Commissioner of Income-Tax Bombay vs Manilal Dhanji

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

Court: supreme-court

Case Number: Civil Appeal No. 323 of 196

Decision Date: 31 January 1962

Coram: S.K. Das, M. Hidayatullah, J.C. Shah

In the matter titled Commissioner of Income‑Tax Bombay versus Manilal Dhanji, the Supreme Court of India delivered its judgment on 31 January 1962. The opinion was authored by Justice S.K. Das, with Justices M. Hidayatullah and J.C. Shah forming the bench. The petition was filed by the Commissioner of Income‑Tax, Bombay, and the respondent was Manilal Dhanji, also of Bombay. The case is reported in the 1963 volume of All India Reporter at page 433 and in the 1962 Supplement to the Supreme Court Reports (Part 2) at page 902, with additional citations in later reports. The issues concerned the taxation of income arising from trusts created in favour of a minor child and whether such income could be charged to the respondent as part of his total taxable income under the Indian Income‑Tax Act of 1922, particularly sections 16 (3) and 41 (1), as well as the applicability of section 8 of the Indian Trusts Act, 1882.

The factual background revealed two distinct trusts. In 1953 the respondent established a trust with a sum of money, stipulating that the interest earned should be accumulated and added to the principal, and that his minor daughter, identified as C, would receive the income of the increased corpus upon attaining the age of eighteen. During the relevant assessment year, while C remained a minor, the trust generated an income of Rs. 410. Earlier, in 1941, the respondent’s father had created a separate trust involving certain shares and monetary assets, directing the trustees to pay the net interest and income to the respondent for “the maintenance of himself and his wife and for the maintenance, education and benefit of all his children till his death.” In the same assessment year, the respondent earned an amount of Rs. 14,170 from this earlier trust. The tax authorities treated both the Rs. 410 and the Rs. 14,170 as part of the respondent’s total income and assessed tax accordingly. The Court held that neither sum could be included in the respondent’s total income. Relying on section 16 (3)(b) of the Income‑Tax Act, the Court explained that income from a trust that is meant for the benefit of a minor can be taxed in the hands of the settlor only when, in the year of account, the minor actually receives the income, the income accrues to her, or she possesses a beneficial interest in that income. In the present case, although the trustees had received income and were liable for tax on it, the minor daughter derived no benefit during the year, and consequently the Rs. 410 could not be added to the respondent’s taxable total. Furthermore, the 1941 trust deed was found to create two separate trusts: the first obligating the trustees to pay income to the respondent, and the second obligating the respondent to spend that income for his own and his family’s maintenance, education and benefit. The Court concluded that the respondent could not be treated as the sole beneficiary of either trust for tax purposes, and thus the tax department was not entitled to include the Rs. 14,170 in his total income.

The judgment observed that the trust established by the settlor expressly directed that the income be applied to the maintenance of the settlor himself, his wife, and for the maintenance, education and benefit of his children. It was emphasized that the settlor did not merely convey a wish, hope or desire; rather, he gave a definite direction which gave rise to a trust over the income that was in the possession of the assessee, to the benefit of himself, his wife and his children. The court clarified that the assessee had not created a second trust concerning the beneficial interest he held under the trust created in 1941, and that section 8 of the Indian Trusts Act, which would forbid the creation of such a trust, was held to be inapplicable to the present situation. The assessee was described as a trustee and not as the sole beneficiary of the trust. Because the shares of the beneficiaries were described as indeterminate, the tax Department was deemed to have the authority to levy and recover tax at the maximum rate from the assessee in his capacity as trustee, in accordance with the first proviso to section 41(1). However, the Department was not entitled to treat the sum of Rs 14,170 as part of the assessee’s total income as if he were the sole beneficiary under the trust deed.

The appeal, recorded as Civil Appeal No. 323 of 196, challenged a judgment and order dated 25 September 1958 issued by the Bombay High Court in I.T.R. No. 3 of 1958. Counsel for the appellant and counsel for the respondent appeared before the court. The judgment was delivered on 31 January 1962 by Justice S. K. Das. The Commissioner of Income‑Tax, Bombay City I, had filed the appeal on a certificate of fitness granted by the High Court under section 66A(2) of the Income‑Tax Act, 1922. The respondent, who was the assessee, had been assessed as an individual for the assessment year 1954‑55. The assessing authorities had included in his total income two amounts: a sum of Rs 410 and a sum of Rs 14,170. The authorities explained that each sum accrued in the relevant account year under different circumstances. Regarding the first sum, it was stated that on 12 January 1953 the assessee had created a trust involving Rs 25,000, with the Central Bank Executor & Trustee Co., the assessee himself, his wife and his brother as trustees. The trust deed provided that the Rs 25,000 would be set apart, that interest on that amount would be accumulated and added to the corpus, and that a minor daughter named Chandrika would receive the income from the enlarged corpus when she turned eighteen on 1 February 1959. She would continue to receive that income for the duration of her life, and after her death the corpus would pass to persons not relevant to the present dispute. The income that arose from this trust fund for the year in question amounted to Rs 410. The second sum of Rs 14,170 was described as accruing as income in the hands of the assessee from a different trust established on 1 December 1941 by his father for the benefit of his four sons, including the assessee. The trustees of that trust were the Central Bank Executor & Trustee Co. Ltd., the assessee and another individual, and the trust instrument required that the net interest and income of the trust funds be paid to the assessee “for the maintenance of himself and his wife and for the maintenance, education and benefit of all his children till his death.” The Department’s position, as reflected in the appellate tribunal’s view, was that while tax could be levied at the maximum rate from the assessee in his capacity as trustee, the sum of Rs 14,170 could not be included in the assessee’s total income as though he were the sole beneficiary under the trust deed.

In the year of account that was under consideration, the tax authorities had taken the amount of Rs 410 and added it to the assessee’s total income, asserting that they were acting under section 16(3)(b) and/or section 16(3)(a)(iv) of the Income‑tax Act. Regarding the second amount of Rs 14,170, the record showed that on 1 December 1941 the assessee’s father had created a trust involving certain shares and a cash sum of Rs 30,000 for the benefit of his four sons, the assessee being one of those sons. The trustees of that trust were the Central Bank Executor and Trustee Co. Ltd., the assessee himself and another individual. The trust deed required the trustees to hold the trust property and to pay the net interest and income generated therefrom to the assessee “for the maintenance of himself and his wife and for the maintenance, education and benefit of all his children till his death”. It was stated that the sum of Rs 14,170 had accrued to the assessee as income in the relevant account year from those trust funds. The revenue authorities, as well as the Income‑Tax Appellate Tribunal, held that because the trust deed designated the assessee as the sole beneficiary and because the amount was received by him for his own benefit without any obligation to account to any other person, the amount was required to be included in his total income. The assessee argued, however, that the Rs 410 should not be included in his total income because his minor daughter Chandrika had no right to the income nor any beneficial interest in the trust for that year, and therefore neither section 16(2)(a)(iv) nor section 16(3)(b) applied. Concerning the Rs 14,170, the assessee contended that it should not be treated as his personal income as the sole beneficiary because the trust settlement named not only the assessee but also his wife and children as beneficiaries. He submitted that the amount was received by him in a fiduciary capacity for his family and that the Department could instead invoke the first proviso to section 41(1) of the Income‑tax Act to levy tax on a separate assessment of the assessee as a trustee, applying the maximum rate, since the individual shares of the ultimate beneficiaries were indeterminate and unknown. The Income‑Tax Appellate Tribunal, hearing the appeal by the assessee, rejected these submissions. Consequently, the tribunal framed two questions of law for the High Court: (1) whether the sum of Rs 410 was properly includable in the assessee’s total income either under section 16(3)(b) or section 16(3)(a)(iv) of the Income‑tax Act, and (2) whether the sum of Rs 14,170 was properly includable in the assessee’s total income as the sole beneficiary under the trust created on 1 December 1941.

In this appeal the Court first noted that the parties had raised two questions of law. The first question asked whether the sum of Rs 14,170 /- should be taken into the assessee’s total income as the sole beneficiary of a trust settlement that had been made on 1‑12‑1941 by Dhanji Devsi. The second question concerned the inclusion of a sum of Rs 410 /- in the assessee’s total income as the sole beneficiary of a later trust settlement dated 1‑12‑1941. The Court observed that both questions arose from the order of the Income‑Tax Appellate Tribunal dated 24 April 1957, and that the Tribunal had therefore stated a case under section 66(1) of the Income‑Tax Act. The High Court, by judgment and order dated 25 September 1958, answered both questions in favour of the assessee. After delivering that judgment the High Court granted a certificate of fitness under section 66A(2) of the Income‑Tax Act, and the present appeal was filed in this Court on the basis of that certificate. The Court then turned to the first of the two questions, namely the inclusion of the sum of Rs 410 /‑ in the assessee’s total income. The issue to be determined was whether that sum fell within the ambit of section 16(3)(b) of the Income‑Tax Act. The Court observed that counsel for the appellant, Mr Rajagopal Sastri, had not pressed the claim that the Department had raised before the Tribunal under section 16(3)(a)(iv). Before examining section 16(3)(b), the Court found it necessary to set out the material clauses of the trust deed dated 12 January 1953, namely clauses 3 and 4. Clause 3 provided that the Trustees were to hold the trust fund and its investments, receive all income, interest and rents therefrom, reinvest such receipts and the resulting income, dividend, interest and rents, and allow them to accumulate at compound interest so that these accumulations would be added to the principal trust fund until the settlor’s daughter Chandrika reached the age of eighteen, which was to occur on 1 February 1959; thereafter the Trustees were to deal with the fund as provided later in the deed. Clause 4 stipulated that the Trustees were to hold the trust fund and its accumulations for the benefit of Chandrika, paying her the net interest and income after deducting outgoings and collection charges for her lifetime as maintenance. From these provisions it was clear that during Chandrika’s minority the income of the trust was required to be accumulated and added to the corpus, and that only after she attained majority she would be entitled to receive the income from the enlarged trust fund. The Court noted that in the year of account under consideration Chandrika was still a minor, and that under the terms of the deed she possessed neither a right to the trust income nor any beneficial interest in it; consequently she could neither receive nor enjoy the income, and she derived no benefit from the trust fund during her minority, nor, even after attaining majority, any benefit from the income that had accrued while she was a minor.

It was observed that Chandrika did not acquire any right to the trust income that accrued while she was a minor; her sole entitlement after attaining majority was to enjoy the income generated from the enlarged trust fund, which consisted of the original trust corpus together with the accumulations of trust income during her minority. Consequently, the amount of Rs 410 was not regarded as Chandrika’s income but rather as the income of the trustees, and that income was to be added back to the trust corpus. The question then arose whether section 16(3)(b) of the Income‑tax Act was applicable to this situation. Before addressing that question, the Court considered the overall scheme of section 16. This section governs the computation of total income as defined in section 2(15), specifying which sums must be included or excluded in determining total income. The definition of total income in section 2(15) contains two components: first, the income must comprise the total amount of income, profits and gains referred to in section 4(1); second, it must be computed in the manner prescribed by the Act. The statute provides two kinds of exemption: certain classes of income are exempt from tax and are also excluded from the computation of total income, while other exempt classes must be included in the assessee’s total income. Clause (a) of sub‑section (i) of section 16 directs that sums exempt under specific provisions of the Act are to be included in the assessee’s total income. Clause (b) prescribes the method for computing a partner’s share of profit or loss of a firm. Clause (c) states that any income arising to a person by virtue of a settlement or disposition of assets that remain the property of the settler or disponer is to be taxed as his income. The purpose of these provisions is clearly to prevent taxpayers from avoiding or reducing tax liability through settlements. Sub‑section 2 deals with the gross‑up of dividends and similar items. Sub‑section 3, which is the focus of the present consideration, seeks to thwart an individual’s attempt to avoid or lessen tax by transferring assets to his wife or minor child, by admitting his wife as a partner, or by admitting his minor child to the benefits of a partnership in which the individual is a partner. This sub‑section creates an artificial tax liability and is to be interpreted strictly.

The Court then read the wording of sub‑section 3, which provides: “16. (3) In computing the total income of any individual for the purpose of assessment there shall be included: (a) so much of the income of a wife or minor child of such individual as arises directly or indirectly: (i) from the membership of the wife in a firm of which her husband is a partner; (ii) from the admission of the”.

Section 16, sub‑section 3, clause (a) enumerates four situations whose income must be included in an individual’s total income: first, any income of the wife that arises directly or indirectly from her membership in a firm of which her husband is a partner; second, any income of a minor child that arises directly or indirectly from being admitted to the benefits of a partnership in a firm where the individual is a partner; third, any income of the wife that arises from assets transferred to her by the husband without adequate consideration or in connection with an agreement for the parties to live apart; and fourth, any income of a minor child, who is not a married daughter, that arises from assets transferred to the child by the individual without adequate consideration. Clause (b) adds that the income of any person or association of persons must also be included when that income arises from assets transferred to that person or association without adequate consideration, where the transfer was made by the individual for the benefit of his wife or a minor child or both.

The appellant argued that, in the present case, the conditions specified in clause (b) of sub‑section 3 of section 16 were satisfied, and therefore the Revenue Department was entitled to add to the assessee’s total income the portion of income that accrued to the trustees from assets transferred by the assessee for the benefit of his minor child. The appellant highlighted three conditions laid down in clause (b): first, there must be income in the hands of a person or association of persons, which in this case were the trustees; second, that income must arise from assets transferred to the trustees without adequate consideration; and third, the transfer must have been made for the benefit of the minor child.

The appellant further contended that, once these conditions were fulfilled and the sole exception—where the transfer is for adequate consideration—was excluded, clause (b) should apply and the Revenue Department could therefore include the trustees’ income when computing the individual assessee’s total income. At first glance, this argument appeared persuasive and was supported by the plain language of the provision. However, upon closer examination, the Court observed that clause (b) must be interpreted in the context of the overall scheme of section 16, and that clauses (a) and (b) of sub‑section 3 should be read together.

The Court concluded that the only reasonable interpretation, which the High Court had adopted, required that an assessee could be taxed on income from a trust fund created for the benefit of his minor child only if, in the relevant year of account, the minor child actually derived some benefit under the trust deed. Such a benefit could occur if the child received the income, if the income accrued to the child, or if the child held a beneficial interest in the income during that year. Conversely, if no income accrued to the minor, no benefit was derived, and there was no income at all in relation to the minor, then, consistent with the purpose of section 16, a non‑existent income or benefit for the minor could not be included in the father’s total income.

In the present case the Court examined situations in which assets had been transferred for the benefit of a minor child but the child had reached majority before the year of account in question. The Court observed that once the child attained majority the provision of the subsection ceased to be applicable, and consequently the income derived from the transferred assets could no longer be taxed in the hands of the parent who had made the transfer. The rationale, according to the Court, was that in the relevant year of account there was no benefit to the minor child arising from the transfer, even though the transfer had originally been made for the child’s benefit. A comparable illustration was drawn from a decision of the High Court involving an intermediate beneficiary before the minor actually obtained the benefit under the trust deed. In that case the Department’s counsel had admitted before the High Court that clause (b) of sub‑section (3) of section 16 would not become effective until the minor derived a benefit under the trust deed. Although the same concession was not made before the present Court, the Court considered the underlying principle to be irrefutable: if the minor does not receive a benefit in the year of account, the transfer cannot be said to be for the minor’s benefit for that year. The Court further referred to section 4, the charging provision of the Income‑Tax Act, which makes clear that tax is levied on the total income of the relevant accounting year, and that total income, as defined by section 2(15), consists of the income, profits and gains specified in subsection (1) of section 4 and computed according to the Act’s rules. In other words, tax liability is determined on an annual basis. While it was acknowledged that the trustees of the trust had earned income and were liable to tax on that income, the Court emphasized that this fact was not the issue before it. The real question was whether the trustees’ income could be included in the total income of the settlor under clause (b) of sub‑section (3) of section 16. The Court held that when clause (b) speaks of the benefit of the minor child, it refers to a benefit that arises or accrues to the child in the particular accounting year. Absent such a benefit, the income cannot be brought into the settlor’s total income. The Court also considered a third category of cases in which only a portion of the trust’s income is earmarked for the minor child; in such circumstances clause (b) applies solely to the portion set aside for the child, and that portion is taxable in the hands of the settlor. All of these illustrations, according to the Court, reinforce the principle that the minor must derive some benefit in the relevant year of account before clause (b) can be invoked.

In this matter the Court observed that clause (b) of the sub‑section would apply only when the benefit to the minor child occurs in the relevant year of account. The Court further held that clauses (a) and (b) of that sub‑section must be read together. Clause (a) commences with the words “so much of the income of a wife or minor child of such individual as arises directly or indirectly”, followed by four enumerated circumstances labelled (i) to (iv). Accordingly, the Court affirmed that clause (a) requires that there be income attributable to the wife or minor child. The Court noted that Mr Rajagopal Sastri did not dispute this requirement.

The Court explained that the clear intention of the Legislature in inserting clause (b) was to prevent the provisions of clause (a) from being undermined by an assessee who creates a trust. To counteract that mischief, clause (b) was enacted. Whereas clause (a) speaks of “so much of the income of a wife or minor child”, clause (b) substitutes the expression “so much of the income of any person or association of persons etc.”. The Court observed that, when a trust is created, the income is held in the hands of the trustees. Nevertheless, the underlying principle of both clauses is the same: clause (a) requires that there be income of the wife or minor child, and clause (b) requires that some benefit be derived by the wife or minor child in the year of account.

The Court said that this interpretation aligns with the scheme of section 16, particularly sub‑section (3), which is designed to frustrate attempts by an individual to avoid or reduce tax liability by transferring assets to a wife or minor child. The Court emphasized that if the minor child obtains no benefit under the trust deed in the year of account, it would be inconsistent with the purpose of section 16 to include that income in the total income of the individual, even though no accrual of income or benefit occurred for the minor child in that year.

Turning to section 64 of the Income‑Tax Act, 1961 (Act 43 of 1961), the Court noted that this provision corresponds to section 16 of the Income‑Tax Act, 1922, and that clause (v) of section 64 clarifies the position by employing the phrase “immediate or deferred benefit”. Under that wording, a benefit that is postponed and does not arise in the year of account does not permit the tax Department to include the income in the settler’s total income. However, the Court cautioned that the 1961 Act should not be treated as a declaratory statement of the earlier law, nor should clause (v) be regarded as determinative of the true scope and effect of clause (b) of sub‑section (3) of section 16. The Legislature may have, in its wisdom, chosen to broaden the scope of the earlier law to include deferred benefits as well.

The Court held that the provision concerning deferred benefits must be read in the context of clause (b) of sub‑section (3) as it appeared in the Income‑tax Act of 1922. Reference was made to two English decisions, namely Dale v. Mitcalfe and Mauray v. Commissioners of Inland Revenue. The former decision concerned section 25 of the English Income Tax Act, 1918 (8 & 9 Geo. V. C. 40) and the latter concerned section 20(1)(c) of the English Finance Act, 1922 (12 and 13 Geo. V. C. 17). The Court observed that the English provisions were worded differently and operated in a different statutory context, and therefore the English case law could not be relied upon to determine the true scope and effect of clause (b) of sub‑section (3) of section 16 of the 1922 Act. After considering the proper construction of clause (b) of sub‑section (3), the Court concluded that the view taken by the High Court was correct and that the amount of rupees four hundred and ten did not constitute part of the assessee’s total income. Accordingly, the High Court was affirmed in its answer to the first question that had been referred to it. Turning then to the second question, the Court examined clause 7 of the trust deed dated 1 December 1941, which provides: “The trustees shall hold and stand possessed of the Trust Fund mentioned in the second Schedule hereto and the accumulations thereof referred to in clause 3 thereof upon Trust to pay the net interest and income thereof to the Settler’s son MANILAL for the maintenance of himself, his wife and for the maintenance, education and benefit of all his children till his death.” The issue before the Court was whether, under this clause, the income received by the assessee was held on trust for himself, his wife and his children, rendering him accountable as trustee for the amounts received. In other words, the Court sought to determine whether the deed created two separate trusts: one obligating the trustees to pay the income to the assessee, and a second obligating the assessee to apply that income for his own maintenance, the maintenance of his wife, and the maintenance, education and benefit of his children. The Court noted that when property is transferred to a parent or another person standing in loco parentis with a direction concerning the children’s maintenance, the question often arises whether the settlor intended to impose a binding trust or whether the direction was merely the motive behind the gift. While the distinction between these two classes of cases has not always been sharply drawn, the Court emphasized that, in construing such provisions, it will not treat a mere wish, desire or hope of the settlor as an enforceable obligation.

The Court explained that a direction in a trust deed that merely reflects a wish, desire, or hope of the settlor is not enforceable as a binding obligation. Conversely, where the language of the deed shows a clear and enforceable obligation toward third parties, the Court will treat it as a binding trust and will enforce it. The Court referred to authorities that illustrate both situations, noting that detailed discussions of cases where no trust is created and where a trust is created can be found on pages 85 and 86 of the fifteenth edition of Lewin on Trusts. Applying this principle, the Court found it could not accept that clause 7 of the trust deed at issue expressed only a wish or hope of the settlor. Aligning with the view of the High Court, the Court held that the direction contained in clause 7 created a trust for the benefit of the assessee, his wife and his children. The wording “for the maintenance of himself and his wife and for the maintenance, education and benefit of all his children” was not a mere expression of desire; it imposed a definite and obligatory trust on the parties involved.

The Court supported this conclusion by citing earlier decisions. In Booth v Booth, the testator left the residue of his estate to his executors on trust, directing that the income be paid to his wife or allowed to be received by her during her lifetime “for her use and benefit and for the maintenance and education of my children.” The Court in that case held that the wife received the income subject to a trust for the children’s maintenance and education. Similar reasoning was expressed in Raikes v Ward and in Woods v Woods. Counsel for the appellant referred to section 8 of the Indian Trusts Act, 1882, which provides that the subject matter of a trust must be property capable of being transferred to the beneficiary and must not be merely a beneficial interest under an existing trust. The appellant argued that the assessee already possessed a beneficial interest in the income arising from the December 1, 1941 trust deed and that therefore a further trust in favour of the assessee, his wife and children could not be created. The Court rejected this argument as based on a misconception. It clarified that the assessee had not created a second trust in relation to the beneficial interest he held under the earlier December 1, 1914 deed. Rather, the father of the assessee had, by the 1941 deed, created two distinct trusts: one obligating the trustees to pay the trust income to the assessee, and another obligating the assessee—who himself was a trustee—to apply that income for the maintenance, education and benefit of his children. The Court noted that a single document may validly create more than one trust, and therefore it was inaccurate to describe the subject matter of the present case as merely a beneficial interest under a subsisting trust.

The Court further observed that, under section 41 of the Income‑Tax Act, the tax authorities were entitled to consider two alternative bases for taxation. The department could either tax the trustees of the trust deed directly, or tax those persons on whose behalf the trustees had received the sum. This alternative framework was relevant to the assessment of the income in question and formed part of the Court’s consideration of the proper tax treatment of the amounts received under the trust arrangements.

In this case the Court explained that under section 41 of the Income‑tax Act the tax could be levied on the trustees of the trust deed, or on persons on whose behalf the trustees had received the amount. The true position of the assessee was that he acted as a trustee and was not the sole beneficiary under the trust deed. He held the trust income in trust for himself, his wife and his children. Because the shares of the beneficiaries were not fixed, they were described as indeterminate. Consequently, under the first proviso to section 41(1) of the Income‑tax Act, the revenue department was authorized to levy and recover tax at the maximum rate from the assessee. However, that authority did not permit the department to treat the sum of Rs. 14,170/- as part of the assessee’s total income as though he were the sole beneficiary of the trust. The Department, as clarified by Mr. Rajagopal Sastri, intended to include that amount in the assessee’s total income in order to levy and charge a super‑tax on him. The Court held that the Department was not entitled to that approach. Regarding the amount of Rs. 14,170/-, the Court observed that the assessee was a trustee within the meaning of section 41 of the Income‑tax Act, having been appointed by a trust created through a duly executed written instrument. As a trustee, he was entitled to argue that his assessment with respect to the amount received by him in his capacity as trustee, and not as a beneficiary, could only be made under the first proviso to section 41(1). The Court therefore concluded that the answer given by the High Court on the second question was correct. Accordingly, the appeal was dismissed with costs, and the appeal failed.