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Commissioner of Income-tax Bombay City-ii Vs. Nariman B. Bharucha and Sons - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 24 of 1971
Judge
Reported in(1980)1CTR(Bom)17; [1981]130ITR863(Bom); [1980]4TAXMAN76(Bom)
ActsIncome Tax Act, 1961 - Sections 5
AppellantCommissioner of Income-tax Bombay City-ii
RespondentNariman B. Bharucha and Sons
Excerpt:
.....smt. this amount of 25% of the income of the partnership was, therefore, liable to be clearly diverted before the profits reached the partners of the assessee firm......:(a) mr. jal and mr. minoo shall continue business as equal partners, subject to their paying mrs. aloo nariman bharucha, wife of mr. nariman, 25 np. in the net profits of the partnership-firm after the date of mr. nariman's death and for and during her lifetime but so that the said mrs. aloo nariman shall not be responsible or liable for any of the losses or liabilities of the partnership-firm,(b) the amounts standing to the credit of mr. nariman in the capital and current account of the business of the partnership shall be divided between mr. jal and mr. minoo in equal share and shall belong to them absolutely,(c) the said mr. aloo nariman bharucha will have for payment of the said 25 np. share to her a first charge on all the assets of the partnership as well as on the shares of the.....
Judgment:

Chandurkar, J.

1. The question referred in this reference at the instance of the revenue is as follows :

'Whether, on the facts and in the circumstances of the case, it was rightly held that there was a valid charge in favour of Mrs. Aloo on the profits of the firm and to that extent the income of the firm was diverted by an overriding title ?'

2. One Shri Nariman B. Bharucha was in the assessment year 1965-66 a sole proprietor of the business carried on in the name of the assessee-firm which was then an unregistered firm. The assessee later took his two sons, Shri Jal and Shri Minoo, as partners and formed a partnership. The partnership agreements were changed from time to time, but we are concerned with the deed of partnership dated 24th September, 1963, by which Shri Nariman was made a sleeping partner as from 1st April, 1963, because he was disabled from working as a partner. Each of the two sons was given 37 1/2 paise profits in the partnership and the father, Shri Nariman, was a partner to the extent of 25 paise as against 50 paise originally. One of the clauses on the construction of which the decision of the present reference depends was cl. 17, which reads as follows :

'17. In the event of the death of Mr. Mariman during the continuance of this agreement :

(a) Mr. Jal and Mr. Minoo shall continue business as equal partners, subject to their paying Mrs. Aloo Nariman Bharucha, wife of Mr. Nariman, 25 np. in the net profits of the partnership-firm after the date of Mr. Nariman's death and for and during her lifetime but so that the said Mrs. Aloo Nariman shall not be responsible or liable for any of the losses or liabilities of the partnership-firm,

(b) the amounts standing to the credit of Mr. Nariman in the capital and current account of the business of the partnership shall be divided between Mr. Jal and Mr. Minoo in equal share and shall belong to them absolutely,

(c) the said Mr. Aloo Nariman Bharucha will have for payment of the said 25 np. share to her a first charge on all the assets of the partnership as well as on the shares of the said Mr. Jal and Mr. Minoo.'

3. It is the effect of this clause which is required to be considered. Broadly, the effect was that after the death of Shri Nariman, the business was to be continued by his two sons who were to have an equal share in the partnership, but this was subject to their paying their mother, Smt. Aloo, 25% of the net profits of the partnership after Shri Nariman's death and for and during her lifetime. A charge was created in favour of Smt. Aloo in respect of the payment to her of 25% share on all the assets of the partnership as well as on the shares of the two partners, Shri Jal and Shri Minoo.

4. Shri Nariman died on or about 16th May, 1964. The total amount payable to Smt. Aloo in the assessment year in question, that is, 1965-66, came to Rs. 15,638 in respect of which the firm made a claim for deduction. The ITO rejected this claim on the ground that -

(1) the payment was not for earning the profits of the business,

(2) the widow was the mother of the two surviving partners and the payment was made for considerations other than business, and

(3) the payment was not a charge on the profits since nothing could have prevented the partners from dissolving the partnership.

5. Before the AAC, it was contended on behalf of the assessee that the said amount of Rs. 15,638 did not constitute a part of the assessee's income at all but was diverted by an overriding title. Alternatively, it was contended that the firm and its partners held the said 25 paise where in the profits of the firm in trust for Smt. Aloo Nariman Bharucha. The AAC accepted the contention of the assessee that there was an overriding charge on the assets of the firm as well as the shares of the partners and, hence, the deduction claimed was admissible. The other alternative contention was, therefore, not considered.

6. The revenue carried the matter further to the Tribunal. The statement of the case shows that the appeal filed by the revenue was kept pending to await the decision of this court in a matter in which a similar question arose and the decision in which has since been reported in CIT v. C. N. Patuck : [1969]71ITR713(Bom) . Relying on the judgment in Patuck's case, the Tribunal held that an effective and valid charge was created in favour of Smt. Aloo and the income of the firm to that extent was diverted by an overriding title. The Tribunal further held that even assuming that there was no charge in favour of Smt. Aloo, there was a legally enforceable agreement and a legally enforceable agreement was sufficient to divert the income by overriding title as laid down in Patuck's case : [1969]71ITR713(Bom) . The Tribunal held that the overriding charge was on the profits of the firm and, to that extent, the income of the firm was diverted by an overriding title and the amount paid to Smt. Aloo was, therefore, not taxable in the hands of the firm.

7. At the instance of the revenue, arising out of this order of the Tribunal, the following question has been referred to this court :

'Whether, on the facts and in the circumstances of the case, it was rightly held that there was a valid charge in favour of Mrs. Aloo on the profits of the firm and to that extent the income of the firm was diverted by an overriding title ?'

8. Having heard the counsel for the parties, we are satisfied that the case is expressly covered by the decision of this court in Patuck's case : [1969]71ITR713(Bom) . The Division Bench has in Patuck's case construed the decision of the Supreme court in CIT v. Sitaldas Tirathdas : [1961]41ITR367(SC) , in which the Supreme Court has laid down the test of determining when an amount can be said to be diverted at source as a result of a charge or overriding title. The Supreme Court had observed as follows (p. 374) :

'In our opinion, the true test is whether the amount south to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, 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 deduction 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. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, no as part of his income, but for and on behalf of the person to whom it is payable.'

9. Considering the impact of these observations in a case where a charge is created, the Division Bench observed in Patuck's case : [1969]71ITR713(Bom) as follows at page 721 :

'.... the Supreme Court laid down that where a charge is created or, upon the facts and circumstances, a charge can be found, it would not be a case of mere application of a portion of his income by the assessee to discharge an obligation but a case in which an overriding charge is created by the assessee and he becomes only a collector of another's income. In other words, whenever a charge is created or exists, an overriding title is create in the charge-holder and, to the extent of the charge, the income of the assessee ceases to be his income, because the charge-holder has the paramount right by virtue of his overriding title to recover that income before it reaches the hands of the assessee.' (Underlining is ours.)

10. The Division Bench has thus clearly laid down that whenever a charge is created, the effect of the charge is that to the extent of the charge, the income which has been made the subject of the charge ceases to be the income of the assessee and that the charge creates an overriding title in favour of the charge-holder to recover the income before it reaches the hands of the assessee. The position is further reiterated at p. 725, where the Division Bench again observes as follows :

'Now, it is clear that the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. In deciding the question, the nature of the obligation created in each case is the decisive test. Where, however, coupled with an obligation, the terms of the document give rise to an overriding charge, then there can be no doubt that there would be created in favour of the charge-holder such an overriding or superior title as would make the amount due under the charge cease to be the income of the assessee altogether.'

11. If in the light of the ratio of the decision in Patuck's case : [1969]71ITR713(Bom) , the provision made in cl. 17 of the partnership deed is considered, it is obvious that not only the share in the income of the two partners which is half and half but also the assets of the partnership have been subjected to a charge to the extent of 25% of the income of the partnership firm. This 25% of the income of the partnership firm cannot be said to belong to any of the two partners, and if at all that income is received by the two partners, it was for and on behalf of the charge-holder. The nature of the charge created by the document of partnership in cl. 17 was clearly such that the charge-holder, Smt. Aloo, had an overriding title to the 25% of the profits of the partnership. This amount of 25% of the income of the partnership was, therefore, liable to be clearly diverted before the profits reached the partners of the assessee firm.

12. Consequently, the question referred to us must be answered in the affirmative and in favour of the assessee. The revenue to pay the costs of this reference to the assessee.


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