1966 INSC 0153 Murlidhar Himatsingka and Another Vs Commissioner of Income Tax, Calcutta Civil Appeals Nos. 1108 to 1110 of 1964 (K. N. Wanchoo, S. M. Sikri JJ) 19.07.1966 JUDGMENT SIKRI, J. - These appeals by special leave are directed against the judgment of the High Court of Calcutta in two cases referred to it by the Income-tax Appellate Tribunal, Calcutta Bench, under section 66(1) of the Indian Income-tax Act, 1922 (XI of 1922) (hereinafter called the Act). One of the references (Income-tax Reference No. 20 of 1959) was made at the instance of Messrs. Fatehchand Murlidhar, and the other (Income-tax Reference No. 21 of 1959) was made at the instance of Shri Murlidhar Himatsingka. In the former reference the question referred was "whether on the facts and in the circumstances of the case, the income of Murlidhar Himatsingka for his share in the firm of Messrs. Basantal Ghanshyamdas for the assessment year 1952-53 and 1953-54 was rightly exclusive from the income of the applicant firm". In the later reference the question referred was "whether on the facts and circumstances of the case the income of Murlidhar Himatsingka for his share in the firm of Messrs. Basantlal Ghanshyamdas fo The facts and circumstances out of which these references were made are common because the real question raised by these references is whether the income of Murlidhar Himatsingka, from the firm of M/s. Basantlal Ghanshyamdas, in which he was a partner should be included in his personal assessment or in the easement of the firm of Fatehchand Murlidhar to which Murlidhar Himatsingka had purported to assign the profits and losses from M/s. Basantlal Ghanshyamdas. It is sufficient to take the facts from the statement of the case in Income- tax Reference No. 21 of 1959 made at the instance of Murlidhar Himatsingka. Murlidhar Himatsingka was carrying on business in shellac, jute, hessian, etc., under the name and style of "Fatehchand Murlidhar" at 14/1, live Raw and 71, Burtolla Street, Calcutta. He was also partner in the registered firm Messrs. Basantlal Ghanshyamdas, having 2 as. 8 ps. share. On December 21, 1949, a deed of partnership was executive by the said Murlidhar Himatsingka and a grandson named Mahabir "The profits and losses for the share of the said Murlidhar Himatsingka as partner in the said partnership and shall be divided and borne by the parties hereto in accordance with the shares as specified hereafter, but the capital with its assets and liabilities will belong exclusively to Murlidhar Himatsingka the party hereto of the first part and the parties hereto of the second, third and fourth parts shall have no lien or claim upon the said share capital or assets of the party hereto of the first part in the business of the said Messrs. Basantlal Ghanshyamdas." Clause 10 provides : "The profits and losses (if any) of the partnership including the shares of the profits and losses of the said partnership firm of Basantlal Ghanshyamdas aforesaid shall be divided and borne by the between the parties in the following manner : Party hereto of the first part - six annas (Murlidar Himatsingka). Party hereto of the second part - four annas (Madanlal Himatsingka). Party hereto of the third part - three annas (Radhaballav Himatsingka). Part hereto of the fourth part - three annas (Mahabir Prasad Himatsingka). Clause 11 provides that "all partnership money and securities for money shall as and when received be paid into and deposited to the credit of the partnership account". In clause 13 it is provided that "the party hereto or the first part shall have the sole control and direction of the partnership business and his opinion shall prevail if there be any dispute between the parties hereto". Clause 16 provides that "the net profits of the partnership after payment of all outgoing, interest on capital or loan and subject to the certain and maintains of any reserve other fund shall belong to the parties and the losses, if any, shall also be borne and paid by the parties in proportion to their shares as stated in clause 10 hereof." For the assessment year 1955-56 the Income-tax Officer included the income from the share in the registered firm of Basantlal Ghanshyamdas in the individual assessment of Murlidhar Himatsingka. Murlidhar Himatsingka appealed to the Appellate Assistant Commissioner. Referring to section 23(5) (a) of the Act, he held that as Murlidhar Himatsingka was a partners in the registered firm of Basantlal Ghanshyamdas, his share had to be assessed in his hands. He further held that the agreement was merely an arrangement which came into force after the profits were earned and not before they were earned. He held that this agreement being a subsequent disposition of profits, after that had been earned, had to be disregarded. Murlidhar Himatsingka appealed to the Income-tax Appellate Tribunal. The Appellate Tribunal heard this appeal together with the two appeals filed by M/s. Fatehchand Murlidhar. The Appellate Tribunal agreeing with the view of the appellate assistant Commissioner, dismissed the appeal. The High Court held that it was a case of diversion of income by Murlidhar Himatsingka after it had accrued to him and it was not a diversion at the source by any overriding interest. In the result, the High Court answered the questions in the affirmative in both the references. Murlidhar Himatsingka and M/s. Fatehchand Murlidhar having obtained special leave, the appeals are now before us. The learned counsel for the appellants, Mr. A. K. Sen, contends that a partners share is property capable of being assigned, mortgaged, charged and dealt with as any other property, and where a partner sells his share to a stronger, though that stranger does not become a partner yet the vendor partner holds the property as trustee for the purchaser and, consequently, the income received by the partnership is not his income but the income of the purchaser. He says that, similarly if a partner assigns part of his share the same result follows. He further contends that in this case, by the agreement dated December 21, 1949, Murlidhar Himatsingka had entered into a sub- partnership with his two sons and a grandson in respect of his share in the firm Basantlal Ghanshyamdas, and it is the sub-partnership that is entitled to the income from the firm Basantlal Ghanshyamdas and not Murlidhar Himatsingka who must be taken to be acting on behalf of the firm, Fatehchand Murlidhar. Mr. Sen further urges that the Indian In Mr. Hajarnavis, on the other hand, contends that this agreement is a mere device for dividing income which had crude to Murlidhar Himatsingka among his sons and grandson. In the alternative he contends that the India Income-tax Act does not contemplate the application of section 23(5) (a) twice. He says that the firm of Basantlal Ghanshyamdas was a registered firm and the Income-tax Officer was bounds, under section 23(5) (a), to assess Murlidhar in respect of the income receive from this firm; he could not carry this income to the assessment of another registered firm, namely, Fatehchand Murlidhar, and then apply section 23(5) (a). The first point that arises is whether the agreement dated December 21, 1949, has succeeded in diverting the income from Murlidhar's share in M/s. Basantlal Ghanshyamdas to M/s. Fatehchand Murlidhar before it reached Murlidhar. What is the effect of the agreemen ? In our opinion the agreement dated December 21, 1949, constituted a sub-partnership in Court in this connection observed : "At best it could be called a sub-partnership entered into by Murlidhar with stranger in respect of his share of the partnership." In arriving at this conclusion we attach importance to the fact that losses were also to be share and the right to receive profits and pay losses became an asset of the firm, Fatehchand Murlidhar. In Commissioner of Income-tax v. Sitaldas, Tirathdas, Hidayatullah J. speaking for the court, laid down the following test for determining questions like the one posed above. After reviewing a number of authorities, he observed : "In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kids of payment which can truly be exclusive and not the second. The second payment is merely an obligation to pay another a portion of ones own income, which has been received and is since applied. The first is a case in which the income never reached the assessee, who even if he were to collect it, does This test clearly shows that it is not every obligation to apply income in a particular way that result in the diversion of income before it reaches the assessee. In its judgment in the above case (Sitaldas Tirathdas v. Commissioner of Income-tax the High Court of Bombay had observed : "It is not essential that there should be a charge, it is quite sufficient if there is a legally enforceable claim". These observation must be treated as unsound. The test laid down by this court is quite clear, though like some other tests it is not easy of application in all cases. The other cases cited before us, namely, K. A. Ramachar v. Commissioner of Income-tax and Provat Kumar Mitter v. Commissioner of Income-tax do not assist us in disposing of this case because the facts are not similar. Only two cases, one of the Bombay High Court and the other of the Calcutta High Court, have close resemblance to the facts of this case and we may now consider them. In Ratilal B. Daftari v. Commissioner of Income-tax the assessee who was one of the sixteen partners in a registered partnership had contributed Rs. 25,000 out of the capital of partnership, Rs. 3,45,000. In order to contribute this capital or Rs. 25,000 he had entered into an agreement with four others on the same date on which the registered partnership deed was executed, which provided for contribution of diverse sums by the four others and it was further provided in this agreement that the five parties would share the profits and losses in proportion to their individual contribution. It was also mentioned that the terms and con "A sub-partnership is, as it were, a partnership within a partnership; it pre-supposes the extends of a partnership to which it is itself subordinate. An agreement to share profits only constitutes a partnership between the parties to the agreement. If, therefore, several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the strange a partner in the original firm. The result of such an agreement is to constitute what is called a sub-partnership, that is to say, it make the patties to it partners inter se; but it in no way affects the other members of the principal firm." He further states : "Since the decision of the House of Lords in Cox v. Hickman a sub partner could not before the Partnership Act, 1890, be held liable to the creditors of the principle firm by reason only of his participation in the profits thereof, and there is no the in that Act to alter the law in this respect." Sub-partnership have been recognised in India and registration accorded to them under the Indian Income-tax Act (see Commissioner of Income-tax v. Laxmi trading Company). The question then arises whether the interest of the sub-partnership in the profits received from the main partnership is of such a nature diverts the income from the original partner to the sub- partnership. Suppose that A is carrying on a business as a sole proprietor and he takes another person B as a partner. There is no doubt that the income derived by A after the date of the partnership cannot be treated as his income; it must be treated as the income of the partnership consisting go A and B. What difference does it make in principle where A is not carrying on a business as a sole proprietor but as one of the partners in a fir ? There is no doubt that there is this difference that the partners of the sub-partnership do not become partners of the original partnership. This is because the law of partnership does not permit a partner, unless there is an agreement to the contrary, to bring strangers into the firm as partners. But as far as the partner himself is concerned, after the deed of agreement of sub The decision of this court in Charandas Haridas v. Commissioner of Income-tax seems to support, at lease by inference, this conclusion. In that case the facts were as follows : Charandas Haridas was the karta of a Hindu undivided family consisting of his wife, his three minor sons and himself. He was a partner in six managing agency firms and the share of the managing agency commission received by him as such partner was being assessed as the income of the family. By a memorandum executed by the coparceners of the family a partial partition of the income from the managing agency was brought about. The memorandum stated : "We have decided that... in respect of the commission which accrues from 1st January, 1946, and, received after that date each of us become absolute owner of his one-fifth share and, therefore, from that date... these commissions cease to be the join property of our family." This court held that the document effectively divided the income and the income could no longer be treated as that of the Hindu undivided family This case shows that although the karta continued top be a partner in the managing agency firms, yet the character in which he received the come vis-a-vis the Hindu undivided family had changed and the court gave effect to the change of his position. Previously he was acting as a karta on behalf of the Hindu undivided family in the managing agency firms; later he became a partner on half of the member of the family. It seems to us that when a sub- partnership is entered into, the partner changes his character vis-a-vis the sub-partners and the income-tax authorities, although other parties in the original partnership are not affected by the changes that may have taken place. In our view the Calcutta High Court decision relied on by the High Court and the learned counsel for the respondent (Mahaliram Santhalia v. Commissioner of Income-tax) was wrongly decided. The facts in that case where these : Mahaliram Santhalia was a partner in the firm, M/s. Benares Steel Rolling Mills. He was also a partner in another firm named M/s. Radhakissen Santhalia. By agreement dated April 3, 1944, between the partners of M/s. Radhakissen Santhalia, it was provided that the partnership income from M/s. Benares Steel Rolling mills would belling not to Mahaliram Santhalia individually but top the firm of M/s. Radhakissen Santhalia. The High Court of Calcutta held that the agreement amounted only to voluntary disposition by Mahaliram Santhalia of his income and there was no diversion of income to the firm M/s. Radhakissen Santhalia, before it became Mahaliram Santhalia income. The High Court observed at page 272 : "If, as Mr. Mitra conceded, Mahaliram was rightly taken as a partner of the Benares Steel rolling Mills in his personal capacity and if a one fourth share of the income was rightly allocated to him, any agreement between him and his three partners of the firm of Radhakissen Santhalia, under which the income was to be treated as the income of the whole firm, could only be an agreement by which Mahaliram Santhalia was allowing what was really his income to be treated as the income of the firm or, in other words, an agreement by which he was applying or districting an income which he had already himself earned and received. Such application or distribution would be a voluntary act of Mahaliram Santhalia in respect of a sum which, it was conceded, had rightly been included in his own total income and, therefore, was his income and liable as such to be included in his own total income and therefore, was his was income. If the moment the share of the income from the Benares Steel Rolling Mills was allocated to Mah With respect we are unable to agree with moist of this reasoning. In our view, in the case of a sub- partnership the sub-partnership creates a superior title and diverts the income before it becomes the income of the partner. In other words, the partners in the maintain firm receives the income not only on his behalf but on behalf of the partners in the sub-partnership. The Calcutta High Court also seems to be, in our opinion erroneously impressed by the argument that "it is impossible top see how, after a proportionate share of the income had this need include in the total income of a partner for the purpose of his personal assessment, it could then go anywhere else or could be further divided between such partners and other parties." We will deal with this aspect while dealing with the second point raised by the learned counsel for the revenue. Mr. Hajarnavis, in this connection, drew our attention to the following passage in K. A. Ramachar v. Commissioner of Income-tax : "This, in our opinion, is neither in accordance with the law of partnership nor with the facts as we have found on the record. Under the law of partnership, it is the partner and the partner along who is entitled to the profits. A stranger, even if he were an assignee, has and can have no direct claim to the profits. By the deeds in question, the assessee merely allowed a payment to his wife and daughters to constitute a valid discharge in favour of the firm; but what was paid was, in law, a portion of his profits or in other words, his income." This passage was also relied on by High Court. In our opinion these observation have to be read in the context of the facts found in that case. In that case it was neither urged nor found that a sub- partnership came into existence between the assessee who was a partner in a firm and his wife, married daughter and minor daughter. It was a pure case of assignment of profits (and not losses) by the partner during the period of eight years. Further the fact that a sub-partner can have no direct claim to the profits vis-a-vis the other partners of the firm and that it is the partner alone who is entitled to profits vis-a-vis the other partners does not show that the changed character of the partner should not be taken into consideration for income-tax purposes. This court held in Commissioner of Income-tax v. A. Abdul Rahim & Co. that registration of the firm could not be refused on the ground that a partner was a benamidar and that a benamidar is a mere trustee of the real owner and he has no beneficial interest In conclusion we hold that the High Court was in error in holding that there was no question of an overriding obligation in this case and that the income remained the income of Murlidhar Himatsingka in spite of the sub-partnership created by him under the agreement dated December 21, 1949. The second contention raised by Mr. Hajarnavis was not debated in the High Court, but in our opinion, there is no substance in this contention. We have already mentioned that a benamidar can be partner in a firm. Now if Mr. Hajarnavis's contention is right, under section 23(5) (a) of the Act it is only he who could be assessed, but there is no warrant for this proposition. In Commissioner of Income-tax v. Kalu Babu Lal Chand this court mentioned with approval Kaniram Hazarimull v. Commissioner of Income-tax where income from a partnership received by a karta was held to be assessable in the hands of the Hindu undivided family. This court observed at page 128 as follows : "If for the purpose of contribution of his share of the capital in the firm the karta brought in movies out of the till of the Hindu undivided family, then he must be regarded as having entered into the partnership for the benefit of the Hindu undivided family and as between him and the other members of his family he would be accountable for all profits received by him as his share out of the partnership profits and such profits would be assessable as income in the hands of the Hindu undivided family. Reference may be made to the cases of Kaniram Hazarimull v. Commissioner of Income-tax and Dhanwatay v. Commissioner of Income-tax in support of this view." The object of section 23(5) (a) is not to assess the firm itself but to apportion the income among the various partners. After the income has been apportioned, the Income-tax Officer has to find whether it is the partner who is assessable or whether the income should be taken to be the real income of some other person. If it is the real income of another firm, it is that firm which is liable to be assessed under section 23(5) (a) of the Act. This view was taken by the Bombay High Court in Ratilal B. Daftari v. Commissioner of Income- tax. The Bombay High Court observed at page 24 as follows : "The principle asserted in that case is that even in the case of a partner in a registered firm, when the question arises as to his individual assessment, what is to be considered is not the income allocated to his share by employing the machinery of section 23(5) (a), but his real income, and that real income is what remains after deducting the amounts which may beside to have been diverted and never constituted his real income and such amount will have to be excluded before his real income is reached." In conclusion we hold that there is nothing in section 23(5) (a) that prevents the income from the firm, Basantlal Ghanshyamdas, being treated as the income of M/s. Fatehchand Murlidhar and section 23(5) (a) being applied again. In the result we accept the appeals, set aside the judgment of the High Court and answer the questions in the negative. The appellants will be entitled to costs here and in the High Court. One hearing fee. Appeals allowed.