K. A. Ramachar And Another vs Commissioner Of Income Tax, Madras

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 142 and 143 of 1960

Decision Date: 10 January 1961

Coram: M. Hidayatullah, J.L. Kapur, J.C. Shah

In the case K. A. Ramachar and another versus Commissioner of Income Tax, Madras, the Supreme Court of India delivered its judgment on 10 January 1961, with the opinion authored by Justice M. Hidayatullah and pronounced by a bench consisting of Justices M. Hidayatullah, J. L. Kapur and J. C. Shah; the decision is reported in 1961 AIR 1059 and 1961 S. C. R. (3) 380 and has been cited subsequently in authorities such as RF 1965 SC 59 and D 1967 SC 383. The dispute centered on the application of section 16(1)(c) of the Income‑Tax Act, 1922 (11 of 1922), to a situation where an assessee assigned a portion of the profits of his partnership firm to his wife and two daughters. The factual background recorded that one Rangachari, a partner in a partnership firm, executed a deed of settlement by which he allotted one‑fourth of the firm’s profits to each of three persons—his wife, an adult married daughter and a minor daughter—for a period of eight years, granting the designated persons the absolute and exclusive right to receive their respective shares directly from the firm. The question referred by the Madras High Court under section 66(1) of the Income‑Tax Act was whether the amounts settled on the wife and the two daughters could be lawfully included in the assessee’s total income for the purposes of tax assessment. Rangachari, relying on the rule laid down by the Privy Council in Bijoy Singh Dudhuria’s case, contended that the sums payable to his wife and daughters never became his income because they were diverted by an overriding title, and that the third proviso to section 16(1)(c) therefore excluded those amounts from his assessable income. The High Court rejected this argument, holding that the third proviso was not attracted and that the income first accrued to the assessee before being applied to the payments specified in the deeds; consequently, the amounts could be included in his total income. On appeal, the Supreme Court, after granting a certificate of the High Court’s correctness, affirmed the lower court’s view. An examination of the deeds of settlement showed that the disponer expressly stated that from the profits “payable to him” certain amounts in specified shares were to be paid to his wife and two daughters, thereby creating a right in favour of the disponees to receive those amounts directly from the firm of which the assessee was a partner. The tenor of the document indicated that the profits first accrued to the assessee and were thereafter applied for the payments to the disponees. Under partnership law, only the partner himself is entitled to the partnership profits, and a stranger, even if designated as an assignee, does not acquire a direct claim to those profits. By the deeds in question, the assessee merely allowed a payment to

The Court observed that the amounts paid to the assessee’s wife and daughters, although made through a deed, were in substance a portion of the assessee’s own profits and therefore constituted his income. The language of the deed allowed the beneficiaries to receive a share of the profits that ultimately accrued to the assessee, but under partnership law only the partner himself is entitled to the profits; a stranger, even if designated as an assignee, cannot claim a direct right to those profits. Consequently, the payment acted as a valid discharge in favour of the firm, yet for tax purposes it remained a part of the assessee’s earnings. The Court held that the rule articulated in Bijoy Singh’s case did not apply to the present facts. Moreover, in light of the precedent set by the Court in Sitaldas Tirathdas’s case, it could not be said that the profits were diverted by an overriding title before they accrued to the assessee. The decisions in Provat Kumar Mitter v. Commissioner of Income‑tax, West Bengal [1961] 3 S.C.R. 37 and Tulsidas Kilachand v. Commissioner of Income‑tax [1961] 3 S.C.R. 351 were applied, whereas the ruling in Bijoy Singh Dudhuria v. Commissioner of Income‑tax, Bengal [1933] 1 I.T.R. 135 was held inapplicable.

The appeals, numbered 142 and 143 of 1960, were filed in the Civil Appellate Jurisdiction against the judgment and order dated 21 July 1955 rendered by the Madras High Court in C.R. No. 32 of 1952. Counsel for the appellants were G. S. Pathak and Naunit Lal, while the respondent was represented by K. N. Rajagopal Sastri and D. Gupta. The judgment was delivered on 10 January 1961 by Justice Hidayatullah. The two appeals were brought by the legal representatives of the late A. R. Rangachari, who had died while the reference under section 66(1) of the Income‑tax Act was pending before the Income‑tax Appellate Tribunal, Madras Bench. The reference posed the question to the High Court: whether the inclusion in the assessee’s total income of the profits settled on his wife and two daughters was justified under law. The High Court answered affirmatively, and the appeals were pursued with a certificate of the High Court. At the material time, Rangachari was one of five partners of the firm Messrs. Chari and Ram and held a six‑anna share in its profit and loss. On 22 September 1947 he executed three deeds of settlement (Exhibits A, A‑1 and A‑2) in favour of his wife, an adult daughter and a minor daughter, assigning each a one‑fourth share of his profit entitlement (excluding losses) for a period of eight years, and stipulating that the beneficiaries would receive that share absolutely, exclusively and irrevocably. The deeds contained clauses stating that the settlor transferred all rights to the beneficiaries regarding one‑fourth of his profit share, that the settlor would have no further interest in that portion, and that the beneficiaries would be entitled to receive the profits directly from the firm for the specified eight‑year term.

The deed continued with the following terms: First, it declared that the Settlor assigned to the Beneficiary all of the Settlor’s rights in respect of one‑fourth of his share of the firm’s profits, excluding any losses, for a period of eight years beginning on the date of the deed, and that the Beneficiary would enjoy this right in an absolute and exclusive manner. Second, the deed stated that the Settlor would retain no right or interest in that one‑fourth share once it was settled, and that the exclusive right to receive that portion of the Settlor’s share for the eight‑year period would vest solely in the Beneficiary. Third, it provided that the Beneficiary would be entitled to receive directly from the firm the share of profits transferred for the specified eight‑year period. Subsequent clauses continued in the same manner, and clause eight expressly declared that the settlement was irrevocable. These provisions were identical in each of the three deeds executed in favour of the Settlor’s wife, his married adult daughter, and his minor daughter.

For the assessment year 1947‑48, which corresponded to the financial year ending on 13 April 1947, the firm’s profits attributable to Rangachari amounted to Rs 86,491‑13‑0. That amount was credited to Rangachari’s account, and one‑fourth of it, amounting to Rs 21,622‑15‑3, was transferred to the accounts of each of the three disponees in accordance with the deeds. The same method of allocation was applied to the profits of the subsequent year ending on 13 April 1948. The assessee argued that the transferred amounts could not be included in his total income for assessment purposes because they were excluded by the third proviso to section 16(1)(c) of the Income‑Tax Act. He further contended that the amounts payable to his wife and two daughters never became his income, being diverted by an overriding title, and that the case should be governed by the rule established by the Privy Council in Bijoy Singh Dudhuria v. Commissioner of Income‑Tax, Bengal, [1933] 1 I.T.R. 135. The Income‑Tax Officer rejected these contentions, and the assessee’s appeals to the Appellate Assistant Commissioner and to the Tribunal were also dismissed. Regarding the assessment year 1947‑48, the Officer held that the income had already accrued to the assessee because the deeds were executed five months after the close of the account year. He further observed that the transfer to the minor daughter fell within section 16(3), as there was no adequate consideration for the transfer. Concerning the wife and the married daughter, the Officer concluded that section 16(1)(c) was inapplicable because the transferred amount was income first accruing to the assessee, whereas section 16(1)(c) dealt with income accruing to the recipient. The same reasoning, except for the first point, was applied to reject the assessee’s contentions for the other assessment year. The High Court, in an elaborate judgment, affirmed that section 16(1)(c) did not apply to these transactions and that the third proviso was therefore not attracted. The Court also held that the income had initially accrued to the assessee and was subsequently applied for payment under the deeds.

It was observed that the income had first accrued to the assessee and only afterwards had been applied for payments under the deeds. The Court noted that it had recently decided three authoritative cases that were directly relevant to the matter before it. In the first case, Provat Kumar Mitter v. Commissioner of Income‑tax, West Bengal (1), the assessee had executed a deed of trust whereby dividends from certain shares that remained his legal assets were transferred to his wife. The Court held that this arrangement did not fall within section 16(1)(c) of the Income‑tax Act and that the rule articulated in Bijoy Singh Dudhuria’s case (2) was inapplicable. The second case, Tulsidas Kilachand v. Commissioner of Income‑tax, Bombay (1), involved a husband who created a trust of shares, appointing himself as trustee, to pay dividends from those shares to his wife for a period of seven years. The Court decided that the provisions of section 16(1)(c) were not governing, but rather the case was governed by section 16(3)(b). The third case, Commissioner of Income‑tax, Bombay v. Sitaldas Tirathdas (4), examined the rule laid down by the Privy Council in Bijoy Singh Dudhuria’s case together with the Privy Council decision in P. C. Mullick v. Commissioner of Income‑tax, Bengal (5). It was clarified that the rule in Bijoy Singh Dudhuria’s case applied only where, by virtue of an overriding title, the income was diverted in such a manner that it never became the income of the assessee. The Court expressed the view that these three decisions together provided a complete answer to the contentions raised by the appellants.

The Court then turned to the specific deeds of settlement that were under scrutiny. An examination of those deeds revealed that the disponer had expressly provided that from the profits “payable to him” certain specified sums were to be paid to his wife and two daughters. There was no doubt, the Court said, that the assessee in those deeds created a right in favour of the disponees to receive the amounts directly from the firm of which he was a partner. The tenor of the documents demonstrated that the profits first accrued to the assessee and were subsequently applied for payment to the disponees. Counsel for the appellants argued that the assigned right was an actionable claim to the profits and that, consequently, the profits were diverted before they could accrue to the disponer. The Court rejected this argument, holding that it was inconsistent both with the law of partnership and with the factual findings on record. Under partnership law, only the partner himself is entitled to the profits; a stranger, even if an assignee, does not acquire a direct claim to the partnership profits. By virtue of the deeds, the assessee merely permitted a payment to his wife and daughters as a valid discharge in favour of the firm; however, the amounts in question were, in law, portions of his own profits, that is, his income. Accordingly, the Court concluded that the profits had accrued to the assessee before any distribution, and that the earlier authorities applied, rendering the appellants’ contentions untenable.

In this case, the Court observed that the amounts paid under the deeds constituted, in legal terms, a part of Rangachari’s profits, which is to say, his income. The Court examined the firm’s account books of Messrs. Chari and Ram and found that the sums were initially entered in the account, or Khata, belonging to Rangachari. Subsequently, following his explicit instructions, those sums were moved from his Khata to the accounts of his wife and his daughters. Accordingly, the Court held that the dispositions represented, both legally and factually, portions of Rangachari’s income after such income had already accrued to him, and that tax liability arose for him at the moment of accrual. The Court referred to its earlier judgment in Sitaldas Pirathdas’s case (1) and concluded that it could not be said that the profits had been diverted by any superior title before they accrued to Rangachari; likewise, the rule articulated in Bijoy Singh Dudhuria’s case (2) could not be invoked. For these reasons, the Court agreed fully with the High Court’s answer, ordered that the appeals be dismissed, and awarded costs. The appeals were therefore dismissed. Consequently, the matter was finally closed. (1) [1961] 2 S.C.R. 634. (2) [1933] 1 I.T.R. 135.