RAJAGOPALA AYYANGAR, J. – This is a reference under section 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 settlees 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 settlees 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 settlees 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 settlees 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. Under section 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 under section 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 settlees 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 settlees 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(3) (a) (iii) 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 under section 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 under section 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 under section 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.