Case Note & Summary
This civil appeal arose from income tax references concerning the correct assessment of income derived from a partner's share in a registered firm. The appellant partnership firm, Fatehchand Murlidhar, and the individual partner, Murlidhar Himatsingka, challenged the Calcutta High Court's decision that the partner's share income from the main firm Basantlal Ghanshyamdas should be taxed in his personal assessment rather than in the assessment of the sub-partnership firm. The dispute centered on an agreement dated December 21, 1949, by which Murlidhar Himatsingka, a partner in the registered firm Basantlal Ghanshyamdas with a 2/8 share, formed a partnership with his two sons and a grandson under the name Fatehchand Murlidhar. The deed recited that Murlidhar had become old and infirm and that his sons were already managing the business; it provided that the profits and losses of Murlidhar's share in Basantlal Ghanshyamdas would belong to the new partnership and be divided among the parties in specified shares, while the capital and assets remained exclusively with Murlidhar. For assessment years 1952-53 and 1953-54, the Income Tax Officer had excluded the share income from the assessment of Fatehchand Murlidhar firm, while for 1955-56, the same income was included in Murlidhar Himatsingka's personal assessment. The Appellate Assistant Commissioner and the Income Tax Appellate Tribunal sustained the inclusion in the partner's hands, holding that the agreement operated only after the profits were earned and was a subsequent disposition. The Calcutta High Court affirmed, viewing the arrangement as a diversion of income after accrual, not a diversion at source by overriding title. The legal issues before the Supreme Court were whether the agreement constituted a sub-partnership that diverted income before it reached the partner, and whether Section 23(5)(a) of the Indian Income-tax Act, 1922 permitted assessment of that income in the hands of the sub-partnership firm. The appellants argued that a partner's share is assignable property, that the sub-partnership created an overriding title, and that the real income belonged to the sub-partnership; they contended that the Act taxes real income, not notional income. The revenue argued that the agreement was a device to divide income after accrual and that the Act did not allow Section 23(5)(a) to be applied twice. The Supreme Court, speaking through Sikri J., allowed the appeals. It held that the agreement did constitute a sub-partnership, particularly because losses were also shared and the right to receive profits and bear losses became an asset of the new firm. Applying the test from Commissioner of Income Tax, Bombay v. Sitaldas Tirathdas, the Court distinguished between an obligation to apply income after receipt and an obligation that diverts income before it reaches the assessee. The sub-partnership created a superior title; the partner received profits on behalf of the sub-partnership, so the income never became his own. Regarding Section 23(5)(a), the Court held that its object is to apportion income among partners, not to finally assess the firm. After apportionment, the Income Tax Officer must determine who is really liable; if the real income belongs to another firm, the section can be applied again. The Court overruled Mahaliram Santhalia v. CIT and followed Charandas Haridas v. CIT and Sitaldas Tirathdas. Consequently, the Supreme Court set aside the High Court's judgment and directed that the partner's share income be assessed in the hands of the sub-partnership firm, Fatehchand Murlidhar, for the relevant assessment years.
Headnote
A) Income Tax - Sub-Partnership - Diversion of Income by Overriding Title - Indian Income-tax Act, 1922, Section 23(5)(a) - The agreement dated December 21, 1949 between a partner in a registered firm and his two sons and grandson, sharing profits and losses of the partner's share, constituted a sub-partnership. This sub-partnership created a superior title and diverted the income before it became the partner's own income; the partner received profits on behalf of the sub-partnership. Held that the income from the main firm belonged to the sub-partnership and was rightly assessable in its hands, not in the partner's personal assessment ([461E-F; 462C]). B) Income Tax - Assessment of Registered Firms - Object and Scope of Section 23(5)(a) - Indian Income-tax Act, 1922, Section 23(5)(a) - The object of Section 23(5)(a) is not to assess the firm itself but to apportion the income among the partners. After apportionment, the Income-tax Officer must determine who is really liable on that income; if the real income belongs to another firm, Section 23(5)(a) can be applied again to that firm. Held that the section did not prevent the income from being assessed in the sub-partnership's hands ([463C, F]). C) Income Tax - Real Income Principle - Assignability of Partner's Share - Indian Income-tax Act, 1922, Section 23(5)(a) - A partner's share in a firm is property capable of assignment, and a sub-partnership sharing profits and losses passes the real income to the sub-partnership. The Income-tax Act taxes real income, not notional income; the agreement was not a mere device or post-earning disposition. Held that the partner held the share as trustee for the sub-partnership, so the income must be assessed in the sub-partnership's hands. D) Precedent - Overruling of Mahaliram Santhalia - Indian Income-tax Act, 1922, Section 23(5)(a) - The Supreme Court followed Charandas Haridas v. CIT and CIT v. Sitaldas Tirathdas, and overruled Mahaliram Santhalia v. CIT which had required assessment in the partner's hands. Held that the earlier contrary view was no longer good law.
Issue of Consideration
Whether the income of a partner from a registered firm, which he had assigned to a sub-partnership formed with his sons and grandson, should be included in his individual assessment or in the assessment of the sub-partnership firm under Section 23(5)(a) of the Indian Income-tax Act, 1922.
Final Decision
Supreme Court allowed the appeals, set aside the High Court's judgment, and held that the income from the registered firm should be included in the assessment of the sub-partnership firm Fatehchand Murlidhar, not in the personal assessment of Murlidhar Himatsingka. The agreement constituted a sub-partnership and diverted income before it reached the partner; Section 23(5)(a) could be applied again to the sub-partnership.
Law Points
- Legal points not extracted
- Sub-partnership creates superior title and diverts income before reaching partner
- Partner's share is assignable property
- Real income principle applies
- Section 23(5)(a) apportions income but does not prevent reassessment to true owner
- Object of Section 23(5)(a) is apportionment among partners
- Double application of Section 23(5)(a) permissible
- Agreement sharing profits and losses constitutes sub-partnership
- Income-tax Act taxes real income not notional income
