J.H Gotla v. The Commissioner Of Income Tax .

The asessee, an individual, was carrying on business in the purchase and sale of groundnut oil and also running an oil mill. He was also an abkari contractor. On 1st June, 1957, he gifted away a part of the oil mill machinery, viz., what is called a solvent extraction plant, to his wife and three minor children and a firm was constituted by the assessee's wife and another person to the profits of which the three minor sons of the assessee were also admitted. The mill premises as well as the remaining machinery of the assessee were leased out to this firm which carried on the business of the manufacture and sale of groundnut oil. The assessee also entered into agreements with this firm under which, for certain services rendered to the firm by way of management, the assessee was entitled to get commission at the stipulated rates on the purchases of oil cake and sale of deoiled cake made by the firm. The assessee him self continued to carry on business in the purchase and sale of groundnut cake and oil on a small scale. The assessee also continued his business as abkari contractor. The share income of the assessee's wife and his minor children from this firm was included in the assessee's assessment for the year under reference viz., 1959–1960, under Section 16(3) of the Act. The assessee had incurred business losses in the earlier years which were being carried forward from year to year upto the assessment year 1958–1959. The assessee claimed a set off of these losses against the share income of his wife and his minor children which were included in his assessment under Section 16(3). While the Income Tax Officer negatived the assessee's claim, the Appellate Assistant Commissioner, on appeal, allowed it on the ground that although the assessee himself was not carrying on the business of manufacture and sale of ground nut oil during the year under appeal, he must be deemed to be carrying on the said business in as much as that business was being carried on by the firm in which his wife was a partner and his minor children were admitted to the benefits of the partnership and the share income of his wife and minor children was included in the assessee's income under Section 16(3).

The Department, being aggrieved by the order of the Appellate Assistant Commissioner, preferred appeal against the assessment year in question to the Tribunal.

On behalf of the Department, the order of the Appellate Assistant Commissioner was assailed, firstly, on the ground that the business of manufacture of oil and the business of sale of oil were different businesses and, secondly, on the ground that under Section 24(2) of the Income Tax Act, 1922, the set off of a loss could only be against the profits and gains of a business, profession or vocation carried on by the assessee. On behalf of the assessee, the reply was that the assessee himself was carrying on the business of the purchase and sale of groundnut cake and oil as well as running the oil mill upto the date of gift, namely, 1st June, 1957. Thereafter, he leased out the remaining machinery along with the mill premises to the firm. It was stated that although the assessee thereaffter did not himself run the oil mill, but he continued to carry on the business of the purchase and sale of cake and oil during the relevant accounting years. It was, therefore, submitted that the business in which the assessee sustained the loss confined to be carried on by him even for the year in question. It was further submitted, as had been submitted before the Appellate Assistant Commissioner also, that the assessee must be deemed to be carrying on the business against whose income the set-off of loss was claimed, in as much as that business was being carried on by the firm in which his wife was a partner and his minor children were admitted to the benefits of the partnership and their share of income was held by the Department as an income of the assessee, althrough under Section 16(3) of the Income Tax Act, 1922.

The Tribunal did not accept the first contention raised by the Department and held that it was too much of a fine distinction to say that the business of manufacture of oil and the business of sale of oil were different businesses. The Tribunal, for the reasons given in para 4 of its order, held that although the assessee was not carrying on the business of manufacture and sale of oil during the year under appeal, he was continuing to carry on the business in oil in general and consequently the loss originally sustained by the assessee was in a business which continued to be carried on by him during the year in question. The Tribunal, however, accepted the second contention raised on behalf of the Department, namely, that the set off could not be claimed against the profits or gains of a business with which the assessee had no concern. Dealing with this point, the Tribunal observed that in order to claim the benefit of set off under Section 24(2) of the Income Tax Act, 1922, two conditions had to be satisfied; (i) that the business, profession or vocation in which the loss was originally sustained continued to be carried on by him in that year and (ii) that the business, profession or vocation against the profits and gains of which the set off was claimed was carried on by him. So far as the first condition was concerned, the Tribunal held in favour of the assessee, of which mention has already been made above. With regard to the second contention, the Tribunal observed that the assessee sought to satisfy this condition on the basis of a legal fiction. The argument of the assessee in this respect had two limbs (i) that there was indentity of the business hitherto carried on by the assessee in his individual capacity and the business carried on by the firm of which the assessee's wife was a partner and to the benefits of which his minor children had been admitted and (ii) that in as much as the share income of the assessee's wife and minor children had been included in the assessee's total income under Section 16(3) of the Income Tax Act, 1922, such income must be deemed to have been earned by the assessee himself or, in other words, the assessee must be deemed to carry on the business which was actually carried on by Commissioner his wife and minor children. The Tribunal held that there could be no doubt that the firm did carry on the same business as was hitherto carried on by the assessee, but, apart from this similarity, there was no connection between the assessee and the business carried on by the firm. They were two distinct and separate entities. The fact that the business against the profits of which the set off was claimed was of the same nature as the business in which the assessee incurred, the loss was, therefore, wholly immaterial. In the opinion of the Tribunal, section 24(2) did not require that the nature of the business should be the same. Rather, it required that whatever be the business, it must be carried on by the assessee and it is only against the profits and gains of such business that the loss could be set off. The Tribunal accordingly held that the assessee's claim to set off his loss was not admissible inasmuch as the business against the profits of which the set off was claimed, was not carried on by him.

Dealing with the other question as to whether, by reason of fact that the share income of the assessee's wife and minor children was included in his total income, the income could be said to have arisen out of a business carried on by the assessee, the Tribunal's attention was drawn by the assessee to the language of Section 10(1) and Section 16(3) of the Act with a view to support the proposition that the income, though included in the assessee's income under Section 16(3) of the Act, by reason of Section 10(1), it would still remain an income from business, profession or vocation carried on by the assessee. The Tribunal repeled that argument observing that it did not justify the inference that the assessee himself must be deemed to be carrying on the business the income from which was including in his assessment under Section 16(3) of the Act. Section 16(3) according to the Tribunal, created a fiction by which income arising to someone else was deemed to be the income of the assessee. That it was a deeming provision was supported by the Tribunal, relying upon the decision in the case of Dayalbhai Madhavji Vadera v. Commissioner Of Income-Tax, Gujarat, (1966) 60 I.T.R 551. The Tribunal accordingly held that the income which was includible in the assessee's total income under section 16(3) was not deemed to be the assessee's income not could the assessee be said to be carrying on the business out of which such income arose. The assessee's claim to set off his losses against the income arising to his wife and children and added to his income by virtue of section 16(3) of the Act was accordingly held to be inadmissible. The order passed by the Appellate Tax Assistant Commissioner was, therefore, reversed.

The question of law that arises out of the order of the Tribunal is:

“Whether on the facts and circumstances of the case, the assessee would be entitled to the carry forward and set eff the losses against the share income of the assessee's wife and minor children in respect of the assessment year 1959–1960 under Section 24(2) of the Income Tax Act, 1922?”

The Judgment of the Court was delivered by

Govinda Bhat, J.:— These are three references made at the instance of the Assessee by the Income Tax Appellate Tribunal, Bangalore Bench, under Section 66(1) of the Indian Income Tax Act, 1922, hereinafter called ‘the Act’. They relate to the assessment years 1959–1960, 1960–1961 and 1961–1962. The question of law referred in I.T.R.C No. 33 of 1970 is:

“Whether on the facts and circumstances of the case, the assessee would be entitled to the carry forward and set off of the losses against the share income of the assessee's wife and minor children in respect of the assessment year 1959–1960 under Section 24(2) of the Income Tax Act, 1922?”

Similar question has been referred in respect of the assessment years 1960–1961 and 1961–1962 in I.T.R.C Nos. 34/1970 and 35 of 1970 respectively.

2. The assessee is an Individual who was carrying on the business of manufacture and sale of groundnut oil and cake. He was also an abkari contractor. On 1st June, 1957 he gifted away a part of the oil mill machinery to his wife and three minor sons and a firm was constituted by the assessee's wife and another person to the profits of which the minor sons were admitted. The mill premises as well as the remaining machinery of the Assessee were leased to the said firm and the firm carried on the business of manufacture and sale of groundnut oil. The Assessee also entered into agreements with the said firm under which for certain services rendered to the firm by way of management, the Assessee was entitled to get commission at the stipulated rates on the purchase and sale of oil and cake made by the firm. The Assessee himself containued to carry on the business in the purchase and sale of groundnut oil and cake on a small scale. He also continued his business as abkari contractor.

3. The Assessee had incurred huge losses in his individual business in the earlier years which were being carried forward from year to year upto the assessment year 1958–1959. The loss carried forward from the assessment year 1958–1959 was Rs. 7,88,734. The Assessee's profits from his own business for 1959–1960 was Rs. 14,324. The share income of the Assessee's wife and minor children from the firm for the assessment year 1959–1960 was Rs. 24,592. The said income was included in the computation of the total income of the Assessee under Section 16(3) of the Act for the assessment year 1959–1960. The Assessee claimed set off of the loss carried forward from the assessment year 1958–1959 against the profits of his own business as also the share income of his wife and minor children. The Income Tax Officer rejected the claim for set off in so far as it related to the share income of his wife and minor children. Similar claims for set off were made in the assessment years 1960–1961 and 1961–1962 but were rejected.

4. On the appeals preferred by the Assessee, the Appellate Assistant Commissioner allowed the set off claimed on the ground that the Assessee himself is deemed to be carrying on the business from which the share income was derived by his wife and minor children. The Department appealed to the Income Tax Appellate Tribunal, Hyderabad Bench. The Tribunal held that although the Assessee was not carrying on the business of manufacture and sale of oil during the years under appeal, he was continuing to carry on the business of oil in general; that the firm did carry on the same business as was hitherto carried on by the Assessee but there was no connection between the Assessee and the business carried on by the firm and they were two different entities and as such the Assessee cannot be said to be carrying on the business out of which the share income of the wife and minor children arises. Accordingly it held that the Assessee is not entitled under Section 24(2) of the Act to claim set off of his losses against the income of his wife and minor children.

5. The claim for carry forward and set off of loss is made under Section 24(2)(ii) of the Act which reads thus:

“24(2):

Where any assessee sustains a loss or profits or gains in any year, being a previous year not earlier than the previous year for the assessment Tax for the year ending on the 31st day of March 1940, in any business, profession or vocation, and the loss cannot be wholly set off under sub-section (I), so much of the loss as is not so set off or the whole loss where the assessee had no other head of income shall be carried forward to the following year, and

(i) ………………

(ii) Where the loss was sustained by him in any other business, profession or vocation it shall be set off against the profits and gains, if any, of any business, profession or vocation carried on by him in that year: provided that the business, profession or vocation in which the loss was originally sustained continued to be carried on by him in that year;”

In order to entitle the Assessee to carry forward the loss to the following year and claim set off, the following conditions have to be fulfilled:

(1) The loss must be in a business;

(2) the business, profession or vocation in which the loss was originally sustained must be continued to be carried on by the assessee in the year in which the carried forward loss is sought to be set off; and

(3) the business, profession or vocation against the profits of which set off is claimed must be carried on by the assessee in that year.”

That the loss is from business is not disputed and therefore the first condition is satisfied. That the business in which the loss was originally sustained was continued to be carried on by the Assessee in the years in which the carried forward loss is sought to be set off has been found in favour of the Assessee by the Tribunal. The only ground on which the Tribunal denied the right to set off was that the Assessee cannot be said to be carrying on the business out of which the share income of his wife and minor children was derived.

6. The argument of Sri K. Srinivasan, learned counsel for the Assessee was that the share income of the assessee's wife and minor children included in the assessee's income under Section 16(3) of the Act was brought to charge under the head ‘business income’ under Section 10 which section provides that the tax shall payable by the assessee under the head ‘profits and gains of business, profession or vocation’ in respect of the profits or gains of any business, profession or vocation carried on by him. Therefore, when the charge to tax of the income of the assessee's wife and minor children is on the basis that the business from which the income is derived is carried on by the assessee, the said fiction cannot be limited for the purpose of charging to tax, but has to be given its full play for all purposes including the benefit under Section 24(2) of the Act.

7. Sri Rajashekhara Murthy learned counsel for the Department however contended that the share income of the Assessee's wife and minor children included in the Assessee's income under Section 16(3) was not brought to charge under Section 10 under the head of ‘Business income’ but under the head ‘other sources’ and that income against which set off is claimed not being income from business, the right to set off cannot be claimed. Sri Rajasekhara Murthy relied on the assessment order made by Income Tax Officer wherein the share income of the Assessee's wife and minor children has been shown under the head ‘other sources’.

8. Sri K. Srinivasan learned counsel for the Assessee submitted that the argument of Sri Rajasekhara Murthy cannot be accepted as the Appellate Assistant Commissioner had in the first instance remanded the matters in appeal holding that the share income in the hands of the Assessee under Section 16(3) is ‘business income’ and that finding has not been challenged by the Department before the Tribunal and the Tribunal has proceeded throughout on the basis that the share income brought to charge in the hands of the assessee under Section 16(3) is ‘business income’.

9. If the share income of the Assessee's wife and minor children has been brought to charge in the hands of the assessee not under Section 10 but under Section 12 under the head ‘other sources’, then, it is clear that the benefit of Section 24(2) cannot be claimed by the Assessee. But it has to be pointed out that no such contention was urged by the Department before the Tribunal. The Appellate Assistant Commissioner in Paragraph 9(iii) of his order has stated thus:

‘The question now is whether this benefit is denied to the appellant because of the fact that in the firm, the partner is not the assessee, but his wife and that the appellant's minor children are admitted to the benefits. Now I find that the issue had been decided in favour of the appellant by my predecessor thus ‘so the share income from Jai Hind Fertiliser Co., assessed in the hands of the appellant under Section 16(3) is business income eligible for set off against brought forward loss subject to the provisions of Section 24(2)’. Apart from this, I find that the ratio of 1958 (34 I.T.R 553) and 1962 (44 I.T.R S.C 1) is that the character of income does not change by reason of the fact that such income is included in an assessment under Section 16(3) of the Act. As such, I will hold that the appellant is entitled to claim the benefit of the set off of oil mill losses against the business income assessed for each of the three years.”

In the Memorandum of Appeal before the Tribunal, no ground was taken by the Department that the above finding of the Appellate Assistant Commissioner is erroneous. Sri Rajasekhara Murthy submitted that we should call for a fresh finding from the Tribunal on the question whether the share income of the assessee's wife and minor children included in the assessee's assessment under Section 16(3) should be regarded as income from business or income other sources’. We are unable to accede to the request of the learned counsel for the Revenue since no such ground was taken before the Tribunal and the finding of the Appellate Assistant Commissioner was accepted and the Tribunal proceeded on the basis that the said income was ‘business income’. It is necessary to note that the Tribunal has agreed with the view of the Appellate Assistant Commissioner and has held that ‘the income which is includible under Section 16(3) partakes of the same nature as the income which is actually derived by the Assessee's wife, minor children, etc.’.

10. The precise question for decision is whether the business from which the share income of the assessee's wife and minor children was derived can be regarded as business carried on by the assessee in the relevant years. There is no direct authority of any court and therefore we have to decide this case on first principles.

11. The decision of the Supreme Court in Commissioner of Income Tax v. Marimuthu Nadar(1) and the decision of this court in Dr. T.P Kapadia… v. Commissioner Of Income Tax….(2) are of some assistance in deciding the question. In Nadar's case, the question was whether the assessee was entitled to regard the income of his minor sons included in his income under Section 16(3) as the assessee's earned income. Minor sons were admitted to the benefits of partnership in a firm of which the assessee was a partner. It was held by the Madras High Court in S.A.S. Marimuthu Nadar, Vridhunagar v. Commissioner Of Income Tax, Madras(3) that such income should be regarded as the assessee's earned income. That view was affirmed by the Supreme Court and it was held that earned income relief should be granted to the assessee not only on the basis of his shares in the profits of the business but also on the minor's shares in the profits of the firm which were included in his total income. In Dr. Kapadia's case, the assessee was a partner in a registered firm in which his wife was also a partner. The income of the wife including the losses were included in the assessee's total income during the assessment years 1961–1962, 1962–1963 and 1963–1964 and the assessments were completed. After the assessments were completed, the Income Tax Officer became aware of the decision of the Gujarath High Court, in Dayalbhai Madhavji Vadera v. Commissioner Of Income-Tax, Gujarat(4) in which it was held that where the share of the wife or minor child in a firm in which the assessee is a partner is a loss, such loss cannot be allowed in computing the total income of the assessee. Thereupon, the Income Tax Officer reopened the assessments under Section 147(b) of the 1961 Act and withdrew the benefit of the loss sustained by the assessee's wife which had been taken into account while computing the total income of the assessee. The Tribunal affirmed the order of the Income Tax Officer. On reference to this Court, it was held disagreeing with the view of the Gujarath High Court in Vadero's case that the share of loss of the wife in the registered firm in which the assessee was also a partner can be set off against the income of the Assessee while computing his total income. It was held that it is possible to take the view that the loss incurred by a spouse should be treated as if it were a loss sustained by the assessee. The ratio of the decision in Nadar's case as well as Kapadia's case is that the income or the loss included under Section 16(3) in the total income of the assessee has to be treated as income or loss sustained by the assessee. The object of Section 16(3) of the Act was to foil an individual's attempt to avoid or reduce incidence of income tax by transferring his assets to his wife or minor child or admitting his wife as a partner or admitting his minor child to the benefits of partnership in a firm in which such individual is a partner. In such a case, the income of the wife or minor children is regarded as the income of the assessee. The transfer is ignored and the natural family consisting of the assessee, his wife and minor children are regarded as one unit for purpose of assessment. The character of the income also does not change by reason of the fact that such income is included in the total income of the assessee under Section 16(3) of the Act.

12. Section 3 which is the charging section charges income tax on the total income of the previous year of every individual, Hindu Undivided Family etc. Section 4 states that the total income of any previous year of any person includes all income, profits and gains from whatever source derived which are received or are deemed to be received in the taxable territories in such year by or on behalf of such person. The various heads of income which are charged to tax are enumerated in Sections 6 to 12. Income from business, profession or Vocation falls under Section 10. Tax is payable by an assessee under the head ‘profits and gains of business, profession or vocation’ in respect of profits or gains of any business, profession or vocation carried on by him. The business income included-in the total income of the assessee under Section 16(3) has to be treated as business income of the assessee under Section 10. Such income is taxable only on the basis that the business is carried on by the assessee. By legal fiction the business income of his wife or minor children included in the assessee's total income under Section 16(3) is regarded as the business income of the assessee arising from the business carried on by the assessee.

13. The Tribunal has dealth with this question in paragraph 6 of its order which reads thus:

“It is said that the share income of the assessee's wife and minor children was included in his total income under Section 16(8) and, therefore, by a legal fiction he must be deemed to have earned that income or, in other words, carried on the business out of which the said income arose. Support for this contention is sought to be found from the language of section 10(1) and of Section 16(3). No doubt, under Section 10(1), the income which is assessed under the head ‘Business’ is, strictly speaking, the income of business, profession or vocation carried on by the assessee. The income which is included under Section 16(3) also, no doubt, is assessed under the same head. There is no separate head of income as income under Section 16(3). The income which is includible under Section 16(3) partakes of the same nature as the income which is actually derived by the assessee's wife minor children, etc. But this by itself, in our view, does not justify the inference that the assessee himself must be deemed to be carrying on the business the income from which is sought to be included in his assessment under Section 10(3). Section 16 makes a distinction between the income of other persons which is deemed to be the income of the assessee and income which is merely included in the total income of the assessee. The distinction has been educated in Dayalbhai Madhavji Vadera v. Commissioner Of Income-Tax, Gujarat, (1966) 60 I.T.R 551. We respectfully produce the relevant observations of their Lordship;

‘The scheme of clause (a) in sub-section (3) thus is not to set off loss arsing under any one of the sub-clauses against income arising from the other or the rest of the sub-clauses. Such a thing perhaps might have been possible if instead of providing for the inclusion of income of a wife or and minor child in the total income of an assessee, such income had, by a legal fiction been made the income or the share of the assessee himself. That, however, has not been done in this sub-section though such, a deeming fiction is to be found in section 16(1)(c). While enacting therefore, sub-section (3), the legislature had before it such a deeming fiction in section 16(1)(c). Yet the legislature did not follow that method, but followed a different method as set out in sub-section (3).’

“It would, therefore, appear that the income which is includible in the assessee's total income under Section 16(3) is not deemed to be the assessee's income nor can the assessee be said to be carrying on the business out of which such income arises.”

The above view of the Tribunal was based on the decision of the Gujarath High Court Vadera's case which has been dissented by this Court in Dr. Kapadia's case.

14. On a consideration of the scheme of the Act and the provisions therein referred to earlier, we are of the opinion that the share income of the assessee's wife and minor children included in the assessee's total income under Section 16(3) of the Act should be regarded as business income derived from business carried on by the assessee and in that view the assessee is entitled to set off of his loss carried forward from the previous years. Accordingly, we answer the question referred in each of the case in the affirmative and in favour of the assessee. The assessee is entitled to his costs of these references. Advocate's fee Rs. 250 One set.