Commissioner of Income Tax, West Bengal v. Kalu Babu Lal Chand

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 431 of 1957

Decision Date: 15 May 1959

Coram: Natwarlal H. Bhagwati, M. Hidayatullah, Sudhi Ranjan Das

The case titled Commissioner of Income-Tax, West Bengal v. Kalu Babu Lal Chand was decided on 15 May 1959 by the Supreme Court of India. The bench that heard the matter included Justice Natwarlal H. Bhagwati, Justice M. Hidayatullah and Chief Justice Das, Sudhi Ranjan. The judgment was reported in 1959 AIR 1289 and in 1960 SCR (1) 320. The dispute concerned the provisions of the Income-Tax Act relating to the income of a Hindu undivided family, specifically whether the remuneration received by a family member who acted as managing director of a company, after using family funds to promote and finance that company, should be taxed as income of the undivided family.

According to the factual matrix, the respondent, referred to as R, was the karta of a Hindu undivided family that became interested in acquiring an existing business that was then being carried on by other persons. To take over the business as a going concern, a private limited company was formed, and R participated as one of the promoters. In accordance with an agreement with the vendors of the business and in anticipation of the company’s incorporation, R, acting on behalf of the company, took over the concern, continued its operations and provided the necessary financing at every stage using only the joint family funds. The contemplated company was incorporated on 19 December 1930 under the Indian Companies Act as a private company with limited liability. Of the total 950 ordinary shares issued, R held 326 shares while his brother held 356 shares. The Articles of Association of the company expressly provided for the appointment of R as its first managing director. Prior to the accounting year that corresponded to the assessment year 1943-44, the amount that R received as remuneration for his services as managing director was entered in the books of the Hindu undivided family in the same manner as dividends on the shares owned by R and his brother. For the assessment year 1943-44, the assessee contended that the remuneration was his personal earnings and should not be added to the income of the Hindu undivided family. The Income-Tax Officer rejected this contention. The assessee further argued that, under the Indian Companies Act, a Hindu undivided family could not be appointed as a managing agent of a company as per the definition in section 2(9-A), and that the office of managing director inherently involved a personal element requiring the appointment of a particular individual based on his personal skill and qualities, making the remuneration personal income. The Court held that although the managing director was undeniably the individual appointed in relation to the company and the company itself did not have any concern with the family or its members, the crucial question was whether the amount received by the karta as managing-director’s remuneration constituted his personal income or the income of the Hindu undivided family.

The Court examined whether the sum in question should be treated as income of the Hindu undivided family or as the personal earnings of the karta. It observed that the determination depended on whether the earnings were generated with the assistance of the joint family assets. In the facts of the present case, the Court found that the promotion of the company, the acquisition of the concern, and the financing of those activities were all carried out using the joint family funds. It further noted that the respondent, identified as R, did not make any contribution from his own personal resources. Consequently, the Court held that the remuneration received by R in his capacity as managing director was, in the relationship between him and the Hindu undivided family, the income of the family and therefore had to be assessed in the hands of the family. The Court relied upon the authorities in Kaniram Hazarimal v. Commissioner of Income-tax, West Bengal (1955) 27 I.T.R. 294; V. D. Dhanwatay v. Commissioner of Income-tax, Madhya Pradesh and Bhopal (1957) 32 I.T.R. 682; In re Haridas Purshottam (1947) 15 I.T.R. I24; and Gokul Chand v. Humam Chand Nath Mal (1921) 48 I.A. 162. It distinguished the cases of Commissioner of Income-tax, Madras v. S. N. N. Sankaralinga Iyer (1950) 18 I.T.R. 194; Murugappa Chetty v. Commissioner of Income-tax, Madras (1952) 21 I.T.R. 311; Sardar Bahadur Indra Singh v. Commissioner of Income-tax, Bihar and Orissa (1943) 41 322 11 I.T.R. 16; and Commissioner of Income-tax, Bihar and Orissa v. Darsaram (1945) 13 I.T.R. 419, which were held not to be applicable to the present circumstances.

The judgment was rendered in a civil appellate jurisdiction concerning Civil Appeal No. 431 of 1957. The appeal was filed by special leave against the order dated September 8, 1955, of the Calcutta High Court in Income-tax Reference No. 77 of 1951. Counsel for the appellant included the Solicitor-General of India and other legal representatives, while counsel for the respondent comprised several advocates. The decision was delivered on May 15, 1959, by the Chief Justice of India. The appeal challenged the High Court’s decision, which had been made on a reference from the Income Tax Appellate Tribunal under section 66(1) of the Indian Income-tax Act. The High Court had answered the first referred question in the negative and the second in favor of the respondent-assessee. The Court recounted that the respondent was, at all material times, a Hindu undivided family whose eldest male member, B. K. Rohatgi, acted as its karta. In 1930, B. K. Rohatgi became interested in a business known as India Electric Works, operated by Milkhi Ram and others who were not members of the family. It was decided to form a company to acquire and continue the concern as a going concern, and B. K. Rohatgi was one of the promoters of that company.

In this case, the Court recorded that B K Rohatgi, acting on behalf of the company that was to be formed, took over the business of India Electric Works as a going concern on 1 March 1930 and continued to operate it until 19 December 1930, when the contemplated company was finally incorporated under the Indian Companies Act as a private limited company named India Electric Works Ltd, referred to as “the said Company.” Article 132 of the Articles of Association of the said Company stipulated that the first Managing Director would be B K Rohatgi or his assigns or successors in business, whether they used his name or any other style or firm, and that B K Rohatgi would remain Managing Director until he resigned, was found guilty of fraud or dishonesty, or was removed in the manner provided. Article 133 set out the circumstances and conditions under which the Managing Director might be removed. Article 135 fixed the Managing Director’s remuneration at Rs 6,000 per annum or a commission of fifteen per cent on the net profits of the Company, to be computed as specified. Article 136 listed the powers of the Managing Director under twenty sub-heads. Article 138 required the Company to “forthwith enter into an agreement under the seal with Mr Benoy Krishna Rohatgi in terms of the draft which has been approved on behalf of the Company.” For reasons not apparent from the record, the agreement was not executed until 31 January 1934, but the terms, conditions, and powers conferred by the agreement were essentially the same as those mentioned in the Articles of Association. Of the total nine hundred fifty ordinary shares of Rs 500 each issued and subscribed, three hundred twenty-six shares were held in the name of B K Rohatgi, three hundred fifty-six shares in the name of his brother R K Rohatgi, and ten shares in the name of one Laxminarain, who was described as an employee of the assessee family. There was no dispute that, prior to the accounting year relevant to the assessment year 1943-44, the Managing Director’s remuneration received by B K Rohatgi was credited in the books of the Hindu undivided family in the same manner as dividends on the shares held in the names of his brother and himself. Paragraph 6 of the Statement of the Case stated that the Assessee did not deny that India Electric Works Ltd was floated primarily with funds provided by the Assessee, that Mr Rohatgi made no contribution in that respect, and that throughout its existence the Company was financed from time to time by the Assessee Hindu Undivided Family.

It was established that the financing of India Electric Works Limited had been provided by the assessee Hindu Undivided Family. The record further showed that, for the first time in the assessment year 1943-44, the assessee asserted that the remuneration received by the managing director, Mr. B. K. Rohatgi, pertained to him personally. Up to and including the assessment year 1942-43, both Mr. Rohatgi and the Hindu Undivided Family had, in their respective accounts, treated the entire remuneration paid to Mr. Rohatgi as income of the Hindu Undivided Family. In the accounting year relevant to the assessment year 1943-44, the managing director’s remuneration received by Mr. B. K. Rohatgi amounted to Rs 61,282. During the assessment proceedings for 1943-44, the assessee claimed that the whole of this sum represented the personal earnings of Mr. Rohatgi and therefore should not be added to the income of the Hindu Undivided Family, which was the respondent before the Court. The Income-Tax Officer rejected this claim. On appeal, the Appellate Assistant Commissioner concurred with the Income-Tax Officer’s view. The assessee then appealed to the Income-Tax Appellate Tribunal.

The Tribunal examined the claim and held that the sum of Rs 61,282 consisted of two distinct categories of remuneration. The first category represented remuneration for services rendered by the assessee’s family in the flotation and financing of the company, while the second category represented remuneration for the personal services performed by Mr. B. K. Rohatgi. Accordingly, the Tribunal apportioned the amount between the two categories, allocating Rs 30,000 – calculated at a rate of Rs 2,500 per month – to the personal services of Mr. Rohatgi and assigning the balance to the remuneration attributable to the services of the Hindu Undivided Family. Acting on the respondent-assessee’s application, the Tribunal made a reference under section 66(1) of the Indian Income-tax Act, posing the following questions: (1) whether, on the facts and circumstances of this case, the Tribunal was justified in apportioning the sum of Rs 61,282 into two parts, assessing one in the hands of the Hindu Undivided Family and the other in the hands of Mr. B. K. Rohatgi; and (2) if the answer to the first question was negative, whether the assessment of the entire sum should be made on Mr. Rohatgi personally or on the Hindu Undivided Family.

When the reference was presented before the High Court for hearing, the learned judges expressed the view that the statement of case submitted by the Tribunal was inadequate for answering the referred questions. They observed that certain additional facts needed to be clearly stated before a determination could be made. Consequently, the High Court directed the Tribunal to submit a further statement of case and to answer the following specific inquiries: (a) with whose funds the shares, on the basis of which Mr. Rohatgi had been appointed and continued to serve as Managing Director, were purchased, and to whom those shares truly belonged; (b) who had enjoyed the dividends paid on those shares; (c) in what capacity Mr. Rohatgi had originally been appointed to and was holding, at the relevant time, the office of Managing Director of India Electric Works Limited – whether in his personal and individual capacity or otherwise; and (d) whether, besides the qualifying shares, any additional shares of the company stood in the name of Mr. Rohatgi, and if so, with whose funds those additional shares were acquired and to whom they truly belonged.

In the proceedings, the Tribunal was asked to answer two additional queries. The first query asked in what capacity Mr. B. K. Rohatgi had originally been appointed to, and was then holding, the office of Managing Director of India Electric Works Ltd., specifically whether he acted in his personal individual capacity or in some other capacity. The second query sought to know whether, apart from the qualifying shares, any other shares of the company stood in Mr. Rohatgi’s name, and if so, whose funds had been used to acquire those shares and to whom the shares truly belonged. The Tribunal submitted a further statement of case and then delivered its findings. Regarding questions (a), (b) and (d), the Tribunal held that all shares of India Electric Works Ltd. shown in the name of Mr. B. K. Rohatgi (326 shares) and Mr. R. K. Rohatgi (356 shares) had been purchased with funds belonging to the assessee Hindu undivided family, that the shares consequently belonged to that family, and that the family had enjoyed the dividends paid on those shares. In addition, the Tribunal observed that besides the ten qualifying shares, there were an additional 316 shares in the name of Mr. B. K. Rohatgi, and those shares likewise belonged to the assessee family. Concerning question (c), the Tribunal concluded, by inference from the foregoing facts, that Mr. B. K. Rohatgi had originally been appointed to, and at the relevant time was holding, the office of Managing Director of India Electric Works Ltd. in his capacity as a member and karta of the assessee family.

The counsel appearing before the High Court did not seek to defend the Tribunal’s intermediate finding but conceded that the income in question could be characterised either as income of the family or as personal income of Mr. B. K. Rohatgi. The counsel further argued that it would be untenable to attribute part of the income to Mr. Rohatgi’s remuneration as a company officer and to attribute the remaining part to a return made by the company to the family for benefits received. Accordingly, the High Court answered the first question in the negative. Regarding the second question, the High Court held that the matter fell within the principles laid down in Commissioner of Income-tax, Madras v. S.N.N. Sankaralinga Iyar (1) and expressed the view that the assessment of the sum of Rs. 61,282 should be made against Mr. Rohatgi personally. Dissatisfied with that answer, the Commissioner of Income-tax obtained special leave to appeal to this Court. The Solicitor-General, appearing for the Commissioner, did not challenge the correctness of the High Court’s answer to the first question and therefore the present consideration was limited to the correctness of the High Court’s answer to the second question. It is now well settled that a …

The Court observed that a Hindu undivided family, by its very nature, cannot itself become a party to a partnership contract with other persons. However, the karta of such a family may, and frequently does, enter into a partnership with outsiders on the family’s behalf and for the family’s benefit. In doing so, the other members of the family do not become partners in relation to the outsiders; they are unable to take part in the firm’s management, cannot claim any share of the partnership accounts, and are deprived of all rights that a partner normally enjoys. Consequently, the outsiders recognise only the karta as the lawful partner.

The Court held that determining whether the karta acted in his personal capacity for his own advantage or acted as the representative of the joint family for its advantage is a question of fact. If the karta contributed the family’s capital to the partnership by withdrawing money from the family’s treasury, the partnership must be regarded as entered into for the benefit of the Hindu undivided family. In such circumstances the karta becomes accountable to the other family members for the profits he receives as his share of the partnership earnings, and those profits are to be assessed as income of the Hindu undivided family.

The Court referred to the authorities of Kaniram Hazarimull v. Commissioner of Income-tax, West Bengal and Dhanwatay v. Commissioner of Income-tax, Madhya Pradesh and Bhopal to support this view. The same principle was applied when a karta was appointed the treasurer of a bank; the remuneration he earned for performing treasurer duties was treated as income of the Hindu undivided family and was taxed in the family’s hands. This principle was further extended to the remuneration received by a karta acting as managing agent of a limited-liability company, as highlighted in the case of In re Haridas Purshottam. Stone, C.J., joined by Chagla, J., observed that because the managing agency arose from, or was obtained with the assistance of, the joint family property—specifically the mills in which the karta held a beneficial interest—the income derived from that agency must be treated as the family’s income.

The Court also noted that certain decisions have taken a contrary position, but those decisions were based on the particular facts established in those cases. For example, in Murugappa Chetty v. Commissioner of Income-tax, Madras, it was not established that the managing agency agreement had been secured by the karta on behalf of the Hindu undivided family or that the income had been earned by using the joint family property. Hence, those cases could not be applied to the facts of the present matter.

It was observed that the respondents had failed to demonstrate that the income in question was derived from the Hindu undivided family, nor had they shown that the income had been earned by employing the joint family property or by utilizing it to the family's detriment. The earlier decision in R. Hanumanthappa v. Commissioner of Income-tax, Madras simply follows the reasoning in Murugappa Chetty and does not advance the principle further. The Court concluded that, given the facts established in the present case, those two precedents could not be applied. The argument then advanced was that the position of a Managing Director differs fundamentally from that of a partner or a managing agent, and consequently the principles that apply to income earned by a karta acting as a partner or managing agent should not be applied to remuneration received by the karta in the capacity of Managing Director of a company.

The first contention relied upon the Indian Companies Act, specifically the definition in section 2(9-A), to assert that a Hindu undivided family could not be appointed as a managing agent of a company. The second contention emphasized that the office of Managing Director entails a personal element, because the appointment must be made of a particular individual possessing the requisite skill and personal qualities, and therefore the remuneration received by such an individual must constitute his personal earnings. The Court noted the citations to earlier authorities: (1) [1947] 15 I.T.R. 124, (2) [1952] 21 I.T.R. 311, and (3) [1952] 22 I.T.R. 364. The Court found neither of these considerations persuasive. It held that, with respect to the company, the Managing Director is undeniably the individual person appointed to that office, and the company does not concern itself with the Managing Director’s Hindu undivided family or its members, just as external partners are aware of the karta only in his personal capacity as their partner and are not concerned with his family. Consequently, the question of whether the amount received by the karta as Managing Director’s remuneration, or as his share of partnership profits, is his personal income or the income of his Hindu undivided family does not arise in the relationship between the company and the karta as Managing Director, nor between outside partners and the karta as a partner. Neither the company nor the outside partners have any interest in that question. Such a question can arise only between the karta and the members of his family, and the answer depends on whether the remuneration or profit was earned with the assistance of joint family assets. The Court distinguished the case of Sardar Bahaditr Indra Singh v. Commissioner of Income-tax, Bihar and Orissa (1), noting that the Articles of Association of the company in that case expressly provided that the Managing Director’s remuneration would be his personal income. In Commissioner of Income-tax, Bihar and Orissa v. Darsanram (2), the factual finding was that the joint family property had not been spent in earning the remuneration, reinforcing the view that the income was personal to the karta.

In the earlier authority, the Court held that the remuneration received by the managing director was the personal earnings of the karta who had been appointed to that office, because the joint family property had not been employed in obtaining the remuneration. The Court observed that the decision in Commissioner of Income-tax, Madras v. S. N. N. Sankaralinga Iyer could not be applied to the present respondent, since the factual circumstances differed. In that Madras case, the Court had found that the managing director’s remuneration was earned as consideration for the services he rendered to the bank, and that none of the family funds had been expended or utilised to obtain that remuneration, except that the shares required to qualify for the managing-directorship were purchased from the joint family funds. The Court further noted that there was no detriment to the family property, because the shares generated dividends that were already included in the family’s income. Justice Satyanarayana Rao held that, on the facts of that case, it was impossible to infer that the appointment was made on behalf of, or for the benefit of, the undivided family; in other words, the karta did not become managing director as a representative of the family. In a separate but concurring judgment, Justice Viswanatha Sastri expressed that merely possessing a certain quantity of shares as a manager of a joint family did not automatically enable a person to function as managing director. He emphasized that the individual’s personal qualifications, together with the shareholding, were the primary reasons for his selection and appointment as the bank’s managing director. According to that learned judge, the remuneration was essentially a quid pro quo for the work performed under a service contract with the bank, and the managing directorship was in fact a contract of service; it was not the family, represented by the manager, that acted as managing director, but the individual himself. With due respect to those judgments, the Court observed that the learned judges appeared to have overlooked the principles laid down by the Judicial Committee in Gokul Chand v. Hukam Chand-Nath Mal, where it was observed that no valid distinction could be drawn between the direct use of joint family funds and the use that enabled a member to earn income through his own efforts. The Committee explained that a member of a joint family might join the Indian Civil Service because of his intelligence and other personal attainments and might enter into a personal agreement with the Secretary of State in Council, receiving a salary for personal service; nevertheless, that opportunity was made possible by the use of joint family funds which enabled him to acquire the necessary qualification, and that fact rendered his earnings part of the joint family property.

The Court first observed that the preceding decisions did not squarely address the matter presently before it. The factual matrix involved a Hindu undivided family whose karta was B. K. Rohatgi. This family acquired an interest in the business then carried on by Milkhi Ram and others under the name India Electric Works. The karta acted as one of the promoters of a new company that he organized with the purpose of taking over India Electric Works as a going concern.

In anticipation of the incorporation of the proposed company, the karta of the family assumed control of the existing concern, continued its operations, and provided financing at every stage exclusively from the joint family funds. The Court found that the karta never contributed any amount from his own separate property, if he possessed any. The Articles of Association of the newly formed company expressly provided for the appointment of the managing director to be the very person who, in his capacity as the family’s karta, had promoted the company.

The Court held that the acquisition of the business, the flotation of the company, and the appointment of the managing director were inseparably linked. The joint family assets were employed both to acquire the concern and to finance its operations. In consideration of this substantial depletion of the joint family property, the family received not only shares that were held in the names of two family members but also, as an integral part of the same arrangement, the managing directorship of the company upon its incorporation.

It was also noted that up to the accounting year relevant to the assessment year 1943-44, the income derived from the business had been treated as the income of the Hindu undivided family. Although there was no issue of res judicata, the Court considered the fact that the remuneration was credited to the family as a material circumstance.

The Court found that the principles articulated in Haridas Purshottam’s case governed the present dispute. The recitals in the agreement clearly indicated that B. K. Rohatgi had been appointed managing director because he was a promoter of the company and because he had actually taken over the concern of India Electric Works from Milkhi Ram and the other proprietors, as reported in B. K. Rohatgi [1947] 15 I.T.B. 124.

The Court concluded that the promotion of the company, the takeover of the concern, and the financing thereof were all accomplished with the aid of the joint family funds, and that B. K. Rohatgi made no contribution from his personal resources, if any existed. In these circumstances, the Court was of the clear opinion that the remuneration received by B. K. Rohatgi in his capacity as managing director, as between him and the Hindu undivided family, constituted income of the family and therefore should be assessed in the hands of the family.

Consequently, the Court set aside the answer previously given by the High Court to the second question and substituted it with a ruling that the entire assessment of the sum of Rs. 61,282 should be levied on the Hindu undivided family.

The Court held that the amount of Rs. 61,282 must be treated as income of the assessee Hindu undivided family. Accordingly, the Court ordered that the present appeal be allowed and that costs be awarded both in this Court and in the lower Court. In sum, the appeal was allowed and the costs were granted as directed.