il Appeal Nos
1108 to 1110 of 1964
Appeals by special leave from the judgment and order dated August 1 1962 of the Calcutta High Court in Income tax Reference Nos 20 and 21 of 1959
AK Sen section C Mazumdar and J Datta Gupta for the appellants
RM Hazarnavis R Ganapathy Iyer and R N Sachthey for the respondent
The Judgment of the Court was delivered by 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 661 of the Indian Income tax Act XI of 1922 hereinafter called the Act
One of the references Income Tax Reference No 20 of 1959 was made at the instance of Ms 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 Basantlal Ghanshyamdas for the assessment years 1952 53 and 1953 54 was rightly excluded from the income of the applicant firm
In the latter reference the question referred was whether on the facts and circumstances of the case the income of Murlidhar Himatsingha for his share in the firm of Messrs Basantlal Ghanshyamdas for the assessment year 1955 56 was rightly included in his personal assessment for that year
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 Ms Basantlal Ghanshyamdas in which he was a partner should be included in his personal assessment or in the assessment of the firm of Fatehchand Murlidhar to which Murlidhar Himatsingka had purported to assign the profits and losses from Ms 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
Murli dhar Himatsingka was carrying on business in shellac jute hessian etc
under the name and style of Fatehchand Murlidhar at 14 1 Clive Row and 71 Burtolla Street Calcutta
He was also a partner in the registered firm Messrs Basantlal Ghanshyamdas having 28 share
On December 21 1949 a deed of partnership was executed by the said Murlidhar Himatsingka and his two sons Madanlal Himatsingka and Radhaballav Himatsingka and a grandson named Mahabir Prasad Himatsingka
The deed recited that Murlidhar Himatsingka had become too old and infirm 455 to look after the various businesses and that Madanlal and Radha Ballav were already practically managing the business and that they had signified their intention to become the partners of the said firm Fatehchand Murlidhar and had agreed to contribute capital Rupees ten thousand Rupees five thousand and Rupees five thousand respectively
The parties further agreed to become and be partners in the business mentioned in the deed
Clause 5 of this deed is important for our purpose and reads as follows The profits and losses for the share of the said Murlidhar Himatsingka as partner in the said partnership firm of Basantlal Ghanshyamdas shall belong to the present 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 and between the parties in the following manner Party hereto of the First Part Six annas Murlidhar Himatsingka
Party hereto of the Second Part Four annas Madanlal Himatsingka
Party hereto of the Third Part Three annas Radhaballav Himatsingka
Party hereto of the Fourth Part Three annas Mahabirprasad Himatsingka
Clause 11 provides that all partnership moneys 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 of 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 outgoings interest on capital or loans and subject to the creation and maintenance of any reserve or 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 456 Basantlal Ghanshyamdas in the individual assessment of Murlidhar Himatsingka Murlidhar Himatsingka appealed to the Appellate Assistant Commissioner
Referring to section 235a of the Act
he held that as Murlidhar Himatsingka was a partner 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 they 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 Ms Fatehchand Murlidhar
The Appellate Tribunal agreeing with the views of the Appellate Assistant Commissioner dismissed the appeal
The High Court held that it was a case of diversion of in come 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 Ms Fatehchand Murlidhar having obtained special leave the appeals are now before us
The learned counsel for the appellants Mr A K Sen con tends that a partner s 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 stranger 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 partner 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 Income Tax Act taxes real income and not notional income and the real income in this case belonged not to Murlidhar but to Ms Fatehchand Murlidhar
Mr Hazarnavis on the other hand contends that this agree ment is a mere device for dividing income which had accrued to Murlidhar Himatsingka among his sons and grandson
In the alternative he contends that the Indian Income Tax Act does not contemplate the application of section 235a twice
He says that the firm of Basantlal Ghanshyamdas was a registered firm and the 457 Income Tax Officer was bound
under section 235a to assess Murlidhar in respect of the income received from this firm  he could not carry this income to the assessment of another registered firm namely Fatehchand Murlidhar and then apply section 235a
The first point that arises is whether the agreement dated December 21 1949 has succeeded in diverting the income from Murlidhu s share in Ms Basantlal Ghanshyamdas to Ms Fatehchand Murlidhar before it reached Murlidhar
What is the effect of the agreement In our opinion the agreement dated December 21 1949 constituted a sub partnership in respect of Murlidhar s share in Ms Basantlal Ghanshyamdas
The High Court in this connection observed At best it could be called a sub partnership entered into by Murlidhar with strangers 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 shared and the right to receive profits and pay losses became an asset of the firm Fatehchand Murlidhar
In Commissioner of lncome tax Bombay vs Sitaldas Tirath
das1 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 kind of payment which can truly be excused and not the second
The second payment is merely an obligation to pay another a portion of one s own income which has been received and is since applied
The first is a case in which the income never reaches the assessee who even if he were to collect it does so not as part of his income but for and on behalf of the person to whom it is payable 
458 This test clearly shows that it is not every obligation to apply income in a particular way that results in the diversion of income before it reaches the assessee
In its judgment in the above case Sitaldas Tirathdas vs Commissioner of Income tax Bombay1 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 observations 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 vs Commissioner of Income tax Madras1 and Provat Kumar Mitter vs Commissioner of Income tax West Bengal1 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 Daftri vs Commissioner of Income tax Bombay1 the assessee who was one of the sixteen partners in a registered partnership had contributed Rs 25000 out of the capital of the partnership Rs 345000 
In order to contribute this capital of Rs 25000 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 conditions mentioned in the registered partnership were to be applicable and binding on them
The Bombay High Court held that the assessee was liable to be assessed only in respect of his share of the profits of the registered partnership
In coming to this conclusion the High Court relied on two other decisions of the same Court namely Motilal Manekchand vs Commissioner of Income tax1 and Sitaldas Tirathdas vs Commissioner of Income tax1 As pointed out by the learned counsel for the respondent Mr Hazarnavis Sitaldas Tirathdas vs Commissioner of Income tax1 was reversed by this Court in Commissioner of Income tax vs Sitaldas Tirathdas4 Hidayatullah J at p 374 of his judgment reversing the judgment of the Bombay High Court had also referred to Motilal Manekchand vs Commissioner of Income tax 5 but did not expressly dissent from this case
In our opinion the case of Ratilal B Daftari vs Commis sioner of Income tax Bombay1 was rightly decided although the reasoning given by the learned Judges of the High Court has to some extent not been accepted by Hidayatullah J in Commissioner of Income tax vs Sitaldas Tirathdas3
We say so far the follow
1 394
2 3  4 36 ITB Is
5 6 459 ing reasons
Lindley on Partnership 12th Edition page 99 deals with sub partnerships as follows A sub partnership is as it were a partnership within a partnership it presupposes the existence 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 stranger 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 makes the parties 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 vs Hickman   a sub partner could not before the Partnership Act 1890 be held liable to the creditors of the principal firm by reason only of his participation in the profits thereof and there is nothing in that Act to alter the law in this respect
Sub partnerships have been recognised in India and registration accorded to them under the Indian Income Tax Act
See Commissioner of Income tax Punjab vs Laxmi Trading Company1 The question then arises is whether the interest of the sub partnership in the profits received from the main partnernship is of such a nature as 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 of 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 firm 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 subpartnership he cannot treat the income as his own
Prior to the case of Cox vs Hickman1 sub partners were even liable to the creditors of the original partnership
Be that as it may and whether he is treated as an assignee within section 29 of the Indian Partnership Act as some cases do a sub partner has definite enforceable rights to claim a share in the profits accrued to or received by the partner
124 ITB 173
2  460 The decision of this Court in Charandas Haridas vs Commissioner of Income tax 1 seems to support at least 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 co parceners of the family a partial portion 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 becomes absolute owner of his one fifth share and therefore from that date these commissions cease to be the joint 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 to be a partner in the managing agency firm yet the character in which he received the income 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 firm  later he became a partner on behalf of the members 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 partners in the original partner
ship 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 vs Commissioner of Income tax1 was wrongly decided
The facts in that case were these
Mahal  Santhalia was a partner in the firm Ms Benares Steel Rolling Nills
He was also a partner in another firm named Ms Radhakissen Santhalia
By agreement dated April 3 1944 between the partners of Ms Radhakissen Santhalia it was provided that the partnership income from Ms Benares Steel Rolling Mills would belong not to Mahaliram Santhalia individually but to the firm of Ms 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 Ms Radhakissen Santhalia before it became 1  2 33 IT 261
461 Mahaliram Santhalia s income
The High Court observed at p 272 If
as Mr Mitra conceded Mahaliram was rightly taken as a partner of the Benares Steel Rolling Mills in personal capacity and if a one fourth share of the income was rightly allocated to him any agreement bet ween 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 as agreement by which he was applying or distributing 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 own income
If the moment the share of the income from the Benares Steel Rolling Miffs was allocated to Mahaliram Santhalia it became his income and liable to be included in his own total income for the purpose of his personal assessment an agreement by him with other persons regarding the rights to that income could only be a voluntary disposition of his income by him
No question of a diversion by superior tide could possibly arise
 With respect we are unable to agree with most 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 partner in the main 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 to see how after a proportionate share of the income had thus been included in the total income of a partner for the purposes 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 Hazarnavis in this connection drew our attention to the following passage in K A Ramachar vs Commissioner of Income tax Madras1 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 alone who is entitled to 142 ITB 25 29
462 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 the High Court
In our opinion these observations 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 Gujarat vs Abdul Rahim1 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 the profits of the business of the real owner
Under the law of partnership it is the benamidar who would be entitled to receive the profits from the other partners but for income tax purposes it does not mean that it is the benamidar who alone can be assessed in respect of the income received by him
In conclusion we hold that the High Court was in error in holding that there was no question of an overriding ogligation 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 Hazarnavis 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 a partner in a firm
Now if Mr Hazarnavis s contention is right under section 255a of the Act it is only he who could be assessed but there is no warrant for this proposition
In Commissioner of Income tax West Bengal vs Kalu Babu Lal Chand2 this Court mentioned with approval Kaniram Hazarimull vs Commissioner of Income tax1 where income from a partnership received by a karta was held to be assessable in the hands of Hindu Undivided famlly
This Court observed at p 12 as follows If for the purpose of contribution of his share of the capital in the firm the karta brought in monies out 1 2 3 463 of the till of the Hindu undivided family then he must be regarded as having entered into the partnernship 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 b y 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 vs Commissioner of Income tax1 and Dhanwatav vs Commissioner of Income tax1 in support of this view
The object of section 235a 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 235a of the Act
This view was taken by the Bombay High Court in Ratilal B Daftri vs Commissioner of Income tax1
The Bombay High Court observed at p 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 235a but his real income and that real income is what remains after deducting the amounts which may be said to have been diverted and never constituted his real income and such amounts will have to be excluded before his real income is reached
In conclusion we hold that there is nothing in section 235a that prevents the income from the firm Basantlal Ghanshyamdas being treated as the income of Ms Fatehchand Murlidhar and section 235 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
127 ITR 294
2 336 ITR 18


Summary:
The assessee was a partner in a registered firm
In 1949 he entered into a partnership with persons who were strangers to the registered firm and a deed of partnership was executed between them
It recited that the profits and losses for the share of the assessee in the registered firm should belong to the new firm and be divided and borne by the partners of the new firm in accordance with the shares specified in the deed
On the question whether the income of the assessee from the registered firm for the years 1952 53 1953 54 and 1955 56 should be included in his individual assessment HELD The income should be included in the assessment of the new firm and not in the personal assessment of the assessee iThe new partnership constituted a sub partnership in respect of the assessee s share in the registered firm
In the case of a subpartnership it creates a superior title and diverts the income before it becomes the income of the partner that is the partner in the main firm receives the income not only on his own behalf but on behalf of the partners in the sub partnership
The fact that a sub partner can have no direct claim to the profits vis a vis the other partners of the main firm and that it is the partner alone who is entitled to the profits vis a vis the other partners in the main firm does not show that the changed character of the partner should not be taken into consideration for income tax purposes
461E F 462C iiThe object of section 235a 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 the section
There is nothing in the section that prevents the income of the assessee from the registered firm being treated as the income of the sub partnership and the section being applied again
463C F Charandas Haridas vs Commissioner of Income Tax   and Commissioner of Income Tax Bombay vs Sitaldas Tirathdas  followed
Commissioner of Income Tax Punjab vs Laxmi Trading Co and Ratilal B Daftari vs Commissioner of Income Tax  Bombay  referred to
Mahaliram Santhalia vs Commissioner of Income Tax 33 ITR 261 overruled