Skip to content


Commissioner of Income-tax Vs. S. Arumugham Pillai - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtChennai High Court
Decided On
Case NumberTax Case No. 105 of 1965 (Reference No. 41 of 1965)
Judge
Reported in[1969]73ITR382(Mad)
ActsIncome Tax Act, 1922 - Sections 10(1), 23(5) and 66(1)
AppellantCommissioner of Income-tax
RespondentS. Arumugham Pillai
Appellant AdvocateV. Balasubrahmanyan and ;J. Jayaraman, Advs.
Respondent AdvocateP. Balasundaram, Adv. for S. Swaminathan and ;K. Ramagopal, Advs.
Cases ReferredMurlidhar Himatsingka v. Commissioner of Income
Excerpt:
.....assistant commissioner as well as the tribunal were of a different view and held: ' 7. thus, it is by now well settled that income which is susceptible to tax is real income as is commercially understood......profits received by him as partner of the firm, erode bleaching and finishing company, was not his real income, but was income which he was bound to share with other persons under an agreement therefor.2. the assessee is a partner of jyothikrishnan and company, erode, which has two others as partners thereto. the assessee is entitled to a one-third share of the profits in this firm. the assessee is also a partner in the firm, erode bleaching and finishing company, erode, in which there are four others as partners. jyothikrishna and company, hereinafter referred to as ' j ' firm, found the wherewithal for the erode bleaching and finishing company, hereinafter called the ' b ' firm, and advanced moneys from time to time to provide a building and machinery for the ' b ' firm. such advances.....
Judgment:

Ramaprasada Rao, J.

1. This reference under Section 66(1) of the Indian Income-tax Act, 1922, on an application by the department, arises out of an order of the Tribunal which accepted the contention of the assessee, that, the share of profits received by him as partner of the firm, Erode Bleaching and Finishing Company, was not his real income, but was income which he was bound to share with other persons under an agreement therefor.

2. The assessee is a partner of Jyothikrishnan and Company, Erode, which has two others as partners thereto. The assessee is entitled to a one-third share of the profits in this firm. The assessee is also a partner in the firm, Erode Bleaching and Finishing Company, Erode, in which there are four others as partners. Jyothikrishna and Company, hereinafter referred to as ' J ' firm, found the wherewithal for the Erode Bleaching and Finishing Company, hereinafter called the ' B ' firm, and advanced moneys from time to time to provide a building and machinery for the ' B ' firm. Such advances amounted up to Rs. 25,000. This amount was treated, for mercantile purposes, as the capital of the assessee in the books of the ' B ' firm. There was an understanding between the partners of the 'J' firm which was later reduced to writing on August 15, 1951. Pursuant to the arrangement so recorded, and as there was no stipulation for payment of interest over the advances made as above by the ' J ' firm to the ' B ' firm it was agreed that the income of the assessee from the ' B ' firm as such partner therein, shall be shared by all the three partners of the ' J ' firm, including the assessee.

3. The agreement dated August 15, 1951, which forms part of the record, inter alia, provides that such income of the assessee was divided as set forth above till the year ending March 31, 1951. The agreement postulates that the income to be secured by the assessee from the ' B ' firm shall for the years to come and until the advance is recovered, be similarly dealt with. For the assessment years 1951-52 to 1957-58 the revenue accepted the position that the share income of the assessee in the ' B ' firm was the real income of all the three partners of the ' J ' firm, and assessments were levied on that basis. But, for the assessment year 1958-59, the department made a departure and would not treat the income of the assessee in the ' B ' firm as that of the three partners of the ' J ' firm. For the assessment year 1959-60, the share income of the assessee in the ' B ' firm was determined at Rs. 34,470. But the assessee only showed a third of this amount in his return for the year, as his real share income in the ' B ' firm. The Income-tax Officer rejected the return and treated the entire amount of Rs. 34,470 as the income of the assessee. The Appellate Assistant Commissioner as well as the Tribunal were of a different view and held:

'... what was to be considered was not the income allocated to the share of a partner in a registered firm under Section 23(5)(a), but his real income, and that the real income was what remained after deducting the amounts which might be said to have been diverted and never constituted his real income, that, therefore, the entire amount of Rs. 34,470 which was allotted to the assessee from the Erode Bleaching and Finishing Company did not represent the assessee's real income and that it was only a one-third share of that amount that constituted his real income. . . '

4. The Commissioner of Income-tax sought for a reference under Section 66(1) of the Act and the following question has been referred to us:

' Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that only one-third of the share income of Rs. 34,470 was includible in the assessment '

5. Mr. Balasubrahmanyan, for the revenue, contends that the totality of the share income of the assessee in the ' B ' firm is exigible to tax and the agreement to share such profits as between the partners of the ' J ' firm is an internal arrangement, which could not be pressed for relief under the provisions of the Indian Income-tax Act. According to him, the assessee earned the profits by reason of his accepted status as partner in the ' B ' firm and any collateral, anterior or posterior arrangement to divide the earned profits between the earner of the income and third parties cannot entitle the assessee to any relief in taxation. According to him, in the absence of a contemporaneous agreement between the partners of the ' J ' firm to share the losses which the assessee may sustain in the 'B' firm, the arrangement cannot be interpreted to the benefit of the assessee. He relied upon K.A. Ramachar v. Commissioner of Income-tax, : [1961]42ITR25(SC) . Mr. Swaminathan, however, relying upon Ratilal B. Daftari v. Commissioner of Income-tax, : [1959]36ITR18(Bom) , Poona Electric Supply Co. Ltd. v. Commissioner oj Income-tax, : [1965]57ITR521(SC) , Siddhi Vinayagar & Co. v. Commissioner of Income-tax, : [1966]60ITR771(Mad) and Murlidhar Himatsingka v. Commissioner of Income-tax, : [1966]62ITR323(SC) , urged that the agreement dated August 15, 1951, is a specific pointer to the arrangement between the partners of the ' J ' firm, whereby the income of the assessee has sloped down in accordance with its tenor. It is not the notional income, but the real income of an assessee that has to be reckoned for purposes of taxation. He thus supports the order of the Tribunal.

6. The answer to the question referred to, which is obviously wide enough, depends upon the true scope of the word ' income ' which is exigible to tax. It is not every income of an assessee but the real income earned by him in the commercial and normal sense, which enters into the magnitude of its monetary value. When Section 10(1) of the Indian Income-tax Act of 1922 prescribes that tax shall be paid by an assessee in respect of the profits or gains of any business, profession or vocation carried on by him, it cannot be said that the word ' income ' has been deployed in the abstract and all notional income earned would also come within its mischief. Thus, interpreting the word ' income ' in its natural and proper sense, tax is exigible on income earned in reality. The assessee may undertake or be bound by an obligation of an overriding nature to others which might compel him to make payments to earn the profits. If, as a result of such an overriding obligation, the profits earned in the books are to be shared with a third party, then the notional income earned cannot form the basis of taxation; it is only the real income earned by him that has to be taxed. In such a case, the sharing cannot be deemed to be a payment made out of profits; on the other hand, it is one made to earn the profits. This distinction is unexceptional: see Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax. The concept of real income, as expounded in H. M. Kashiparekh & Co. Ltd. v. Commissioner of Income-tax, [1960] 39 I.T.R. 705 and which has been accepted by the Supreme Court, is as follows :

'The principle of real income is not to be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect of managing agency commission is made, agreed to or given on grounds of commercial expediency, simply because it takes place some time after the close of an accounting year. In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it. It will lay greater emphasis on the business aspect of the matter viewed as a whole when that can be done without disregarding statutory language.'

7. Thus, it is by now well settled that income which is susceptible to tax is real income as is commercially understood.

8. Even so, in ascertaining the real income of a partner in a registered firm under Section 23(5)(a) of the Act, it is obligatory on the part of the revenue to find after apportioning the income of a partner in a partnership firm, as to what, are the obligations which are overriding in character which obviates the diversion of such reckoned profits to others, other than the assessee, and after such exclusion, arrive at the real profit of the partner concerned. This principle, which was accepted by the Bombay High Court in Ratilal B. Daftari v. Commissioner of Income-tax, has been reaffirmed by the Supreme Court in Murlidhar Himatsingka v. Commissioner of Income-tax. Observed the Supreme Court in the said decision :

' The object of Section 23(5)(a) is not to assess the firm itself but to apportion the income among the various partners. After the income has been apportioned, the Income-tax Officer has to find whether it is the partner who is assessable or whether the income should be taken to be the real income of some other person. If it is the real income of another firm, it is that firm which is liable to be assessed under Section 23(5)(a) of the Act. '

9. In fact, the Supreme Court has also recognised a partner in a firm being a benamidar for another; and the actual share obtained by the banamidar would be the correct specification of his share of profits in the partnership firm : see Commissioner of Income-tax v. A. Abdul Rahim & Co., [1965] 51 I.T.R. 651 Elucidating this further the Supreme Court said in Murlidhar Himatsingka v. Commissioner of Income-tax:

' Under the law of partnership it is the benamidar who would be entitled to receive the profits from the other partners but for income-tax purposes it does not mean that it is the benamidar alone who can be assessed in respect of the income received by him. '

10. The only citation relied upon by the revenue, K.A. Ramachar v. Commissioner of Income-tax, is indeed distinguishable. On the facts it appears that the assessee therein earned the income and devised a scheme for its division. It Was a case of assignment of profits by the partner for a period of time. In fact, this decision was noticed when the Supreme Court laid down the dicta in Murlidhar Himatsingka v. Commissioner of Income-tax.

11. In the instant case, the agreement envisages a clear and inflexible obligation on the part of the assessee to share the profits in the ' B ' firm with others in the 'J' firm. That a partner can share his profits with strangers under a valid agreement cannot be disputed : see Commissioner of Income-tax v. Sivakasi Match Exporting Co., : [1964]53ITR204(SC) The problem is whether the profits earned by the assessee are diverted before it reached him. The poser has to be answered in the affirmative. To earn ' income ' there should be a source. If such a source has been provided not by the earner of the income but by others with a contemporaneous stipulation that the source should be used to earn the profits and such earned profits should be shared between the earner and the persons responsible to provide the source, then there is a conceivable nexus between the source and the income, as a result of which the stipulations attendant upon the earning of the profits and the resultant sharing thereof become enforceable in the eye of law including taxing statutes.

12. It is clear in this case that the investment of capital by the ' J ' firm in the name of the assessee in the ' B ' firm was legitimate and bona fide adopted for the diversion of profits, which the assessee may secure ultimately in the ' B' firm. The agreement dated August 15, 1951, lays down the formula for division of profits. This is, therefore, a scheme to earn the profits, which has to be implemented. If it is lightly brushed aside, the assessee would be subject to taxation on a notional income and not real. The genuineness of the agreement is not in dispute and in fact the revenue accepted it for a long number of years. The accidental absence of a stipulation by the ' J ' firm to bear the losses may not be the only criterion to hold otherwise. Judging the agreement as a whole it appears to be bona Me and not forged with any oblique purpose. We are of the view that the agreement has the effect of making an effective alienation at source of the profits by an overriding title created by it. The real income of the assessee in the ' B ' firm has been rightly stated by him in his return, as one-third of his share income therein.

13. We, therefore, answer the question referred in the affirmative and in favour of the assessee and against the revenue. Counsel's fee Rs. 250.


Save Judgments// Add Notes // Store Search Result sets // Organizer Client Files //