S. Srinivasan vs Commissioner of Income Tax

Srinivasan , J.—In the firm of Ranjaneya Motor Transport constituted by a deed dated 17th December 1951, the assessee is a partner. The

other partners in the firm are his wife Shambagammal and one other stranger Sivachidambaram Pillai, the two minor sons of the assessee were

admitted to the benefits of the partnership. For the assessment year 1957-58, the previous- year ending on the 30th September 1956, the assessee

claimed that the share of the profit and the interest allowed by the firm on such shares to his wife and the two minor sons should be excluded from

the operation of Section 16(3)(a)(i) and (ii). During the relevant account year, the share of the profit credited to the accounts of the wife and the

two minor sons were the sums of Rs. 1944/, Rs. 23336 and Rs. 19447 respectively. Under a clause or the deed of partnership, members of the

firm or persons admitted to the benefits of the partnership were entitled to receive interest on the amounts standing to their credit at the rate of 12

annas per cent per mensem, i.e., nine per cent per annum. Such interest was not credited in any of the previous years, and on the accumulation of

the profits of these persons, interest was credited for the first time in the year ended 30th September 1956. These interest amounts were Rs. 7879,

Rs. 6971 and Rs. 7702 in respect of the wife and the two minor sons. Relief from the application of Section 16(3)(a)(i) and (it) was sought both in

respect of the profits earned during the year of account and the interest payment credited as above. The Income Tax Officer rejected the

assessee''s contention, which was that the shares held by his wife and the two minor sons had been gifted to them by other persons and since it

was not as a result of a transfer from him that these persons had obtained their interest in the firm, their share income should not be included in the

total income of the assessee. This contention was rejected. Appeal was taken to the Appellate Assistant Commissioner before whom it was urged

that the provision, Section 16(3)(a)(i) and (ii) was ultra vires the Constitution, and that the interest earned by the wife and the minor children on the

accumulated profits in that firm could not in any event be included in the total income of the assessee. Before the Appellate Authority, the decision

in Bhogilal Laherchand Vs. Commissioner of Income Tax, Bombay City, was relied upon. The Appellate Assistant Commissioner thought that this

decision applied and accordingly excluded only the interest portion of the amount brought to assessment.

Against this decision, both the assessee and the department appealed, the assessee again raising the constitutional validity of Section 16(3)(a)(i)

and (ii), and the department contending that the exclusion of the interest earnings from the assessee''s total income was erroneous. The tribunal

rejected the first contention relying upon a decision of this Court in B.M. Amina Umma Vs. Income Tax Officer, Kozhikode, . On the question of

the interest earnings, the Tribunal thought that in so far as the interest was attributable to the two sums gifted to the two minors by certain other

persons, that interest could not be said to be income arising directly or indirectly from the admission of the wife or the admission of the minors to

the benefits of the partnership and that, if at an, such interest should be regarded as interest arising from investment of the amounts with the firm. To

this extent, the view taken by the Appellate Assistant Commissioner was confirmed. But with regard to the remaining portion of the interest which

accrued on the balances of profits of the firm credited to the wife and the two'' minor sons, the Tribunal was of the view that Section 16(3)(a)(i)

and (ii) directly applied. Accordingly, the Departmental appeal was allowed in part. It is from these orders of the Tribunal that the present

questions of law arise and the questions so referred to us u/s 66(1) of the Act are :

Whether the provisions of Section 16(3)(a)(i) and (ii) offend Clauses (f) and (g) of Article 19(1) of the Constitution of India?

Whether interest by the aforesaid firm to the assessee''s wife and minor children attributable to past profit accumulations only is includible in the

assessment of the assessee u/s 16(3)(a)(i) and (ii)?

Learned counsel for the assessee concedes that in so tar as the first of these questions is concerned, the authority of a decision of this Court (Sic)

(Supreme Court ?) in Balaji Vs. Income Tax Officer, Special Investigation Circle, is against his contentions. This question is, therefore, answered

against the assessee.

The second question has given rise to some difficulty for the reason that the decision of the Bombay High Court in Bhogilal Laherchand Vs.

Commissioner of Income Tax, Bombay City, appears to be in favour of the assessee. Before dealing with the facts of that decision and the

reasoning that appealed to the learned Judges who decided that case, we may refer to the relevant clauses of the partnership deed in the present

case. The partnership was entered into between the assessee, his wife Shanbagammal and one Sivachidambara Pillai. It provided that the account

shall be closed on the 30th September of each year and net profits or loss determined as on that date. After setting out the profit sharing ratio as it

obtained previously, the document provided that the profits for the year ending on the 30th September 1952 and for subsequent years shall be

shared in the ratio of 190/300, 25/300 and 30/300 among the three partners, and that the two minors be entitled to 30/300 and 25/300 of the

profits. In the event of there being a loss, it was to be shared among the three partners in certain proportions. The further clauses read :

If any of our partners require excess amount, he shall draw such amount by way of debt transactions. Such amount shall be deducted from the net

profit or loss by such partner at each year and the balance shall be paid to him.

If the firm requires any sum for meeting the expenses for its management and if any of the partners has and is willing to give such amount, he may

advance (such amount) as loan. He may receive interest for such sum at the rate of twelve annas per cent per mensem.

It is seen from this clause that a partner becomes entitled to receive interest at nine per cent per annum in the case of amounts advanced by him

to the firm, should the firm require any sums for its expenses of management. In the present case, however, there is no indication anywhere that it

was as a result of any separate agreement between the parties stemming from the above clause that the balances standing to the credit of the wife

and the two minor sons were taken over and utilised by the firm, or that it was on the basis of any such separate agreement that the interest was

paid to these parties. On the one hand, it is common ground that the share of the profits credited to the wife and the two"" minor members was left

to accumulate in the accounts of the firm year after year and for the first time in the account year, relevant to the assessment year 1957-58 an

interest calculation was made and a further sum by way of interest was added to the amounts so standing to the credit of these persons, the short

question is whether this interest can be said to be income of the wife or the minor children which arises directly or indirectly from the membership

of the wife in the firm of which her husband is a partner or from the admission of the minor to the benefits of the partnership in a firm of which the

assesses is a partner.

Considering the matter from first principles and without any reference to authority, it seems to us to be difficult to see how the receipt of this

amount or the right to receive this amount cannot but be the consequence of the membership of the wife in the partnership or the admission of the

minors to the benefits of the partnership. Even apart from any provision in the partnership deed, a is seen that u/s 13(d) of the Partnership Act the

partner or a person admitted to the benefits of the partnership is entitled to receive interest on the balances standing to his credit. The statute itself

accordingly provides that one of the rights following the membership or the admission to the benefits of a firm shall include the right to receive the

interest. Turning to the clause in the partnership deed, the firm undertakes to pay a member or a person admitted to the benefits of the partnership

interest at a rate specified. This right in the stricter sense flows from the contractual relationship created between the parties by the partnership

document It would therefore appear that the receipt of this amount cannot be dissociated from the agreement of partnership and can be said to

flow directly from the membership of the wife in the one case or the admission of the minors in the other case.

In the Bombay decision to which reference has been made, the facts were these; The assessee therein started a partnership business with his

major son. Two of his minor sons were admitted to the benefits of the partnership. The share of the profit of the minors was included in the total

income of the assessee. In addition thereto, the interest which the minors received on the deposits standing to their credit in the firm was also

sought to be included in the total income of the assessee, and the question was whether this interest came within the mischief of Section 16(3)(a)

(ii). The teamed Judges observed.

Now, what Section 16(3)(a)(ii) requires is that a minor must be admitted to the benefits of the partnership in a firm of which the assessee is a

partner and income must arise either directly or indirectly to the minor from his admission to such a partnership. Therefore, there must be a

connection between the income and the admission of the minor to the ''partnership. The connection need not be direct; it may even be indirect. We

have to look to the partnership deed in order to determine whether there was a connection direct or indirect between the interest received by the

minors on the deposits and their admission into the partnership. For this purpose the relevant clause in the partnership deed is Clause (3) and that

clause provides : Interest at the rate of six per cent per annum shall be paid to each partner on the moneys for the time being standing to his credit

out of the gross profits of the business and such interest shall be cumulative so that any deficiency in any one year shall be made up out of the gross

profits of any succeeding year or years.'' It is significant to note that this clause does not cast any obligation upon the minors to maintain any deposit

in the firm. It is equally significant that this clause does not cast any obligation upon the firm to keep any deposits made by the miners. Therefore it

is optional on both sides, on the side of the depositor and on the side of the depositee, whether to have deposits or not.

Dealing with the contention of the department that the clause made it obligatory upon the firm to Keep the profit in the partnership and to pay

interest upon it, learned Judges repelled that argument and said:

The only obligation upon the firm is to credit to the account of the partners their share of the profits. But mere is no further obligation, after having

credited the share in the profits, to retain that share and to pay interest under clause (3)."" Proceeding, the learned Judges concluded thus :

It is clear that the minors earned interest primarily and substantially by reason of the fact that they deposited moneys in the firm. It is not by reason

of the fact that they were partners, nor was it by reason of the fact that they were obliged under the partnership deed to make the deposits, that

this interest was earned. Therefore, this income arose to the minors not from their admission to the benefits of the partnership, but the income arose

Because the minors chose to keep moneys in the partnership firm. They could have earned interest on their deposits without being partners, they

could have earned interest on their deposits by keeping the deposits in any other firm, and really apart from the fixing of the rate of interest there is

no connection whatsoever between the minors being admitted to the benefit of the partnership and their earning interest on the deposits which they

have made or on the moneys that stand to their credit. The position undoubtedly would have been different if there was any obligation upon the

minors to make deposits or, on the other hand, if the partnership firm was under an obligation to keep the moneys, of the minors, whether they

need them or not.

We regret we are unable to adopt the reasoning of the learned Judges of the Bombay High Court. For one thing, it appears to us that if the

partnership document itself provided that the firm should pay interest on the accumulated profits of the members of the firm, such interest cannot

but be regarded as arising directly from the membership at the person or the admission of the person to the benefits of the partnership. It is true

that in the present case also it is not compulsory on the part of these persons to leave the amount in the deposit with the firm. The clause states that

the member may receive interest for any sum advanced as loan if the firm required any such amount and the partners so advanced the amount. This

clause provides for an independent transaction creating the relationship of debtor and creditor and only provides that in case where the creditor is a

partner, he shall be entitled to nine per cent interest. Whether or not it is possible to treat the interest payment arising on foot of a separate

transaction as falling Within the mischief of Section 16(3)(a)(i) or (ii) it is not necessary to consider. In the present case, however, the payment of

this interest was fully and clearly rested on the solitary consideration, viz., that the party who was paid interest was either a member of the

partnership or a person admitted to the benefits of the partnership. Let us look at the matter in a different way. If both the wife or the minor was

called upon to launch legal proceedings against the firm for recovery of the interest, it is manifest that they have to rely only upon the terms of

partnership in enforcement of that claim. If that is the case, we see no reason why it should not be said that the interest payment arises directly from

the relationship as between them and the firm.

It is hardly possible to equate the present case to one where these parties had or could have earned interest by investing their profit receipts in

some other manner, either by entering into a separate loan transaction with the firm or investing it with other firms or in any other manner.

This decision of the Bombay High Court has been referred to by the Assam High Court in Chouthmal Kejriwal Vs. Commissioner of Income

Tax, Assam, , that was a case where a minor admitted to the benefits of the partnership had supplied capital. The question arose whether the

income accruing to the minor as interest on capital came within the mischief of Section 16(3)(a)(ii). The learned Judges took the view that the

supply or capital by a person could not but be on the basis of his relation to the partnership, that is, his admission to the benefits of the partnership,

so that this interest receipt arose directly from that relationship. Though the learned Judges referred to the Bombay decision and observed that case

of contribution of capital differed from deposits made by the minor with the firm, it seems to us that the reasoning which they applied to the capital

contribution and their conclusion that the right to receive interest thereupon arose only by reason of the relationship of the parties to the partnership

applies equally to a case where under a clause in the partnership document a member of the firm and a minor admitted to the benefits of the

partnership receives interest on the profits standing to, his credit.

It follows that the question has to be answered against the assessee. The assessee will pay the costs of the department. Counsel''s fee Rs. 250.