANs are updated. At the end of the assessment year individuals and businesses are allowed to file for income tax return if they are eligible for the same.

What is the difference between direct and indirect tax?

Direct taxes are the taxes levied by the government on the individuals and business entities whose burden and liability is on the assessee themselves. The person pays this tax by virtue of making an income in this country. Whereas indirect tax are the taxes which are being collected on the goods and services the consumer purchase and use.

What is a TAN?

TAN stands for Tax Collection and Deduction Account Number which is issued by the income tax department to the businesses or persons who are responsible for tax collection at source or tax deduction at source. TAN is a 10 digit alphanumeric number consisting of four alphabets, five numbers and lastly one alphabet. TAN is mandatory for each and every deductor operating in India.

What is a PAN?

PAN stands for Permanent Account Number which is a 10 digit alphanumeric number allocated to tax payers by the income tax department. Through the PAN, the income tax department calculates and computes tax incurred on persons and businesses on the income they make.

What are the principles of good taxation?

Taxation is an integral part of a modern economy without which a country might not function to its optimum threshold. As far as the principles of a good taxation system are concerned, low cost of collection, simplicity in computation, easy payment of tax, proportional and progressive taxation, universal applicability of rates throughout the territory of the country, easy and accessible tax dispute remedies are some of the principles of a good taxation system.

Are Adam Smith’s canons of taxation absolute?

Adam Smith’s canons of taxation are not absolute, rather they are advisory and recommendatory in nature. They are a set of prescriptions to the policy formulation bodies who are involved in the formulation of tax structures. These canons help in policy formulation in such a way that the burden of tax is less felt in the mind of taxpayers.

What are other canons of taxation apart from Adam smith’s canons of taxations?

Other canons of taxation apart from Adam Smith’s canons are canon of simplicity, canon of productivity, canon of flexibility and canon of diversity. These canons are given by Charles F. Bastable.

Why are canons of taxation fundamental to any tax structure?

Canons of taxation are an indispensable part of any modern taxation system. They ensure that the tax mechanism functions in the most optimal way possible. These canons ensure that the tax system is designed in such a way, it reflects simplicity, transparency, justiciable, economically viable and lastly productive.

Why is the canon of simplicity important ?

Canon of simplicity plays a significant role in the designing the framework of a tax mechanism. It ensures that the tax system is less complicated and computation of the tax liability is easy to calculate. A simple and easy tax mechanism is always preferred over a complex and overly complicated tax computations structure.

What is the significance of the canon of diversity ?

Canon of diversity ensures that tax burden is spread across a number of different taxes rather than on a single individual tax. A single high rate of tax is detrimental and it can also hurt public sentiments. Further, it can create dissatisfaction regarding the single high tax burden incurred on individual taxpayers. Hence, it is always necessary to distribute the tax burden among a varied number of taxes.

References

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Identifying predicate offences under the PMLA

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November 6, 2024

This article has been written by Yash Agarwal pursuing a Diploma in White Collar Crime Litigation and Specialty Legal Defense from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Table of Contents

Introduction

The offence of money laundering, as per the Oxford English, is “the concealment of the origin of illegally obtained money, which can involve foreign banks and legitimate businesses.” Going further with this definition, it can be said that the offence of money laundering is a form of financial offence that infers money that is illegally obtained by an underlying offence. To curb these types of offences, the Prevention of Money Laundering Act, 2002 (PMLA) was enacted. This act is enacted to protect the economy of the nation and with the enactment of this act, it has given immense powers to the Enforcement Directorate (ED). Under PMLA, only the ED can register any case against any person. Although any person can complain to the ED with information of money laundering, only the ED can register a case under PMLA.

Predicate offence

The most essential element in a PMLA case is the predicate offence. If PMLA can be considered a genesis, then a predicate offence can be considered as a species. No offence of money laundering can take place without a predicate offence. A predictive offence can be termed the primary crime, which generates the proceeds to a bigger crime that can be subjected to money laundering. It can also be defined as the component of a complex criminal activity. Predicate and scheduled offences are defined under Section 2(y) of the PMLA Act. The schedule provides a wide list of offences under various penal legislation, such as the Indian Penal Code, 1860, the Narcotic Drugs and Psychotropic Substances Act, 1985, the Unlawful Activities (Prevention) Act, 1967, and the Prevention of Corruption Act, 1988. The scheduled list of predicate offences are divided into 3 parts: Part A, Part B, and Part C.

Genesis of predicate offence

The intention of the legislation behind the enactment of predicate offences was not only to curb illicitly gained wealth but also to curb the income that is legally acquired but concealed with the eyes of public authority. While presenting the prevention of money laundering act bill in Rajya Sabha Mr. P. Chidambaram read that “it postulates that there must be a predicate offence and it is dealing with the proceeds of a crime. That is the offence of money-laundering. It is more than simply converting black money into white or white money into black. That is an offence under the Income Tax Act.” The reasons can be as follows:

Some individuals intend to conceal income to escape their statutory contributions, which are put in place for the social welfare of society.
Escaping income from tax authorities, be it income tax, sales tax, or excise duty, resulting in money laundering.
Some entities are involved in concealing income to avoid compliance with various industrial laws such as the Minimum Wages Act, Factories Act, etc.

Mapping predicate offences: a follow up to predicate offences

Predicate offences are classified by the legislation in different schedules consisting of three parts: Part A, Part B, and Part C. These schedules have undergone several amendments by expanding their scope and incorporating new offences.

Part A: This section deals with the offences that are under Indian Penal Code, 1860. From offences like criminal conspiracy, kidnapping for ransom, to forgery of a valuable security, Part A deals with all the criminal activities.

Part B: In this section, offences under the Customs Acts become predicate offences if their value exceeds one crore rupees. This section specifically deals with the offences under customs duties and regulations.

Part C: This section deals with the offences that involve cross-border implications and are specified in Part A of the schedules, along with the offences against property under Chapter XVII of the Indian Penal Code. Additionally, it deals with the offence of the wilful attempt to evade any tax, penalty or interest referred to in Section 51 of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

Significance of a predicate offence and its relationship with money laundering

The essence of predicate offences in the context of PMLA lies in their pivotal role in the larger framework of money laundering. A predicate offence acts as the foundation on which money laundering is built. For e.g., offences under Part A such as the offence of kidnapping for ransom under Section 354A, here the predicate offence is kidnapping for ransom, which will result in the receiving of illicit money from ransom, which will result in money laundering. The illicit gains generated by the predicate offence become the ‘dirty money’ that can be laundered to make it appear legitimate. A predicate offence is necessary to find out the source of that ‘dirty money’. In the case of Kavitha G. Pillai vs. The Joint Director (2015), the importance of predicate offence is laid down. This case highlighted that a predicate offence is the underlying criminal activity that generates proceeds, which, when laundered, gives rise to the offence of money laundering. This alignment between predicate offences and money laundering emerges as an integral aspect of maintaining international standards and coherence within the legal framework. The Apex Court in the case of Pavana Dibbur vs. The Directorate of Enforcement (2013) has held that it is not necessary to have a linkage between the date of the predicate offence and the commitment of money laundering because there can be ample time between the commission of a predicate offence and the time when the money is brought back to the system.

Case laws

Chidambaram vs. Directorate of Enforcement

In 2019, the Supreme Court of India ruled on the case of Chidambaram vs. Directorate of Enforcement, addressing the issue of bail in relation to allegations of money laundering connected to predicate offences. The case involved senior politician P. Chidambaram, who was accused of money laundering based on predictive offences related to corruption.

The court delved into the evidentiary requirements necessary to establish a predicate offence and the subsequent laundering of proceeds. The judgement emphasised the significance of the Enforcement Directorate (ED) presenting prima facie evidence of both the predicate offence and the laundering activities to justify detention.

During the trial, the prosecution needed to demonstrate that Chidambaram had committed the predicate offence, which in this case was corruption. To establish this, the prosecution had to present evidence that Chidambaram had engaged in corrupt practices, such as accepting bribes or misusing his position for personal gain.

Once the predicate offence was established, the prosecution then had to demonstrate that the proceeds from that offence were laundered. This could involve showing that Chidambaram had transferred or concealed the money or assets obtained through corruption, with the intention of disguising their illicit origin.

The court highlighted the need for the ED to present strong evidence linking Chidambaram to both the predicate offence and the subsequent money laundering activities. This could include financial records, witness testimonies, or other forms of evidence that establish Chidambaram’s involvement in the crimes.

The judgement in Chidambaram vs. Directorate of Enforcement set an important precedent for future cases involving money laundering. It emphasised the importance of due process and the need for the prosecution to present sufficient evidence to justify detention in money laundering cases.

The case also raised questions about the role of the ED in investigating and prosecuting money laundering offences. Critics argued that the ED’s broad powers could lead to abuse and that there needed to be more robust safeguards to protect the rights of accused individuals.

Overall, the Chidambaram vs. Directorate of Enforcement case highlighted the complex legal and evidential issues surrounding money laundering offences and the need for a balanced approach to ensure both the effective investigation of such crimes and the protection of individual rights.

Rohit Tandon vs. Enforcement Directorate (2018)

This case involved the alleged laundering of proceeds derived from a predicate offence of tax evasion and other financial irregularities. The Delhi High Court discussed the scope of the ED’s powers to investigate and attach properties linked to predicate offences. The judgement emphasised that the prosecution must establish a clear connection between the predicate offence and the alleged money laundering activities.

Satyam Computer Services Ltd. vs. Directorate of Enforcement (2011)

In this case, the Andhra Pradesh High Court dealt with the infamous Satyam scam, in which the company’s founder was accused of embezzling funds and falsifying accounts. The court examined the concept of predicate offences in detail, noting that fraudulent activities and misappropriation of funds constituted predicate offences under the PMLA. The judgement clarified the process of tracing the proceeds of these offences and the subsequent steps for prosecution under money laundering laws.

State of Maharashtra vs. Ishrat Ali Rizvi (2019)

This case involved the investigation of organised crime activities, which were considered predicate offences under the Maharashtra Control of Organised Crime Act (MCOCA). The Bombay High Court discussed the interrelation between predicate offences and the charges of money laundering. The judgement provided insights into how proceeds from organised crime are treated under the PMLA and the evidentiary standards required to prove such offences.

Enforcement Directorate vs. M/s Obulapuram Mining Company Pvt. Ltd. (2017)

In the case of Enforcement Directorate vs. M/s Obulapuram Mining Company Pvt. Ltd. (2017), the Supreme Court of India addressed the significant issue of illegal mining activities being used as predicate offences for money laundering. The court’s primary focus was on examining the connection between illegal mining operations and the subsequent laundering of proceeds derived from these activities.

The judgement delved into the procedural aspects of attaching properties obtained through criminal activities, emphasising the need for a clear and established link between the predicate offence (illegal mining in this case) and the laundered money. The court recognised the importance of distinguishing legitimate business activities from those involving illegal proceeds.

The Supreme Court’s judgement in this case set a precedent for how predicate offences related to illegal mining should be treated in the context of money laundering cases. It emphasised the necessity of thoroughly investigating the source of funds and establishing a direct connection between the criminal activity and the laundered money. Furthermore, the court highlighted the significance of following due process and adhering to the principles of natural justice while attaching properties believed to be derived from illegal activities.

The judgement also underscored the importance of international cooperation in combating money laundering. It acknowledged the global nature of financial crimes and emphasised the need for collaboration among nations to effectively address the problem of illicit financial flows. The court recognised the value of mutual legal assistance treaties and international conventions in facilitating the exchange of information and evidence related to money laundering investigations.

Overall, the Supreme Court’s decision in Enforcement Directorate vs. M/s Obulapuram Mining Company Pvt. Ltd. (2017) provided valuable guidance on handling cases involving illegal mining as predicate offences for money laundering. It established essential principles for investigating and attaching properties associated with such criminal activities, highlighting the significance of procedural fairness and international cooperation in combating money laundering effectively.

Sanjay Kansal vs. Assistant Director, Directorate of Enforcement

Sanjay Kansal vs. Assistant Director, Directorate of Enforcement is a significant case from 2023 that delves into the intricate relationship between becoming an approver in a predicate offense and its implications on subsequent proceedings under the Prevention of Money Laundering Act (PMLA).

The central issue debated in this case was whether the evidence provided by an accused who becomes an approver in a predicate offense could be utilized in a money laundering proceeding against that same individual. The Delhi High Court, in its order, delivered a landmark ruling, holding that such evidence cannot be used for the purpose of a money laundering proceeding.

The court’s reasoning hinged on the principle of fairness and the right to a fair trial. It recognized that an accused who becomes an approver does so in exchange for certain concessions, including the promise of pardon in the predicate offense. Allowing the evidence given by the approver to be used against them in a subsequent money laundering proceeding would undermine the spirit of this arrangement and potentially expose them to double jeopardy.

Furthermore, the court highlighted the distinct nature of money laundering proceedings under PMLA. It emphasised that PMLA is a special statute aimed at combating the menace of money laundering and that the evidentiary requirements and procedures in such proceedings may differ from those in regular criminal cases. Therefore, the court reasoned, the evidence provided by an approver in a predicate offence cannot be automatically transposed and utilised in a PMLA proceeding.

In addition to this key legal principle, the Delhi High Court also considered the specific circumstances of the case before it. The accused, Sanjay Kansal, had become an approver in a predicate offence and had fulfilled the conditions laid down in Section 45 of PMLA. Based on these factors, the court granted him bail.

The Sanjay Kansal judgement serves as a valuable precedent in the interpretation of PMLA and its interplay with other criminal laws. It reinforces the importance of ensuring a fair and just process for individuals who choose to cooperate with authorities as approvers and provides clarity on the evidentiary parameters in money laundering proceedings.

Conclusion

It can be concluded that the predicate offence is necessary for prosecuting the case of money laundering against any individual by the Enforcement Directorate. The legislative intent to curb both illegal gains and concealed legal income within the framework of PMLA law has shown the intention to combat financial wrongdoings. To curb these illegal gains and concealed legal income, the importance of a predicate offence cannot be neglected, as without a predicate offence, these individuals cannot be prosecuted with the due course of law. As this law will evolve with time, the importance of predicate offences cannot be neglected at any stage. Traversing the intricacies of predicate offences highlights the nuanced yet essential interaction among legality, illegality, and the quest for justice, which is yet to evolve further.

References

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November 6, 2024