1. The question that has been referred for our determination at the instance of the revenue is as under :
'Whether, on the facts and in the circumstances of the case, and having regard to the annexures 'A', 'B' and 'C', the payment made to the widow or widows of the deceased partner or partners were to be excluded from the assessments of the assessee in the respective years ?'
2. The question relates to the assessment years 1959-60 to 1963-64, the relevant previous years being the financial years preceding the assessment years. From April 1, 1957, the constitution of the firm of Messrs. Crawford Bayley & Co. (the assessee) was governed by a partnership deed dated March 14, 1957 (which in the question is referred to as annexure 'A'). Under this deed of partnership one of the partners of the firm was Mr. V. R. Nath. He died on May 27, 1958. After his death a new deed of partnership was executed on April 16, 1959, and it was to take effect from April 1, 1959. This deed of partnership is referred to as annexure 'B' in the question. Mr. D. T. Lawrie who was a partner of this firm died on July 16, 1959. After his death a supplementary deed came to be executed on April 29, 1960 (which is referred to in the question as annexure 'C').
3. Clause 33 of annexure 'A' is as follows :
'33. In the event of death of an active partner or a sleeping partner leaving a widow, the continuing active partners shall during her life (or until the firm is wound up as provided in clause 38) make to such widow a monthly payment equivalent to Rs. 15 for each year of her husband's service as a partner prior to his death, or his becoming a sleeping partner, whichever be the earlier, but subject to a maximum payment of Rs. 300 per month and under deduction of any income-tax payable by the widow in respect of such monthly payment.'
4. From June 1, 1958, to August 31, 1959, a total payment of Rs. 3,000 was made to Mrs. Nath at the rate of Rs. 300 per month and this sum or Rs. 3,000 is claimed as deduction in the assessment year 1959-60. Thereafter, each year payment at the rate of Rs. 300 per month came to be made to her and the said amounts are claimed as deductions in the later assessment years.
5. The relevant provisions of the deed of partnership dated April 16, 1959 (annexure 'B'), were substantially the same as those of annexure 'A' but clauses 8 and 34 thereof were different. These clauses are as under :
'8. The partners from the 1st April, 1959, will pay to the widow of late Mr. Nath the sum of Rs. 300 monthly during her life in manner provided in clause 33 of the 1957 agreement, but subject as in that clause provided.'
'34. In the event of the death of an active partner or a sleeping partner leaving a widow the continuing active partners shall during her life (or until the firm is wound up as provided in clause 39) make to such widow a monthly payment equivalent to Rs. 50 for each year of her husband's service as a partner prior to his death, or his becoming a sleeping partner, whichever be the earlier, but subject to a maximum payment of Rs. 1,000 per month and under deduction of any income-tax payment by the widow in respect of such monthly payment. Provided that in the event of there being three or more widows entitled to receive payments under this clause the aggregate amount payable to all of them shall be limited to Rs. 2,500 per month and the monthly amount payable to each of them shall suffer proportionate abatement accordingly.'
6. After the death of Mr. Lawrie on July 16, 1959, Mrs. Lawrie was paid Rs. 1,000 per month as required by clause 34 above. The payment made to Mrs. Nath was claimed as deduction in the assessment year 1960-61 and the payments made to Mrs. Nath and Mrs. Lawrie were claimed as deductions in the assessments for the subsequent years, i.e., 1961-62 onwards.
7. When claim for deduction was made by the assessee-firm such claim was rejected by the Income-tax Officer for the following reasons, viz., the widows were not parties to the agreement, that they had no rights against the firm and that the payments made to them were purely voluntary. The further reason was that it was open to the partners to modify or stop making payments without the consent of the widows. He further took the view that as the payments had to be made irrespective of profits or losses resulting to the firm, the payments had no bearing on the income of the firm and was not a charge on such income.
8. Being aggrieved by the order of the Income-tax Officer the assessee-firm preferred an appeal before the Appellate Assistant Commissioner. The Appellate Assistant Commissioner dismissed this appeal holding that there was no diversion by overriding title in the case of these payments; that no charge was created on any property of the firm for making the payments. He further took the view that the payments could not be allowed as expenditure laid out for the purpose of the assessee's business.
9. In a further appeal by the assessee-firm before the Appellate Tribunal it was urged on behalf of the assessee that payments made to Mrs. Nath and Mrs. Lawrie represented amounts that were diverted from the firm's coffers by an overriding title and that as the legal representatives of Mr. Nath and Lawrie did not receive anything towards the goodwill of the firm the payments to Mrs. Nath and Mrs. Lawrie should be looked upon as the rent of goodwill so as to be allowable as business expenditure. On the other hand, it was contended on behalf of the revenue that the payments made to Mrs. Nath and Mrs. Lawrie constituted application of income after it accrued to the assessee-firm and that there was no binding obligation for making these payments as it was open to the partners to dissolve the firm and enter into a fresh agreement whenever a partner died without undertaking any liability towards the widow of the deceased partners. The Tribunal took the view that the obligation to pay an annuity to the widow of any deceased partners was not an undertaking ex gratia. Each partner when he entered into the firm as a partner knew that on his death or retirement the firm is not going to be dissolved because it was expressly provided in the partnership deed that the firm will continue indefinitely. Ordinarily, when a partner dies or retires, the firm is dissolved and accounts are drawn up and the retiring partner or in the case of the death of a partner his legal representative will be entitled to a share in the goodwill of the firm and the properties of the firm. In the present case, the outgoing partner or the legal representative of a deceased partner was only entitled to get back his capital and that too in installments without interest. Provision for payment to a widow of the deceased partner was made on a modest scale. The Tribunal rejected the contention on behalf of the revenue that the widow had no enforceable right against the surviving partners, or the obligation to pay was a mere voluntary obligation. The Tribunal took the view that there was an obligation in the nature of a trust on the surviving partners to make payment and it was for these reasons that the contention on behalf of the assessee-firm was accepted by the Tribunal. It is from this order of the Tribunal that the above question is referred for our determination.
10. Mr. Joshi on behalf of the revenue made the following submissions. Firstly, he submitted that in respect of payments to Mrs. Nath and/or to Mrs. Lawrie there was no diversion by overriding title; that in respect of such payments, no charge was created on any of the properties of the assessee-firm. Secondly, he submitted that in respect of payments to Mrs. Nath and Mrs. Lawrie, the case was one of application of income after it accrued to the assessee-firm and when such is the case the amounts paid to the widows cannot be regarded as a permissible deduction for determining the assessable income of the assessee-firm. Thirdly, he submitted that the expenditure incurred was not laid out wholly and exclusively for the purposes of the business, and, lastly, he submitted that there was no obligation in the nature of trust in respect of the payments made to the widows. He relied upon the decision of the Supreme Court in the case of Commissioner of Income-tax v. Sitaldas Tirathdas : 41ITR367(SC) .
11. The first two contentions of Mr. Joshi can be discussed together, because they are different phases of the same question. In respect of this matter the material question to be considered is, is there diversion of income by an overriding title or whether there is an application of income after it accrued to the assessee-firm. The true test in determining this question is laid down in Sitaldas Tirathdas's case : 41ITR367(SC) . The true test for the application of the rule of diversion of income by an overriding charge, is whether the amount sought 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 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 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.
12. If regard be had to the relevant provisions of the partnership deeds, annexures 'A', 'B' and 'C', it is quite apparent that this is not a case of application of income after it accrued due to the assessee, but it is clearly a case of diversion of income by an overriding title in respect of payment. Under these partnership deeds the assessee-firm is to continue for an indefinite period and it is not going to be dissolved by mere death or retirement of any partner. There is a clear and explicit provision in all the partnership deeds that an active partner becoming a sleeping partner or upon the death or retirement of any active partner, the surviving or continuing active partner or partners shall succeed to the share of the outgoing active partner in the partnership business and the property and goodwill thereof. The surviving or continuing active partners are also to undertake all the debts, liabilities and obligations of the partnership. Thus, it is quite clear having regard to these provisions that even though a partner may cease to be a partner by reason of his death, his legal representative will not be entitled to any share in the goodwill of the firm or compensation in lieu thereof. The payment to the widow of a deceased partner under these partnership deeds is not dependent upon the assessee-firm incurring any profits or losses. It is an absolute obligation and even though there may be no profits in a particular year made by the assessee-firm the obligation to pay to the widow under clause 33 of the partnership deed, annexure 'A', and clauses 8 and 34 of the partnership deed, annexure 'B', is absolute. When the obligation to pay such amount to the widow of a deceased partner is absolute, there can be no question of application of income by the assessee-firm after it accrued to it. In fact, such payment is to be made even though no profits whatsoever may have been made. This provision shows that it is an obligation in the nature of trust. Ordinarily, it is true that a person who is not a party to the contract cannot enforce it, but there are several well recognised exceptions to this rule. One of the well recognised exceptions is a cestui que trust. In a cestui que trust even though a person may not be a party to a contract he can enforce his right under contract by adopting appropriate legal proceedings. Such is the case so far as the rights of a widow of a deceased partner under these partnership deeds are concerned. Such payments have to be made by reason of an overriding title and there is no question of income being applied by the assessee-firm after it accrued to it. Further, it should be noted that no question of allowing an expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922, or the corresponding provisions of the Income-tax Act, 1961, arise in the present case, because deduction is claimed not as an expenditure under the exception but it is claimed by way of payment made in respect of items which are obligations in the nature of trust and such payments are required to be made before the income even accrued to the assessee. Since a deduction is permissible under section 10(1) of the Act the question whether it is permissible under section 10(2)(xv) does not arise for consideration.
13. In the result, our answer to the question referred is in the affirmative. The revenue shall pay the costs of the assessee.