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Commissioner of Income-tax Vs. Natwarlal Tribhovandas - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 6 of 1970
Judge
Reported in[1973]87ITR703(Guj)
ActsFinance (No. 2) Act, 1962 - Sections 2(7)
AppellantCommissioner of Income-tax
RespondentNatwarlal Tribhovandas
Appellant Advocate J.M. Thakore, Adv. General and; M.G. Doshit, Adv.
Respondent Advocate K.H. Kaji, Adv.
Cases ReferredRamdoss Purushothamdoss v. Commissioner of Income
Excerpt:
direct taxation - income - section 2 (7) of finance (no.2) act, 1962 - whether assessee's income was earned income within section 2 (7) (iii) (b) - earned income means any income of assessee who is taxed as individual where assessee is partner actively engaged in conduct of business or profession - actively engaged in conduct of business means partner who devotes time, attention and labour to some activity or assignment calculated or designed to lead to preservation, growth or advancement of business of firm - assessee sent abroad by firm for further studies for purpose of its business - assessee actively engaged in conduct of business of firm - business income earned by him was earned income - assessee could not participate in actual transaction of day-to-day business of firm - knowledge.....p.d. desai, j.1. this reference raises a short but interesting question as to whether the income of the assesses derived from partnership business is earned income or unearned income. the assessee, who was assessed in the capacity of an individual, was a partner in two firms, namely, messrs. ramjibhai hirjibhai & sons and messrs. vishvakarma construction co. both the firms carried on the business of construction work. for the assessment year 1962-63 (corresponding accounting year being s. y. 2017, i.e., the period from 21st october, 1960 to 5th november, 1961), the assessee filed a return showing, inter alia, an income of rs. 78,454 and rs. 3,061 being his share respectively in the profits of the said two firms. the assessee claimed in the course of the assessment-proceedings that the.....
Judgment:

P.D. Desai, J.

1. This reference raises a short but interesting question as to whether the income of the assesses derived from partnership business is earned income or unearned income. The assessee, who was assessed in the capacity of an individual, was a partner in two firms, namely, Messrs. Ramjibhai Hirjibhai & Sons and Messrs. Vishvakarma Construction Co. Both the firms carried on the business of construction work. For the assessment year 1962-63 (corresponding accounting year being S. Y. 2017, i.e., the period from 21st October, 1960 to 5th November, 1961), the assessee filed a return showing, inter alia, an income of Rs. 78,454 and Rs. 3,061 being his share respectively in the profits of the said two firms. The assessee claimed in the course of the assessment-proceedings that the income was 'earned income ' because during the relevant period he was actively engaged as a partner in the conduct of the business of the firms. The Income-tax Officer negatived the claim of the assessee on the ground that since the assessee had gone to the U.S.A. for prosecuting further studies in January, 1961, and was away from India for a period of about nine months during the relevant accounting year, the assessee could not be said to have been actively engaged as a partner in the conduct of the business of the firms. The Income-tax Officer accordingly treated the said income as unearned income and brought it to tax on that basis.

2. The assessee carried the matter in appeal to the Appellate Assistant Commissioner who confirmed the order of the Income-tax Officer and dismissed the appeal. The Appellate Assistant Commissioner was of the view that during the relevant accounting year, even for the broken period of about three months prior to his departure for the U. S. A., the assessee could not be said to have been actively engaged in the conduct of the business of the firms because he was then only a student and was engaged in matters connected with the proposed trip to the U. S. A.

3. The assessee carried the matter in further appeal to the Income-tax Appellate Tribunal. The contention of the assessee before the Tribunal was that since prior to his departure for the U.S.A., he was working as an active partner of the firms and was sent abroad at the expense of one of the firms to obtain better educational qualifications and technical knowledge in engineering so that he could on return help in advancement of the business of the firm. The assessee also contended that, in any event, during the relevant accounting year he was in India for a period of about three months prior to his departure for the U.S.A. and since he was actively engaged in the business of the firms during that period, the income earned by him as a partner of the firms was required to be treated as earned income. The Tribunal found that from the material on record it appeared that even before the assessee attained the age of majority on 17th January, 1957, he was admitted to the benefits of partnership as a minor partner (presumably in the firm of M/s. Ramjibhai Hirjibhai & Sons) and the income then earned by him as his share in the profits of the said firm was assessed as unearned income. However, from the assessment year 1958-59, that is, since after the assessee attained the age of majority, income earned by the assessee as a partner of the said firm was treated as earned income because it was found that the assessee was actively engaged as a partner in the conduct of the business of the firm. The Tribunal further found that there was material on record which also showed that the expenses for sending the assessee abroad were incurred by the firm of M/s Ramjibhai Hirjibhai & Sons and in the assessment of the said firm to income-tax for the assessment year 1962-63, a part of the expenditure incurred for that purpose was allowed 'in computing the income of the firm on the footing that it was laid out wholly and exclusively for the purpose of the business of the firm. The Tribunal observed that the firm was carrying on the business of construction work and the said business necessarily required technical knowledge in the line of civil engineering. The Tribunal, therefore, concluded that, in the facts and circumstances of the case, although the assessee was not in India for a period of nearly nine months during the relevant accounting period, it could still be said that the assessee was actually engaged in the conduct of the business of the firm. The Tribunal accordingly allowed the appeal and directed that the business income of the assessee should be taxed as earned income in the assessment year in question.

4. The revenue was obviously aggrieved by the decision of the Tribunal and at the instance of the Commissioner of Income-tax, the Tribunal has referred the following question to this court under Section 256 of the Income-tax Act, 1961 :

' Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee's income was earned income within the meaning of Section 2(7)(iii)(b) of the Finance (No. 2) Act, 1962 ?'

5. Now, in order to ascertain the true answer to the question posed to us, we will have to construe the relevant words of Section 2 of the Finance (No. 2) Act, 1962, which read with the First Schedule thereof prescribed the rates of income-tax and super-tax chargeable for the assessment year commencing on the 1st day of April, 1962. The Act treats earned income on a somewhat lenient basis in certain respects. Sub-section (7) of Section 2 defines some of the expressions for the purpose of the said section and of the rates of tax imposed thereby and 'earned income' is one of the expressions therein defined. The species of earned income with which we are concerned in the present case is thus defined in Section 2(7)(iii)(b):

' the expression ' earned income' means any income of an assessee who is an individual, Hindu undivided family, unregistered firm or other association of persons or body of individuals, whether incorporated or not, not being a company, a local authority, a registered firm or a firm assessed under Clause (b) of Section 183 of the said Act--......

(b) which is chargeable under the head ' Profits and gains of business or profession' where the business or profession is carried on by the assessee or, in the case of a firm, where the assessee is a partner actively engaged in the conduct of the business or profession ; or.....'

6. Leaving aside words that are not necessary to be noticed for the purpose of this case, earned income, according to the said definition, means any income of an assessee who is taxed as an individual, which is chargeable under the head ' Profits and gains of business or profession ' where the assessee is a partner actively engaged in the conduct of the business of a firm. The words underlined fall for consideration in this case and two rival constructions have been suggested by the contesting parties.

7. The learned Advocate-General appearing on behalf of the revenue urged that each one of the words used in that part of the definition which is underlined above has a clear and distinct meaning and effect must be given thereto. Accordingly, before the business income of an assessee, who is a partner of a firm, could be treated as earned income, the conditions which are required to be satisfied are that the assessee should be; (i) actively, (ii) engaged in, (iii) the conduct of the business of the firm, (iv) for the whole of the previous year. The submission was that the first three of the four conditions are expressly found in Section 2(7)(iii)(b) and the fourth condition is necessarily implied therein having regard to the manner in which a partnership functions and its accounts are made up. Unless the assessee is able to show, therefore, that for the whole of the relevant previous year he was continuously and in an active manner occupied or busy with, the work of carrying on or transacting the business of the firm, the business income earned by him as a partner would not qualify for the earned income relief.

8. Mr. Kaji, learned counsel for the assessee, contended on the other hand that the words now under consideration require to be construed broadly having regard to the context in which they are used. He urged that it is not unknown that in a partnership there are partners who, in popular parlance, are called ' sleeping partners' and who are brought into the firm either because of their financial contribution or family ties or the like. A sleeping partner, though really not engaged in the conduct of the business of the firm, would nevertheless be considered as having been so engaged in the eye of law because of the principle of mutual agency involved in partnership and his share in the profits of the firm would, therefore, qualify for the earned income relief in his hands. The word ' actively ', which is prefixed to the expression ' engaged in the conduct of the business ', is used precisely with a view to ensuring that a partner who participates in the conduct of the business of the firm only through the agency of his co-partners does not get the benefit of the earned income relief. The expression 'actively engaged in the conduct of the business ', proceeded the argument, read in the context and as a whole, meant that the partner should personally participate in some manner in the business of the firm, that is, undertake some activity which is necessary or desirable for the preservation and growth of the business of the firm. The expression, according to the assessee, did not signify that the partner should take active part in the actual day-to-day transaction of the business of the firm. It was also urged that participation in the conduct of the business need not have continued for the whole of the previous year and that if it is shown that the concerned partner has participated in the conduct of the business of the firm for a substantial part of the previous year, the business income earned by him would qualify for the earned income relief.

9. The question is as to which out of the two rival constructions' suggested at the Bar should be preferred. Leaving out of consideration for the time being the question whether or not the engagement in the conduct of the business must be for the whole of the previous year, we shall first attempt to ascertain the plain grammatical meaning of the expression ' actively engaged in the conduct of the business '. The word ' actively ' ordinarily means in an active manner, that is, effectively, energetically and diligently. It is sometimes also used to signify direct participation in contradistinction to impersonal interest or passive role. The expression ' engaged in ' is a term of various meanings depending on the context in which it is used but ordinarily it is intended to signify continuous occupation or employment; it involves the concept of continuity of action as well as of physical participation. However, the term is often employed to denote a present obligation to devote time, attention and efforts to a particular activity, although, for the time being, there may not be any active participation or wholetime involvement in such activity. The expression 'the conduct of the business' in a narrower sense means actual direction, handling, management or regulation of business day-after-day. In a broader sense, however, it is also capable of connoting contribution to the business by carrying out some assignment or undertaking, some activity unconnected with the day-to-day management of the business, which might ultimately lead to the preservation and development of the business. It would thus appear that on a plain meaning of the words comprised in the relevant phrase, both constructions--the narrower as well as the broader--for which the parties have contended are possible. We would, in these circumstances, naturally prefer that construction which favours the assessee. But apart from that consideration, there are other weightier considerations which persuade us to accept the construction for which the assessee contends and we shall briefly notice them.

10. Section 2(7)(iii)(b) deals with two classes of assessees--proprietors of firms and partners of firms--and prescribes different sets of conditions on the satisfaction of which business income derived by assessees belonging to each of the two classes can be treated as earned income. While dealing with the business income of a proprietor of a firm, the legislature speaks of the income derived from 'business......carried on by the assessee', whereas while dealing with the business income of a partner of a firm, it speaks of income derived by a ' partner actively engaged in the conduct of the business of the firm'. The proprietor of a firm, even if he carries on his business through an agent, cannot remain passive in the conduct of the business and in dealing with the case of such an assessee, the legislature did not think it necessary to prefix the term 'actively' to the expression 'carried on by the assessee'. However, while dealing with the case of the partner of a firm, the legislature, conscious as it was of the concept of mutual agency on which a partnership functions, took care to provide that the assessee concerned, in order to earn the earned income relief, must be ' actively ' engaged in the conduct of the business of the firm. If the word 'actively ' did not find place in the latter part of Section 2(7)(iii)(b), it could have been contended with some force that every partner should be considered as engaged in the conduct of the business of the firm through his co-partners although he might play purely passive role and not personally participate in some manner in the conduct of the business of the firm. It is to meet this situation and to ensure that an assessee claiming the earned income relief must personally, and not indirectly, participate in some manner in the conduct of the business of the firm that the word ' actively ' is used in Section 2(7)(iii)(b) and having regard to the context, the concept of active day-to-day participation in the actual transaction of the business of the firm is not implied in the use of the said word.

11. Turning next to the expression ' engaged in the conduct of the business ', it appears to us that the said expression again is not used to signify continuous occupation or employment of a partner in the direction or regulation of the business of the firm. It does not contemplate actual participation in the day-to-day management of the business of the firm. The expression is used in a broader sense so as to take in the case of a partner who devotes time, attention and labour to some activity calculated to lead to the preservation and advancement of the business of the firm. In the context of the present day advance in the field of trade and commerce, a partner who is not physically present to attend to the actual handling of the business of the firm or who does not even otherwise manage the business of the firm may yet be said to be engaged in the conduct of the business of the firm by engaging himself in some course of action which would lead to the stability and growth of the business of the firm. Take, for illustration, the case of a partner of a manufacturing firm who goes abroad for visiting factories which manufacture and market articles similar to those produced by his firm with a view to getting acquainted with the latest technological advancement in the process of manufacture of modern techniques and in the marketing of the products. The partner buys nothing and sells nothing on behalf of the firm and he may be absent for quite a long time so as not to be able to participate in the direction or regulation of the business of the firm. Could it, however, be said that such a partner is not engaged in the conduct of the business of the firm It would be possible to answer the question in the affirmative only by unduly restricting the meaning and connotation of the expression 'engaged in the conduct of the business'. Such constricted construction would exclude any activities necessary or designed for the preservation and expansion of business and since the language employed by the legislature does not compel up to take such a view, there is no reason why we should prefer it.

12. The learned Advocate-General relied upon two English decisions in support of the construction of the words 'engaged in' for which the revenue contends. In Benninga (Mitcham) Ltd. v. Bijstra, [1946] K.B. 58; [1945] 2 All E.R. 433, 435, 437 (C.A.) and R. F. Fuggle Ltd. v. Gadsden, [1948] 2 K.B. 236 (C.A.) the Court of Appeal was dealing with the expression ' reasonably required by the landlord for occupation as a residence for some person engaged in his whole-time employment' occurring in the Rent and Mortgage Interest Restrictions (Amendment) Act, 1933, in paragraph (g) of the First Schedule to that Act. The facts in the former case (Benninga's case) were that the plaintiffs had issued a plaint on March 20, 1945, claiming possession of a dwelling house which was in possession of their ex-employee on the ground that it was reasonably required by them for one Schuler, a person engaged in their whole-time employment. The county court judge made an order for possession in favour of the plaintiffs on May 2, 1945, and the defendant appealed. The defendant pointed out in the Court of Appeal that though the plaintiffs had arranged with Schuler to succeed the defendant as their employee in February, 1945, he was able to commence work for the plaintiffs only on April 15, 1945, since he had to give notice to his then employers and get relief. The argument on behalf of the defendant before the Court of Appeal was that the expression 'engaged, in' meant ' actually working for ' and since Schuler was not actually working for the plaintiffs till April 16, 1945, he could not be said to have been engaged in the whole-time employment of the plaintiffs at the material time, that is, on March 20, 1945, which was the date on which the plaint was issued. Mackinnon L.J., dealing with this argument, observed that ' the word ' engaged ' is deplorably ambiguous ' and proceeded to state :

'An employer 'engages' a servant when he makes an agreement with him for his services. A workman is 'engaged ' on work when he is actually carrying it out. In fact, ' engage ' of a master has an entirely different meaning to ' engaged in ' of a workman. In the phrase we are concerned with the use is of the workman. I do not find it necessary to express a final opinion on the point, but I am inclined to think that it was not until April 16, 1945, that Schuler became a 'person engaged' in the whole-time employment of the plaintiffs, however obvious it may be that the plaintiffs had ' engaged ' him long before that date.'

13. Morton L. J., who delivered a concurring judgment in that case, brought out succinctly the distinction between the expressions ' engaged in ' and ' engaged for ' in the following words :

' It seems to me that from February to April, 1945, Schuler had been engaged for whole-time employment in the future by the plaintiff-company but was engaged in the whole-time employment of other persons.' (emphasis by underlining supplied here to indicate words printed in italics in the report).

14. The Court of Appeal, however, dismissed the appeal because in its opinion the material date for the purpose of the decision of the case was May 2, 1945, when the case was heard by the county court judge and Schuler had actually commenced work before that date on April, 16, 1945.

15. The facts in the latter case (Fuggle's case) were that proceedings for possession of a dwelling house in possession of their ex-employees were begun by the plaintiffs on the ground that it was reasonably required by them for one Wilson, who, according to the arrangement arrived at on July 11, 1947, was to have entered their whole-time employment on September 10, 1947. Before the joining time, Wilson had freed himself from his previous occupation ; however, just three days before September 10, when he was due to enter his employment, Wilson was taken ill and be began work only on October 30, 1947. In the meantime, the hearing of the case had begun on October 1 and was adjourned to October 22. The county court judge delivered judgement on October 29 and dismissed the claim on the ground that Wilson could not be said to be engaged in the whole-time employment of the plaintiffs since he was not actually working with them at the relevant date owing to his physical inability. In taking this view, the county court judge relied upon the decision of the Court of Appeal in Benninga's case. The plaintiffs carried the matter in appeal and before the Court of Appeal they contended that Benninga's case, which the county court judge thought precluded him from making an order for possession, was clearly distinguishable. The Court of Appeal accepted the contention of the plaintiffs and allowed the appeal holding that Wilson was, at the relevant date, engaged in the whole-time employment of the plaintiffs. Lord Greene M. R. observed (at page 240 of the report):

' The position with Wilson was this. He was not, at the relevant date, the date of the hearing, under contract to anybody else. He was under contract with the plaintiffs. Under that contract he was bound to begin his work on September 10. Had the matter stood there there is no question but that the county court judge would have made the order. The only reason why he did not make the order was that the man was not physically able to commence work on September 10. In my opinion that is a misreading of the language of the section. The language of the section, in my opinion is satisfied in a case where there is a contract for services, and the date thereby fixed for the commencement of the services has already arrived at the time of the hearing. If the date for the commencement of the services arrives at some future date, the observations in this court on which the county court judge relied would no doubt apply, because in that case that is actually what happened.'

16. Evershed L.J., in the course of a concurring judgment, said (at page 246 of the report) :

' For my part, I do not think that the observations of MacKinnon L. J. and Morton L.J., lead to any such view of the construction of the material terms of para. (g). In any case, in my judgment, this servant, Wilson, was, according to the ordinary acceptation of the English language, in fact at the material time engaged in the whole-time employment of the plaintiffs. He was at that time under an existing obligation by contract to work whole-time for the plaintiffs, though in fact he was not able to work owing to illness. This however does not, in my judgment, negative the view that he was engaged at that time in the whole-time employment of th.e plaintiff just as much as he would have been if he had happened, on the material date, to be away on a day's holiday or on his annual holiday.

It seems to me that if one asks the question, say, of a postal worker, whether he is engaged in the whole-time employment of the Crown, the answer cannot be in the negative merely because on the day on which one asks the question the postal worker happens to be ill in bed or away on his holiday. I venture to think that the learned county court judge really misread the language which he cited, though it is no doubt true that one sentence particularly in MacKinnon L.J.'s judgment might lead at first sight to the other conclusion.'

17. Now it is true that these two decisions deal with the import of the expression ' engaged in ' but we fail to appreciate how they help the revenue in the present case. Two things require to be noted in this connection: first, that the court was there construing the expression occurring in a different context and in a statute of a wholly different nature and, secondly, that the meaning there assigned to the expression ' engaged in' was obviously coloured by the words ' his whole-time employment' immediately following upon it. That apart, the decisions, and more particularly the decision in Fuggle's case which explains some of the observations made in Benninga's case, far from militating against the view that we are inclined to take, actually support it. The decisions clearly hold that in order that a person could be said to be engaged in a whole-time employment, it is not necessary that he should be actually working with his employees at the relevant point of time; it would be sufficient if at that time he was under an existing obligation by contract to work whole-time for his employers and the fact that he was not physically able to start work on the date fixed for the commencement of services would not alter the situation. The authorities, therefore, support the view that the concept of actual or physical participation in work does not inhere in the term 'engaged in'.

18. The learned Advocate-General also cited a decision of the Madras High Court in Ramdoss Purushothamdoss v. Commissioner of Income-tax, [1961] 41 I.T.R. 66 (Mad.). In that case the assessee, who was the financing partner of a firm, claimed earned income relief on the ground that his case was covered by Section 2(6AA) of the Indian Income-tax Act, 1922, the material portion of which was in terms identical to Section 2(7)(iii)(b) with which we are concerned. The Appellate Tribunal had in that case found that all that the assessee did was : (i) to finance the partnership, (ii) to sign the cheques for the expenses of the firm, and (iii) to keep in his custody, outside the usual working hours, the books, cash and the key of the firm. The Madras High Court took the view that the activities carried on by the assessee in that case were not such as would show that the assessee had actively engaged himself in the conduct of the business of the firm within the meaning of Section 2(6AA). We find that there is no discussion in this decision as to the true meaning of the expression ' actively engaged in the conduct of the business ' and the decision turns upon the facts of the case which were glaring. This decision is also, therefore, of no assistance to us.

19. From the foregoing discussion it is evident that having regard to the plain meaning as well as to the context and collocation of the words, the expression 'actively engaged in the conduct of the business' occurring in Section 2(7)(iii)(b) must be given a liberal meaning. The expression does not necessarily signify active and continuous participation in the actual transaction of the day-to-day business of the firm ; it is flexible enough to take in the case of a partner who devotes time, attention and labour to some activity or assignment calculated or designed to lead to the preservation, growth or advancement of the business of the firm.

20. We may now proceed to consider in the light of what we have said above as to whether the assessee in the present case could be said to have been actively engaged in the conduct of the business of the firm. The findings of the Tribunal bearing on this question are : (i) that even before the assessee attained the age of majority, on 17th January, 1957, he was admitted to the benefits of partnership as a minor partner, (ii) that for the assessment years 1958-59 and 1959-60, the business income of the assessee was assessed as earned income since it was found that he was actively engaged in the conduct of the business of the firm, (iii) that the assessee was sent to the U. S. A. by one of the firms in which he was a partner, namely, Messrs. Ramjibhai Hirjibhai & Sons, and that a part of the expenses incurred by the firm was treated as allowable deduction in the course of the assessment of the firm to income-tax for the assessment year 1962-63 on the basis that the said expenditure was laid out wholly and exclusively for the purpose of the business of the firm, and (iv) that the firm was carrying on the business of construction work and the assessee who prior to his departure was an active partner in the firm was sent abroad to obtain further technical qualification and knowledge in the line of business in which the firm was engaged. From these facts and circumstances, the Tribunal concluded that the assessee was sent abroad by the firm for further studies for the purpose of its business and, therefore, the assessee was actively ;engaged in the conduct of the business of the firm and the business income earned by him was earned income. It appears to us that the view taken by the Tribunal on the findings recorded by it is correct. It is true that for a period of nearly as many as nine months during the relevant previous year, the assessee was away from India and could not, therefore, have participated in the actual transaction of the day-to-day business of the firm. At the same time, it cannot be gainsaid that the assessee was, during the relevant period, devoting the whole of his time, attention and labour to an activity calculated or intended to lead to the preservation and growth of the business of the firm. The higher educational qualifications in civil engineering which the assessee would get would undoubtedly widen the horizon of his knowledge and enable him to more effectively participate in the business and serve the firm on return to India. The knowledge and equipment gained by the assessee in the U. S. A. would ultimately benefit the firm and help it in carrying on its business more efficiently as also in expanding its business. The Tribunal was, therefore, right in coming to the conclusion that the assessee's income was earned income within the meaning of Section 2(7)(iii)(b) of the Finance (No. 2) Act, 1962.

21. In the view which we are taking, the question whether a partner who is undisputedly engaged actively in the conduct of the business of the. firm not for the whole of the previous year but for a part thereof does not arise for our consideration and, therefore, we do not propose to express any opinion upon it.

22. We, therefore, answer the question referred to us in the affirmative. The Commissioner will pay the costs of the reference to the assessee.


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