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AMICUS AI
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Sujata Manohar
  • Dhanuka, JJ.
Acts
  • provisions of section 16(3)(a)(iii) of the Indian Income-tax Act, 1922.
  • provisions of section 16(3) of the Indian Income-tax Act, 1922.
  • section 256(2) of the Income-tax Act, 1961. Income-tax
  • section 64(2)(b) of the Income-tax Act, 1961.
  • section 256(2) of the Income-tax Act, 1961,
  • section 256(1) of the Income-tax Act,
  • section 256(2) of the Income-tax Act
  • family.4. Section 64(2)
  • section 16(3)(a)(iii).
  • section 16(3)(a)(iv)
  • section 64(2)(b).6.
  • Section 64(2)(b)
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Cites
Cited by
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Sujata Manohar
  • Dhanuka, JJ.
Acts
  • provisions of section 16(3)(a)(iii) of the Indian Income-tax Act, 1922.
  • provisions of section 16(3) of the Indian Income-tax Act, 1922.
  • section 256(2) of the Income-tax Act, 1961. Income-tax
  • section 64(2)(b) of the Income-tax Act, 1961.
  • section 256(2) of the Income-tax Act, 1961,
  • section 256(1) of the Income-tax Act,
  • section 256(2) of the Income-tax Act
  • family.4. Section 64(2)
  • section 16(3)(a)(iii).
  • section 16(3)(a)(iv)
  • section 64(2)(b).6.
  • Section 64(2)(b)
See more information ...
Smart Summary

Structured Summary of the Opinion — Sujata Manohar, J.

Factual and Procedural Background

The opinion concerns several matters arising from income-tax assessments for multiple assessment years. Income-tax Reference No. 62 of 1987 relates to the assessment years 1972-73, 1973-74, 1975-76 to 1977-78 and 1979-80. Income-tax Reference No. 733 of 1987 relates to the assessment year 1978-79. Income-tax Application No. 144 of 1990 relates to assessment year 1981-82 and is filed under section 256(2) of the Income-tax Act, 1961; it was heard along with the references.

The assessee, an individual, had originally been a partner in two firms (Variety Plywood and Quality Plywood, Bombay) in his individual capacity. On 20 August 1970 he impressed Rs. 30,000 of his separate self-acquired funds with the character of Hindu undivided family (HUF) property. He retired as a partner effective 1 October 1970 and, on the same day, re-entered the partnerships as karta of his HUF, contributing Rs. 15,000 to each firm out of the Rs. 30,000 as the HUF's capital share.

The Department maintained that the assessee's share of profits from the two firms should be taxed as his individual income under Section 64(2)(b) of the Income-tax Act, 1961. The Tribunal held that Section 64(2)(b) was not attracted and that the HUF's share of the firms' profits was not includible in the assessee's income. The Tribunal referred the question (set out in the opinion) to the High Court under section 256(1) in the referenced matters. For assessment year 1980-81 the Tribunal declined to refer any question; consequently the application under section 256(2) (Apln No. 144/1990) was heard along with the references.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the share of profits earned by the Hindu undivided family in the firms (Variety Plywood and Quality Plywood) is not assessable in the hands of the individual assessee in view of the provisions of section 64(2) read with section 64(1) of the Income-tax Act, 1961.
  2. Whether the income in the form of share of profits of the firms can be considered as "income derived from the converted property" within the meaning of Section 64(2)(b) (as applicable for the relevant assessment years).

Arguments of the Parties

Department's Contentions

  • The Department consistently contended in the income-tax proceedings that the assessee's share of profits from the two firms should be taxed as his individual income under Section 64(2)(b) of the Income-tax Act, 1961.

Argument Urged by Mr. Upponi

  • Mr. Upponi urged that the position of a HUF in a partnership should be treated differently because a HUF cannot personally exert itself in the business; its right to a share in the profits is derived only because of the capital contributed by it, thus implying a closer nexus between capital contribution (converted property) and profits.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
CIT v. Prem Bhai Parekh, [1970] 77 ITR 27 (Supreme Court) Interpreted phrase "income as arising directly or indirectly" (under section 16(3) of the Indian Income-tax Act, 1922) and held that where the connection between transferred assets and income is remote, the income does not arise directly or indirectly from the transferred assets. The court applied the ratio to Section 64(2)(b): because the connection between capital contribution (converted property) and share of partnership profits is remote (profits arise from partnership business, not directly from the capital), the profits cannot be said to be derived from the converted property.
Bhaichand Jivraj Muchhala v. CIT, [1976] 102 ITR 385 (Bombay High Court) Held that where a wife contributed gifted money as capital to a partnership, only interest on such capital (if any) would be includible in the husband's income under the then provision; the wife's share of profits could not be included because there was no nexus between transfer and profits. The court relied on this decision to support the conclusion that a share of partnership profits does not have the required nexus with the transferred/converted assets to be treated as income derived from those assets under Section 64(2)(b).
CIT v. Cochin Refineries Ltd., [1982] 135 ITR 278 (Kerala High Court) Interpreted the phrase "derived from" in section 80J (analogous principle): "derived from" does not have an overly wide meaning so as to include any income that can in some manner be attributed to the business; there must be a direct connection between the business and the income. The court invoked this decision by analogy to stress that "derived from" requires a direct connection between the converted property and the income; partnership profits lack such a direct connection with the capital contribution.

Court's Reasoning and Analysis

The court first accepted the factual finding that the capital contributed by the assessee as karta of the HUF to both firms constituted "converted property" under Section 64(2) (i.e., separate property converted into family property by impressing the character of family property).

The pivotal legal question was whether the HUF's share of profits from the firms can be treated as "income derived from the converted property" within the meaning of Section 64(2)(b). The court performed a textual and precedent-based analysis:

  1. The court compared the language of Section 64(2)(b) ("the income derived from the converted property") with the language considered by earlier decisions (for example, "income as arising directly or indirectly" in section 16(3) of the 1922 Act). It concluded that both formulations require a sufficient nexus between the transferred/converted asset and the income claimed to have arisen from it.
  2. Relying on the Supreme Court decision in CIT v. Prem Bhai Parekh, the court noted that where the connection between the transfer/contribution and the income is remote — e.g., income arising because an assignee/minor is admitted to partnership benefits rather than arising directly from the transferred capital — the income is not regarded as arising from the transferred assets. The court found that rationale directly applicable to Section 64(2)(b).
  3. The court cited the High Court's decision in Bhaichand Jivraj Muchhala v. CIT which similarly held that a share of partnership profits lacked the requisite connection to the transferred capital and that only interest (if any) on capital might be attributable; the High Court relied on the Supreme Court's reasoning and the present court adopted the same analysis.
  4. By analogy to CIT v. Cochin Refineries Ltd., the court emphasised that "derived from" must be given a limited meaning requiring a direct connection; a broad construction that treats any income attributable in some manner as "derived from" would be impermissible.
  5. The court further observed that Section 64(2)(b) contains a deeming provision and therefore requires strict construction; such a provision should not be extended to capture income (partnership profits) that arise from business operations rather than directly from the capital contributed.
  6. The court rejected the argument (urged by Mr. Upponi) that a HUF's position in partnership justifies special treatment because the HUF cannot personally carry on business — reasoning that the karta is a partner like any other and that contribution of capital does not guarantee profits (the partnership might make losses). Thus, no special nexus arises for a HUF that would differ from the principles established in the cited precedents.

Holding and Implications

Holding: The court answered the referred question in the affirmative and in favour of the assessee. In concrete terms, the court held that the share of profits of the firms earned by the HUF is not assessable in the hands of the individual assessee under Section 64(2)(b) of the Income-tax Act, 1961.

Core Ruling: The Tribunal was right in law in holding that the HUF's share of partnership profits is not includible in the individual assessee's income under Section 64(2)(b).

Direct consequences and orders:

  • Income-tax References Nos. 62 of 1987 and 733 of 1987 were answered in the assessee's favour as above.
  • Because of this decision, the court declined to order the reference under section 256(2) (Application No. 144 of 1990 for assessment year 1981-82) to be made to the Tribunal as doing so would be academic. Income-tax Application No. 144 of 1990 was dismissed and the rule discharged.
  • No order as to costs was made.

Broader implications: The opinion applies and affirms existing precedent requiring a direct nexus between transferred/converted property and any income said to be derived from it; it does not purport to establish a new broader principle beyond the application of those precedents. The decision's effect is to confirm that partnership profits, being profits of business operations rather than income arising directly from capital contribution, are not to be treated as income derived from converted property under Section 64(2)(b) in the circumstances described.

Show full summary ...

    Commissioner Of Income-Tax v. Khimji Nenshi.

    Sujata Manohar, J.:— The present Application No. 144 of 1990, relates to the assessment year 1981-82. It is under section 256(2) of the Income-tax Act, 1961. Income-tax Reference No. 62 of 1987 relates to the assessment years 1972-73, 1973-74, 1975-76 to 1977-78 and 1979-80. Income-tax Reference No. 733 of 1987 relates to the assessment year 1978-79. The relevant facts are as follows:

    The assessee who is an individual was originally a partner in the firms styled as Variety Plywood and Quality Plywood, Bombay, in his individual capacity. On August 20, 1970, out of his separate and self-acquired funds, he impressed a sum of Rs. 30,000 with the character of his Hindu undivided family property. He retired from the two partnership firms with effect from October 1, 1970. On the same day, he entered into these partnerships again in his capacity as the karta of his Hindu undivided family. He contributed a sum of Rs. 15,000 in each of these partnerships out of the aforesaid sum of Rs. 30,000, as his share, on behalf of the Hindu undivided family, in the capital of the two firms.

    2. It has been throughout contended by the Department in the income-tax proceedings pertaining to the assessee that the income, in the form of the share of profits derived by the assessee from these two firms, should be taxed as his individual income under Section 64(2)(b) of the Income-tax Act, 1961. The Tribunal has, however, held that Section 64(2)(b) is not attracted in the present case. It has, therefore, held that the share of income of the Hindu undivided family in the form of profits derived from the businesses of these two firms is not includible in the computation of the assessee's income. For the assessment years 1972-73, 1973-74, 1975-76, 1976-77, 1977-78 and 1979-80 (I.T Reference No. 62 of 1987), the Tribunal has referred the following question to us under section 256(1) of the Income-tax Act, 1961:

    “Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the share of profits in the firms of Messrs. Variety Plywood, Bombay, and Messrs. Quality Plywood, Bombay, earned in the capacity of the Hindu undivided family of Shri Khimji Nenshi is not assessable in the hands of Shri Khimji Nenshi as individual in view of the provisions of section 64(2) read with section 64(1) of the Income-tax Act, 1961?”

    3. The same question has been referred to us under section 256(1) of the Income-tax Act for the assessment year 1978-79 in I.T Reference No. 733 of 1987. For the assessment year 1980-81, the Tribunal has declined to refer any question. Hence, Income-tax Application No. 144 of 1990 is filed under section 256(2) of the Income-tax Act which is being heard along with these references. Section 64(2), as it was applicable for the assessment years up to 1975-76, was as follows:

    “Section 64(2). Where, in the case of an individual being a member of a Hindu undivided family, any property having been the separate property of the individual has, at any time… been converted by the individual into property belonging to the family through the act of impressing such separate property with the character of property belonging to the family… then… for the purpose of computation of the total income of the individual…—

    (b) the income derived from the converted property or any part thereof, in so far as it is attributable to the interest of the individual in the property of the family, shall be deemed to arise to the individual and not to the family.”

    4. Section 64(2) was amended with effect from April 1, 1976, by deleting, inter alia, the words “in so far as it is attributable to the interest of the individual in the property of the family” from Section 64(2)(b). For the assessment years 1977-78 and subsequent assessment years, therefore, the amended Section 64(2)(b) was in force.

    5. On the facts as found there is no dispute that the capital contributed by the assessee to both the firms in his capacity as the karta of the Hindu undivided family is converted property as per section 64(2) above. The only question that arises for consideration is whether the income which the Hindu undivided family has derived by way of a share of the profits from both these firms can be considered as income derived from the converted property under Section 64(2)(b).

    6. In the case of CIT v. Prem Bhai Parekh, [1970] 77 ITR 27, the Supreme Court was required to consider the provisions of section 16(3) of the Indian Income-tax Act, 1922. In that case, the assessee who was a partner in the firm retired from the firm. Thereafter, he gifted Rs. 75,000 to each of his four sons three of whom were minors. The firm was, thereafter, reconstituted whereby the major son became a partner while the minor sons were admitted to the benefits of partnership. The amounts gifted by the assessee were given to the firm as capital contribution on behalf of the sons. 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. The Supreme Court said that the connection between the gifts made by the assessee and the income of the minors from the firm was a remote one and the income arising to the three minor sons could not be considered as income arising directly or indirectly from the transfer of assets by the assessee to the minors. The operative words of section 16(3)(a)(iv) were “income as arising directly or indirectly”. Section 64(2)(b) uses the words “the income derived from the converted property”. The Supreme Court in the above case said that the connection between the income derived and the transferred assets was remote. The income arose on account of the minors being admitted to the benefits of partnership. Undoubtedly, they were admitted to the benefits of partnership because of the capital contribution made by them. But, there was no nexus between the transfer of assets to them and the income in question. Hence, the income did not arise directly or indirectly from the transferred assets. For the same reasons, therefore, the income also cannot be said to be derived from the assets so transferred under Section 64(2)(b) of the Income-tax Act, 1961. The ratio of the above Supreme Court case is, therefore, directly applicable.

    7. In the case of Bhaichand Jivraj Muchhala v. CIT, [1976] 102 ITR 385, our High Court was required to consider the provisions of section 16(3)(a)(iii) of the Indian Income-tax Act, 1922. In the case before our High Court, the assessee gifted some money to his wife. She gave this money as her capital contribution in a partnership firm in which she was taken as a partner. The court said that only the interest paid by the partnership firm on the capital so contributed would be includible in her husband's income under section 16(3)(a)(iii). But her share of profits from the firm cannot be so included in her husband's income. Our High Court relied upon the Supreme Court decision in the case of CIT v. Prem Bhai Parekh, [1970] 77 ITR 27 above and held that there was no nexus between the transfer of assets and the income derived by way of a share in the profits of the partnership.

    8. The same reasoning applies to the language used in Section 64(2)(b) of the Income-tax Act, 1961 also. In order that the income can be considered as being derived from the converted property, there should be a nexus between the converted property and the income which is so derived. When such income has no direct or indirect nexus with the converted property, it cannot be said to be derived from the converted property.

    9. Our attention was also drawn to a decision of the Kerala High Court in CIT v. Cochin Refineries Ltd., [1982] 135 ITR 278, where the court said that the words “derived from” in section 80J cannot have a wide import so as to include any income which can in some manner be attributed to the business. There must be some direct connection between the business and the income generated. Similarly, in the present case, there must be a nexus between the converted property and the income received. In our view, the profits earned in business do not have such a direct connection with the capital of the partnership.

    10. Moreover, Section 64(2)(b) contains a deeming provision and hence requires to be construed strictly. An income which is derived from the profits of the firm and not from the capital contributed as such cannot be considered as income derived from the converted property.

    11. It was urged by Mr. Upponi that the position of a Hindu undivided family in a partnership must be considered differently because a Hindu undivided family cannot exert itself personally in the business of the partnership. Its right to a share in the profits is derived only because of the capital contributed by it. This reasoning is fallacious. The karta of a Hindu undivided family is a partner in the partnership firm like any other partner and may be required to discharge his obligations as a partner. Moreover, the mere fact that some amount is contributed by the Hindu undivided family as capital in a partnership firm does not necessarily result in profits being earned by the Hindu undivided family because the partnership may still make a loss. There can, therefore, be no special case carved out for a Hindu undivided family which earns a share in the profits of a partnership which would exclude it from the reasoning of the Supreme Court as well as our High Court in the cases cited above.

    12. In the premises, the question which is referred to us in Income-tax References Nos. 62 of 1987 and 733 of 1987 is answered in the affirmative and in favour of the assessee.

    13. In view of our decision above, no purpose can now be served by referring the same question to the Tribunal for the purpose of it being referred to us under section 256(2) of the Income-tax Act, 1961, for the assessment year 1981-82 as the exercise would be academic. The Income-tax Application No. 144 of 1990 is, therefore, dismissed and the rule is discharged.

    14. No order as to costs.

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    Comments

    Commissioner Of Income-Tax v. Khimji Nenshi.
    (Aug 9, 1990)