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C.I.T. V. SUNIL J. KINARIWALA (2003) 1 SCC 660

C.I.T. V. SUNIL J. KINARIWALA (2003) 1 SCC 660

FACTS-

  • The assessee was a partner in the firm "M/s Kinariwala R.J.K. Industries" in Ahmedabad, owning a ten percent share.
  • On December 27, 1973, he established the "Sunil Jivanlal Kinariwala Trust" by transferring fifty percent of his partnership interest (excluding capital) and a sum of Rs. 5,000 from his capital in the firm to the trust.
  • The trust had three beneficiaries: the assessee's brother's wife, his niece, and his mother.
  • In the assessment year 1974-75, the assessee claimed that fifty percent of the income attributable to his share in the firm, transferred to the trust, should not be included in his total income because it constituted a diversion of income at the source.
  • The Income Tax Officer rejected the claim, stating that it was an application of income rather than diversion at the source, and Section 60 of the Income Tax Act applied as there was only income transfer without an asset transfer.
  • The Appellate Assistant Commissioner of Income Tax allowed the appeal, excluding a sum of Rs. 20,141 transferred to the trust from the assessee's total income.
  • However, the Tribunal overturned the Appellate Assistant Commissioner's decision on appeal by the Revenue, leading to the referral of legal questions to the High Court by the Tribunal.
  • The High Court, referencing past rulings in CIT v. Bagyalakshmi & Co. (1965) and Murlidhar Himatsingka v. CIT (1966), determined that when an assessee assigned fifty per cent share in a firm, the income from that share belonged to the Trust by overriding title. As a result, this income could not be included in the total income of the assessee. 
  • Hence, present appeal before the Supreme Court filed by Revenue challenging HC order. 

 

ISSUE-

  • Whether, on the facts and in the circumstances of the case, assignment of 50 per cent out of the assessee ‘s ten per cent share in right, title and interest (excluding capital) in M/s Kinariwala R.J.K. Industries in favour of Sunil Jivanlal Kinariwala Trust under a deed of trust dated 27-12-1973 creates an overriding title in favour of the Trust and whether the income accruing to the Trust can be treated as the income of the assessee? 
  • Whether, on the facts and in the circumstances of the case, the sum of Rs 20,141 being the profits referable to 50 percent, out of the assessee ‘s right, title, and interest of ten percent, in the partnership firm of Messrs Kinariwala R.J.K. Industries is not the real income of the assessee, but of Sunil Jivanlal Kinariwala Trust and as such assessable only in the hands of the Trust? 

PETITIONER- 

  • The argument put forward was that according to the settlement terms, only fifty percent of the assessee's share of profits was assigned. Therefore, there was no superior right held by the Trust to divert the income at the source. The High Court's decision to treat the assignment as resulting in income diversion was erroneous. 

RESPONDENT- 

  • Argued that under Section 29(1) of the Indian Partnership Act, 1932, the Trust became entitled to receive fifty percent share of the assessee ‘s income from the firm by assignment under the settlement deed and, therefore, the Trust was getting the income by virtue of the overriding title.

RULE-

  • Share of income of assessee assigned in favour of Trust is to be included in the total income of the assessee as there is no diversion of income, only share of profits are assigned and no Sub-partnership is created.
  • Section 29(1) of the Indian Partnership Act, 1932- A transfer by a partner of his interest in the firm, either absolute or by mortgage, or by the creation by him of a charge on such interest, does not entitle the transferee, during the continuance of the firm, to interfere in the conduct of the business, or to require accounts, or to inspect the books of the firm, but entitles the transferee only to receive the share of profits of the transferring partner, and the transferee shall accept the account of profits agreed to by the partners.

HELD-

  • In CIT v. Sitaldas Tirathdas [(1961) 41 ITR 367], The Privy Council laid down the test, the true test is 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 that can truly be excused and not the second.
  • In the Murlidhar Himatsingka case, a partner in a firm formed a sub-partnership with his family members provided that the profits and losses of the partner in the main firm shall belong to the sub-partnership. The court ruled that the income from the main partnership belonged to the sub-partnership due to an overriding obligation, and thus income should be assessed as part of the sub-partnership's income. In such a case, even if the partner receives the income from the main partnership, he does so not on his behalf but on behalf of the sub-partnership.
  • Himatsingka case in Distinguishing K.A. Ramachar case, it was observed:

In that case, it was found that there is no sub-partnership created by the assessee (partner in the firm). Only the profits are shared for eight years and not losses (i.e., among the sub-partnership). therefore, the partner income was assessed as a whole, not as per sub-partnership share.

  • There's a clear difference between a partner assigning their share to a third party and forming a sub-partnership with their share. When assigned, the assignee has limited rights, mainly to profits related to the assignment and assets in case of dissolution. However, in a sub-partnership, the sub-partnership gains a unique interest in the main partnership.
  • In the present case, although the Trust received the assigned share under Section 29(1) of the Indian Partnership Act, it wasn't considered a sub-partnership. Instead, the Trust became entitled to the assigned share as an assignee of the income of the assigning partner.
  • For the aforementioned reason, HC decision was set aside. Consequently, the share of the income of the assessee assigned in favour of the Trust has to be included in the total income of the assessee. Both the issue/question are answered in favour of revenue.

COMMENTARIES RATIO/NOTE-

  • Where an assessee does not alienate or assign the source of income, but merely applies the income so that it passes through their hands to be received by another, it would still remain their income as it is a mere application of income received by them. For example, where mines are leased by the proprietor to a creditor with a direction to apply the royalty income in liquidation of the debt owed, royalty income would be assessable as income in the hands of the lessor as it is a mere application of income and not diversion by an overriding title. [CIT v Manager of Katras Encumbered Estate (1934) 2 ITR 100 (Pat)]