A. R. Rangachari vs Commissioner of Income Tax, Madras

Rajagopala Ayyangar, J.—This is a reference u/s 66(1) of the Indian Income Tax Act, and the question referred to this Court for its decision

is :

Whether the inclusion in the assessees total income of the profits settled by him on his wife and two daughters is justified in law ?

The facts giving rise to this reference are briefly these. The question raised arises out of the assessment proceedings for the assessment years

1947-48 and 1948-49 of the income of the assessee, A. R. Rangachari, from the profits of the firm of Messrs. Chari and Ram, in which the

assessee was one of five partners. Under a deed of partnership, dated 22nd April, 1946, entered into among the partners of this firm, the assessee,

A. R. Rangachari, was entitled to a 6 annas share in the partnership, the four other partners being entitled to the other 10 annas. While so,

Rangachari executed on 22nd September, 1947, 3 deeds of settlement, which have been appended to the statement of the case and marked as

annexures A, A-1 and A-2. Under annexure A, the assessee settled in favour of his wife, Srimathi Vedam Ammal, a ""one-fourth share of the

profits in the firm (but not the losses) payable to him"" during a period of 8 years commencing from the date of the document. This was expressed

to be out of natural love and affection, and clause 2 of this settlement deed provided ""that the settlor shall not have any manner of right or interest in

the said one-fourth share hereby settled and the right to receive from the firm one-fourth of the settlors share during the said period of 8 years shall

exclusively vest in the beneficiary."" Clause 3 empowered the beneficiary ""directly to receive and collect from the firm the share of profits hereby

transferred for the said period of 8 years."" Clause 4 made provision for the settlor having the right to the profits from the firm on the expiry of the 8

years period. Clause 5 stated that the settlement deed was not to absolve the settlor from his obligation to maintain the beneficiary. Clause 6

provided that the settlement was not to be construed as conferring upon the beneficiary any right or interest in the partnership asset or property but

the settlers right was limited to the one-fourth share of the settlor in the profits of the firm settled under the deed. Clause 8 expressly stated that the

settlement deed was to be irrevocable.

The relevant provisions of annexures A-1 and A-2 are almost in identical terms, and they need not therefore be separately set out. It is sufficient

to mention that under annexure A-1 there was a transfer of a similar right to a one-fourth share in the profits of the firm in favour of his married

daughter Kripa Bai, and under annexure A-2 in favour of a minor unmarried daughter Meera Bai, with himself as guardian.

After the execution of these deeds, the assessee wrote a letter, dated 13th October, 1947, to the firm of Messrs. Chari and Ram, informing

them of these 3 deeds, and that ""these settlements operate and apply also in respect of the share of profits for the chargeable accounting period

ended 13th April, 1947, and that as the assessee was entitled only to a one-fourth share after these 3 dispositions, the firm were requested to

credit to the three beneficiaries the one-fourth share of the profits settled in favour of each of them.

When the assessment of Rangachari for 1947-48, the accounting period being that ended on 13th April, 1947, came to be made, the assessee

contended that the three-fourths share of the income from the firm attributable to his 6 annas share in its profits belonged to the three settlers and

should be excluded in computing his assessable income. This was rejected by the Income Tax Officer, who made the assessment on the footing,

that, notwithstanding these dispositions or settlements, the assessee had received the entire profits attributable to his share. A similar finding was

reached by the Income Tax Officer in respect of the next accounting year, 1948-49.

The assessee appealed to the Appellate Assistant Commissioner and to the Tribunal; but his contention was overruled.

It is unnecessary to set out the grounds upon which the Income Tax authorities and the Tribunal negatived the assessees claim. Before us the

points raised, and the arguments advanced covered a very wide ground and require detailed examination.

The principal contention raised on behalf of the assessee was that the deeds in favour of the wife and the daughters fell within section 16(1) (c)

of the Income Tax Act, and they satisfied all the requirements of the 3rd proviso to clause (c) and that the result of this was that there was no basis

for treating the income of the settlers as that of the assessee. The relevant portion of section 16(1) (c) is in these terms :-

Section 16(1) :- ""In computing the total income of an assessee ....

(c) all income arising to any person by virtue of a settlement or disposition whether revocable or not, and whether effected before or after the

commencement of the Income Tax (Amendment) Act, 1939 (VII of 1939) , from assets remaining the property of the settlor or disponer, shall be

deemed to be income of the settlor or disponer, and all income arising to any person by virtue of a revocable transfer of assets shall be deemed to

be income of the transferor.

The provisos to section 16(1) (c) run thus :-

Provided that for the purposes of this clause a settlement disposition or transfer shall be deemed to be revocable if it contains any provision for the

retransfer directly or indirectly of the income or assets to the settlor, disponer or transferor, or in any way gives the settlor, disponer or transferor a

right to reassume power directly or indirectly over the income or assets :

Provided further that the expression ""settlement or disposition"" shall for the purposes of this clause include any disposition, trust, covenant,

agreement, or arrangement and the expression ""settlor or disponer"" in relation to a settlement or disposition shall include any person by whom the

settlement or disposition was made :

Provided further that this clause shall not apply to any income arising to any person by virtue of a settlement or disposition which is not revocable

for a period exceeding six years or during the lifetime of the person and from which income the settlor or disponer derives no direct or indirect

benefit but that the settlor shall be liable to be assessed on the said income as and when the power to revoke arises to him.

There is one other provision in section 16 which would have bearing on the present case, since two of the dispositions now in controversy are in

favour of the wife and an unmarried daughter of the assessee, and that is sub-section (3) , the relevant clauses of which are these :

Section 16(3) :- ""In computing the total income of any individual for the purpose of assessment, there shall be included -

(a) so much of the income of a wife or minor child of such individual as arises directly or indirectly -

....... ....... .......

(iii) from assets transferred directly or indirectly to the wife by the husband otherwise than for adequate consideration or in connection with an

agreement to live apart; or

(iv) from assets transferred directly or indirectly to the minor child, not being a married daughter, by such individual otherwise than for adequate

consideration.

Founding himself on these provisions, the argument of learned counsel for the assessee was broadly this :

The fundamental and basic foundation for the provision in section 16(1) (c) is that but for it, the income of the settlee or disponee would be their

own and could not be treated as income of the settlor or disponer and the moneys paid over to the settlers could not be aggregated with the latter.

If the law were otherwise, that is, if even without section 16(1) (c) the income of the settlee or transferee could be treated as the income of the

settlor, there was no need for such a clause and the Legislature should not be presumed to have enacted an unnecessary and otiose provision.

Section 16(1) (c) together with the provisos thereto should therefore be deemed as a comprehensive legislative statement regarding the entire law

on the subject of dispositions of income or transfer of assets. Whenever there is an income accruing from a settlement, the first question to be

answered is whether the settlement falls within the language of the first paragraph of that clause. This deals with two somewhat dissimilar types of

transactions. First, cases where there is no transfer of an asset but only a disposition of income. In this category of cases it is immaterial whether

the disposition is revocable or not, and regardless of revocability or otherwise the income so disposed of is treated statutorily notwithstanding the

disposition, as the income of the settlor. The second type comprehends cases where there is a transfer of an asset and only if such transfer is

revocable, is the income which the asset produces in the hands of the transferee treated as the income of the transferor. But both the sets of

transfers are subject to the conditions of the third proviso which, so to speak, enacts an escape from the operation of the main clause. In cases

where the conditions of this proviso are satisfied, the income so disposed of, or the income from the asset so transferred, cannot be deemed to be

that of the disponer or transferor.

The primary contention of learned counsel was that there was in the present case a transfer of an asset, the asset being the right to receive the

profit from the firm and, as the transfer of that asset was to enure for a period of 8 years, that is, a period exceeding the six years mentioned in the

third proviso and as there was admittedly no benefit reserved to the settlor directly or indirectly under the settlement - even the settlors obligation

to provide maintenance for the wife and unmarried daughter being saved in express terms, it should be held that the conditions of that proviso were

satisfied. These two premises being granted namely, that there was a transfer of an asset within section 16(1) (c) whose operation was saved by

the requirements of the third proviso being satisfied, the argument naturally was that there was no basis for the income of the transferee being

treated as the income of the transferor. But on the assumption that there was a transfer of an asset effected under the deeds, counsel had

necessarily to deal with the effect of sub-section (3) of section 16 which provided for treating the income of a wife and an unmarried daughter

accruing from assets transferred by an assessee. In regard to this his contention was that as there were two provisions, viz., section 16(1) (c) and

section 16 (3) , both of which directly applied to the case, the one operating in favour of the assessee and the other against him, the proper rule of

construction to resolve the conflict was to hold that that provision would apply which was more beneficial to the assessee. If this interpretation

were adopted, the income under all the three deeds would be saved from being included in the total income of the assessee. It was further argued

that if this submission of counsel were not accepted, and if section 16(3) were held to override the provisions of section 16(1) (c) as being a

special provision to meet settlements in favour of particular relations, the latter being general in its nature, and applicable to transfers in favour of

any person, even then the income arising from the settlement in favour of the married daughter could not be included as part of the income of the

assessee.

It was urged in the alternative that even if the deeds constituted a settlement involving no transfer of assets but only a disposition of income, the

asset, viz., the interest in the partnership, remaining the property of the settlor, as the disposition of income was for a term longer than six years,

and no beneficial interest was reserved to the settlor, the conditions of the third proviso were satisfied. Since this argument proceeds upon there

being no transfer of an asset, section 16(3) does not, of course, apply. On this basis also it was contended that the income disposed of under each

of these three deeds should be deemed to be the income of the settlee or beneficiary and not that of the settlor.

Before dealing with the construction and scope of section 16 (1) (c) of the Act it would be necessary to refer to the law that existed prior to

1939 when this section was introduced by the amending Act VII of 1939, in order to determine the change effected by it. u/s 3 of the Act which is

the charging section, an assessee was bound to pay tax on all income, profits and gains from all sources. Where the source of income consisted of

income from some property or asset the assessee might get rid of his liability by ceasing to be the owner of that property or asset. But, short of

divesting himself of the ownership of the property or the source of income there was no means by which an assessee could get rid of his obligation

to pay tax on the income accruing from an asset of which he continued to be the owner. The transfer of an asset was therefore one method by

which an assessee could get rid of the liability to tax. Where, however, a settlement or disposition was effected not of the asset which was the

source of the income but of the income itself, it would be a case of expenditure of the income earned by an assessee and unless the expenditure

were deductible the assessee could ordinarily get no benefit by settling or disposing the income in favour of some other person. In regard to this

type of transactions the decisions drew a distinction between an application of income and a diversion of it, the latter representing a disposition of

income in circumstances such that when received, it did not belong to the assessee but only to the recipient. The difference between an application

of income and diversion is illustrated by two decision of the Privy Council, Bejoy Singhs case and Mullicks case, i.e., Bejoy Singh Dudhuria v.

Income Tax Commissioner and Mullick v. Commissioner of Income Tax, Bengal. Bejoy Singhs case was decided in 1923 and the Judicial

Committee had to consider whether moneys paid under a consent decree for maintenance out of an estate belonging to an assessee could be

treated as part of his income. The assessee succeeded to the family ancestral estate in 1894. Subsequently his step-mother who under the Hindu

law had a right to be maintained out of the estate in the assessees hands filed a suit for maintenance and the litigation was compromised by a

consent decree under which the assessee undertook to make a monthly payment of Rs. 1,100 to this claimant. In computing the income of the

assessee for 1923-24, the Income Tax authorities levied tax upon the assessee on the total income without taking into account the sum payable to

the step-mother under this decree. The High Court of Calcutta, before which the matter was brought by a reference u/s 66, held that though the

payment was not voluntary in the sense that it was an obligation which had fastened on the estate which the assessee had inherited from his father,

it was not a deductible expenditure under any of the provisions of the Income Tax Act, and so disallowed the assessees claim. The assessee took

the matter on appeal to the Privy Council and Lord Macmillan, delivering the judgment of the Board, while agreeing with the High Court that the

payment of this maintenance was not a permissible deduction, allowed the assessees appeal on the ground that the sum paid to the step-mother

was not the income of the assessee at all. The reasoning upon which this decision was rested is to be found in the following passage in the judgment

of the learned Lord :

When the Act by section 3 subjects to charge all income of an individual, it is what reaches the individual as income which it is intended to charge.

In the present case the decree of the court by charging the appellants whole resources with a specific payment to his step-mother has to that extent

diverted his income from him and has directed it to his step-mother; to that extent what he receives for her is not his income. It is not the case of

application by appellant of part of his income in a particular way : it is rather the allocation of a sum out of his revenue before it becomes income in

his hands.

It will be noticed that in this case there was an antecedent obligation attaching to the estate under which what the assessee inherited from his

ancestor was the asset less this liability. No doubt, at the moment when the estate passed to him this liability was not quantified. But when it was so

done by the decree of the Court the entirety of the estate became, so to speak, charged with it and that portion of the income payable to the step-

mother and exigible out of the charges had to be treated as the income of the step-mother and not of the assessee. On the other hand, P. C.

Mullick v. Commissioner of Income Tax, Bengal was an instance of an application of income, that is, an expense incurred by the assessee out of

the income which has become his. The assessees were the executors under a will of one Akshoy Kumar Ghose who died in October, 1931. The

testator by his will besides directing his executors to pay his debts, enjoined on them the duty of having his first Shradh performed at an

expenditure of Rs. 10,000. The executors incurred this expenditure as directed and sought to deduct this sum as an allowable expenditure or as a

diversion of income within the meaning of Bejoy Singhs case. There was no doubt that the expenditure so far as the executors were concerned was

of an obligatory nature. But the Privy Council negatived the assessees claim to deduct the sum holding that it was merely an application of income.

Lord Russell of Killowen in delivering the judgment of the Board said :

The payment of the Shradh expenses and the costs of probate were payments made out of the income of the estate coming to the hands of the

appellants as executors, and in pursuance of an obligation imposed by their testator. It is not a case like the case of Raja Bejoy Singh Dudhuria v.

Commissioner of Income Tax, Calcutta in which a portion of income was by an overriding title diverted from the person who would otherwise

have received it. It is simply a case in which the executors, having received the whole income of the estate, apply a portion in a particular way

pursuant to the directions of their testator in whose shoes they stand.

The decision in Bejoy Singh Dudhuria v. Commissioner of Income Tax was distinguished by the Patna High Court in Commissioner of Income

Tax v. Katras Estate. The assessee was the proprietor of certain coal producing mines. He was heavily indebted to a limited liability company and

in order to secure the repayment of the debt, the assessee leased the mines to the creditor and also executed a mortgage in its favour. Under the

lease there was a considerable amount of royalty due to the lessor but the terms of the mortgage were that the mortgagee-lessee was bound to pay

to the assessee only a sum of Rs. 8,000 by way of dead rent per year, the mortgagee being permitted to adjust the balance of the royalties towards

the discharge of the debt due to it. The argument raised on behalf of the lessor-assessee was that the entire balance in excess of the dead rent of

Rs. 8,000 per year became by reason of the mortgage document the income of the mortgagee and could not be treated as the income of the

assessee. This contention however was negatived by the learned Judges who held that there was no difference between the case before them and

one where the assessee executed a lease in favour of a third party, obtained the royalties himself and then retaining Rs. 8,000 to himself paid over

the balance to a mortgagee. They held therefore that, notwithstanding that there had been an agreement under which the assessee was bound to

permit the income to be appropriated by the mortgagee, it was still the income of the assessee and taxable as his. It is unnecessary to multiply

authorities which were rendered prior to 1939 in which the distinction between the application of income which could not be deducted in the

computation of an assessees total income and a diversion of income where the income when received is not that of the assessee himself but of

some other who is legally entitled to it, has been brought out.

The position therefore before the amendment of 1939 may be summarised thus : Where there was an effective transfer of an asset the tax

payer was enabled to divest himself of the income flowing from that asset without reference to the duration of the transfer or any conditions subject

to which the transfer might cease to be effective. In cases where there was no transfer of an asset but merely a diversion of income a distinction

was drawn between cases where the transfer was in pursuance of an antecedent obligation of the taxpayer, i.e., where obligations existed de hors

the will of the transferor and cases where the assessee obliged himself by a voluntary act on his part to render certain income of his the income of

another. The former class of cases was treated as a diversion, as flowing from an overriding previous title, sufficient to divest the assessee from the

character of the recipient of that income. Bejoy Singhs case was an instance of that type. On the other hand where the disposition arose out of a

voluntary act on the part of the taxpayer, the fact that he created a binding obligation on himself to make the payment was held insufficient to alter

its character as the transferors income and the transaction was treated as an expenditure or an application of income and unless the deduction was

allowable under any particular provision of the Act, with the result that the disposition was disregarded in computing the total income of the

assessee. The decision of the Board in Mullicks case is an instance of the latter type.

This was the law when section 16(1) (c) was introduced by the amendment of 1939. The enactment was as in the case of the somewhat similar

legislation in England, in the words of Lord Macmillan, ""designed to overtake and circumvent a growing tendency on the part of tax-payers to

endeavour to avoid or reduce tax liability by means of settlements. Stated quite generally, the method consisted in the disposal by the taxpayer of

part of his property in such a way that the income should no longer be receivable by him, while at the same time he retained certain powers over,

or interests in, the property or its income. The Legislatures counter was to declare that the income of which the tax-payer had thus sought to

disembarrass himself should, notwithstanding, be treated as still his income and taxed in his hands accordingly."" These observations, it will be

noted, dealt with a case where there is a transfer of an asset and that is the means adopted by an assessee for divesting himself of an income which

was his before the transaction.

We shall now consider the language of section 16(1) (c) to determine the exact change that was introduced by this amendment. This clause as

stated before deals with two dissimilar types of transfers : (1) revocable transfer of assets and (2) dispositions of income revocable or irrevocable

without any corresponding transfer of an asset. Where the settlement takes the form of a transfer of an asset and the transfer is wholly irrevocable it

is altogether outside the scope of the statutory fiction by which the income of the transferee is treated as the income of the transferor. Revocable as

well as irrevocable dispositions of income, as well as revocable transfer of assets are the subject matter dealt with by the enacting portion, namely,

the first paragraph of section 16(1) (c) and in either case the income of the settlee is, to start with, statutorily deemed to be that of the settlor. The

function of the first proviso to the clause is to define what constitutes a revocable transfer. It is unnecessary for our present purposes to deal in

detail with the language of this proviso as this is irrelevant on the terms of the settlements before us. The second proviso is merely a statutory

definition of the settlements, transfers and dispositions dealt with by the clause and therefore this also need not detain us. It is the third proviso that

is important for the consideration of the present case. When the terms of this proviso are satisfied the statutory fiction enacted by the main clause is

negatived and the transaction is taken out of its operation. The conditions laid down by the proviso are two-fold : (1) as regards the duration of the

settlement or disposition, the minimum period during which it should operate is laid down alternatively as six years or the lifetime of the transferee.

(2) The second condition is that no benefit should accrue to the settlor directly or indirectly from the income so settled. The effect of a settlement or

disposition satisfying the two conditions of the third proviso is ""that the clause shall not apply to such income.

The position may be explained and summarised thus. Under the law before 1939 any effective and unconditional transfer of an asset absolutely

was sufficient to divert the income accruing from such asset from the transferor. The position continues unaltered and clause (c) of section 16(1)

does not apply to such transfers. Where, however, the transfer is not absolute but is revocable or is for a limited period, the previous law

considered the transfer good until revocation or for its duration with the result that during the period when the transfer was operative the income

flowing from the asset was treated as the income of the transferee and not that of the transferor. The amendment has effected a change in the law

and unless the duration of the transfer or the period when the power of revocation could arise were beyond the limits specified in the third proviso

the income from the transferred asset was treated as continuing to be that of the transferor liable to be aggregated with his other income for the

purpose of computing his total income. The change is thus a tightening in the law in favour of the Revenue and eliminates certain transfers from

being operative to effect a diversion of income from the transferred asset. So far there is no controversy or dispute regarding the effect of the

amendment.

It is only in cases where there is no transfer of an asset but merely a disposition of income that the position becomes a little ambiguous. The

question is whether the distinction which formerly obtained between an application of income and its diversion, as we have endeavoured to state a

little earlier, continues still to be crucial. On the one hand the contention urged on behalf of the assessee is that such a distinction is out of place in

the scheme of the provisions embodied in section 16(1) (c) and its provisos and if a settlement or disposition of income, whether it be an

application or a diversion of income, satisfied the requirements of the third proviso, the income disposed of ceases effectively to be that of the

transferor thus conferring an advantage on transferors which they did not previously enjoy. The contention urged on the other hand on behalf of the

tax authorities is that the law in regard to cases of an application of income continues to be the same even after the amendment of 1939, whereas

there is a change in favour of the Revenue is cases where there is a diversion of income under an overriding title. Formerly the period during which

the diversion operated was immaterial as also whether any benefit accrued to the disponer by the settlement. Now, under main clause (c) every

disposition of income is disregarded in computing the total income of the disponer but by reason of the third proviso dispositions of a particular

character and enuring for a particular duration are saved. In other words, settlements and dispositions which are merely applications of income are

not within section 16(1) (c) or the provisos, while dispositions which are diversion of income are saved only when the conditions of the third

proviso are satisfied. The main question for our consideration is which of these alternative constructions is correct.

On the basis of this analysis it will be seen that the question as to whether there is a transfer of an asset involved in these settlements is of

crucial importance to determine the precise manner in which section 16(1) (c) would apply. We shall therefore first consider the argument

addressed on behalf of the assessee that there was a transfer of an asset in favour of the settlers under these settlements A to A-2.

The asset transferred was stated to be the right to receive a fourth part of the profits payable to the settlor under the deed of partnership. The

argument was that though the effect of the deeds was not to make the transferees partners, the deeds nevertheless transferred to the respective

settlers a right to a share in the profits. In support of this contention reliance was placed on the following passage at page 73 in the judgment of

Lord Selborne in Cassels v. Stewart :

... Is there any authority which says that the beneficial interest of one partner in a partnership, apart from a special contract or stipulation, may not

be given or sold by him to another of the co-partners ? .................. The share of an individual partner is his own property, not the property of the

firm ....

We do not, however, see any relevance of the observations quoted to the point now in issue. The asset in the present case which is the source

of the income now in controversy is undoubtedly the business of which the assessee was a part owner. When section 16(1) (c) speaks of an asset,

it obviously means a source of income and when this is transferred, it means that the transferor is no longer the owner of that asset or there is at

least a diminution in the quantum of his ownership in that income-producing source, be it movable or immovable property or an intangible asset as

a business. In the present case however, the assessee continues to be the owner of the business with the same quantum of interest in it even after

the execution of the deed. There can be no doubt that on the plain terms of the settlement deeds, the only subject of transfer is the right of the

assessee to receive the profits, the assessee continuing to remain a partner with interest in the assets of the firm out of which the profits arose. We

have therefore no hesitation in holding that there was no transfer of assets under the deeds.

On the assumption that there was a transfer of an asset involved in the transfer evidenced by the deeds, the further contention was that, as it

was irrevocable for a period of 6 years it was saved by the third proviso, and so the aggregation of that income with the assessees was not

justified. In view however of our finding that there is no transfer of assets involved in the settlement deeds, this argument has to be repelled as one

not arising for consideration.

Again, on the footing that there was a transfer of an asset, a question was raised as to whether even an irrevocable transfer, satisfying the

requirements of the third proviso to section 16(1) (c) , would not fall within the mischief of section 16 (3) (a) (iii) so as to permit the inclusion of the

income received by the transferee with the income of the assessee in the case of the wife and the unmarried daughter, the contention of Mr. Rama

Rao Saheb, the learned counsel for the department, being that as section 16 (3) (a) (iii) is a provision applicable even to out and out transfers in

favour of certain relations of the assessee, there can be no reason for excepting transfers satisfying the requirements of the third proviso to section

16(1) (c) from the scope of section 16 (3) (a) (iii). In view of our conclusion as regards the nature of the interest transferred, this question does not

arise, but we are clearly of the opinion that if there was a transfer of an asset, notwithstanding the transfer or the settlement satisfying the terms of

the third proviso, the aggregation of the income of the wife and the unmarried daughter under annexures A and A-2 would be justified and upheld

by reason of the express terms of section 16 (3) (a) (iii). Section 16(1) (c) is a general provision applicable to all transfers in favour of any

individual. The former provision, however, is a special one, and takes into account the peculiar relationship between the assessee and the

transferee, and having regard to that relationship directs aggregation on the footing that they really constitute one unit, notwithstanding their separate

identity. In these circumstances, section 16(1) (c) will prevail over and override the exemption from aggregation granted by section 16(1) (c) read

with the third proviso. In this connection we do not feel inclined to follow the decision in Commissioner of Income Tax v. Bosotto Brothers,

Limited, but, as this question does not really arise for consideration in view of our conclusion as to the nature of the interest transferred, we do not

propose to examine in detail this and the other decisions referred to us in this context.

It will now be convenient to deal with the decisions, on which Mr. Jagadeesa Aiyar sought support for his argument regarding the construction

and legal effect of section 16(1) (c).

In Ramji Keshavji v. Commissioner of Income Tax, Bombay, the Bombay High Court had to consider whether the third proviso to section

16(1) (c) applied only to the transactions set out in the main part of section 16(1) (c) , or whether same would not govern the type of settlements

deemed revocable by reason of the definition of the term in the first proviso to the section. There was a litigation in the family of the assessee, by

reason of a suit filed by some of the sons of the assessee claiming a share in certain properties as ancestral, the assessee contending that they were

his self-acquisitions. The matter was settled by a consent decree that was passed, declaring that all the properties in the assessees possession were

his self-acquired properties. Under this decree and as part of its terms the assessee was required to execute a deed of trust transferring a house to

trustees who were directed to realise the income and pay it over to the assessees wife during her lifetime. Under the deed, which was executed by

the assessee, he was given a right to occupy a portion of the house during his lifetime, and also to use a garage in it for his purposes. The Income

Tax department sought to include the income of this property in his total income. The assessee relied upon the third proviso to section 16(1) (c) ,

but this was disputed by the Commissioner on the ground that the provision enabling the settlor to reside in a portion of the premises, and to use

the garage amounted either to a right reassume the asset or the income transferred, or that there was a direct or indirect benefit to the settlor. This

contention of the department was repelled in these terms by Kania, J., as he then was :

The relevant and material provision is contained in proviso 3 to section 16(1) (c). The question is whether proviso 3 applies only to the substantive

provisions of section 16(1) (c) or is a proviso to that sub-section and also to proviso 1, which I have discussed above. On behalf of the

Commissioner it is urged that proviso 3 governs only the substantive provisions of sub-section (c). According to that contention the law provides

that if there is a revocable trust, provided firstly it is made not revocable for a period exceeding six years or not revocable during the lifetime of the

person (meaning the person for whose benefit under the trust deed the income is settled) and secondly, from which income the settlor derives no

direct or indirect benefit, the income is not to be considered the income of the settlor. On behalf of the Commissioner it is urged that in the present

case this is not a revocable transfer of assets on the face of the settlement itself, and therefore the case is not covered by the substantive provision

of section 16(1) (c). The particular settlement is deemed a revocable settlement by reason of proviso 1 to that sub-section. It was, therefore,

argued that on the true construction of proviso 3, it does not apply to such a settlement at all. In my opinion this contention is unsound.

The scheme of section 16(1) (c) appears to be this. The first stage is that when there is a revocable transfer of assets, the income derived from

such assets is still to be considered the income of the settlor. The law next specifies by proviso 1 what would be deemed a revocable transfer, in

spite of the deed being apparently irrevocable. The relevant question for that proviso is this : Is this transfer revocable because it fulfils the

conditions contained in this proviso ? The answer to that question can be only, it is revocable, or it is not. If the answer is in the negative no further

discussion can arise because, on the face of it, the deed is not revocable and, therefore, it does not come u/s 16(1) (c). If, however, the answer to

the question is in the affirmative, the deed although ostensibly irrevocable, is deemed to be revocable, and thus becomes a revocable transfer of

assets, within the meaning of the substantive provision of section 16(1) (c). Having reached that stage, the law proceeds to consider further what is

found in proviso 3. The scheme appears to be that although in fact, after leading the provisions of section 16(1) (c) with proviso 1, the transfer is

revocable, the law will not still consider the income derived from such a settlement the income of the settlor, provided the settlement is not

revocable for a period exceeding six years or during the lifetime of the person for whom the income is settled, and, further, from which income the

settlor derives no direct or indirect benefit.

In our opinion, this decision has not much bearing on the questions arising for our decision in the present case. In that case there was a transfer

of an asset to the trustees to be held on behalf of the wife. Under the general law, apart from section 16(1) (c) , the income accruing from the

property so transferred could not have been treated as the income of the assessee. The tax authorities, however, sought to bring it within section

16(1) (c) to enable this income to be added to the other income of the transferor. The contention urged was that, as it was a revocable transfer, by

reason of the extended definition of revocability introduced in the first proviso, the compliance with the conditions set out in the third proviso could

not save the transfer from the operation of the artificial extension of the concept of the assessees income introduced by section 16(1) (c).

It was this argument that was repelled. It does not, therefore, help the present assessee in the contention that section 16(1) (c) is designed or

operates to effect the treatment as the income of the assessee, that which is not normally his but is also apt to grant an exemption in favour of an

assessee, when without a transfer of an asset, income alone is alienated under a transaction essentially voluntary in its nature. Only one thing more

remains to be noticed in regard to this decision and that is as regards the applicability of section 16(3) to its facts. No argument was raised on

behalf of the tax authorities that as the disposition or transfer of asset was in favour of the wife of the settlor there ought to be aggregation. The

reason possibly is to be found in the observation of Kania, J., as he then was, at page 108 where he said :

To carry to its logical conclusion, the contention of the Commissioner must be that, even after a mans wife and children have established in a Court

of law a right of separate residence and maintenance, and under an order of the Court he is ordered to settle separate property for the maintenance

and residence of his wife and children, and although in those circumstances the settlor has got no control over the income or the disposal because

he is by this arrangement absolved from the legal obligation of maintaining his wife and children, he derives benefit from that and is thus directly or

indirectly retransferring the income to himself.

The next decision referred to was also that of the Bombay High Court in D. R. Shahapure v. Commissioner of Income Tax, Bombay. There

the assessee made an entry in his books embodying a family arrangement, whereby he set apart a sum of Rs. 20,000, stipulating that the income

from the investment of the said sum should belong to his wife, who was, however, to have no right to or interest in the capital itself. During the

relevant accounting period the investment of this sum in the money-lending business of the assessee resulted in an income of Rs. 280 on this

account. It was the inclusion of this sum in the total income of the assessee, that was the subject-matter of debate before the Court. The Income

Tax Officer and the Appellate Assistant Commissioner had held that there had been a transfer of assets to bring the case within section 16(3) (a)

(iii) of the Income Tax Act. The Tribunal, however, held that under this arrangement there had been no transfer of any assets to attract the

operation of this provision. But they sustained the inclusion of this sum of Rs. 280 in the assessable income of the husband on the ground that it was

the income of the assessee under the first part of section 16(1) (c) , overruling in this respect the contention raised by the assessee that the third

proviso saved this settlement. Stone, C.J., with whom Kania, J., as he then was, agreed, held in favour of the assessee. The reasoning is to be

found in the following passage :

It is common ground that section 16(1) (c) of the Act applies ......... The clause provides that such income shall be deemed to be the income of the

transferor. This is the substantive part of clause (c).

Referring to the second proviso, the learned Judge said :

The words settlement or disposition used in the first part of clause (c) are thus given an extended meaning. Therefore, although there may be no

trust as defined by the Trusts Act, if there is a covenant, agreement or arrangement which fulfils the conditions mentioned in the clause, such a

covenant, agreement or arrangement is covered by section 16(1) (c). The question therefore arises whether the third proviso applies to the

arrangement contained in the entry in question.

The only contention that was raised on behalf of the Commissioner and which the Court was called upon to decide was whether the third

proviso would apply, when no transfer of assets was made. This argument was repelled, the learned Judge stating :

The proviso (third) opens with the words Provided further that this clause shall not apply ......... There is no warrant for reading the word clause as

applicable only to the second half of clause (c) , and not the first half also. In my opinion, the last words of the proviso, quoted above also do not

help the Commissioner, because the power to revoke may be equally applicable to the income, which is payable, as to the assets which are

transferred.

The further argument that was urged, that before the third proviso could be applied the settlement must be revocable, was rejected as unsound.

On the learned Judges holding that the third proviso applies, the reference was answered in favour of the assessee. The question that is now raised

before us, whether the settlements constitute a diversion under a paramount or overriding title or whether it was not a mere application of income,

which had accrued to the assessee, was not raised before the learned Judges; nor was it considered by them.

The decision of the Bombay High Court in Ratilal Nathalal v. Commissioner of Income Tax which has been affirmed by the Supreme Court in

Commissioner of Income Tax, Bombay v. Ratilal Nathalal was the next decision to which our attention was invited. In this case also as in Ramji

Keshavji v. Commissioner of Income Tax, Bombay there was a transfer of property. The transferor was an undivided Hindu family, and by reason

of the execution of the trust deed, the properties ceased to belong to the family and with it necessarily the income. Long after the creation of this

document, one of the beneficiaries under the trust happened to be the manager of the undivided family. The question was as to whether this

circumstance could enable aggregation to be made. The High Court held that Hindu undivided family was a unit for the purposes of Income Tax,

and should be treated as an independent entity, with the result the income, which the manager derived as a beneficiary under the trust, could not be

treated as the income of the family. The argument that was put forward was that, since the then manager had also been a party to the transfer in his

capacity as a co-parcener of the transferor-family, when he became a beneficiary, it should be held that there was a re-transfer of the assets to the

transferor. This argument was repelled for the reason that the capacity in which the assessee executed the deed of trust was quite distinct from his

capacity as a beneficiary under the trust, which had been created by the family. There having been a transfer of an asset, and the property having

by reason of such transfer ceased to belong to the family, there would have been no power in the Income Tax authorities to have included the

income of the settlee with the income of the settlor but for section 16(1) (c) , and as it was held that the third proviso was satisfied, the aggregation

was not possible. This case, therefore, cannot render any assistance to the present one, where there is no transfer of an asset involved in the

settlement.

Reliance was also placed on the decision of the Calcutta High Court in Commissioner of Income Tax v. Sir S. M. Bose. The facts were that

the assessee settled certain properties on his daughter, constituting himself as trustee. The deed was in the form of an out and out trust on the

English model. The settlor settled the property on himself as trustee, and held the property in trust for the benefit of his daughter. There was an out

and out divesting, and there was no power of revocation and the settlor did not retain any right over the property, either the corpus or the income.

It was the duty of the trustee to take possession of the property, and after paying the outgoings hand over the net income to the daughter during the

term of her natural life for her sole and separate use. The only clause, upon which reliance was placed on behalf of the Commissioner to bring it

within section 16(1) (c) was one inserted to provide against frivolous litigation. The clause ran as follows :-

As long as the present trustee, namely, the settlor or persons named as trustees in addition or substitution shall act as trustees, they shall not

accountable to any of the beneficiaries under these presents relating to his or their dealings as to the income of the trust estate.

The learned Judges held that this provision did not detract from the absolute nature of the trust created nor did it constitute a reservation of a

power over the income directly or indirectly. As in this case also there was a transfer of an asset, which under the law would prevent the income

therefrom from being aggregated with that of the settlor it does not furnish any analogy for the decision of the present case.

Learned counsel for the Commissioner on the other hand invited our attention to the decision of the Patna High Court in Jagadish Chandra v.

Dhanpathi Singh where the precise scope of the decision in Bejoy Singh Dudhuria v. Commissioner of Income Tax, Bengal, had to be considered.

Under the will of the proprietor of an estate, an estate devolved on the defendant, with an obligation to pay to the plaintiff an annuity, which was

made a charge on the estate. The plaintiff filed a suit for the annuity, and the question before the Court was whether the defendants claim to deduct

from the annuity directed to be paid to the plaintiff by the testator, the agricultural Income Tax paid by him under the Bihar Agricultural Income Tax

Act of 1938. The learned Judges drew a distinction between cases where payment of a portion of the income was made under an obligation

created anterior to the title of the assessee, and subject to which alone, the assessee took the property and those where the assessee himself

voluntarily imposed an obligation on himself to pay a portion of the income. The former was held to be governed by the principle laid down by the

Privy Council in Bejoy Singh Dudhuria v. Commissioner of Income Tax while in the latter there was held to be only an application of the income,

and not a diversion of it. To the latter type belongs the cases which arose for consideration by the Lahore High Court in Estate of Lala Shankar

Shah v. Commissioner of Income Tax. There was a will under which the executors, who were managers on behalf of the beneficiaries, held the

property. They were under an obligation to make certain payments to the testators minor sons, and grandsons, and other members of his family.

The Income Tax authorities proceeded to assess the estate in the hands of the executors, on the entire income obtained from the properties of the

deceased, including the allowances paid under this direction. The learned Judges, Din Mohammad and Sale, JJ., negatived this contention, holding

that, as the beneficiaries could in no circumstances go behind the directions made by the testator in his will and refuse to pay the allowances to the

various persons under the will, the allowances paid were not assessable as income in the hands of the executors.

The ratio decidendi in such case is that if the payment of an allowance is voluntary, it must be included in the income of the assessee; but if the

charge is obligatory with which the beneficiary cannot interfere in any manner, the sum so charged must be excluded from his income.

A similar conclusion was reached by the same learned Judges in Hira Lal, In re and this decision was rendered a week later. There, the

widowed mother and step-mother of the assessee sought a partition of the family property in the hands of the assessee and his brother. The matter

went to arbitration, and under the award the widows, on their request, were granted maintenance allowances in lieu of a share in the family

property this payment being made a charge on the property of the assessee. The question raised before the Court was the deductibility of the sum

paid as maintenance allowances in computing the income of the assessee. The learned Judges held that as these payments were obligatory subject

to an overriding charge, and were in discharge of that obligation, they could not be taxed as the income of the assessee, but must be excluded.

There was really no distinction between this and Shankar Shahs case which they followed.

The net result of this examination is that, except the one decision in D. R. Shahapure v. Commissioner of Income Tax, Bombay in every other

case where, without a transfer of an asset the income alone is the subject-matter of the deposition, the distinction has been drawn between those

cases where the obligation was imposed adversely to the assessee and arose by a title superior to his own, and those where the obligation owed its

origin to a voluntary act on the part of the assessee himself. These decisions have held that in the latter case there is only an application of the

income and not a diversion by virtue of an overriding title, and that the alienated or disposed of income was the income of the assessee. It might

also be noted that this aspect of the case was not put before the Court in D. R. Shahapure v. Commissioner of Income Tax, Bombay.

The short question which has to be considered therefore is as to what is the effect of a transfer or settlement of the right to receive the income,

whereunder the nature and the duration of the transfer satisfies the third proviso to the section.

It will now be convenient to consider the language of the provision in order to decide the proper construction of the provision. In the case of a

transfer of an asset where no interest accrues directly or indirectly to the settlor and the duration of the transfer is for the period exceeding 6 years

or for the life of the grantee the transfer would be deemed an irrevocable transfer of assets and therefore outside the purview of section 16(1) (c).

In such cases, the income of the transferee would not statutorily be deemed to be the income of the transferor u/s 16(1) (c) with the result that the

immunity which attached to that income under the general law re-attaches to it by reason of the exclusion of the applicability of section 16(1) (c). In

cases where there is no transfer of an asset but a disposition of income, the effect of satisfying the third proviso would be that the disposition would

be treated as an irrevocable disposition and the income of the disponee would not by statutory fiction be treated as part of the total income of the

disponer. But this does not necessarily mean that in any particular cases the settlement of the income may not be an application of income and not a

diversion under an overriding title, sufficient u/s 3 to take it out of the category of being part of the income of the assessee. In other words, the

effect of a disposition satisfying the requirements of the third proviso is merely to take it out of the scope of section 16(1) (c) , viz., out of the

statutory fiction created by the use of the expression ""deemed"" in the clause. It should be noted that the words of the third proviso when its

requirements are satisfied are ""this clause shall not apply"" a mere negation and not any positive provision such as that ""the income in such

circumstances shall not be deemed to be the income of the settlor."" The contention on behalf of the assessee is that the effect is wider than a mere

negative and that when the conditions of this proviso are satisfied not merely is it taken out of section 16(1) (c) but also out of sections 3 and 4 and

that when a disposition satisfies the third proviso, the income disposed of or accruing from the asset is positively deemed not to be the income of

the settlor : but neither the language of the proviso nor the principle underlying it can justify this construction. The only authority appearing to favour

such a view is the decision of the Bombay High Court in D. R. Shahapure v. Commissioner of Income Tax, Bombay. But as stated already, the

point in this form was not argued on behalf of the Revenue and it cannot therefore be treated as any direct authority. On the other hand the

decisions of the Patna and Lahore High Court to which we have referred are against any such construction.

In our view the question whether the income of the disponee which is thus not statutorily deemed to be the income of the disponer could be

treated as part of the total income of the disponer or not, it is not the function of section 16(1) (c) to resolve, and that would depend upon whether

under the charging provision, section 3, the income so disposed of has been merely expended by the assessee or has been effectively diverted from

him. This can be answered only by an examination of the facts of each case and ascertaining whether on those facts the principle of Bejoy Singhs

case or Mullicks case applies.

The next head of the argument on behalf of the assessee was this. There is no doubt a distinction between the application of an income, and its

diversion. It is also true that the diversion must be by an overriding title. But such a title need not precede the title of the assessee, in the sense that

it was anterior to the accrual of his rights to the source of the income. It is sufficient if this title preceded the accrual of the income. Where, under an

obligation created by the assessee voluntarily he agrees to divert a portion of his income to another, the transferee can of course insist as against

the transferor for transfer of that portion of the income settled or agreed to be settled. He can file a suit and obtain a decree as against the

transferor, but he need not necessarily do so. And the title created in such a transferee would override the title of the assessee and is, therefore, an

overriding title, such as is described by the Privy Council in Bejoy Singh Dudhuria v. Income Tax Commissioner and Mullick v. Commissioner of

Income Tax, Bengal. We are, however, unable to agree with this interpretation of the effect of section 16(1) (c). In the first place the language of

the first portion of the third proviso does not warrant this construction, and taken along with the general principle regarding the objects of the

section, we feel that the matter has clearly to be decided in favour of the Revenue.

We have throughout proceeded upon the footing that the settlement in question in this case satisfied the requirements of proviso 3 to section

16(1) (c) and that indeed is the basis upon which the tax authorities and the Tribunal have proceeded. It was indeed a matter of surprise to us that

though in all the three deeds, there was a reference to the deed of partnership dated 22nd April, 1946, entered into among the partners of the firm,

under which the settlor was entitled to a share of profits in the business in the proportion of 6as. in the rupee, the partnership deed referred had not

been called for or produced before the Income Tax authorities or the Tribunal. As there had been an assignment of the right to the profits accruing

to the settlor under this partnership for a period of 8 years, we desired to know whether under the deed of partnership, the firm would last with

reasonable certainty for the period of 8 years mentioned in the settlement deed. We therefore called upon the learned counsel for the assessee, to

produce before us the deed of partnership, which was referred to in these settlement deeds. When this was produced we found that under clause 6

of the said deed, the partnership was stated to have come into force on 13th April, 1946, and to continue until 13th April, 1947. It will be noticed

that the deeds of settlement are dated 22nd September, 1947, and by that date, the partnership, which has been referred to and the profits of

which venture were assigned to the wife and daughters, had ceased to be operative. Learned counsel for the assessee also filed before us a copy

of a partnership deed executed on 19th November, 1947, which was to have retrospective effect from 14th April, 1947. There was no term fixed

for the duration of this firm but under clause 12 of this deed the partnership could be determined at any time by any partner giving to the other

partners not less than 3 months notice in writing and on expiry of such notice the partnership was to determine; that is to say it was a partnership at

will. It would, therefore, be apparent that there was no deed subsequently executed in November, 1947, purported to have retrospective

operation. On these documents being filed, the question naturally arose as to whether the assignment of the right to receive the profits of such a firm

would be governed by proviso 3 to section 16(1) (c). The question may be viewed from two aspects. (1) Can an asset, which is not certain to last

for a period of at least 6 years, or a source of income which might not endure with certainty for such a period, be the subject of a transfer or

settlement, to which the third proviso to section 16(1) (c) could apply. (2) As the partnership was one at will and as the assessee could put an end

to the disposition of income at any time, could it be said that the disposition was irrevocable for a duration of 6 years. We are inclined to hold

against the assessee on both these points. In our opinion the third proviso does contemplate the asset or the source of the income which is the

subject matter of the transaction referred to in the enacting portion of section 16(1) (c) capable of lasting with certainty for at least 6 years. We are

also of the view that having regard to the right of the assessee to terminate the payment at any time by dissolving the firm by the mere exercise of

his will without reference to any other person, this disposition cannot be held to be irrevocable for a period exceeding six years. Learned counsel

for the assessee objected to our looking into the terms of these documents, or to basing any conclusions thereon, the objection being that as these

documents were not before the Tribunal, and the point had not been considered by them, we had no jurisdiction to embark on an enquiry in regard

to a matter which was not before the tax authorities. We consider this objection well-founded and do not, therefore, rest our decision on the nature

of the interest, which was the subject matter of transfer or settlement as disclosed by the partnership deeds. Only we wish to add that if we had

reached a conclusion favourable to the assessee on the construction of section 16(1) (c) and we are inclined to follow the decision of the Bombay

High Court in D. R. Shahapure v. Commissioner of Income Tax, Bombay we would have directed the Tribunal to take these documents into

consideration and submit a better statement of the case, with reference to the conclusions to be drawn on the nature of the property or asset, which

was the subject matter of the disposition. But in view of the conclusion we have reached on the construction of section 16(1) (c) even on the

footing that the transfer in the present case satisfied the requirements of the third proviso we do not find it necessary to refer the case back to the

Tribunal.

The result is that the question which has been referred to this Court for its decision has to be answered in the affirmative and against the

assessee. The assessee will pay the costs. Counsels fee Rs. 250. Reference answered in the affirmative.