B. PALANISWAMY VS COMMISSIONER OF INCOME-TAX
1999 P T D 623
[225 I T R 432]
[Madras High Court (India)]
Before K. A. Thanikkachalam and N. V. Balasubramaniam, JJ
B. PALANISWAMY
Versus
COMMISSIONER OF INCOME-TAX
Tax Cases Nos.509, 510 (References Nos.451 and 452 of 1984), decided on 14/03/1996.
Income-tax---
----Total income---Firm---Inclusions in total income---Amount gifted by assessee to daughters-in-law invested as capital in firm in which assessee was a partner---Share income from firm received by daughter-in-law of assessee- No direct or indirect connection between gift and such income---Share income not includible in total income of assessee---Indian Income Tax Act, 1961, S.64(1)(vi) [prior to its amendment w.e.f. 1-4-1989].
The assessee was an individual who derived share income from two firms, S.P. and P.P. The assessee made two gifts to his daughter-in-law, V, totalling Rs.12,000 of which Rs.6,000 each was invested on April 14, 1974, as her capital in two firms, V.C. and S.P. The Income-tax Officer was of the view that, but for the capital contribution by her father-in-law, V could not have contributed capital in the two firms and derived share income therefrom. Thus, in the assessment years 1976-77 and 1978-79, the share income derived by the daughter-in-law from the abovesaid two firms was clubbed with the income of the assessee in his assessment. This was upheld by the Tribunal. On a reference:
Held, that V was recognised as a partner in her own right because of her capital contribution and because of the business done by the firm the capital contribution earned interest and accordingly share income was payable to the partners. Hence, it could not be said that there was any nexus between the gifts given by the assessee and the share income earned by the daughter-in-law by contributing the said gift in the firms as capital. Explanation 3 was made applicable to clause (vi) of subsection (1) of section 64 by the Direct Tax Laws (Amendment) Act, 1989, with effect from April 1, 1989. Therefore, Explanation 3 had no relevance to the facts arising in this case. The share income, which arose to the assessee's daughter-in-law from the two firms, V.C. and S.P., was not includible in the total income of the assessee.
C.I.T. v. Kanji Bhai Tivraj Bhai (1989) 176 ITR 273 (MP); C.I.T. v. Prahladrai Agarwala (1989) 177 ITR 398 (SC); C.I.T. v. Prem Bhai Parekh (1970) 77 ITR 27 (SC); C.I.T. v. Shivji Ram Agarwal (1986) 162 ITR 793 (Raj.) and Ethirajulu (G.) v. C.I.T. (1972) 85.ITR 16 (AP) fol.
Jose v. C.I.T. (1967) 64 ITR 29 (Ker.) ref.
K. C. Rajappa for the Assessee.
C.V. Rajan for the Commissioner
JUDGMENT
K.A. THANIKKACHALAM, J.------At the instance of the assessee, the Tribunal referred the following common question, for the assessment years 1967-77 and 1978-79, for the of the Court, under section 256(1) of the Income Tax Act, 1961:
"Whether, on the facts and circumstances of the case, the Appellate Tribunal was justified in law in holding that the share income which arose to the assessee's daughter-in-law in the two firms, Vijayalakshmi Colour Company and Singarappan Palayakat Company, were includible and assessable in the hands of the assessee under section 64(1)(vi) of the Income Tax Act, 1961?"
The assessee is an individual and derives share income from two firms called Singarappan Palayakat Co. and Palaniappan Palayakat Co., both at Pudupet, in which he is a partner. During the previous year relevant for the assessment year 1977-78 (sic), the assessee made two gifts to his daughter-in-law, Smt. P. Vijalakshmi, totalling Rs.12,000 of which Rs.6,000 each was invested on April 14, 1974, as her capital in the two firms, Vijayalkshmi Colour Company and Singarappan Palayakat Co. The Income-tax Officer was of the view that but for the capital contribution by her father-in-law, Smt. Vijayalakshmi could not have contributed capital in the abovesaid two firms and derived the share income therefrom. Hence, he treated the share income earned by the daughter-in-law applying the provisions, of section 64(1)(vi) of the Income Tax Act, 1961, and clubbed the same with the income of the assessee. Thus, in the assessment years 1976-77 and 1978-79, the share income derived by the daughter-in-law from the abovesaid two firms was clubbed with the income of the assessee in his assessment.
On appeal, the Appellate Assistant Commissioner was of the view that there is no nexus between the share income earned by the daughter-in -law and the gifts made by the father-in-law to the daughter-in-law. According to the Appellate Assistant Commissioner, the share income arose out of the capital contributed by the daughter-in-law, who is a partner in the abovesaid firms. Hence, the Appellate Assistant Commissioner came to the conclusion that the share income earned by the daughter-in-law in the abovesaid two firms in the assessment years under consideration cannot be included in the income of the assessee.
Aggrieved, the Department filed appeals before the Appellate Tribunal. On appraising the facts arising in the case, the Tribunal came to the conclusion that there was nexus between the gift made by the father-in- law and the share income earned by the daughter-in-law out of her capital contribution made in the abovesaid two firms. The Tribunal held that on facts, the provisions of section 64(1)(vi) of the Income Tax Act, 1961, would be applicable and the share income earned by the daughter-in-law should be clubbed with the income in the hands of the assessee.
Before us learned counsel appearing for the assessee submitted that unless the Department established the nexus between the gift made by the father-in-law and the share income earned by the daughter-in-law by contributing the said gift as capital in the abovesaid two firms, the share income cannot be includible in the hands of the father-in-law, who is the assessee. According to learned counsel, the Department failed to establish such a nexus in the present case so as to warrant application of the provisions contained in section 64(1)(vi) of the Income Tax Act, 1961. It was further submitted that the capital contributed by the daughter-in-law in the abovesaid firms was later on withdrawn by her and, therefore, there is no evidence on record to show that there is any nexus between the gift made by the father-in-law and the share income earned by the daughter-in-law from the abovesaid two firms It was further submitted that the share income was earned from the abovesaid two firms because of the capital contribution made by the daughter-in-law as a partner, and hence, it cannot be said that the share income from the firths arose directly or indirectly out of the gift made by the father-in-law. In support of his contention, learned counsel appearing for the assessee relied upon various decisions. On the other hand, learned standing counsel appearing for the Department, while supporting the order passed by the Tribunal, submitted that there is a clear nexus between the gifts and the capital on the one hand and the capital and share income on the other hand. It was claimed that the facts in the assessee's case clearly justify inclusion and the cases cited by the assessee's counsel are clearly distinguishable on the facts available in the present case. According to learned standing counsel, the partnership deed supported the conclusion that the firms had no fixed capital and her interest in partnership was for her participation and not because of capital. Therefore, inasmuch as there is nexus between the gift made by the father-in-law and the share income earned by the daughter-in-law by contributing the said gifts as capital in the partnership-firm, the provisions of section 64(1)(vi) of the Act are applicable to the facts of this case.
We have heard both learned counsel appearing for the assessee as well as learned standing counsel for the Department. Section 64(1)(vi) of the Income Tax Act, 1961, authorises inclusion of income as arises directly or indirectly to the son's wife of such individual from assets transferred directly or indirectly on or after the 1st day of June, 1973, to the son's wife by such individual otherwise than for adequate consideration. It is admitted that the capital amounts contributed to the two firms by the son's wife, Vijayalakshmi, were out of the gifts received from the father-in-law, who is the assessee herein. The amounts received by way of gift were credited al Rs.6,000 each in the abovesaid two firms as her capital contribution. No other capital was contributed by her. The point for consideration is, whether the share income earned from the partnership by the daughter-in-law in the abovesaid two firms is attributable to her capital. A reading of the partnership deed would go to show that there is no fixed capital for the firm and the moneys contributed by the partners will be treated as their capital. Smt. Vijayalakshmi is recognised as a partner in her own right because of her capital contribution. She could have utilised the gift received from her father- in-law in any other manner, which she likes, but she chose to contribute the said amount in the abovesaid two firms as capital in her name. Because of the business done by the firm the capital contribution earned interest and accordingly share income was payable to the partners Hence, it cannot be said that there is any nexus between the gifts contributed by the father-in-law and the share income earned by the daughter-in-law by contributing the said gift in the firms as capital.
In C.I.T. v. Prem Bhai Parekh (1970) 77 ITR 27 (SC), the assessee, who was a partner in a firm having seven annas share therein, retired from the firm on July 1, 1954. Thereafter, he gifted Rs.75,000 to each of his four sons, three of whom were minors. There was a reconstitution of the firm with effect from July 2, 1954, whereby the major son became a partner and the minor sons were admitted to the benefits of partnership in the firm. The question was whether the income arising to the minors by virtue of their admission to the benefits of partnership in the firm could be included in the total income of the assessee under section 16(3)(a)(iv). While answering this question, the Supreme Court held that (headnote): "the connection between the gifts made by the assessee and the income of the minors from the firm was a remote one and it could not be said that that income arose directly or indirectly from the transfer of the assets. The income arising to the three minor sons of the assessee by virtue of their admission to the benefits of partnership in the firth could not be included in the total income of tile assessee"
A similar question came up for consideration before the Andhra Pradesh High Court in G. Ethirajulu v. C.I.T. (1972) 85 ITR 16. In the abovesaid decision, the following question was referred to the Andhra Pradesh High Court for its opinion (page 17):
"Whether, on the facts and in the circumstances of the case, the share income of the minor son from Ranganatha Silk House is liable, to be included in the assessment of the father, i.e., the assessee;' under section 64(iv) of the Income Tax Act, 1961?"
While answering this question, the Andhra Pradesh High Court, following the decision of the Supreme Court in C.I.T. v. Prem Bhai Parekh (1970) 77 ITR 27, held that (headnote): "the share income of the assessee's minor son from Ranganatha Silk House did not arise as a result of the transfer by the assessee, but arose as a result of the admission to the benefits of partnership and, as such, it was not liable to be included in the total income of the assessee under section 64(iv) of the Act".
In C.I.T. v. Prahladrai Agarwala (1989) 177 ITR 398 (SC), the facts are: The respondent made two gifts of money to his wife in November, 1960, and another gift to his mother. They became partners in a firm in which the other partners were the respondent's grand-father, his brother and a stranger. The wife contributed both the amounts of the gifts as capital to the firm. The question was whether the share of profits of the wife in the firm for the assessment year 1962-63 could be included in the total income of the respondent under section 64(1)(iii) of the income Tax Act, 1961. While answering this question, the Supreme Court, following an earlier decision of its own in C.I.T. v. Prem Bhai Parekh (1970) 77 ITR 27 held that (headnote): "there had to be a proximate connection between the accrual of income and the assets transferred. No doubt, the wife became a partner because of the capital contributed by her in the firm, but it was upon agreement by the remaining partners that she became a member of the partnership. The mere contribution of capital by the wife would not automatically have entitled her to partnership in the firm: the partnership was based on agreement, and it is the event of agreement between the partners that brought the respondent's wife into the firm as partner. The share of profits of the wife could not be included in the respondent's total income under section 64(1)(iii) of the Act".
The Rajasthan High Court had an occasion to consider a question of similar nature while considering the provisions of section 64(1)(vi), Explanation 3, to section 64(1) of the Income Tax Act, 1961, in C.I.T. v. Shivji Ram Agarwal (1986) 162 ITR 793, wherein it was held that (headnote): "a perusal of Explanation 3 to section 64(1) of the Income Tax Act, 1961, shows that its applicability is confined to clauses (iv) and (v) of section 64. It does not apply to section 64(1)(vi) and income from investments in business made with assets gifted to a daughter-in-law cannot be clubbed with that of the assessee under that provision. It was further pointed out that the question whether there is intimate connection between a gift made by the assessee to his daughter-in-law and the daughter-in-law becoming a partner with the assessee in a firm by investing the amount gifted is a question of fact".
A similar question also came up for consideration before the Madhya Pradesh High Court in C.I.T. v. Kanji Bhai Tivraj Bhai (1989) 176 ITR 273. According to the facts arising in that case, the assessee, who was a partner in a firm, gifted a sum of Rs.25,100 to his son's wife, who contributed that amount to the capital of that firm and also became a partner of that firm. For the assessment year 1977-78, the Income-tax Officer rejected the claim of the assessee that the share income amounting to Rs.19,920 from the firm received by the daughter-in-law was not includible in the income of the assessee under section 64(1) of the Income Tax Act, 1961. The Income-tax Officer included the amount in the total income of the assessee under clause (vi) of section 64(1). On these facts, on a reference, the Madhya Pradesh High Court held that (headnote): "the share income of the daughter-in-law of the assessee arose primarily on account of the fact that she was admitted to the partnership. The said income could not be said to have arisen directly or indirectly from the investment of the gift made by the assessee to his daughter-in-law. Therefore, the Tribunal was right in holding that the provisions of section 64(1)(vi) were not attracted to the case of the assessee and that the income earned by the daughter-in-law from her share in the firm could not be included in the total income of the assessee".
However, learned standing counsel for the Department, drew our attention to a decision of the Kerala High Court in Jose v. C.I.T. (1967) 64 ITR 29. According to the facts arising in that case, where a person makes a gift of a sum of money to his wife and the wife contributes the same towards the capital of a firm, a question arose whether the share of profits received by the wife can be included in the income of the husband under section 16(3). The Kerala High Court held that it would depend on whether the income derived from the partnership was entirely due to the investment of the gifted money or whether in the making of that income other elements were also in operation. According to the Kerala High Court, since no other element operated, it was held that the wife's share of profits arose wholly and exclusively from the sum, which the assessee had given to his wife and her share of the profits could be included in the assessee's income.
In the decision in C.I.T. v. Prahladrai Agarwala (1989) 177 ITR 398, the Supreme Court held that the mere contribution of capital by the wife would not automatically have entitled her to partnership in the firm; the partnership was based on agreement, and it is the event of agreement between the partners that brought the respondent's wife into that firm as a partner. Therefore, the share of profits of the wife could not be included in the respondent's total income under section 64(1)(iii) of the Act.
Our attention was also drawn to Explanation 3 to section 64(1) brought out by the Taxation Laws (Amendment) Act, 1975, with effect from April 1, 1976. But this was made applicable only to sub-clauses (iv) and (v) of section 64(1) and not to sub-clauses (vi) of subsection (1) of section 64. However, Explanation 3 was made applicable to clause (vi) of subsection (1) of section 64 by the Direct Tax Laws (Amendment) Act, 1989, with effect from April 1, 1989. Therefore, Explanation 3 has no relevance to the facts arising in this case. Thus, considering the facts arising in the present case, in the light of the judicial pronouncements cited supra, we hold that the Tribunal was not correct in coming to the conclusion that there is nexus between the gift made by the father-in-law and the share income earned by the daughter-in-law from the abovesaid two firms out of the capital investment made by the gift amount. We have already held that the share income was earned on account of contribution of capital by the daughter-in -law and it has no direct or indirect connection with the gift made by her father-in-law. Accordingly, we answer the question referred to us in both the assessment years under consideration in the negative and in favour of the assessee. No costs.
M.B.A./1728/FCReference answered.