Gujarat High Court
Sunil J. Kinariwala vs Commissioner Of Income Tax on 29 October, 1993
Equivalent citations: [1995]217ITR127(GUJ)
Author: M.B. Shah
Bench: J.M. Panchal, M.B. Shah
JUDGMENT M.B. Shah, J.
1. The assessee is a partner in a partnership firm known as 'Kinarivala R.J.K. Industries', Ahmedabad. The assessee was having 10% share in the said partnership firm. On 27th Dec., 1973, he created a trust called 'Sunil Jivanlal Kinarivala Trust' by executing the trust deed. As per the trust deed, beneficiaries were Smt. Daksha Sharadbhai Kinariwala, who is assessee's brother's wife, minor Avani Bharatbhai Kinariwala, who is assessee's niece and Smt. Indumatiben Kinariwala, who is assessee's mother. By the said trust deed, the assessee has settled in trust, 50% (fifty) right, title and interest out of his 10% right, title and interest in the partnership firm 'M/s Kinarivala R.J.K. Industries', and also Rs. 5,000 out of his capital in the said firm. In the trust deed, the expression 'trust fund' is given, inter alia, the following meaning :
"(i) 50% of the right, title and interest excluding capital out of the settlor's 10% right, title and interest in the partnership of M/s Kinariwala R.J.K. Industry carrying on business at Ahmedabad or any conversion thereof;
(ii) The sum of Rs. 5,000 out of settlor's capital in the said firm of M/s Kinariwala R.J.K. Industry settled in trust as above."
2. The assessee submitted his IT return for the asst. yr. 1974-75. The ITO took the view that this was not the case of diversion of income at source but it was merely a case of an application of income. He, therefore, held that income earned by the assessee could not be said to have been diverted at source. He further held that in view of s. 60 of the IT Act it was a transfer of income without a transfer of assets from which income arose and, therefore, the entire income earned by the assessee from the partnership firm is required to be included in his income. He, therefore, added Rs. 20,141 to the income of the assessee, which the assessee contended that it represents the income of the trust.
Against the order of the ITO, the assessee preferred an appeal before the AAC. After referring to the decision of the Supreme Court in the case of CIT vs. Bhagya Laxmi & Co. (1965) 55 ITR 660 (SC) and the decision of the Bombay High Court in the case of CIT vs. C.N. Patuck (1969) 71 ITR 713 (Bom) the AAC held that there was no application of income in the present case, but it was a case of diversion of income at source. He, therefore, allowed the appeal and directed the ITO to exclude the addition of Rs. 20,141.
Being aggrieved by that order, the Department filed an appeal before the Tribunal. The Tribunal held that, in a partnership firm partly income arises to the partner from the assets of the partnership which include the capital brought by a partner and it would not be correct for the assessee to contend that the right, title and interest of a partner are the assets from which the income arises. It further held that a partner gets a right and share in partnership because he contributes the capital as agreed upon. Therefore, it cannot be said that the partner gets a share in the profits of partnership because he has right, title and interest in the partnership assets. The Tribunal further held that the capital contributed by a partner does not cease to be the asset of a partner simply because it is not immediately payable or because it might not be available to a partner if on dissolution it transpires that the capital so contributed had to be utilised to wipe out the liabilities of the firm; that a partner agrees to contribute capital to a firm in order to enable the firm to make profit or more profits; and hence in the present case as capital was not transferred provision of s. 60 was applicable as it was a case of transfer of income without transfer of assets from which income arises.
3. Being aggrieved by the said order, the assessee filed reference application before the Tribunal and the Tribunal under s. 256(1) of the IT Act referred the following questions for the opinion of this Court :
"1. Whether, on the facts and in the circumstances of the case, 50% out of the assessee's 10% right, title and interest in the partnership firm of M/s Kinariwala R.J.K. Industries belongs to Sunil Jivanlal Kinariwala Trust and the income arising therefrom belongs to the said trust by overriding title ?
2. Whether, on the facts and in the circumstances of the case, the sum of Rs. 20,141 being the profits referable to 50% out of the assessee's right, title and interest of 10% in the partnership firm of M/s Kinariwala R.J.K. Industries is not the real income of the assessee, but of Sunil Jivanlal Kinarivala Trust and as such assessable only in the hands of the trust ?
3. Whether, on the facts and in the circumstances of the case, 50% out of the assessee's 10% share in the firm of M/s Kinarivala R.J.K. Industries has been validly assigned to Sunil Jivanlal Kinarivala Trust under the deed of trust dt. 27th Dec., 1973 and whether the income arising therefrom belongs to the said trust by way of overriding title ?"
4. At the outset, we should note that genuineness of the trust deed dt. 27th Dec., 1973 is not challenged or doubted by the Department nor it is contended that the said settlement is not genuine. By the said trust deed the assessee has transferred his 50% right, title and interest excluding the capital in the partnership firm. He has further settled Rs. 5,000 out of his capital in the partnership firm as 'trust fund'. The settlement deed is fully effective and on the basis of the said deed, the right, title and interest of the assessee in the partnership firm is divided between him and 'Sunil Jivanlal Kinarivala Trust'. No doubt, this trust deed would have no effect with regard to the contract of partnership between the assessee and other partners of M/s Kinariwala R.J.K. Industries. At the same time, there is nothing in the Partnership Act which prevents its partner from dividing his partnership assets.
5. This aspect is dealt with by the Supreme Court in the case of CIT vs. Bhagya Laxmi & Co. (supra).The Supreme Court dealt with the question of registration of firm under s. 26A of the IT Act, 1922. It was contended in that case that partnership deed did not specify the correct shares of 2 partners; even though they were entitled to 2 annas and 1 anna 4 pies share in accordance with the partition deed they were shown in the partnership deed as holding 7-1/2 annas and 2- 1/2 annas respectively in 2 different firms. On behalf of the assessee it was contended that because of partition of families, beneficial interest in the partnership business was partitioned by the deed between the members of HUF but that has no relevance to the question of registration of partnership firm under the IT Act. In that context the Supreme Court observed that a partnership is a creature of contract; a contract of partnership has no concern with the obligation of the partners to others in respect of their shares of profits in the partnership; and it only regulates the rights and liabilities of partners. The Supreme Court further observed as under :
"A partner may be a Karta of a joint Hindu family; he may be a trustee; he may enter into a sub-partnership with others; he may under an agreement, express or implied, be the representative of a group of persons, he may be a benamidar for another. In all such cases he occupies a dual position. Qua the partnership, he functions in his personal capacity; qua the third parties, in his representative capacity. The third parties, whom one of the partners represents, cannot enforce their rights against the other partners nor the other partners can do so against the said third parties. Their right is only to a share in the profits of their partner-representative in accordance with law or in accordance with the terms of the agreement."
Hence, it will be difficult to hold that because the capital held by the assessee is not divided or partitioned between the assessee and the trust, the income received by the assessee from the partnership firm would be his income. Once it is held that by a genuine trust deed an assessee has assigned his 50% right, title and interest in favour of a trust, then the consequences would be, 50% of income from the partnership firm would be that of the assessee and 50% income would be that of trust.
6. Similar questions with regard to sub-partnership by a partner are dealt with by the Supreme Court in the case of Murlidhar Himatsingka vs. CIT (1966) 62 ITR 323 (SC). In that case, the Supreme Court considered whether the income of the assessee Murlidhar Himatsingka from the firm of M/s Basantlal Ghanshyamdas, in which he was a partner, should be included in his personal assessment or in the assessment of the firm of Fatehchand Murlidhar to which Murlidhar Himatsingka had purported to assign the profits and losses from M/s Basantlal Ghanshyamdas. Murlidhar had entered into a sub-partnership with his two sons and a grandson from 21st Dec., 1949. Clause 5 of the deed of partnership provided that profits and losses of Murlidhar in the firm of Basantlal Ghanshyamdas shall belong to sub-partnership and shall be borne and divided in accordance with the shares specified therein, but the capital with its assets and liabilities would belong to Murlidhar exclusively. In the background of the said facts, the Supreme Court held that the agreement dt. 21st Dec., 1949 constituted a sub-partnership in respect of Murlidhar's share in M/s Bansantlal Ghanshyamdas and that the right to receive profits and pay losses became an asset of the firm, Fatehchand Murlidhar (sub-partnership). Thereafter, the Supreme Court dealt with its previous decision in the case of CIT vs. Sitaldas Tirathdas (1961) 41 ITR 367 (SC) and held that the test laid down in the aforesaid case, viz., the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable, clearly shows that it is not every obligation to apply income in a particular way that results in the diversion of income before it reaches the assessee. Applying the same test, the Supreme Court posed a question whether the interest of sub-partnership in the profits received from the main partnership is of such nature as it diverts the income from the original partner to the sub-partnership, and observed as under :
"Suppose that A is carrying on a business as a sole proprietor and he takes another person B as a partner. There is no doubt that the income derived by A after the date of the partnership cannot be treated as his income; it must be treated as the income of the partnership consisting of A and B. What difference does it make in principle where A is not carrying on a business as a sole proprietor but as one of the partners in a firm ?"
The Court further observed that under s. 29 of the Indian Partnership Act, a sub-partner has definite enforceable right to claim a share in the profits accrued to or received by a partner; that when a sub- partnership is entered into, the partner changes his character vis-a- vis the sub-partners and the IT authorities, although other partners in the original partnership are not affected by the changes that may have taken place; that in a case of sub-partnership the sub- partnership creates a superior title and diverts the income before it becomes the income of the partner. In other words, the partner in the main firm receives the income not only on his behalf but on behalf of the partners in the sub-partnership. The Supreme Court thereafter finally upheld the contention of the assessee and reversed the finding of the High Court.
7. Further, this Court had an occasion to deal with similar contentions in the case of CIT vs. Nandiniben Narottamdas (1983) 140 ITR 16 (Guj). In that case, the assessee Nandiniben was a partner in two partnership firms, namely, Amrit Chemicals and Star Radio & Electric Co. In Amrit Chemicals her share was one anna in a rupee, whereas in Star Radio & Electric Co., her share was 8%. By a declaration dt. 7th Dec., 1956 she assigned all benefits of one anna share in Amrit Chemicals in favour of Panna, Pratiksha and Mamta Trust. By a subsequent declaration made on 4th May, 1967 the assessee made a similar donation of 8 paisa share in the firm of Star Radio & Electric Co., for the benefit of the beneficiaries named in the said trust. As per the said declarations the assessee held her share in the said partnerships in the capacity of trustee of the said trusts and not in the capacity of a partner in the same. In the assessment proceedings for the year 1967-68 the assessee contended that the amount received as and by way of share in the profits of the partnerships was not liable to be included in her total income as her income was diverted at source in favour of the beneficiaries named in the Panna, Pratiksha and Mamta Trust. The ITO rejected the contention of the trust [sic-assessee] on the ground that the transaction evidenced by the declarations amounted only to the gift of the share in the profits of the two partnership firms and that the asset, namely, the assessee's interest as a partner in each of the two partners (hips) continued to remain the property of the assessee. According to the ITO under such circumstances the provisions of s. 60 of the IT Act, 1961 were attracted and the amounts received by the assessee were taxable as income in her hands. The AAC confirmed the order while the Tribunal reversed the decision of the Departmental authorities holding that there was diversion of income at source by creation of an overriding title in favour of the beneficiaries of the Panna, Pratiksha and Mamta Trust and that such income could not have been assessed in the hands of the assessee. In reference against the said order, this Court dealt with the similar contentions. This Court referred to its earlier decision rendered in the case of CIT vs. Ramanlal Chimanlal (IT Ref. No. 46 of 1970, dt. 19th Aug., 1972), wherein the Court has held, "Income-tax is a levy on income but every sum of money which appears to have been earned by a taxpayer is not necessarily income chargeable to tax. When the charging section of the IT Act subjects to charge the total income of the taxpayer, it is what reaches him as income which it is intended to charge. In other words, income in respect of which liability to tax is attracted must be the real income of the taxpayer and not his artificial or notional income. In a case where the income of a taxpayer is required to be diverted even before it reaches him as a result of an overriding obligation, there would be neither accrual nor receipt of income which can be brought to tax in his hands. The income, in such a case, is taken away from him even before its accrual since it is already allocated for a particular purpose prior to its receipt, in his hands. The taxpayer, even if he collects it, does so, not as a part of his income, but for and on behalf of the person to whom it is payable and such income is not subject to tax in his hands. A case falling in this class must, however, be ditinguished from a case falling in another distinct class, though both cases might sometimes appear deceivably similar, namely, where a portion of the taxpayer's income is applied after its accrual or receipt in a particular manner to meet an obligation. The payment in the latter case, which is really made out of the taxpayer's income pursuant to an obligation undertaken or incurred by him, would be chargeable to tax because a subsequent application of the income is of no concern to the Revenue". The Court further observed that, in the former case, there would be diversion of income in such a way that it never became the income of the taxpayer and such artificial or notional income would not be subject to tax in his hands. The latter case would be one of application of income in a particular manner after its accrual or receipt and the portion of income so applied would be chargeable to tax in the taxpayer's hands. Thereafter, the Court arrived at the conclusion that the assessee had made a gift of her respective shares in the two firms in question in favour of the beneficiaries of Panna, Pratiksha and Mamta Trust. The Court observed that by shares mean the share in profits and losses of the firms. The Court, therefore, held that there was no doubt that the assessee has divested herself of the income producing apparatus or asset and that by overriding title created in favour of the beneficiaries of the Panna, Pratiksha and Mamta Trust, the share income of the assessee stands diverted even before it reaches her; that she undoubtedly continues to collect it but she does so, not as a part of her own income, but for and on behalf of t he beneficiaries of the said trust; and that such income could not, therefore, have been taxed in her hands.
8. In the present case, the assessee has transferred 50% of his right, title and interest in the partnership of M/s Kinariwala R.J.K. Industries, that is to say the assessee has divested himself of the income producing apparatus or assets by overriding title created in favour of the beneficiaries of Sunil Jivanlal Kinariwala Trust.
9. In the case of Nandiniben (supra) and in the case of Murlidhar (supra) decided by the Supreme Court, it is apparent that what has been diverted by the assessee in both the cases was right to receive profits and to pay losses and that the amounts standing in the capital account of the firm continued to belong to the assessees. The Supreme Court had not given any importance to the factor that capital is not transferred. The Supreme Court has observed that, right to receive profits and to contribute to losses constituted the income producing apparatus or 'assets' and hence that stood transferred by gift to the beneficiaries and hence s. 60 of the IT Act cannot be invoked.
10. In this case also, same would be the result. The assessee has transferred his 50% right, title and interest to share profits/losses of his 10% share in the partnership firm namely M/s Kinariwala R.J.K. Industries. By the deed, assessee's assets in the partnership firm are assigned and, for that purpose, it is not necessary that the capital owned by the assessee ought to be transferred. In the result, s. 60 would not be applicable to the facts of the present case. We, therefore, answer the questions Nos. 1, 2 and 3 in the affirmative, in favour of the assessee and against the Revenue.
11. The reference stands disposed of accordingly with no order as to costs.