Karnataka High Court
Commissioner Of Income-Tax vs M. Vinoda Rao And Others on 20 November, 1992
Equivalent citations: [1993]200ITR50(KAR), [1993]200ITR50(KARN)
JUDGMENT K. Shivashankar Bhat, J.
1. The two questions referred in I.T.R.Cs. Nos. 45 to 65 of 1989, under section 256(2) of the Income-tax Act ("the Act" for short), pertain to the assessment years 1977-78 to 1980-81, they read as follows :
"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in law in confirming the orders of the Commissioner of Income-tax (Appeals) who held that the provisions of section 40(b) of the I.T. Act is not applicable when the money deposited with the firm is out of the funds of the partners, and particularly when the existence of the Hindu undivided family has not been accepted ?
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in law in confirming the orders of the Commissioner of Income-tax (Appeals) who held that the provisions of section 64(1)(vii) or section 64(2) are not applicable in the assessee's case and the income accruing or arising to the spouse, minor children or the Hindu undivided family is not chargeable to tax in the assessee's hands ?"
2. The three question referred in I.T.R.C. No. 23 of 1990 pertain to the assessment year 1981-82 and they are as follows :
"1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the provisions of sections 64(1)(vii) and 64(2) are not applicable to the interest income accruing to the Hindu Undivided Family on account of the deposit made with the firm to make an addition to the individual income of the assessee ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the provisions of section 40(b) of the Income-tax Act are not applicable to the income earned by the Hindu undivided family on the deposit made with the firm ?
3. Whether, on the facts and in the circumstances of the case, the interest income earned by the Hindu undivided family on account of the deposit made with the firm should be treated as the income of the assessee applying the principle laid down by the Supreme Court in the case of McDowell and Co. Ltd. holding that the entire transaction was a device to avoid tax ?"
3. The first two questions are substantially the same; the third question purports to raise a question of law, under the same set of facts ultimately leading to the results sought to be reached by the Revenue under the first two questions.
4. M/s. Mangalore Ganesh Bedi Works is a firm. M. Vinoda Rao. M. Viswanatha Rao, M. Suresh Rao, M. Janardhana Rao and M. Ananda Rao are all partners of the said firm. The firm in all had 13 partners. The firm in all had 13 partners. The five partners referred to had withdrawn funds lying in the capital account of the firm which were not earning any interest and advanced the same to their respective wives, minor children and joint families at a nominal rate of 1 per cent. per annum. Thereafter, the same funds were deposited with the firm by the wives, the minor children and joint families and the firm had interest to them at the rate of 15 per cent. per annum. The Income-tax Officer disallowed the interest in each of years under consideration in the hands of the firm and brought to tax the amounts in the hands of each of the partners. In the case of M/s. Mangalore Ganesh Beedi Works, i.e., the firm, the Income-tax Officer, in the assessment year 1980-81, had made the following disallowances under section 40(b) :
(Rs.)
(i) The interest paid to the minor children of the partners 8,76,678
(ii) The interest paid to HUFs of which the partners are the kartas 7,35,041
(iii) The interest paid to wives of partners 5,42,705
-----------
21,54,424
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5. The Commissioner (Appeals), after stating the facts above referred to, held that no disallowance was permissible, by his order dated March 8, 1984, in the case of the firm. In the case of each of the partners, for the assessment years 1977-78, 1978-79 and 1979-80, the Income-tax Officer had made reassessments under section 147 and included similar interest amounts. For the assessment year 1980-81, the amount was included in the original assessment itself. Each of the partners appealed and the Commissioner (Appeals) passed orders on March 15, 1984, deleting the additions. The contentions of the Revenue before the Appellate Tribunal were that (a) a loan transaction is a transfer within the meaning of section 64(1)(vii) so that the income accruing therefrom was to be taken as the income of the partner himself, (b) under section 64(2), the income accruing to the joint family should be deemed to have accrued to the partner, (c) in the alternative, the loan was not a transfer at all so that the income accruing to the wives, minor children and joint families should be deemed to be the income of the partners under section 64(1)/ section 60 and (d) consequently, section 40(b) applied to the facts of the case and the income which accrued or should be deemed to have accrued to the partner should be added to the income of the partner and consequently should be disallowed in computing the total income of the firm. The Tribunal observed that in the case of one of the partners, M. Ananda Rao, the matter had come up to the Tribunal for the assessment years 1969-70 and 1970-71 and the Tribunal in I.T.A. Nos. 415 and 416/Bang/1971-72 dated August 1, 1972, had rejected all the contentions of the Revenue and that order had become final. The Tribunal, therefore, was of the opinion that there was no need to differ from the same. The Tribunal also held that the contentions of the Revenue were not tenable in any view of the matter. All the appeals of the Revenue were dismissed.
6. In I.T.R.C. No. 23 of 1990, the assessee is one of the partners of the said firm who had withdrawn funds from the capital account of the firm which were not earning any interest : thereafter he advanced the same to the HUF of which he was the karta at a nominal rate of 1 per cent. per annum. The HUF deposited the said amount with the firm and earned interest at 15. per cent. per annum. For the first time before the Appellate Tribunal, the Revenue contended that the entire transaction should be viewed in the light of the decision of the Supreme Court in McDowell's case . The Appellate Tribunal held that "the question of device cannot arise unless there is evidence to show that the income that is sought to be evaded was, in fact, the income of the assessee" and that there was no dispute that the income which is sought to be added to the total income of the assessee "certainly arose only to the HUF which was the legal owner of the income, and, therefore, the question of any device for avoiding the tax on income of assessee does not arise at all."
7. The question under section 40(b) is now concluded in the very assessee's case in CIT v. Mangalore Ganesh Beedi Works . The Explanations inserted in section 40(b), by the Taxation Laws (Amendment) Act, 1984, were held to be declaratory of the law, enacted to settle the controversy caused by conflicting decisions of the various High Courts as to the scope of section 40(b). At page 88, the Bench concluded thus :
"(1) Section 40(b) did not affect the payment of the sums referred to therein made by the firm to a partner, when such a payment to the partner was only a payment in its physical sense, but the real recipient was someone else; the real legal nature of the payment has to be the criterion to consider the applicability of section 40(b).
(2) There was real and substantial doubt as to the scope of section 40(b) which was remedied by the insertion of the three Explanations by the Amendment Act, 1984.
(3) The Explanations convey the real meaning of section 40(b) from the very inception of the said section. By applying the Explanations to consider the scope of section 40(b), the court will be advancing the real purpose of the Explanations. This is not a case of unduly stretching the amendment to make it retroactive, in the sense retroactivity is normally understood, Explanations are to be applied in the manner in which, normally, a 'legislative Explanation' is understood."
8. Hence the first question in I.T.R.Cs. Nos. 45 to 65 of 1989 and the second question in I.T.R.C. No. 23 of 1990 are answered in the affirmative and against the Revenue.
Re : Sections 64(1)(vii) and 64(2) :
9. Learned counsel for the Revenue contended that the loan resulted in a transfer, and, therefore, in all these cases, the loans advanced by the individual partners to their respective spouses, minor children or the HUF came within the purview of section 64 of the Income-tax Act. It is necessary to not that in no case the genuineness of the transaction has been doubted by the Revenue; the plea is raised purely as a question of law on the assumption that loan transactions were genuine. Therefore, the only question to be considered is whether loan is a "transfer".
10. The expansive definition of the term "transfer" under section 63 does not govern the provisions of section 64; this is quite clear from the opening clause of section 63. Though section 64 is in the same Chapter along with sections 60 to 63 and 65, the term "transfer" is to be understood in its normal sense in section 64 and the extended meaning given to the said term for the purposes of sections 60 to 62 cannot be applied while construing section 64. When the stature is quite clear and explicit as to its intention with regard to the meaning to be given to a word, confining the stretched meaning only to a few provisions, it is not possible for the court to extend it to other provisions.
11. The distinction between terms "transfer" and "loan" could be appreciated by comparing the "act of transfer" with the act of "lending". In the former case, some legal interest is created in the transferee over the subject-matter of the transfer, while, in the case of lending, except a possessory interest - which may be momentary also no other interest is created. In the case of immovable properties, a distinction of this sort is easily noticed by comparing a lease with a licence. When money is lent, the debtor is not expected to return the same coins or currency notes; he had to return an equivalent worth of money; in the meanwhile, the debtor is free to use loan in whatever manner he likes; the investments made by utilising the loan need not necessarily be disturbed at the time of returning the loan.
12. Reference to the Oxford Dictionary in no way advances the case of the Revenue. The basic idea is "conveyance from one person to another of property". Even according to the dictionary "to transmit, transport; to give or hand from one to another", are some of the meanings given in the dictionary. Law Lexicon, again, show that "transfer" means "to convey; to make over from one to another". Some sort of conveying of "right" is implicit in the word "transfer".
13. The decision of the Supreme Court in Tulsidas Kilachand v. CIT arose out of a trust created by the assess; the assessee continue to be the trustee, while the beneficiary of the income from the trust property was his wife. The property was certain shares. The assessee contended that section 16(1)(c) of the Indian Income-tax Act, 1922, was not attracted to the case (this was similar to the present section 63). This contention was not accepted and the income from the trust property was included in the assessee's income. The assessee's contention that there was no transfer at all was not accepted. At page 6, the Supreme Court held thus :
"The contention that there was no transfer at all in this case is not sound. The shares were previously held by Mr. Tulsidas Kilachand for himself. After the declaration of trust by him they were held by him not in his person capacity but as a trustee. No doubt, under sections 5 and 6 of the Indian Trusts Act, if the declared of the trust is himself the trustee also, there is no need that he must transfer the property to himself as trustee : but the law implies that such a transfer has been made by him, and no overt act except a declaration of trust is necessary. The capacity of the declared of a trust and his capacity as trustee are different and, after the declaration of trust, he holds the assets as a trustee. Under the Transfer of Property Act, there can be a transfer by a person to himself or to himself and another person or person. In our opinion, there was in this case a transfer by Mr. Tulsidas Kilachand to himself as a trustee, though there was no formal transfer.
The assessee also stresses the words 'any person or association of person' in section 16(3)(b) and contends that such a person must be other than the husband who transfers. The word 'any person' is wide enough to include the husband when he transfers property to himself in another capacity. The change of capacity makes him answer the description 'any person'. In our opinion, this deed must be regarded as involving a transfer by the husband to a trustee, and, even though the husband is the same individual, in his capacity as a trustee he must be regarded as a person distinct from the transferor."
14. This decision in no way aids the Revenue's case before us. Denuding himself of the title to the shares, by the assessee, and vesting it is in the trust, was an act of "transfer". Law recognises a dual capacity in a person, so that he can interact in different capacities through himself.
15. The above decision to some extent supports the case of the assesses before us. It shows that an assessee may act on his behalf, as well as on behalf of his minor children in the same transaction. He acts for himself and at the same time acts as natural guardian of his minor children; he may also act as the karta of his HUF. All these three distinct legal capacities are recognised in the assessee which he may exercise in respect of a single transaction.
16. R. K. Murthi v. CIT [1961] 42 ITR 379 is a decision of the Madras High Court. The reference arose regarding section 16(3) of the Income-tax Act. The husband had lent money to the wife to pay off towards the purchase of certain shares. The main question was whether the assessee had transferred shares to his wife directly or indirectly. It was held that no such transfer was involved. The relevant observation of the Bench is at page 388 :
"No question of a transfer of the husband's assets, direct or indirect, could arise. Title to the shares vested on the date of transfer; there being no intention by the husband to provide the purchase money on that date, no question of transfer of any of his assets can arise. If subsequently the husband advanced monies for discharging the obligation undertaken by the wife, such conduct could at best amount to an intention to lend that sum of money for her use on that date, but that indirectly transferred by the husband. It is now found that the payments made by the husband to Mr. Jackson had ultimately been recouped out of the dividends obtained by the wife from Messrs. Taylor and Co. For the purpose of the application of section 16(3), it must be assumed that the title to the transferred shares vested in the wife and the dividends belonged to her. When, therefore, those monies are taken by the husband to recoup what he had paid to Mr. Jackson, it follows that what Mr. Murthi did was only to give a loan or temporarily to accommodate his wife to meet the demands of the assignor. Being only a loan, the payments cannot amount to a transfer of assets. There is no prohibition against a husband advancing monies to his wife for the acquisition of property by her. Whether in such cases there was a loan by the husband to the wife or whether it was merely a camouflage to cover a case of transfer of assets is a question of fact."
17. The underline sentence clearly brings out the real position in law that a loan is not a transfer.
18. In CIT v. Keshavlal Lallubhai Patel , the assessee had thrown all his self-acquired properties into the common hotchpot of the HUF. Subsequently, there was an oral partition. The question was whether there was an indirect transfer of the properties allotted to the wife and minor son in the partition within the meaning of section 16(3)(a) (iii) and (iv) of the Indian Income-tax Act, 1922 (similar to section 64 of the present Act). The Revenue's contention that there was an indirect transfer was not accepted by the Supreme Court. The Supreme Court pointed out that the provision of section 16 (3) created an artificial income and had to be construed strictly. Section 16 (1) (c) - which was similar to sections 62 and 63 of the present Act - was compared with section 16(3). At page 640, it was held :
"Some assistance is derived in ascertaining the meaning of the word 'transfer' by looking at the language of section 16 (1) (c). In that clause, the Legislature uses the words 'settlement', 'disposition' and 'transfer', and in the expression 'settlement or disposition' is included 'any disposition, trust, covenant, agreement or arrangement. In this clause, the word 'transfer' is clearly used in the strict sense. If the Legislature were minded to include an arrangement or agreement, not amounting to transfer, in section 16 (3) (a) (iii), it could have used these words. It seems to us that the word 'transfer' has been used in the strict sense and not in the sense of 'including every means by which the property may be passed from one to another'. This conclusion is reinforced by the consideration that, as observed by this court in Philip John Plasket Thomas v. CIT [1963] 49 ITR (SC) 97, section 16 (3) 'creates an artificial income and must be construed strictly."
19. The approach to the present section 64 cannot in any way be different.
20. One of the earliest decisions is of the Madras High Court in Secretary to the Chief CIT v. M. Doraiswami Ayyangar, AIR 1923 Mad 682; [1923] 1 ITC 214. The court pointed out that members of a HUF are free to utilise the HUF funds for business in which case the trade will be of the HUF. If they engage in an adventure without using the HUF funds, the business may not be of the HUF. The members of the HUF may enter into partnership inter se along with a stranger. At page 683, the court held :
"It is not conclusive to show that some funds of the joint family were invested in the trade; because they might have been borrowed by the trading members as a loan of a definite sum to be paid by the trading firm just as if it was a loan from strangers."
21. The facts of the case in the decision of the Delhi High Court in CIT v. Mridu Hari Dalmia are distinguishable. It was found as a fact that there was no lawful agreement of loan between the assessee and his minor son. The decision of the Madras High Court in R. K. Murthi's case [1961] 42 ITR 379 was referred to as to the nature of a loan; the Delhi High Court did not dissent from the view expressed by the Madras High Court (vide page 556 of 133 ITR). The loan was held to be a contract by the Delhi High Court and such a contract with a minor was not possible. However, at page 557, the following observation is found :
"Nor can the transaction be viewed as one of loan by the father in his individual capacity to himself acting as the guardian of the minor son. It is quite true, as Shri Harihar Lal points out, that the law recognises different capacities in which an individual can function. An individual may act in certain matters in his own individual capacity. He may act as an agent or a trustee or a guardian or a partner or a shareholder or a director and so on. But the concept of 'capacity' cannot be equated to a concept of 'legal personality. A contract of loan requires two persons. There cannot be a loan by the same person to himself merely because he functions in two different capacities. Just as there cannot be a contract of a partnership between a person in his individual capacity and in his capacity as a trustee (vide Mohan Lal Shyam Lal's case [1942] 10 ITR 219, 226 (All), there can be no transaction of loan by the assessee to himself."
22. With utmost respect, we disagree. Whether the loan granted by a father to his minor son, representing the minor as his maternal guardian, is a valid transaction would depend upon the particular facts and circumstances of a case. A father may have to manage a property which admittedly belongs to his minor son, as his guardian. In the course of the management, if it becomes necessary to borrow to save or improve the property, law would not bar the father from advancing his personal funds to the minor son; in such transaction, the father would have dual capacity-one, on his own as the creditor and the other as the guardian of his minor son, acting for the son's benefit. The Delhi high Court has referred to Salmonds Jurisprudence (12th Edition, page 304, para 65). In the light of the decision of the Supreme Court in Tulsidas Kilachand's case ) (which we have already quoted), we are constrained to depart from the unqualified proposition stated by the Delhi High Court.
23. In Gopal Ramanarayan v. CIT [1989] 175 ITR 32 (a decision of this court), there was a transfer involved, which fell within the purview of section 64(2).
24. The dual capacity of the karta of a HUF was recognised by the Supreme Court in Jugal Kishore Baldeo Sahai v. CIT . The karta was managing the family business for which he was paid remuneration. The question was whether salary paid to the karta was a deductible expenditure from the income of the HUF. The Supreme Court held that if remuneration is paid to the karta of a Hindu undivided family under a valid agreement which is bona fide and in the interest of, and expedient for, the business of the family and the payment is genuine and not excessive, such remuneration would be an expenditure laid out wholly and exclusively for the purpose of the business of the family and would be allowable as an expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922.
25. C. Arunachalam v. CIT [1985] 151 ITR 172 is a decision of a Full Bench of this court; the dual capacity of the karta of a HUF was not accepted; the court further held that, where the karta of a HUF is a partner in a firm representing his HUF along with his wife, and his minor children are admitted to the benefits of partnership in that firm, the share income of the wife and minor children cannot be assessed to tax in the hands of the karta in his individual status. The approach to fiscal statute is stated, at page 180, thus :
"So far as the fiscal statutes are concerned, we must remember one more principle. The provisions in a fiscal statute are not to be so construed as to furnish a chance of escape and a means of evasion. In case of doubt, the fiscal statute should be construed in favour of and beneficial to the subject."
26. We repeat the genuineness of the transaction was not challenged by the Revenue and in fact the Revenue admitted the bona fide character of the advances in question. The finding given in respect of the earlier year also has been accepted by the Revenue, as noted by the Appellate Tribunal. Before us, the arguments were purely theoretical.
27. As we are of the view that "loan" is not a "transfer", section 64 is not at all attracted to the transactions. The question necessarily has to be answered in the affirmative and against the Revenue.
Re : Third question in I.T.R.C. No. 23 of 1990 :
28. McDowell and Co. Ltd. v. CTO , was relied on heavily by Mr. Raghavendra Rao to press his contention that the assessee has adopted a tax evasion device in the instant case. Chinnappa Reddy J., after referring to several English decisions, observed at page 158 :
"I have referred to the English cases at some length only to show that in the very country of its birth, the principle of Westminister has been given a decent burial, and in that very country, where the phrase 'tax avoidance' had originated, the judicial attitude towards tax avoidance has changed and the smile, cynical or even affectionate though it might have been at one time, has now frozen into a deep frown. The courts are now concerning themselves not merely with the genuineness of a transaction, but with the intended effect of it on fiscal purposes. No one can now get away with a tax avoidance project with the mere statement that there is nothing illegal about it."
At page 160, the test was formulated thus :
"In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it."
29. Other learned judges, speaking through Ranganath Misra J. (as he then was), said at page 171 :
"Tax planning may be legitimate provided it is within the framework of law. Colourable device cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.
On this aspect, one of us, Chinnappa Reddy J. has proposed a separate and detailed opinion with which we agree."
30. According to learned counsel for the Revenue, the assessee could have himself advanced the loan to earn the interest; instead, he advanced the money to the HUF of which he was the karta for a nominal interest, which in turn lent it to the firm at a higher rate of interest. This circuitous route to earn higher interest is on the face of it a device to evade tax; the intended effect of this on the fiscal purpose of taxation should not be ignored by the court.
31. The argument is very attractive. It looks to be strange transaction when looked at in the manner suggested by learned counsel for the Revenue. Why should an individual advance money to his own HUF of which he is the karta on a low rate of interest and thereafter invest the same money as karta of the HUF at a higher rate of interest; why not invest the money directly and earn a higher interest are the questions anyone would naturally ask.
32. However, the question was not raised in this manner by the Income-tax Officer anywhere. Till the matter reached this court, the genuineness of the transaction as such was not doubted. No material is placed to show that the higher interest earned by the HUF escaped income-tax. The taxable income of the assessee attracts the highest rate of income-tax. There is nothing to indicate the tax levied on the HUF; it is not the case of the Revenue that the HUF does not pay any tax. The actual tax that is lost to the Revenue by the alleged device adopted by the assessee is not known.
33. It is quite likely that, in order to strengthen the income structure of the HUF and provide for the members of the HUF, the HUF may have resorted to borrowing from the assessee and investing it to earn higher income. The assessee was not earning any interest on this amount, which was standing to his capital account without any interest; if he had not drawn it and lent it to the HUF, the said money would have continued in the capital account without earning any taxable income, by way of interest in the hands of the assessee. In these circumstances, it is not possible to accept the contention of the Revenue, under question No. 3 referred to us in I.T.R.C. No. 23 of 1990.
34. We may also notice that during the earlier years the very loan was involved and the Revenue never thought it possible to attack the investments by the HUF as a tax evasion device adapted by the assessee. We fail to understand as to how this loan accepted as a genuine transaction in the year of its origin could subsequently become a tax evasion device, in the course of years.
35. Mr. Sarangan, in response to McDowell's decision , relied on the subsequent decision of the Supreme Court in CWT v. Arvind Narottam ; the observation of Sabyasachi Mukharji J. (as he then was) at page 487 was specifically emphasised. We do not consider it necessary to go into the theoretical aspect of the proposition as we have already found that, on the basis of the material placed before, us, it is not possible to accept the contention of the Revenue.
36. Consequently all the questions referred are answered in the affirmative and against the Revenue.
37. Reference answered accordingly.