Chanchalben S. Patel (Decd.) vs Commissioner of Income Tax

G.T. Nanavati, J.—This reference is made by the Income Tax Appellate Tribunal at the instance of the assessee. The following two

questions are referred u/s 256(1) of the Income Tax Act, 1961, to this court for its opinion :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the gift of part of the share of profits and

losses was not valid in law ?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was no overriding title in favour of

the donees under the gift deed ?

The assessee, Chanchalben, was a partner of Navjivan Trimming Factory. There were only two partners. It appears that she had contributed 50

per cent. capital and had also a share of SD per cent. in the profits and losses of the firm. On October 14, 1970, she gifted 40 per cent. share out

of 50 per cent. share in the firm to her brother-in-law, Shankerlal''s seven grandsons and his daughter-in-law, Kusumben Bharatkumar. It appears

that Shankerlal had four sons, viz., Pushpavadan, Ramesh, Suresh and Bharat, and to each branch the assessee wanted to gift 10 per cent. share.

Therefore, by the gift deed of that date, she gifted her 40 per cent. share in their favour as under :

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Share from profit Gift amount

Sl. No. Name of the donor''s from the

50% share capital

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Rs.

Minor Darshan Pushpavadan 0.05 10,000

Minor Satish Pushpavadan 0.05 10,000

Minor Naynesh Rameshbhai 0.05 10,000

Minor Prakash Prakashbhai 0.05 10,000

Minor Sujyot Sureshbhai 0.03 6,000

Minor Mrudul Sureshbhai 0.03 6,000

Minor Nilesh Sureshbhai 0.04 8,000

Smt. Kusumben Bharatkumar 0.10 20,000

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40 80,000

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During the assessment proceedings for the year 1971-72, the assessee did not treat the income which was gifted to the donees as her income,

and contended before the Income Tax Officer that the share out of the profit, due to the said eight persons, was a charge on her income, and that it

directly passed on to them and for that reason the said income was not to be regarded as her income. The Income Tax Officer was of the view that

in spite of the gift, this was a case of application of income by the assessee as the said amounts were paid to the donees out of the share of profit

received by her.

The appeal preferred by the assessee to the Appellate Assistant Commissioner was dismissed as the Appellate Assistant Commissioner was

also of the same view. It may be stated that the assessee died after the said appeal was filed and thereafter the executor of her will, viz.,

Shankerbhai Kashibhai Patel, was brought on the record of the appeal.

Shankerbhai then preferred an appeal to the Tribunal but it also met with the same fate. The Tribunal was of the view that this was not a case

where income was diverted at source. It also held that there was no transfer of the asset of the assessee from which the income arose and,

therefore, in view of section 60 of the Act; the shares or profits gifted by the assessee to the donees had to be included in the total income of the

assessee. The assessee then moved the Tribunal for referring the above stated two questions to this court.

What is contended by learned counsel for the assessee is that the Tribunal has not correctly construed the gift deed and the concept of diversion

of income as a result of an overriding title. Therefore, the finding recorded by the Tribunal that the gift was not valid in law, and that there was no

diversion of income as a result of an overriding title created in favour of the donees, should be regarded as erroneous on facts and in law. After

specifying what was gifted by the donor, it is stated in the gift deed -

And the aforesaid sum and share given to each of the donees out of the aforesaid partnership share shall hereinafter belong to (or be regarded the

property of) each of the donees as each of their (private) personal separate independent and free property and the donor shall have no interest,

right, title or share of any kind in the same.

It is also stated therein that :

So long as the other partner, Shri Shankerbhai Kashibhai Patel, of the aforesaid partnership does not give his assent to change the partnership

deed and admit donees in the partnership aforesaid each of donees shall be considered as co-owners of the share in the name of the donor and

each of them shall be considered proprietor and co-owner to the extent of their respective individual shares in the amount of profit or loss which

may come to the share of the donor.

After considering these provisions in the gift deed, the Tribunal held that there was nothing in the gift deed to show that the interest of the donor in

the firm was transferred as ""transfer of the capital"". The Tribunal held that the transfer of capital of the partner and the transfer of the right to

receive a share in the profits of the partnership by themselves do not amount to a transfer by a partner of his interest in the firm. The Tribunal then

referred to the books of account of the firm and observed that if the income of the assessee was diverted at source then Rs. 55,008 on account of

50 per cent. share in the profits of the firm could not have been credited in her name, and the whole amount could not have been debited to her

account thereafter. Therefore, as the right to receive the property remained with the assessee and as in the account books of the firm 50 per cent.

in the profits of the firm was credited in her name, it was not possible to say that the income was diverted at source but on the contrary it indicated

that this was a case where the income of the assessee was applied in the manner desired by the assessee after it had accrued. It was of the view

that as no charge was created in favour of the donees on the donor''s share of profits in the partnership, it cannot be said that there was diversion

of income because of an overriding title. Even if the gift was to be considered as valid, the Tribunal held that as there was no transfer of any asset

of the assessee from which the income arose in view of section 60 of the Act, the share in the profit gifted by the assessee to the donees had to be

included in the total income of the assessee. The Tribunal was also of the view that ""the gift of part of the share of profits of the donor for the

donees is, in our view, not valid in view of the provisions of section 122 of the Transfer of Property Act.

What is submitted by learned counsel for the assessee is that the Tribunal was wrong in holding that the gift was invalid because it was of ""part

of share of profits of the donor for the donees"" in view of the provisions of section 122 of the Transfer of Property Act. That section defines ""gift

as transfer of certain existing movable or immovable property, made voluntarily and without consideration, by one person called the donor, to

another called the donee, and accepted by or on behalf of the donee. It does not provide that a transfer will amount to a gift only if all the rights in

existing movable or immovable property are transferred. Thus, the finding recorded by the Tribunal in this behalf proceeds upon an erroneous view

of that section. Learned counsel for the Revenue was unable to support this finding of the Tribunal by citing any provision of law or an authority.

It was next submitted that the Tribunal was also wrong in holding that there was no transfer of the assets of the assessee from which the income

arose The assessee transferred her right to receive part of her share in the profits of the firm. Even if we proceed on the basis that the capital

contributed by the assessee was to be regarded as the asset and the profits as the income arising from that asset, the asset was in fact transferred

by the assessee, as 40 per cent. out of 50 per cent. of the capital was also transferred by the assessee in favour of the donees by the very same gift

deed. It is, therefore, difficult to appreciate how the Tribunal was able to persuade itself to come to the conclusion that there was no transfer of

asset and for that reason in view of section 60 of the Act even though the income of 40 per cent. was transferred, that income had to be included in

the total income of the assessee.

The question which now remains to be decided is whether it is a case of application of income, or whether the income of the assessee was

diverted before it could become income in her hands by an overriding title created in favour of the donees. We have already referred to the two

relevant clauses of the gift deed which reflect the intention of the donor and also the change which was brought about. It was in terms stated in the

gift deed that the share, which was transferred in favour of the donees, was thereafter to be regarded as their personal, separate and independent

property. It was clearly stated therein that thereafter the donor was not to have any interest, right, title or share of any kind in the said property. In

fact, because of that gift, the sums which were gifted to the donees were credited in the names of the donees even in the account books of the

partnership firm. That fact is also stated in the gift deed. From the gift deed, it also becomes clear that it was expected that the donees will be made

partners in the partnership business, but then it was provided that, in case the other partner did not agree, then, each of the donees should be

considered as co-owner of the share in the name of the donor, and each of them was to be considered as proprietor and co-owner to the extent of

the respective individual share in the amount of profit and loss, which was to come to the share of the donor. From these recitals of the gift deed, it

becomes quite clear that so far as 40 per cent. share in the partnership firm is concerned, the assessee had completely divested herself of any right,

title or interest therein and had transferred the same absolutely in favour of the donees. After the said gift was made, the donor did not have, nor

did she intend to have, any right or interest in the property, which was gifted. Another important fact which is required to be noted is that thereafter

in respect of the share in profit, which would have become payable to the assessee, the assessee and all the donees were to be regarded as co-

owners to the extent of the respective individual shares in the said amount. Therefore, though the assessee remained a partner of the firm and in

view of the provisions of the Partnership Act only she was entitled to receive a share in the profits from the firm, in respect of that share, the

assessee and the donees were to be considered as co-owners. To that extent, the character of the assessee in the partnership firm stood changed.

All these aspects have not been considered by the Tribunal and merely proceeding on the basis that only a partner has a right to receive a share of

profit from the partnership firm and no outsider has such a right, it came to the conclusion that whatever amount was shown to be the share of the

assessee in the profits of the partnership firm became the income of the assessee and the distribution of the part of that income to the donees

amounted to application of her income. In our opinion, the aspects which we have pointed out together with the correct position of law go to show

that an overriding title was created in favour of the donees and, therefore, even though the assessee alone continued as a partner and even though

50 per cent. share in the profit was credited in her name, the whole of that amount did not become income in her hands as the same got distributed

amongst the assessee and the donees to the extent specified in the gift deed.

In Rajo Bejoy Singh Dudhuria v. CIT [1933] 1 ITR 135 the Privy Council held that even though section 3 of the 1922 Act subjected to

charge ""all income"" of an individual, it is what reaches the individual as income which it is intended to charge. In that case, as a result of the decree

passed by the court in favour of the assessee''s step-mother in a suit for maintenance, a charge was created on the ancestral estate in the hands of

the assessee. The Privy Council held that as a result of that charge, the payment which was required to be made to the assessee''s step-mother was

diverted from his income. To that extent what he received was not his income. The Privy Council further held that it was not a case of application

by the assessee of a part of his income in a particular way. It was rather the allocation of a sum out of his revenue before it became income in his

hands.

In The Commissioner of Income Tax, Bombay City II Vs. Shri Sitaldas Tirathdas, , the Supreme Court also referred to this aspect and held

that it is what reaches the individual as income which is intended to be charged. After considering the case law on the point, the Supreme Court

observed (at page 374) :

The true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. It further observed that obligations,

no doubt, there are in every ease, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a

person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the

assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied

to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment

which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one''s own income, which

has been received and is since applied.

From these two decisions, it becomes amply clear that even though the assessee is entitled to receive an income, the same cannot be regarded

as his income, if, because of an overriding title, it gets diverted before it reaches him. It is no doubt true that under the law of partnership, it is the

partner and the partner alone who is entitled to the profits, and a stranger, even if he were an assignee, does not have and cannot have any direct

claim to the profits, as observed by the Supreme Court in K.A. Ramachar and Another Vs. Commissioner of Income Tax, Madras, . But as

explained by the Supreme Court itself in its subsequent decision in Fatehchand Murlidhar and Another Vs. Commissioner of Income Tax, Calcutta,

, the said observation is required to be read in the context of the facts found in that case. The Supreme Court pointed out that in K.A. Ramachar

and Another Vs. Commissioner of Income Tax, Madras, , it was neither urged nor found that a sub-partnership had come into existence between

the assessee, who was a partner in a firm and his wife, married daughter and minor daughter. The Supreme Court distinguished that decision by

pointing out that it was a pure case of assignment of profits (and not losses) by the partner during the period of eight years. The Supreme Court

observed that even though a sub-partner can have no direct claim to the profits vis-a-vis the other partners of the firm and that it is the partner

alone who is entitled to profits vis-a-vis the other partners, it does not follow that the changed character of the partner should not be taken into

consideration for Income Tax purposes. The Supreme Court then pointed out that under the law of partnership, it is the benamidar who would be

entitled to receive the profits from the other partners but for Income Tax purposes it does not mean that it is the benamidar alone who can be

assessed in respect of the income received by him.

Therefore, if any change is brought about in the character of the partner or his right to receive the profits, then that change has to be taken into

consideration for Income Tax purposes. As what can be charged in the hands of the assessee is the income which, in truth, reaches him, it will have

to be found out in such situations, what amount exactly reached the hands of the assessee. As pointed out above, as a result of the gift made by the

assessee, she divested herself completely of the 40 per cent. share in the capital and profits of the firm. As only she continued as a partner

thereafter, vis-a-vis the partnership firm, she was entitled to receive the share of profits but the whole amount in her hands became of the

ownership of the assessee and the donees who were all to be considered as co-owners. Thus, the assessee was entitled to receive only 10 per

cent. of the profits, and 40 per cent. of the profits, though collected by her, got diverted because of the right created in favour of the donees. On

the facts of this case, it will have to be held that 40 per cent. out of 50 per cent. in the profits, which the assessee received, got diverted by an

overriding title created in favour of the donees and, therefore the while of it could not be regarded as her income in her hands. The Tribunal was,

therefore, wrong in taking a different view.

We, therefore, answer both the questions in the negative, that is, in favour of the assessee and against the Revenue. No order as to costs.