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PETITIONER: COMMISSIONER OF INCOME TAX, CALCUTTA

       Vs.

RESPONDENT: PRAHALADRAI AGARWALA

DATE OF JUDGMENT26/04/1989

BENCH: PATHAK, R.S. (CJ) BENCH: PATHAK, R.S. (CJ) KANIA, M.H.

CITATION:  1990 AIR  270            1989 SCR  (2) 737  1989 SCC  Supl.  (2) 279 JT 1989  Supl.    139

ACT:     Income  Tax Act, 1961: Section 64(1)(iii)--Wife  partner in  firm alongwith husband--Capital contributed by wife  out of  amount gifted by the husband--Share of profit of  asses- see’s  wife--Whether includible in total income of the  hus- band--There must be proximate connection between the accrual of income and assets transferred.

HEADNOTE:     The  respondent-assessee  was one of the partners  In  a firm in which the five other partners were his wife, mother, grand-father, brother, and a stranger. His wife had contrib- uted Rs.51,000 as capital in the firm, which amount came out of  two gifts made to her by the assessee. in the course  of assessment  proceedings for the assessment year  1962-63  in respect of the assessee, the Income Tax Officer included the profits  of  the  assessee’s wife from the  firm,  under  s. 64(1)(iii)  of  the  Income Tax  Act,  1961.  The.assessee’s appeal was dismissed by the Appellate Assistant Commissioner who  observed that the wife would not have become a  partner of  the  firm unless he had contributed  capital  which  was provided  by  the  husband. The  Appellate  Tribunal,  while dismissing the second appeal of the assessee, found that the admission  of the assessee’s wife as a partner in  the  firm was solely on account of her contribution of capital to  the firm.  It was conceded by the assessee before  the  Tribunal that  the  interest received by the assessee’s wife  on  her capital contribution to the firm was includible in the total income of the assessee.     The High Court, while answering the question referred to it in favour of the assessee, took the view that the  income arose  from  the  share of profits only  because  the  other partners  agreed to take the assessee’s wife as partner  and she  was allowed to contribute to the partnership firm,  and that the admission of the assessee’s wife to the partnership was not in consequence of the gift. Dismissing the Revenue’s appeal, it was     HELD:  (1) The income may arise directly or  indirectly, but for application of the provisions of section  64(1)(iii) of the Income Tax Act, 738 1961 there must be a proximate connection between the accru-

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al of the income and the assets transferred by the assessee. [741D]     Commissioner of Income-tax, West Bengal 111 v. Prem Bhai Parekh, [1970] 77 ITR 27 followed.     (2)  The  mere contribution of the capital by  the  wife into  the firm would not automatically have entitled her  to partnership in the firm. The partnership was based on agree- ment, and it is the event of agreement between the  partners that  brought the assessee’s wife into the firm as  partner. [742E]     Commissioner  of  Income-tax, Bangalore v.  J.H.  Gotla, [1985]  156  ITR  323; Commissioner  of  Income-tax,  Assam, Tripura and Manipur v. Jwalaprasad Agarwala,  [1967] 66  ITR 154;  V.D. Dhanwatey v. Commissioner of  Income-tax,  Madhya Pradesh, Nagpur and Bhandara, [1968] 68 ITR 365; Smt. Mohini Thapar  v. Commissioner of Income-tax  (Central),  Calcutta, [1972] 83 ITR 208; Potti Veerayya Sresty v. Commissioner  of Income-tax, A.P., [1972] 85 ITR I94 distinguished.

JUDGMENT:      CIVIL APPELLATE JURISDICTION: Civil Appeal No. 575 (NT) of 1975.     From  the Judgment and Order dated the 24.4.1973 of  the Calcutta High Court in Income Tax Reference No. 202 of 1969. B. Ahuja and Ms. A. Subhashini for the Appellant.     K.P. Bhatnagar, S.P. Mittal and B.P. Maheshwari for  the Respondent.     The Judgment of the Court was delivered by     PATHAK,  CJ.  This appeal by special leave  is  directed against the judgment of the High Court at Calcutta answering the following question in favour of the assessee and against the Revenue:               "Whether,  on  the facts and  in  the  circum-               stances  of the case, the share of  profit  of               the  assessee’s  wife was  includable  in  the               total  income  of the assessee  under  section               64(1)(iii) of the Income Tax Act, 1961?" 739     The assessee was assessed in the status of an individual for the assessement year 1962-63 corresponding to the previ- ous  year 26 March, 1961 to 13 April, 1962. At the  material time the assessee was a partner in a firm, Messrs Ramesh and Co.,  with a share of eight annas therein. The  balance  was shared  by  three  other partners,  the  assessee’s  father, Kunjilal Agarwala, the assessee’s brother, Hariram  Agarwala and a stranger, Jagdish Prasad. On 10 November, 1960 and  on 28  November, 1960 the assessee made two gifts of  Rs.21,000 and Rs.30,000 respectively to his wife, Kaushalya Devi, from his account in the firm. On 28 November, 1960 he made anoth- er  gift  of Rs. 11,000 to his mother Chili  Bai  from  that account. It may be observed that Chili Bai received  another gift  of Rs.20,000 from her husband, Kunjilal,  effected  by similarly drawing from his account with the firm.     The  assessee’s  wife, Kaushalya Devi, as  well  as  his mother Chili Bai became partners with three other persons in a newly constituted firm, Messrs Kunjilal Hariram & Co.  The three  other  partners  were the  assessee’s  grand  father, Moharilal Agarwala, the assessee’s brother, Hariram Agarwala and  the stranger, Jagdish Prasad Gup. ta.  The  Partnership Deed dated 10 November, 1960 provided that the business  was to commence from 12 November, 1960. The preamble to the deed stated:               "Whereas the partner of the Fifth Part who has

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             extensive experience and outstanding talent of               organisation  in Jagree and Grains  Trade  but               little  finance requested the partners of  the               First four Parts to enter into  co-partnership               with him on contributing the necessary finance               to carry on business in Jagree and Grains  and               also act as Commission Agents in Jagree Grains               and  allied commodities to which request  they               acceded."               Clause 4 of the Partnership Deed stipulated:               "That  the  partners of the First  Four  Parts               shall  initially contribute Rs.25,000 each  to               be put in within six months from the commence-               ment  of the partnership. The  said  contribu-               tions augmented by further deposits and  prof-               its  or  depleted by  withdrawals  and  tosses               shall  carry  interest at the rate of  6%  per               annum.  The  amount if any,  standing  to  the               credit of the partner of the Fifth Part  shall               carry interest at the same rate." 740     On   12  November,  1960  Kaushalya   Devi   contributed Rs.21,000 as capital, which came out of the gift made by the assessee   on  10  November,  1960.  She  also   contributed Rs.30,000 as capital, which amount came out of the gift made on 28 November, 1960.     In the course of assessment proceedings for the  assess- ment year 1962-63 in respect of the assessee the Income  Tax Officer included the profits of the assessee’s wife from the firm, Messrs. Kunjilal Hariram & Co., under s. 64(1)(iii) of the Income Tax Act, 1961.     An appeal by the assessee was dismissed by the Appellate Assistant Commissioner of Income Tax, who observed that  the wife would not have become a partner of the firm unless  she had contributed capital, and as the capital was provided  by the  husband the inclusion of the wife’s share of income  in the assessment of the assessee was justified.     In second appeal, it was conceded by the assessee before the Income Tax Appellate Tribunal that the interest received by  the assessee’s wife on her capital contribution  to  the firm was includible in the total income of the assessee, but it was contended that the balance of the share of profit was not so includable as the assessee’s wife had become a  part- ner in the firm in her own right, and it was immaterial that the  capital invested by her had been provided as a gift  by the  assessee. The Appellate Tribunal found that the  admis- sion  of  the  assessee’s wife as partner in  the  firm  was solely  on  account of her contribution of  capital  to  the firm,  that the assets in the form of cash were  transferred directly  by  the assessee to his wife  otherwise  than  for adequate consideration, and that the income must be said  to have  arisen  indirectly from the  assets  transferred.  The second appeal was dismissed. At the instance of the assessee the  question of law set forth earlier was referred  to  the High Court at Calcutta for its opinion.     The  High  Court has taken the view that  the  share  of profits  arose to the assessee’s wife primarily because  the partnership  made  a profit and although it  had  connection with the gift it did not arise as a result of the gift, that the income arose from the share of profits only because  the other partners agreed to take the assessee’s wife as partner and was allowed to contribute to the partnership firm,  that the admission of the assessee’s wife to the partnership  was not  in consequence of the gift, and that,  therefore,  upon all  those circumstances, the connection between the  income

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of the share of profits and the gifts by the assessee to his wife was too remote to be included within the provisions  of s. 64(1)(iii) of the Income Tax Act. 741     S.64(1)(iii) of the Income Tax Act, 1961, as it stood at the relevant time, provides:               "64(1)  In computing the total income  of  any               individual,  there shall be included all  such               income as arises directly or indirectly--               (i) xx      xx      xx               (ii) xx      xx      xx                     (iii)  subject to the provisions of  cl.               (i) of s. 27, to the spouse of such individual               from assets transferred directly or indirectly               to  the  spouse by such  individual  otherwise               than for adequate consideration or in  connec-               tion with an agreement to live apart." The income may arise directly or indirectly, but there  must be a proximate connection between the accrual of the  income and the assets transferred by the assessee. In  Commissioner of  Income-tax,  West  Bengal 111 v. Prem  Bhai  Parekh  and Others, [1970] 77 ITR 27 this Court held that the income  of minor  sons,  who had invested capital in the  firm  out  of moneys  gifted to them by their father (the assessee)  could not be included in the assessment of the assessee. The Court observed:               "Before  any  income of a minor child  can  be               brought  within the scope of section  16(3)(a)               (iv),  it  must be established that  the  said               income  arose  directly  or  indirectly   from               assets  transferred directly or indirectly  by               his  father.  There  is no  dispute  that  the               assessee had transferred to each of his  minor               sons, a sum of Rs.75,000. It may also be  that               the  amount  contributed by  those  minors  as               their  share  in  the  firm  came  from  those               amounts. But the question still remains wheth-               er  it can be said that the income with  which               we are concerned in this case arises  directly               or  indirectly from the assets transferred  by               the  assessee to those minors. The  connection               between  the gifts mentioned earlier  and  the               income in question is a remote one. The income               of  the  minors  arose as a  result  of  their               admission to the benefits of the  partnership.               It is true that they were admitted to the               742               benefits  of  the partnership because  of  the               contribution  made  by them. But there  is  no               nexus  between the transfer of the assets  and               the income in question. It cannot be said that               income  arose directly or indirectly from  the               transferor  the  assets referred  to  earlier.               Section 16(3) of the Act created an artificial               income.  That  section  must  receive   strict               construction  as  observed by  this  court  in               Commissioner  of Income-tax v. Keshavlal  Lal-               lubhai Patel, [1965] 55 ITR 637 (S.C.). In our               judgment before an income can be held to  come               within the ambit of section 16(3), it must  be               proved    to    have    arisen-directly     or               indirectly--from a transfer of assets made  by               the  assessee in favour of his wife  or  minor               children. The connection between the  transfer               of  assets and the income must  be  proximate.

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             The income in question must arise as a  result               of  the transfer and not in some  manner  con-               nected with it." It  seems to us that the observations of this Court in  that case fully cover the case before us. There is no doubt  that the wife became a partner because of the capital contributed by  her in the firm, but, as observed by the High Court,  in the  judgment  under appeal, it was upon  agreement  by  the remaining partners that she became a member of the  partner- ship. The mere contribution of the capital by the wife  into the firm would not automatically have entitled her to  part- nership in the firm. The partnership was based on agreement, and  it is the event of agreement between the partners  that brought  the  assessee’s  wife into  the  firm  as  partner. Learned  counsel for the Revenue relies on  Commissioner  of Income-tax,  Bangalore  v. J.H. Gotla, [1985] 156  ITR  323; Commissioner  of  Income-tax, Assam Tripurn and  Manipur  v. Jwalaprasad  Agarwala, [1967] 66 ITR 154; V.D. Dhanwatey  v. Commissioner  of  Income-tax,  Madhya  Pradesh,  Nagpur  and Bhandara,  [1968] 68 ITR 365 and Smt. Mohini Thapar v.  Com- missioner  of’ Income-tax (Central), Calcutta,  and  Others, [1972] 83 ITR 208 but we are not satisfied that those  cases are  of  assistance to the Revenue. Reliance was  placed  on Potti  Veerayya Sresty v. Commissioner of Income-Tax,  A.P., [1972] 85 ITR 194 where the Andhra Pradesh High Court upheld the  inclusion  of  the wife’s income  from  cloth  business carried on by her, into which cloth business she had invest- ed  a portion of the assets transferred by the assessee.  It is sufficient to observe that the cloth business was her own business  and, as the High Court pointed out, there  was  no necessity  to depend upon the agreement of others. It is  on that  basis  that  the High Court  distinguished  Prem  Bhai Parekh’s case (supra). 743     We  are  of  the view that the High Court  is  right  in answering. the . question referred to it in the negative, in favour of the assessee and against the Revenue.       In  the result the appeal fails and is dismissed  with costs. R.S.S.                                    Appeal dismissed. 744