DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY,

SABBAVARAM, VISAKHAPATNAM

CORPORATE LAW I

INTER-CORPORATE TRANSACTIONS IN GROUP

COMPANIES

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CONTENT

• Introduction
• Provisions of Company Law, 1956
• Provisions of Company Law, 2013
• Concept of Group Companies
• Concept of Inter-corporate Transactions
• Separate Entity of Holding & Subsidiary in US & India
• Rise of Mega Subsidiaries
• Inter-corporate Transactions in Insurance Holding Cos
• Taxation in Inter-corporate Transactions
• Conclusion

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Introduction

The legislation relating to companies has undergone a tremendous change with the enactment
and enforcement of the Companies Act, 2013. The new rules with regard to group companies
stipulate that a “group company” is one where two or more companies can exercise 26% of
voting rights, or can appoint majority of the board members in the other company.1 Where a
holding company is linked with a subsidiary or subsidiaries to form larger and more complex
economic units, it has become usual to refer to these companies as a "group". The basic
characteristic of such a group is that the management of the different and independent holding
and subsidiary companies comprising the group is coordinated in such a way that they are
managed on a central and unified basis in the interests of the group as a whole.2

Inter-corporate Transaction refers to Inter-corporate investments in which investments is made

by one body corporate in the shares and debentures of another body corporate.3 So the project
deals with how the transactions takes place between a holding and its subsidiary, keeping in mind
the permissible number of the layers of the holding company by various provisions of the
Companies Act, 2013.

Provisions of Companies Act, 1956

Section 372-A was brought about in 1998 by merging sections 370 and 372. However, this
application of this section was very restricted. The section was applicable only to those public
limited companies that dealt with loans, guarantees and investment/purchase of shares in another
body corporate. The board of directors could exercise their power for making inter-corporate

1Reserve Bank of India, Foreign Direct Investment (FDI) in India – definition of ‘group company’, RBI/
2013-14/356; A.P. (DIR Series) Circular No.68, (11:41 PM, 11/10/2018), https://www.rbi.org.in/Scripts/
NotificationUser.aspx?Id=8551&Mode=0.

2 D.H. Botha, Recognition of the group concept in Company Law, (1982) 15 De Jure 107 at 108.

3 Report of the High Powered Expert Committee on Companies Act and MRTP Acts (9) – 1978.

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loans or investments up to 60% of the paid up capital and free reserves of the company or 100%
of its free reserves, whichever was higher.

However, there were certain drawbacks of this section. There was no restraint in investments into
a wholly-owned subsidiary or loans made / guarantees given by a holding company to its wholly
owned subsidiary. 4

Odhams Press Ltd. v. Cook5

Here it was held that it is tempting to treat what I called the subsidiary co. as if it was part &
parcel of the appellants, but two company are separate taxable persons. The trade or business of
one Co., even though it may affect very closely the trade or business of another, is not the same
as that other’s trade or business.”

Provisions of Companies Act, 2013

In order to undo the disadvantages or the drawbacks under the provisions of the Companies Act,
1956, sections 185 and 186 were introduced.

Section 186 refers to the investment made by the company in the manner of what, where and
what amount. With respect to the holding and subsidiary relation between the companies, it
imposes an embargo on multi-layered Investments.6 Section 186(1) restrains a company from
making investments beyond two layers of subsidiary, subject to certain exceptions. The fact that
investments can be made through multi-layered structures gives the investor-company a much
needed flexibility in the process of planning and structuring the investments. Sub-section (1) of
section 186 is therefore constrictive in its approach.

4 Government of India, The Second Annual Report on the Working and Administration of the Companies Act, 1956.

5 (1941) 9 I.T.R. 92.

6 Ministry of Corporate Affairs, Government of India, Public Notice, No. 3/3/2017-CL-I, (12:09 AM, 11/10/2018),
http://www.mca.gov.in/Ministry/pdf/Notice_29062017.pdf.

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The Concept of ‘Group Companies’

Where a holding company is linked with a subsidiary or subsidiaries to form larger and more
complex economic units, it has become usual to refer to these companies as a ‘group of
companies’. The basic characteristics of such group is that the management of the different and
independent holding and subsidiary companies, is coordinated in such a way that they are
managed on a central and unified basis in the interest of the group as a whole. This management
on a unified basis is possible because of the control, which the holding company exercises over
the subsidiaries or sub subsidiaries. This control make it possible that the group is managed as an
economic unit, that means holding and subsidiaries company are not the complete economic
independent.

As a result of this economic inter-relationship and the control factor, appear to consider that for
certain purposes the importance of the economic unit of the group as a whole overrides that of
the different economically independent holding and subsidiary companies.

The judgment given by the House of Lords in Salomon v. Salomon & Co. Ltd. is of great
significance in establishing the basis for the legal relationship of the holding company as a
member of its subsidiaries. The following principles are relevant to derive the legal relationship
that exists between the holding and subsidiary companies:
i. In the absence of fraud, the holding company, as, incorporator or otherwise of the
subsidiary, is a separate legal persona possessing its own interests, rights, assets and
liabilities. By the same token will the subsidiary also be a separate legal persona with
its own interests, rights, assets and liabilities.

ii. The mere fact that the holding company is able to control the subsidiary or holds all
the shares in it does not constitute the subsidiary its agent.

As a consequence of the separate personalities of the holding and subsidiary companies the
subsidiary itself and not its holding company will have to institute action and enforce its rights
but subsidiary cannot either institute action to enforce the rights of its holding company.

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Velayudhan (M) & others v. Registrar7

Here, also appointment of majority of director is given by way of the agreement. Here, the word
of Prof. Gower were cited as “control is a matter of degree, ranging from complete legal control
for all purpose over a WOS to de facto control which was exercisable by the existing
management. Here, court held that actual control to be exercised but legal control may be
exercised through agreements.

Concept of Inter-company Transaction

Most economic transactions involve two unrelated economic entities, although transactions may
occur between units of one economic entity. The same is known as inter-company transaction
within the same group of companies. These transactions occur for a variety of reasons, typically
occurring as a result of the traditional business relationships that exist between the units of the
entity. These units could also be the parent and a subsidiary or two subsidiaries. An inter-
company dealing is recognised within the money records of each units of the entity as if it were
associate arm’s-length dealings with associate unrelated party.8

Downstream Transaction: an inter company dealing flowing from the parent to the subsidiary.
During this variety of dealing, the parent company records the dealing and applicable profit or
loss. The dealing is clear or visible solely to the parent company and its stakeholders, to not the
subsidiaries. Example of a downstream dealing is that the parent company marketing associate
degree plus or inventory to a subsidiary.

Upstream Transaction: an inter company dealing flowing from the subsidiary to the parent. The
subsidiary records the dealing and connected profit or loss. For instance, a subsidiary may
transfer an executive to the parent company for an amount of your time, charging the parent by

7 (1980) 50 Comp Cas 33 Kar.

8 Intertax, Vol. 31, Issue 10 (October 2003), pp. 349-352

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the hour for the executive’s services. During this case, majority and minority interest
stakeholders will share the profit or loss as a result of which they share possession of the
subsidiary.

Lateral Transaction: an inter company dealing flowing from one subsidiary associate company
to a different. The subsidiary or subsidiaries record a lateral dealing together with the profit or
loss, which is similar to accounting for an upstream dealing. For example is once one subsidiary
provides data technology (IT) services to a different subsidiary for a fee.

Concept of Separate Entity of Holding & Subsidiary Corporations in US & India

CORPORATE LAWS IN UNITED STATES

The main point for consideration is that the effect of the connection between a parent corporation
and its subsidiary branches. The other point for consideration is also that control exercise by the
corporation on its subsidiaries will involve any type of the responsibility for their acts and
contracts as consider subsidiaries as an agent of corporation.9 


A foreign company can be personally served with process only when it is doing business within
in a state.10 Recently, Supreme Court of the United States consider the issue i.e. whether the use
of subsidiary to a transact business in a state will subject the parent company to the jurisdiction.11
In the Cannon Mfg. Co. v. Cudahy Packing Co,.12 the aforementioned issue was discussed. The
respondent was a corporation based in Maine. It used the instrumentality to the market its
product within the State of North Carolina as a Cudahy Packing company of Alabama. The
goods were packed by defendant in Iowa and shipped direct to the dealers for which the Alabama

9 14, Henry W. Ballantine, Separate Entity of Parent and Subsidiary Corporations, Calfornia Law Review (1), p. 2.

10 14, Henry W. Ballantine, Separate Entity of Parent and Subsidiary Corporations, Calfornia Law Review (1), p.
2.

11 Cannon Mfg. Co. v. Cudahy Packing Co. (1925) 69 L. Ed.

12 267 U.S. 333 (1925).

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Corporation collected the price. All transactions between the two corporations were represented
by entries in their respective books.

The Court held that it was an established law that the use of a subsidiary does not necessarily
subject a parent corporation to the jurisdiction of the state. A subsidiary that transacts business in
a state, even if it is a mere adjunct or instrument of a foreign corporation that owns and controls
it, the same is a separate entity for the foreign corporation not to do business there. The Court
distinguishes cases related to the matter of jurisdiction over a foreign corporation from other
kinds of cases in which there is an attempt to hold the parent responsible for an act or omission
of its subsidiary, or to impose on a subsidiary the liability of the parent company.

In another case,13 it was held by a Court in Texas that a foreign railway company might be sued
in a state or country where they doing business through instrument of a domestic corporation
which operated a line of railway connecting with the foreign corporation's line. The foreign
corporation was considering doing business in the state through a local company as its
representative. The suit for personal injury by process on officer of local company and the parent
corporation was also held liable for the same if the parent corporation is not deemed to be doing
business through its subsidiary in the eye of law.

CORPORATE LAWS IN INDIA

A Company incorporated under the statute has an identity of its own, which is different from its
members and shareholders, etc. A subsidiary company is an incorporated entity which has an

13 Buie v. Chicago R. I. & P, Ry. Co. (1901) 95 Tex. 51, 65 S. W. 27; Central Life Etc. Co. v. Smith (1916) 236 Fed.
170, commented on in 15 Michigan Law Review, 442; In re San Antonio L. & I. Co. (1916) 228 Fed. 984; Colonial
Trust Co. v. Montello Brick Works (1909) 172 Fed. 310; see R. H. Herron Co. v. West Side Elec. Co. (1912) 18 Cal.
App. 778, 124 Pac. 455. In a later Texas case, however, this doctrine was repudiated in view of the fact that it had
been otherwise decided by the United States Supreme Court, which is the final authority upon the question of
jurisdiction.

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identity of its own, which shall be separate from its holding company a ‘subsidiary’14 is as an
entity of which the holding company controls more than one-half of the total share capital (either
directly or indirectly) or controls composition of the board of directors.

Oriental Industrial Investment Corporation Ltd. v. UOI15

In this case, OIICL held less than 10% of equity share of Poonam Hotels Ltd. this was within the
prescribe limit under section 372 of CA 1956. OIICL entered into an agreement with PHL and by
this agreement Article of Association is amended and full and absolute right & power given to
OIICL for appointment of majority of the board of director. Later, OIICL acquired the share
capital in PHL which was to 88%. The question arose whether this amendment is contrary to the
provision of 255, 256, 257 & 372(4) of CA 1956. Pennington Company Law provides for the
dual test16 to determine whether a company is a subsidiary of another. The Court held that PHL is
a subsidiary of OIICL because power of appointment of majority of director is given by a

14(Section 2(87) of Companies Act 2013)

Unless the context requires otherwise, the term ‘subsidiary company’ or ‘subsidiary’ wherever appearing in the
Companies Act, 2013 shall have the following meaning:

“Subsidiary company” or “Subsidiary”, in relation to any other company (that is to say the holding company),
means a company in which the holding company –
• (i) controls the composition of the Board of Directors; or
• (ii) exercises or controls more than one-half of the total share capital either at its own or together with one
or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries
beyond such numbers as may be prescribed.
Explanation – For the purposes of this clause, –
• (a) a company shall be deemed to be a subsidiary company of the holding company even if the control
referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
• (b) the composition of a company’s Board of Directors shall be deemed to be controlled by another
company if that other company by exercise of some power exercisable by it at its discretion can appoint or
remove all or a majority of the directors;
• (c) the expression “company” includes any body corporate;
• (d) “layer” in relation to a holding company means its subsidiary or subsidiaries;

15 (1981) 51 Comp Cas 487 (Del).

16 A body corporate is to be regarded as a subsidiary of another holding company if the holding company
➢ (1) control the composition of its BOD in the sense that it has power to appoint/remove majority of the
board, or
➢ (2) hold more than half of its “equity Share capital”
Control Arise either From
➢ Holding of shares giving sufficient voting rights, or
➢ Special rights conferred by Comp. AoA, or
➢ By a Contract (empowering HC to appoint BOD to SC’s board).

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contract. So, this comes under the preview of Sec. 372(14) on which exception is given on above
mention section.

Velayudhan (M) & Ors. v. Registrar 17

The appointment of majority of director is given by way of the agreement. Here, the word of
Prof. Gower were cited as “control is a matter of degree, ranging from complete legal control for
all purpose over a WOS to de facto control which was exercisable by the existing management.
Here, court held that actual control to be exercised but legal control may be exercised through
agreements.

Smith Stone & Knight Ltd. v. Birmingham Corporation18

Here, SSL have a subsidiary named “Birmingham waste Co. Ltd. (BWC). Here Birmingham
corporation issued a compulsory license regarding purchasing of land of BWC. Here, BWC did
not own the land and not entitled for the compensation according to the Birmingham corp. here
Lord Atksin lifted the corporate veil to know for what purpose BWC incorporated. Here, Court
held that SSK (HC) didn’t transfer the ownership of the land, so they entitled for the
compensation.

Hackbridge -Hewittic &Easum Ltd (HHEL) v. G.E.C. Distribution transformer Ltd.19

In this case, HHEL is subsidiary of Hackbridge & Hewittic Electric Co. (HHEC) in India. HHEC
was incorporated in England. Later HHEC enter into an agreement with General Electric Co.
(GEC) for exchange of technology and HHEL become subsidiary of GEC. But here, no exchange
was done between the parties. Here Court lifted the corporate veil to know whether this
agreement is sham or not. Court held that agreement is mere sham and never enforced. So,
HHEL cannot be a subsidiary of GEC.

17 (1980) 50 Comp Cas 33 Kar.

18 (1939) 4 All ER 116.

19 (1992) 74 Comp Cas 543.

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The Rise of Mega Subsidiaries and its Impact on the Corporate Structure 20

In the light of the background of US reveals the emergence of the mega subsidiaries and its
impact on the corporation and business of the country. It is of the view that the due to the recent
legal and economic developments taking place in and around the world, the subsidiaries has
played a sizable amount of contribution to the country’s business. The unfolding of the study
explores the implications of such development through eyes of law.

An Analysis of the Classification of Mega Subsidiaries

The classification of the mega subsidiaries as been done into two categories namely:
a) where the parent company owns all of the stock ,referred as wholly owned subsidiary,
b) where in the corporation only minority interest is owned by the public, rest all by the
parent company.
However, the author majorly focuses on the former classification. The examples of the same are
Bank of America, Continental Illinois, the First Bank Of Chicago etc. These are wholly owned
mega subsidiaries or where the banking business is done by subsidiaries where they are the
holding companies.21

Mega subsidiaries in case of Commercial Banking

As per the then Bank Holding Company Act, 1956 stated that it would be illegal to the parent
banking corporation where it holds two or more banks (as subsidiaries) to engage in any non
banking business or any incidental activities. However, the drawback of the above regulation
which was grossly misused was that above does not applies in the case the parent company has
only one subsidiary i.e. if the parent company is only “one bank holding company”. Taking

2084, Melvin Aron Eisenberg, MEGA SUBSIDIARIES: THE EFFECT OF CORPORATE STRUCTURE ON
CORPORATE CONTROL,p.2, 1577,HARVARD LAW REVIEW.

2184, Melvin Aron Eisenberg, MEGA SUBSIDIARIES: THE EFFECT OF CORPORATE STRUCTURE ON
CORPORATE CONTROL,p.3, 1577,HARVARD LAW REVIEW.

11
advantage of it, the parent company turned themselves into the wholly owned subsidiaries,22
which was created by them only escaping all the restriction of the Act. Moreover, another
dimension of advantage was the parent company themselves did not engage in banking activities
but through the subsidiaries and escaped the liability and the parent company were free to engage
into any other business, either directly through themselves or through its subsidiaries indirectly.23
Therefore, other companies invested heavily in the activities which proved most successful to
them. One of the benefits was that it could invest into the subsidiary which were not associated
into baking, free of any restriction, which otherwise would have been applicable to the financing
of a particular. As a result of this, there was a tremendous increase of such holding companies
which were mostly formed by the very large banks.

The Counter Back: Amendment

To curb the mushrooming of such banks in the country and also the blatant violation of law, an
amendment24 was made in the Bank Holding Company Act in 1970, which brought within its
purview the one bank holding company. The benefit of this amendment was that such holding
company converted them into multi-bank holding company and prevented these from engaging
into any non-banking activities.25

Inter-company Transactions: Insurance Holding Companies26

2284, Melvin Aron Eisenberg, MEGASUBSIDIARIES: THE EFFECT OF CORPORATE STRUCTURE ON

CORPORATE CONTROL, Harvard Law Review, p. 6.

2384, Melvin Aron Eisenberg, MEGASUBSIDIARIES: THE EFFECT OF CORPORATE STRUCTURE ON

CORPORATE CONTROL, Harvard Law Review, p. 6-7.

24 22 Bank Holding Company Act of I956, 4(a), I2 U.S.C. I843 (a) (1964), as amended, Pub. L. 9I-607, 39 U.S.L.W.
II5 (Dec. 3I, 1970).

2584, Melvin Aron Eisenberg, MEGASUBSIDIARIES: THE EFFECT OF CORPORATE STRUCTURE ON

CORPORATE CONTROL, Harvard Law Review, p. 8.

26
20, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,
American Bar Association.

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There have many uses and abuses of the transactions that take place between the parents holding
and its subsidiaries. The bottom line of the argument is that there is negation of the holding
company to be beneficial to public interest and in the growth of the nation. 27 However, the parent
company is keener to make profits and is nowhere concerned with the success or failure of the
subsidiary company. They are more interested in making profits through the inter-corporate
transactions. Also in the light of the current regulations which controls the inter-corporate
transaction between the holding and the subsidiary is framed to be benefit the holding
company.28 The present law fails to preserve the money of the insurers which they invest in such
company to cover or indemnify the risk.

The Regulations and Questionable Inter-company Transactions

The state insurance holding company laws were designed to protect and encourage the insurers’
growth and their investment in the companies.29 The statutory requirement was that the discreet
company operating within the holding company should be “walled off” i.e. should be segregated
from the parent company and other affiliates. One of the provisions of achieving such an aim was
the empowering the insurance commissioners (given power under the statute) to deny or
disapprove the “extraordinary” dividends by the subsidiaries to the holding company.30 This
would help to scrutinize the actually financial records and profit makings of both the companies
and preventing the misrepresentations done in records to make the transactions legal. Citing the
example of the erstwhile scenario, when the Great American Insurance Company had issued a
huge sum of money as a dividend to its parents none of the insurance commissioners
disapproved it. In the subsequent times, even after the enactment of the act, the subsidiaries
carried the same activities but through a little revised method. Now they avoided issuing big

2720, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 2.

2820, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 2-3.

29 Insurance Department, State of New Report of the Special Committee on Insurance Holding Companies.

30Deregulation of Bank Holding Companies and Insurance Companies: A Compari son of Two Responses to the
Growth of a Financial Services Industry (unpublished paper for the United States Treasury Department).

13
dividends and simply issuing them into little transactions. Hence, the profit making by the
holding had never subsided.

Attention has to be giving that the author does not limit himself to discuss only about the
dividends transaction but has more instance in which the holding managers at skillful at playing
bluff to the insurers like sale of the paper in the form of loans and properties to another affiliate
at inflated rates, use the subsidiaries as operational units with the intent to increase the money
amount that can be passed to the parent through its subsidiary.31 In re Baldwin United Corp.
Litigation,32 the parent had a subsidiary: National Investors Life Insurance Company (NILIC).
The United showed great profits of its subsidiary and for itself by simply moving the money
from one of its insurance subsidiary to another. It created a tax loss to hide such profits from
being taxed.33

Other manner as already stated is the exchange of the subsidiaries/affiliates papers in order to get
the money out from the insurers and simultaneously projecting its image as a financially well and
stable. This is possible because the regulators don’t require any explanation with respect to the
assets transaction. They only requirement of assets are annual statement.34

The Good Investment in Subsidiary

It has been observed that not all the investments in subsidiaries is bad or harmful investment.
Citing the example of Hart Ford Insurance Group, a subsidiary owned by ITT it invests affiliated

3120, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 5.

32 57 B.R.759

3320, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 5, 6, 8.

3420, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 8.

14
companies and through it makes up its 40% assests unlike Balwin United who invested in the
subsidiaries to evade the taxes.35

The Taxation of Inter-company Income36

The Conundrum of Legislation

In the arena of taxation when a corporation receives income through a transaction with another
corporation which is owned or controlled mostly by the same corporate raises a problem when it
comes to dividends income. The transaction can be held similar to the transaction between a
husband and wife when the individual interests are not the priority. In a instance of property
dealing amongst them the husband sells the land to wife for amount X. This creates a doubt
whether the value of the property is really X or not. In case of corporation too such things
happens and the difficulty is to find whether or not the terms of the deals were true or not.37

Before the legislation in 1935 had come up in force the corporation had to pay no tax upon
receiving dividends from another corporation. The same extended to the parent and subsidiary
holding companies too. The scheme of one tax was followed. However, in 1935, the law came in
force38 which stated the corporations receiving the dividends was a part of their gross income
and this income shall be subjected to taxes. The government had made only 10% of such income
taxable.39

Tracing the history back to 1916, it was then proposed to tax the dividend income to its entire
extent. This move was made not to increase the revenue only but also to prevent accumulation of

3520, John R. Dunne, INTERCOMPANY TRANSACTIONS WITHIN INSURANCE HOLDING COMPANIES,

American Bar Association, p. 9, 11.

36 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation.

37 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 1.

38 Revenue Act of 1935, Szo2(h), 49 STAr. 104, xo8

39 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 2,
3, 4.

15
wealth with the stakeholders of the company but can be utilised for other resourceful purposes.
However, the same was rejected and the bill was not passed then.40 The theory41 which supported
the taxation focused that the corporation as separate legal entity and thus its earning should be
taxed just like an individual’s income is taxed. The other side which denied the taxation
emphasized on the part that the taxation will hamper the interest of stockholders of parent
company whose subsidiaries shall be taxed on dividends income.42

One negative aspect of the taxing the income in the eyes of the other is such tax shall be utilized
for non revenue purposes. If such a condition continues then it will hamper the investment
between the corporations. For example, a manufacturing corporation finds it to be essential to
invest in the customer corporations, so as in furtherance of the business, along with the
investment. It would be completely undesirable to tax dividends earned out of such
‘relationship’. Also, no stricter norm should be introduced to have greater revenue generation
rather impetus must be given increase the business capital by more purchasing of stocks.43

When the matter comes to filing the income tax returns before the 1917 legislation each
corporation had to file a separate income tax return irrespective of its close relations with the
other corporation. In 1933, 44 a choice was given to the tax payer whether or not to file the
consolidated tax returns. However, a little later, the Commissioner was given the power to decide
whether a consolidated tax return is to be paid or not. 45

40 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 3.

41 The precise extent to which individual stockholders bear the burden of corporate taxes probably
varies with conditions which affect the corporation's ability to pass on a part of the tax-burden to
customers.

42 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 4.

43 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 4.

44 Revcnue Act of 1932, S45, 47 Star. 69, x56.

45 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 5.

16
The same was applicable in the case of the corporations controlling one or more corporations
directly or indirectly46 The same power was extended in the future Revenue Act of 1934.The
Commissioner used this power in variety of cases one of them being abnormal distribution of
the income where there was common ownership of several corporations. This step of
consolidated income tax proved beneficial for both the Government and to the taxpayer as
mentioned in the Finance Committee Report on the provisions of the Revenue Act 1918. 47

In 1934, Senator Borah was against the provision of consolidation and an amendment48 was
adopted stating that it was a disadvantage to the small corporations as it makes it impossible to
run their own business and as a result of which they would be compelled to accept mergers. The
author believes such a step was bad as it was against the public policy.

Status of the U.S Corporate structure from the 1930s to 2005

Another problem that was seen in the US corporate structure was existence of business group
that transacted within each other for the sole benefit to each other and they formed a pyramid
where one listed corporations holds another and had many layers.49 So the government was
convinced at taxing them on dividends abolition of consolidated tax filing and find a method to
control large pyramidal group from growing.
The pyramidal groups are explained as when a family corporation hold 51% of firm A, further it
hold 51% of B than B holds the same for 6 and so on. By 1999 large companies in the country
were basically the members of the pyramidal group and thus dominated the economy.50

46 7, Robert N. Miller, THE TAXATION OF INTERCOMPANY INCOME, Federal Income and Estate Taxation, p. 5.

47 Ibid at 29.

48 SEN. REP'. No. 558, 73d Cong., ad Ses. (1934) z7-18; z939-z (Ft. 2) CM. BULL. 599-6oo.

4919, Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Intercorporate
Dividends and Other Incisive Uses of Tax Policy, The University of Chicago Press, The National Bureau of
Economic Research.

5019, Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Inter-corporate
Dividends and Other Incisive Uses of Tax Policy, The University of Chicago Press, The National Bureau of
Economic Research, 2005, p. 3.

17
The scheme of double taxation on the inter-corporate dividends was put forth to put an end to
this pyramidal growth. In this, the recipient receiving the dividends was taxed and the dividends
are taxable for the payer as well. The same applied to the transaction when paid by one
corporation to another, although through a lower rate.51 In this way this created a tax liability on
the pyramidal groups.

Interestingly, the US pyramids were concerned more around the public utility corporation52 and
operated through the layer as high up to ten layers. However, this trend seems to see a fall around
the World War I when heavy taxes were levied to finance the war.53 Relating the scenario with
the then taxing statute of 1913 which imposed at first considered the dividend income between
parent subsidiary as any other income, was taxed. Later on, in 1918, the same income was
exempted from taxes yet again. Then again, in 1928, when there were instances of abuse of such
exemption, and where wealth used to accumulate in few hands, a blow to insurers and was
termed as menace to the investor and customer. Unfortunately, the market crashed in 1929
creating the great depression that led these groups to default on their debts which created an
impression amongst the people of the country that such groups were unstable and were majorly
the reason of the market crash.54

Now it was in 1935, the then President decided to eliminate these toxic operation of layering and
pyramidal structures of the corporate groups. It was decided to be done through taxation policy.

5119, Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Inter-corporate
Dividends and Other Incisive Uses of Tax Policy, The University of Chicago Press, The National Bureau of
Economic Research, 2005, p. 10.

52 70, FTC, Utility Corporation, Senate Document No. 92.

5319, Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Inter-corporate
Dividends and Other Incisive Uses of Tax Policy, The University of Chicago Press, The National Bureau of
Economic Research, 2005, p. 14.

5419, Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Inter-corporate
Dividends and Other Incisive Uses of Tax Policy, The University of Chicago Press, The National Bureau of
Economic Research, 2005, p. 15.

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The government proposed to tax the inter-corporations at 15% of the normal dividend tax rate as
a means to deter the companies to evade the taxes though its subsidiaries.55

Another legislation to support the decline of the pyramids was Public Utilities Holding Company
Act (PUHCA) of 1935 which banned the layering not more than two, from holding public
utilities, such as power or water companies.56 Within a few years of the above legislations, the
pyramids of the corporate group broke up and it came under the control of a small number of
holding companies which were further restricted to the layering under the above Act. Finally, by
the establishment of Securities and Exchange Commission, and increased transparency and
stronger shareholder rights, a stable corporate structure was created where the shareholders were
largely public who were willing to pay higher prices for shares.

The judgment given by the House of Lords in SALOMON v. SALOMON & Co. LTD.57, the
result arrived at there is of great significance in establishing the basis for the legal relationship
between the holding company as a member of its subsidiaries. The following principles relevant
to the legal relationship between the holding and subsidiary company can be extracted from the
decision:

i. In the absence of fraud, the holding company, as, incorporator or otherwise of the
subsidiary, is a separate legal persona possessing its own interests, rights, assets and
liabilities. By the same token will the subsidiary also be a separate legal persona with
its own interests, rights, assets and liabilities.

ii. The mere fact that the holding company is able to control the subsidiary or holds all
the shares in it does not constitute the subsidiary its agent.

5519 Randall Morck, How to Eliminate Pyramidal Business Groups: The Double Taxation of Intercorporate
Dividends and Other Incisive Uses of Tax Policy, p 18. The University of Chicago Press , The National Bureau of
Economic Research,2005

56 TitleI, sec 1B (the "Death Sentence Clause") forbids holding companies more than twice removed from an
operating subsidiary.

57 [1896] UKHL 1, [1897] AC 22

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 As a consequence of the separate personalities of the holding and subsidiary companies the
subsidiary itself and not its holding company will have to institute action and enforce its
rights, but a subsidiary cannot either institute action to enforce the rights of its holding
company.

Oriental Industrial Investment Corporation Ltd. v. UOI58

In this case, OIICL held less than 10% of equity share of Poonam Hotels Ltd. this was within the
prescribe limit under section 372 of CA 1956.

OIICL entered into an agreement with PHL and by this agreement Article of Association is
amended and full and absolute right & power given to OIICL for appointment of majority of the
board of director. Later, OIICL acquired the share capital in PHL which was to 88%.

The question is arise that whether this amendment is contrary to the provision of 255, 256, 257 &
372(4) of CA 1956.

Here, Pennington Company Law define the Dual test59 regarding whether a comp. is subsidiary
of another. Here court held that PHL is a subsidiary of OIICL because power of appointment of
majority of director is given by a contract. So, this comes under the preview of Sec. 372(14) on
which exception is given on above mention section.

58 (1981) 51 Comp Cas 487 (Del).

59 A body corporate is to be regarded as a subsidiary of another (HC) if the HC

➢ (1) control the composition of its BOD in the sense that it has power to appoint/remove majority of the
board, or
➢ (2) hold more than half of its “equity Share capital”
Control Arise either From
➢ Holding of shares giving sufficient voting rights, or
➢ Special rights conferred by Comp. AoA, or
➢ By a Contract (empowering HC to appoint BOD to SC’s board).

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Conclusion

Inter-corporate transactions in group companies have been subjected to various changes in and
around the world. A part of such transaction resulted in an asset to the world economy whereas
the other left a dent or gave a blow to the same. An analysis of the US and Indian law and rulings
speaks volumes about the same. The transaction ought to be done not only to keep the profits in
mind but interests of the shareholders and interest of the nation as well, where such practices was
quite prevalent in the US by the holding companies. A stricter role of the government and
regulations can rescue the misuse of transactions as already seen how taxing such transaction can
help to solve the problem.

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