PETITIONER:
COMMISSIONER OF INCOME TAX, CALCUTTA
Vs.
RESPONDENT:
PRAHALADRAI AGARWALA
DATE OF JUDGMENT26/04/1989
BENCH:
PATHAK, R.S. (CJ)
BENCH:
PATHAK, R.S. (CJ)
KANIA, M.H.
CITATION:
1990 AIR 270 1989 SCR (2) 737
1989 SCC Supl. (2) 279 JT 1989 Supl. 139
ACT:
Income Tax Act, 1961: Section 64(1)(iii)--Wife partner
in firm alongwith husband--Capital contributed by wife out
of amount gifted by the husband--Share of profit of asses-
see's wife--Whether includible in total income of the hus-
band--There must be proximate connection between the accrual
of income and assets transferred.
HEADNOTE:
The respondent-assessee was one of the partners In a
firm in which the five other partners were his wife, mother,
grand-father, brother, and a stranger. His wife had contrib-
uted Rs.51,000 as capital in the firm, which amount came out
of two gifts made to her by the assessee. in the course of
assessment proceedings for the assessment year 1962-63 in
respect of the assessee, the Income Tax Officer included the
profits of the assessee's wife from the firm, under s.
64(1)(iii) of the Income Tax Act, 1961. The.assessee's
appeal was dismissed by the Appellate Assistant Commissioner
who observed that the wife would not have become a partner
of the firm unless he had contributed capital which was
provided by the husband. The Appellate Tribunal, while
dismissing the second appeal of the assessee, found that the
admission of the assessee's wife as a partner in the firm
was solely on account of her contribution of capital to the
firm. It was conceded by the assessee before the Tribunal
that the interest received by the assessee's wife on her
capital contribution to the firm was includible in the total
income of the assessee.
The High Court, while answering the question referred to
it in favour of the assessee, took the view that the income
arose from the share of profits only because the other
partners agreed to take the assessee's wife as partner and
she was allowed to contribute to the partnership firm, and
that the admission of the assessee's wife to the partnership
was not in consequence of the gift.
Dismissing the Revenue's appeal, it was
HELD: (1) The income may arise directly or indirectly,
but for application of the provisions of section 64(1)(iii)
of the Income Tax Act,
738
1961 there must be a proximate connection between the accru-
al of the income and the assets transferred by the assessee.
[741D]
Commissioner of Income-tax, West Bengal 111 v. Prem Bhai
Parekh, [1970] 77 ITR 27 followed.
(2) The mere contribution of the capital by the wife
into the firm would not automatically have entitled her to
partnership in the firm. The partnership was based on agree-
ment, and it is the event of agreement between the partners
that brought the assessee's wife into the firm as partner.
[742E]
Commissioner of Income-tax, Bangalore v. J.H. Gotla,
[1985] 156 ITR 323; Commissioner of Income-tax, Assam,
Tripura and Manipur v. Jwalaprasad Agarwala, [1967] 66 ITR
154; V.D. Dhanwatey v. Commissioner of Income-tax, Madhya
Pradesh, Nagpur and Bhandara, [1968] 68 ITR 365; Smt. Mohini
Thapar v. Commissioner of Income-tax (Central), Calcutta,
[1972] 83 ITR 208; Potti Veerayya Sresty v. Commissioner of
Income-tax, A.P., [1972] 85 ITR I94 distinguished.
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 575 (NT)
of 1975.
From the Judgment and Order dated the 24.4.1973 of the
Calcutta High Court in Income Tax Reference No. 202 of 1969.
B. Ahuja and Ms. A. Subhashini for the Appellant.
K.P. Bhatnagar, S.P. Mittal and B.P. Maheshwari for the
Respondent.
The Judgment of the Court was delivered by
PATHAK, CJ. This appeal by special leave is directed
against the judgment of the High Court at Calcutta answering
the following question in favour of the assessee and against
the Revenue:
“Whether, on the facts and in the circum-
stances of the case, the share of profit of
the assessee’s wife was includable in the
total income of the assessee under section
64(1)(iii) of the Income Tax Act, 1961?”
739
The assessee was assessed in the status of an individual
for the assessement year 1962-63 corresponding to the previ-
ous year 26 March, 1961 to 13 April, 1962. At the material
time the assessee was a partner in a firm, Messrs Ramesh and
Co., with a share of eight annas therein. The balance was
shared by three other partners, the assessee’s father,
Kunjilal Agarwala, the assessee’s brother, Hariram Agarwala
and a stranger, Jagdish Prasad. On 10 November, 1960 and on
28 November, 1960 the assessee made two gifts of Rs.21,000
and Rs.30,000 respectively to his wife, Kaushalya Devi, from
his account in the firm. On 28 November, 1960 he made anoth-
er gift of Rs. 11,000 to his mother Chili Bai from that
account. It may be observed that Chili Bai received another
gift of Rs.20,000 from her husband, Kunjilal, effected by
similarly drawing from his account with the firm.
The assessee’s wife, Kaushalya Devi, as well as his
mother Chili Bai became partners with three other persons in
a newly constituted firm, Messrs Kunjilal Hariram & Co. The
three other partners were the assessee’s grand father,
Moharilal Agarwala, the assessee’s brother, Hariram Agarwala
and the stranger, Jagdish Prasad Gup. ta. The Partnership
Deed dated 10 November, 1960 provided that the business was
to commence from 12 November, 1960. The preamble to the deed
stated:
“Whereas the partner of the Fifth Part who has
extensive experience and outstanding talent of
organisation in Jagree and Grains Trade but
little finance requested the partners of the
First four Parts to enter into co-partnership
with him on contributing the necessary finance
to carry on business in Jagree and Grains and
also act as Commission Agents in Jagree Grains
and allied commodities to which request they
acceded.”
Clause 4 of the Partnership Deed stipulated:
“That the partners of the First Four Parts
shall initially contribute Rs.25,000 each to
be put in within six months from the commence-
ment of the partnership. The said contribu-
tions augmented by further deposits and prof-
its or depleted by withdrawals and tosses
shall carry interest at the rate of 6% per
annum. The amount if any, standing to the
credit of the partner of the Fifth Part shall
carry interest at the same rate.”
740
On 12 November, 1960 Kaushalya Devi contributed
Rs.21,000 as capital, which came out of the gift made by the
assessee on 10 November, 1960. She also contributed
Rs.30,000 as capital, which amount came out of the gift made
on 28 November, 1960.
In the course of assessment proceedings for the assess-
ment year 1962-63 in respect of the assessee the Income Tax
Officer included the profits of the assessee’s wife from the
firm, Messrs. Kunjilal Hariram & Co., under s. 64(1)(iii) of
the Income Tax Act, 1961.
An appeal by the assessee was dismissed by the Appellate
Assistant Commissioner of Income Tax, who observed that the
wife would not have become a partner of the firm unless she
had contributed capital, and as the capital was provided by
the husband the inclusion of the wife’s share of income in
the assessment of the assessee was justified.
In second appeal, it was conceded by the assessee before
the Income Tax Appellate Tribunal that the interest received
by the assessee’s wife on her capital contribution to the
firm was includible in the total income of the assessee, but
it was contended that the balance of the share of profit was
not so includable as the assessee’s wife had become a part-
ner in the firm in her own right, and it was immaterial that
the capital invested by her had been provided as a gift by
the assessee. The Appellate Tribunal found that the admis-
sion of the assessee’s wife as partner in the firm was
solely on account of her contribution of capital to the
firm, that the assets in the form of cash were transferred
directly by the assessee to his wife otherwise than for
adequate consideration, and that the income must be said to
have arisen indirectly from the assets transferred. The
second appeal was dismissed. At the instance of the assessee
the question of law set forth earlier was referred to the
High Court at Calcutta for its opinion.
The High Court has taken the view that the share of
profits arose to the assessee’s wife primarily because the
partnership made a profit and although it had connection
with the gift it did not arise as a result of the gift, that
the income arose from the share of profits only because the
other partners agreed to take the assessee’s wife as partner
and was allowed to contribute to the partnership firm, that
the admission of the assessee’s wife to the partnership was
not in consequence of the gift, and that, therefore, upon
all those circumstances, the connection between the income
of the share of profits and the gifts by the assessee to his
wife was too remote to be included within the provisions of
s. 64(1)(iii) of the Income Tax Act.
741
S.64(1)(iii) of the Income Tax Act, 1961, as it stood at
the relevant time, provides:
“64(1) In computing the total income of any
individual, there shall be included all such
income as arises directly or indirectly–
(i) xx xx xx (ii) xx xx xx (iii) subject to the provisions of cl.
(i) of s. 27, to the spouse of such individual
from assets transferred directly or indirectly
to the spouse by such individual otherwise
than for adequate consideration or in connec-
tion with an agreement to live apart.”
The income may arise directly or indirectly, but there must
be a proximate connection between the accrual of the income
and the assets transferred by the assessee. In Commissioner
of Income-tax, West Bengal 111 v. Prem Bhai Parekh and
Others, [1970] 77 ITR 27 this Court held that the income of
minor sons, who had invested capital in the firm out of
moneys gifted to them by their father (the assessee) could
not be included in the assessment of the assessee. The Court
observed:
“Before any income of a minor child can be
brought within the scope of section 16(3)(a)
(iv), it must be established that the said
income arose directly or indirectly from
assets transferred directly or indirectly by
his father. There is no dispute that the
assessee had transferred to each of his minor
sons, a sum of Rs.75,000. It may also be that
the amount contributed by those minors as
their share in the firm came from those
amounts. But the question still remains wheth-
er it can be said that the income with which
we are concerned in this case arises directly
or indirectly from the assets transferred by
the assessee to those minors. The connection
between the gifts mentioned earlier and the
income in question is a remote one. The income
of the minors arose as a result of their
admission to the benefits of the partnership.
It is true that they were admitted to the
742
benefits of the partnership because of the
contribution made by them. But there is no
nexus between the transfer of the assets and
the income in question. It cannot be said that
income arose directly or indirectly from the
transferor the assets referred to earlier.
Section 16(3) of the Act created an artificial
income. That section must receive strict
construction as observed by this court in
Commissioner of Income-tax v. Keshavlal Lal-
lubhai Patel, [1965] 55 ITR 637 (S.C.). In our
judgment before an income can be held to come
within the ambit of section 16(3), it must be
proved to have arisen-directly or
indirectly–from a transfer of assets made by
the assessee in favour of his wife or minor
children. The connection between the transfer
of assets and the income must be proximate.
The income in question must arise as a result
of the transfer and not in some manner con-
nected with it.”
It seems to us that the observations of this Court in that
case fully cover the case before us. There is no doubt that
the wife became a partner because of the capital contributed
by her in the firm, but, as observed by the High Court, in
the judgment under appeal, it was upon agreement by the
remaining partners that she became a member of the partner-
ship. The mere contribution of the capital by the wife into
the firm would not automatically have entitled her to part-
nership in the firm. The partnership was based on agreement,
and it is the event of agreement between the partners that
brought the assessee’s wife into the firm as partner.
Learned counsel for the Revenue relies on Commissioner of
Income-tax, Bangalore v. J.H. Gotla, [1985] 156 ITR 323;
Commissioner of Income-tax, Assam Tripurn and Manipur v.
Jwalaprasad Agarwala, [1967] 66 ITR 154; V.D. Dhanwatey v.
Commissioner of Income-tax, Madhya Pradesh, Nagpur and
Bhandara, [1968] 68 ITR 365 and Smt. Mohini Thapar v. Com-
missioner of’ Income-tax (Central), Calcutta, and Others,
[1972] 83 ITR 208 but we are not satisfied that those cases
are of assistance to the Revenue. Reliance was placed on
Potti Veerayya Sresty v. Commissioner of Income-Tax, A.P.,
[1972] 85 ITR 194 where the Andhra Pradesh High Court upheld
the inclusion of the wife’s income from cloth business
carried on by her, into which cloth business she had invest-
ed a portion of the assets transferred by the assessee. It
is sufficient to observe that the cloth business was her own
business and, as the High Court pointed out, there was no
necessity to depend upon the agreement of others. It is on
that basis that the High Court distinguished Prem Bhai
Parekh’s case (supra).
743
We are of the view that the High Court is right in
answering. the . question referred to it in the negative, in
favour of the assessee and against the Revenue.
In the result the appeal fails and is dismissed with
costs.
R.S.S. Appeal dismissed.
744
