1. One Mahavirprasad Kanoria, who had two sons, Murlidhar and Beniprasad, Murlidhar being the assessee in this reference, died on August 26, 1962. The assessee, Murlidhar, was a partner in two firms, namely, M/s. Banarsilal Mahavirprasad and M/s. Banarsilal Kanoria, having invested joint family funds in the partnerships and he was a partner for and on behalf of the joint family of which he was the karta. After the death of Mahavirprasad, the firm, M/s. Banarsilal Mahavirprasad, whose principal place of business was at Khalilabad, was reconstituted and the other firm, M/s. Banarsilal Kanoria, whose place of business was at Nagpur, was dissolved and was later reconstituted. The partnership deeds evidencing the reconstitution of both these firms are annex. A1 and A2 to the statement of the case.
2. The family of the assessee consisted of himself, his wife, Snehalata, and two minor sons, Ajayprakash and Brahmaprakash. The capital standing in the name of the assessee in the Khalilabad firm was Rs. 1,54,710.21 and in the Nagpur firm it was Rs. 2,96,177. There was a partition of the joint family of the assessee on August 27, 1962. At that partition the capital amount standing in the name of the assessee in two two firms also came to be equally divided between the members of the joint family of the assessee. The partition effect on August 27, 1962, was later reduced to writing and the memorandum of partition is annex. B dated September 15, 1962. The recitals of the memorandum of partition show that the profits of the 'Khalilabad firm' and the firm 'Kanoria Brothers', which was the name of the reconstituted firm at Nagpur, 'shall be the profits the name of the reconstituted firm at Nagpur, 'shall be the profits or losses of the members of the joint family (including party No. 1) severally in their own respective individual right and interest, in the proportion stated hereinafter'. The proportion specified in the document was one fourth share in the profits of each of the separated members of the joint family, i.e., the assessee, his wife and his two minor sons. The memorandum of partition specifically provided that the assessee alone was to remain as a partner in the two partnership firm but it also provided that 'the profits or losses in the said two partnership falling to the share of said party No. 1 shall be the profits or losses of the members of the joint family (including party No. 1) severally in their own respective individual right and interest, in the proportion stated hereinafter'. According to the memorandum, except Murlidhar, the other members of the family did not have any right whatsoever in the conduct of the affairs of the partnership firm. There is a specific clause in the memorandum which provided that the minors shall not be liable for any loss and the losses had to be borne by the assessee and his wife.
3. The assessee requested the ITO by an application dated November 7, 1967, for recognition of the partition for the year 1963-64. This recognition was granted by the ITO by his order dated March 26, 1968. As far as the division of capital was concerned, the ITO accepted the claim of the assessee but he did not accept the claim that the income, which was to be derived from the capital that was invested, was also divided.
4. For the assessment year 1964-65, the assessee filed a return showing income from business as share of profits from M/s. Kanoria Brothers, Nagpur, and the Khalilabad firm. The ITO observed that for the assessment year 1963-64, the assessee was the karta of the family of which there was a partial partition which had taken place and which was recognised by the ITO by an order made under s. 171 of the I.T. Act, 1961 (hereinafter referred to as 'the Act'), and held that for the assessment year 1964-65, there was a change in the constitution of the firm as the assessee was a partner in his individual capacity and not as karta. Considering the memorandum of partition, the ITO added for the assessment year 1964-65, one-fourth share of the profits in the hands of the assessee as a protective measure and observed that the entire share income would be assessable in the hands of the 'AOP' as per the view of the ITO for the assessment year 1963-64. The case of the assessee before the ITO was that there was not only a division of the capital but that after the division, though the assessee alone was to continue as a partner, the assessee was liable to give to the individuals, i.e., the erstwhile members of the joint family, their respective shares having regard to the memorandum of partition. This contention was, however, rejected by the ITO who took the view that s. 64 of the Act was attracted to the case of the assessee. For the assessment years 1967-68 to 1970-71, the facts were identical except that additionally during those years the assessee was a partner in a firm called M/s. Khare and Tarkunde and there was a similar partition between the members of the joint family of the assessee of the capital amount of Rs. 15,000 which was invested in the name of the HUF in the said firm. As in the case of the Nagpur and Khalilabad firms, there was also a partition in the year 1966, between the members of the joint family of the assessee, the terms of which are evidenced by the memorandum dated April 4, 1966, and the arrangement with regard to the profits of the firm of M/s. Khare and Tarkunde is the same, namely, each of the four persons were to have one-fourth share in the profits but the losses were to be borne by the assessee and his wife half and half.
5. In the appeals filed by the assessee the AAC accepted the contentions raised before him and reversed the view taken by the ITO. He found that the family ceased to exist with effect from the date of the partition for the purposes of the capital only, and he further held that a charge was created on the capital and interest of the karta in respect of the amount due to other members. He found that there was an overriding charge and the karta could not be assessed in his individual capacity on the full share income credited in his name in the firms and the share could not also be assessed as belonging to the HUF.
6. The department challenged the correctness of the view of the AAC by an appeal before the Income-tax Appellate Tribunal. The Tribunal held, after considering the memorandum of partition, that there was no transfer, and, therefore, s. 60 of the Act, was not attracted. The Tribunal held that the right to share profits could be divided and that the memorandum of partial partition was not illusory. The Tribunal confirmed the view of the AAC that because of the memorandum of partition there was a creation of overriding title and the income at the very accrual stage belonged to Snehalata and the two minor sons and Murlidhar also. There was thus a diversion of income by overriding title. It appears that it was contended before the Tribunal that the provisions of s. 64 of the Act were attracted to the case of the assessee and the Tribunal found that the mere partition of the property of a family does not result in the creation of a partnership and that since the partition does not give rise to a sub-partnership, s. 64 of the Act was not applicable.
7. Arising out of this order of the Tribunal, the following question has been referred to this court under s. 256(1) of the Act :
'Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the share income of Murlidhar in the profits of the partnership firms was subject to an overriding title in favour of other members of the HUF in proportion to the shares allotted to them in the partial partition deed and as such it could not be taxed in the hands of Shri Murlidhar ?'
8. Having regard to the argument which is advanced at the outset in this reference by the learned counsel for the revenue, to which we shall refer later, it is necessary to point out that originally the revenue in its application under s. 256(1) had asked for three questions to be referred to this court. These three questions included the present question which is already reproduced and was question No. 2. The other two questions, namely, Nos. (1) and (3), were as follows :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in upholding the order of the Appellate Assistant Commissioner ?'
(3) Whether the decision of the Tribunal is in accordance with the provisions of the Income-tax Act ?'
9. In spite of the fact that these two questions were also asked to be referred and both of them appear to be wholly of a general nature, the Tribunal has though it fit to make a reference only in respect of the question reproduced above.
10. The learned counsel appearing on behalf of the revenue has at the outset contended that the applicability of s. 64 of the Act, is merely another aspect of the question which has been referred by the Tribunal and that the revenue was, therefore, entitled to contend that having regard to the provisions of s. 64, the income of the other members of the erstwhile joint family was includible in the income of the assessee. The learned counsel was also obviously referring to the provisions of cls. (1) and (iii) of sub-s. (1) of s. 64. The relevant clauses read as follows :
'64. (1) In computing the total income of any individual, there shall be included all such income as arises directly or indirectly -
(i) to the spouse of such individual from the membership of the spouse in a firm carrying on a business in which such individual is a partner;...
(iii) to a minor child of such individual from the admission of the minor to the benefits of partnership in a firm.'
11. The learned counsel has relied on the decision of the Supreme Court in CIT v. Scindia Steam Navigation Co. Ltd. : 42ITR589(SC) , in support of his contention that s. 64 being one of the aspects of the controversy focused by the question referred, it should be permitted to be argued. Now, it is difficult for us to accept the contention raised by Shri Joshi. It is no doubt true that the question with regard to the applicability of s. 64 was argued before the Tribunal when the appeals of the revenue were argued before it. That, however, would be wholly irrelevant for deciding the scope of the question which has now been referred. The applicability of s. 64 was one of the main contentions raised on behalf of the revenue before the Tribunal in appeal. But when it comes to filing the application under s. 256(1) it is apparent that no such question was specifically raised for being referred to this court. If at all such a question was contemplated it could be held to fall within the original question No. (3) set out in the application under s. 256(1). That question would take in several other controversies and it is obvious that when the Tribunal declined to make a reference in respect of the questions Nos. (1) and (3) it was not even contended before the Tribunal that question No. (3) would take in a controversy with regard to the applicability of s. 64. The applicability of s. 64 in the present case is wholly independent of the question which has been referred. In other words, the question which has been referred has no connection whatsoever with s. 64 because the share income of other erstwhile members of the joint family has been held not to be includible in the income of the assessee on a wholly independent ground on a construction of the memorandum of partition.
12. Secondly, the applicability of s. 64 presupposes a firm and a partnership. The Tribunal has found as a fact that the memorandum of partition did not bring about any partnership firm consisting of the assessee and his wife. There is no ambiguity about the finding of that issue. We have, therefore, not permitted the learned counsel for the revenue to argue this reference on the footing that the order of the Tribunal would become erroneous in view of the provisions of s. 64 of the Act.
13. Coming to the merits of the question, it was contended on behalf of the revenue that so far as the income which arises from being a partner in the firm in which the assessee continued to be a partner even after partition is concerned, that income could be only of the assessee because in a partnership firm a partner alone is entitled to the profits of the partnership. The learned counsel, therefore, contended that the profits of the partnership firms which were allocated to the share of the present assessee must be treated as his income and alternatively it was further submitted that when payments were being made to the other members of the erstwhile joint family, that was only in the nature of the application of the income of the assessee and that there was no question of any diversion consequent upon any overriding title. Reliance was placed by the learned counsel for the revenue on the decision of the Supreme Court in K. A. Ramachar v. CIT : 42ITR25(SC) . We shall refer to this decision later. The learned Advocate-General appearing on behalf of the assessee has placed reliance on the decision of the Supreme Court in Charandas Haridas v. CIT : 39ITR202(SC) , in support of his contention that it was perfectly permissible for the assessee and other members of the joint Hindu family to divide a particular asset which in the instant case was the capital standing to the credit of the HUF in the accounts of the partnership firms. The learned Advocate-General has also referred us to two decisions in CIT v. Travancore Sugars and Chemicals Ltd. : 88ITR1(SC) and CIT v. Sitaldas Tirathdas : 41ITR367(SC) , to show that the payments which were required to be made to the other members of the joint family by virtue of the memorandum of partition as their share in the share of profits in the name of the assessee in the partnership firms amounted to a diversion at source by overriding title.
14. It is clear from the memorandum of partition dated September 15, 1962, and the further memorandum of partial partition dated April 4, 1966, that the assets of the joint family consisting of the assessee, his wife and two minor children in the form of capital standing in the name of the assessee in the respective partnership firms were partitioned. Coupled with this partition the memorandum also contains an agreement between the members of the joint family that though the assessee was to remain as a partner in the two firms, the profits or losses in the two partnership firms falling to the share of the assessee were to be the profits or losses of the members of the joint family 'severally in their own respective individual right and interest' in the proportion stated in the memorandum. The further agreement which is recorded in the memorandum is that the share in the profits in the two firms which was to be received by the assessee 'shall be received for and on behalf of the members (severally)'. Similar is the memorandum of partition dated April 4, 1966, in respect of the partial partition with regard to the capital standing in the firm, M/s. Khare and Tarkunde. These recitals clearly thus provide that were the share of the profits is to be received by the assessee, it is received for and on behalf of the members of the erstwhile joint family who have now separated and this is specifically made clear by using the word 'severally' and not 'jointly'. The agreement contained in this memorandum, therefore, leaves no room for the argument that the share of the profits in the partnership firms is received by the assessee on his own account either in his personal capacity or as the karta of the HUF. Those profits are received by him for and on behalf of the parties to the agreement contained in the two memoranda of partition. Though these amounts are received by him from the partnership firms, those do not belong to him in entirety, but to the extent of the share provided for in the memoranda, the ownership is of the parties to the memoranda of partition.
15. The concept of diversion of income by an overriding charge is explained by the Supreme Court in Sitaldas' case : 41ITR367(SC) . Laying down the test for deciding whether any particular income should be deducted from the income of the assessee on the ground that there is a diversion of income at source by an overriding charge, the Supreme Court has observed as follows (p. 374) :
'In our opinion, the true test 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 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, not as part of his income, but for an on behalf of the person to whom it is payable.'
16. The same test is re-stated in the later decision of the Supreme Court in Travancore Sugars and Chemical's : 88ITR1(SC) , in the following words (p. 13) :
'Where income which accrues to the assessee is not his income, the question of admissible deductions would not arise. Therefore, where income is diverted at source so that when it accrues it is really not his income but is somebody else's income the question as to whether that income falls under sub-section (2) of section 10 does not arise. Again, income can be said to be diverted only when it is diverted at source so that when it accrues it is really not the income of the assessee but is somebody else's income. It is thus clear that 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 it is merely a case of application of income to satisfy an obligation of payment and is therefore not deductible.'
17. The substance of the test in both the cases is identical. The crucial question, therefore, which has to be determined is whether where a particular income is sought to be treated as a diversion by an overriding charge and not an application of income, the income is the income of the assessee or not. The test is not that the assessee collects the income. The test is whose income it is. If on the terms of the memoranda of partition, the assessee by virtue of the fact that he was allowed to continue in the two partnership firms was to receive the share in the profits of those firms and there was an express agreement which provided that he would receive that for and on behalf of the erstwhile members of the joint family who severally and independently had a title to a part of that income in the proportion which was specified in the memorandum of agreement, the entire share income clearly did not belong to him. The assessee had no doubt an obligation to pay a part of the income. That obligation when performed was not in the nature of an application of the income. That was an obligation which flowed from the terms of the memoranda of partition by which the title to a part of the income had already accrued in favour of the other members of the erstwhile joint family.
18. The decision relied upon by the learned counsel for the revenue is clearly distinguishable on facts. In K. A. Ramachar's case : 42ITR25(SC) , the facts were that the assessee was a partner in a firm and he had executed three irrevocable deeds of settlement on September 22, 1947, in favour of his wife, a married daughter and a minor daughter, assigning to each of them one-fourth of his share of the profits in the firm (but not losses-payable to him during a period of eight years from the date of the settlement to be enjoyed by them absolutely and exclusively. They were also entitled directly to receive and collect from the firm their share under the settlements. In the account books of the firm the profits due to the assessee were credited to the assessee's account and one-fourth thereof was transferred to the accounts of each of the three beneficiaries. The assessee had claimed that those amounts could not be included in his total income for purposes of assessment to income-tax. On these facts, the Supreme Court took the view that the tenor of the deeds of settlement showed that the profits were first to accrue to the assessee and were then applied for payment to there beneficiaries and that under the law of partnership it was the partner and the partner alone who was entitled to the profits. On a construction of the deeds, the Supreme Court took the view that by the deeds in question, the assessee merely allowed a payment to his wife and daughters to constitute a valid discharge in favour of the firm, but what was paid was, in law, a portion of his income. The distinguishing feature between the case of the present assessee and the facts in Ramachar's case : 42ITR25(SC) , is clearly that in the present case there was a partition of the assets of the HUF in so far as the capital in the partnership firms was concerned. The memoranda of partition expressly divided that capital between the members of the joint family, with the result that though the capital stood in the name of the assessee in the partnership firms account books that capital was severally owned by the erstwhile members of the joint family, in definite shares, with a further agreement that the assessee was to receive the profits, for and on behalf of the contracting parties severally. That such a partition is permissible would be clear from the decision in Charandas' case : 39ITR202(SC) in which the Supreme Court has clearly observed that there was nothing in the Indian income-tax law or the law of partnership which prevented the members of a Hindu joint family from dividing any asset.
19. In the view which we have taken the question referred to us has to be answered in the affirmative and against the revenue. The assessee to get the costs of this reference.