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1978 DIGILAW 202 (KER)

Varma Varma v. Commr Of Income-Tax Kerala

1978-08-08

S.K.KADER, V.P.GOPALAN NAMBIYAR

body1978
JUDGMENT Gopalan Nambiyar, C.J. 1. The assessee is a firm of Chartered Accountants. The partnership is evidenced by document dated 17th August 1970 which took effect from 1st September 1970 Shri C. P. Parameshwara Rao one of the partners was entitled to 11 per cent share in the profits. He died on 1st November 1971. We are concerned with the accounting year which ended after his death on 31st August 1972. Clause 18 of the partnership deed provided as follows:- "If any partner dies during the time he continues as a partner of the Firm, his widow, if he is survived by his wife or if he is not survived by his wife, then his children if any, or if any partner become permanently disabled during the time he continues as a partner of the Firm and does not elect to continue to associate with the firm as provided in Clause 15 above, then such partner or his wife or children, as the case may be, shall be entitled to receive from the firm an amount by way of gratuity, calculated at the rate of 10 per cent for every year or broken period thereof, which he would have to run to reach the age of 65, of the average annual share of income of the partner concerned based on the actual total income of the Firm for the 3 completed years immediately preceding the year in which the death or disability referred to above occur. This benefit is over and above what is provided in Clause 15(c) above: Provided however, that such amount of gratuity shall not exceed in any case Rs. 50,000 or shall not, in any case, be less than Rs. 25,000. Such gratuity shall be paid to the parties concerned in four equal half yearly instalments, the first instalment starting from a date not later than 6 months after the date of death or occurrence of disability, as the case may. The above sum of gratuity paid shall be an outgoing from the firm's income in the year in which such payments are made" After the death of Shri Parameshwara Rao there was a fresh partnership deed. We need not pause to notice the same. There were entries in the books of account on 1st November 1971 to show that the current accounts of the partners were debited with Rs. We need not pause to notice the same. There were entries in the books of account on 1st November 1971 to show that the current accounts of the partners were debited with Rs. 50,000 as the amount payable to Mrs. Parameshwara Rao, the payments being shown to have been made in four equal instalments commencing from 26th May 1972. The first instalment alone fell within the accounting period. The profit and loss account did not show any deduction of the amount paid to Mrs. Parameshwara Rao. But in the adjustment accounts which accompanied the Income Tax Return, the payment was claimed as a deduction in arriving at the income of the firm for the assessment year 1973-74. The Income Tax Officer did not accept the claim or allow the deduction. He took the view that the expenditure could not be regarded as having been incurred "wholly and exclusively for the purpose of the business or profession ," but was expenditure of a personal nature incurred on account of the contractual relationship of the partners. On appeal by the assessee, the Appellate Assistant Commissioner held that the deduction was allowable. According to him, on the death of a partner, his widow has got a right to get the gratuity and thus it became a liability of the firm. He was of the view that the liability had to be treated as an expenditure incurred by the firm, but for the special provision mentioned in S.40(b). He viewed the provision in clause 18 as an inducement to the partners to remain with the firm. As the firm and the partners were two distinct entities, he was of the opinion that payment to the widow was a business expenditure deductible under S.37 of the Act. On appeal by the Revenue, the Income Tax Appellate Tribunal held that the expenditure was not an allowable deduction under S.37 of the Income Tax Act, 1961. On the construction of the partnership deed, and clause 18 in particular, the Tribunal was of the view that payment of the amount in dispute was only an application of the income after it had accrued to the assessee and not an incurring of expenditure for the purpose of business or profession. On this ground, it allowed the appeal by the Revenue and disallowed the expenditure sought to be deducted. On this ground, it allowed the appeal by the Revenue and disallowed the expenditure sought to be deducted. It has referred the following question of law for our determination: "Whether, on the facts and circumstances of the case, the Income Tax Appellate Tribunal was right in fact and in law in holding that a sum of Rs. 50,000 paid or payable in terms of the contractual obligation under partnership agreement to the widow of a partner who died prematurely while serving the firm as a partner, was not an admissible deduction for the purpose of computing the taxable income of the firm under the Income Tax Act, 1961?'' The Tribunal did not accept the contention that the claim for deduction would be hit by S.40(b) of the Act as being a payment to oneself. That aspect of the matter does not arise for consideration. 2. The question for our consideration is whether the expenditure in question was incurred wholly and exclusively for the purpose of the business under S.37 of the Act; or whether the income having already accrued to the assessee, there was only a diversion of the said income for making the payment. In the former case, the amount would be deductible and in the latter not. An interesting account of the development of the doctrine of application of the income can be seen in the judgment in Devarajulu Chetty's case 18 ITR 357. Briefly stated, the source of the doctrine has been traced to the Pondicherri Railway Company's case ILR 1931 (54) Mad. 691 at 705 and the well known observation of Lord Macmillan therein that: "A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point and the revenue authority is not concerned with the subsequent application of the profits". These observations were differently interpreted and the wide nature of the observation was recognised by Lord Macmillan himself in the House of Lords in the Union Cold Storage 'Co. 's case 16 Tax Cases 293 at 331. In that case, in the Court of Appeal, Romer, L.J., held that . These observations were differently interpreted and the wide nature of the observation was recognised by Lord Macmillan himself in the House of Lords in the Union Cold Storage 'Co. 's case 16 Tax Cases 293 at 331. In that case, in the Court of Appeal, Romer, L.J., held that . where a Company, to enable it to carry on its trade, placed itself under an obligation to make money payments, the amount of which was dependent upon the profits earned, the payments being made in discharge of that obligation, were held to be admissible deductions in computing the profits of the Company. It was this decision of the Court of Appeal that was confirmed by the House of Lords. Lord Macmillan, referring to the earlier observations in the Pondicherri Railway Company' s case ILR 1931 (54) Mad. 691 at 705 stressed that they related to a case in which the obligation was first of all to ascertain the profits in a prescribed manner, after providing for all outlays incurred in earning them, and then to divide them. The question in the Union Cold Storage Co.' s case 16 Tax Cases 293 at 331 was whether the deduction for rent had to be made in ascertaining the profit and the question was not one of distribution of profits at all. In a latter case -- Tata Hydro Electric Agencies Limited v. Commissioner of Income Tax ILR 1937 Bom. 388 = 5 ITR 202, Lord Macmillan himself, who delivered the judgment of the Judicial Committee, allowed the claim for deduction of a percentage of the profits earned, as the payment in question was made in consideration of services by way of financial assistance. The Pondicherri Railway Company's case ILR 54 Mad. 691 was distinguished. The position was further explained by Lord Maugham in the Indian Radio and Cable Communications Ltd. v. Commissioner of Income Tax ILR 1937 Bom. 591. The Pondicherri Railway Company's case ILR 54 Mad. 691 was explained again at some length by Greene, M. R., in the British Sugar Manufacturers Ltd. v. Harris 1938 (2) KB 220. The evolution of this aspect of the law was stressed by counsel for the assessee with particular reference to the pronouncement of the Madras High Court in Devarajulu Chetty's case 18 ITR 357. 691 was explained again at some length by Greene, M. R., in the British Sugar Manufacturers Ltd. v. Harris 1938 (2) KB 220. The evolution of this aspect of the law was stressed by counsel for the assessee with particular reference to the pronouncement of the Madras High Court in Devarajulu Chetty's case 18 ITR 357. But in view of the decisions of the Supreme Court, to which our attention was called by counsel for the Revenue, and in particular, of the terms of the partnership deed, (especially, of the clause with which we are concerned), we think it unnecessary to pursue this line of enquiry or investigation. Counsel for the assessee cited the decision in Calcutta Landing and Shipping Co., Ltd. v. Commissioner of Income Tax, West Bengal 65 ITR 1 to show that payment to a partner's wife is a deductible item of claim. The decision laid down, with respect to S.10(2)(xv) of the Income Tax Act, 1922, (similarly worded as S.37 of the present Act), that expenditure voluntarily incurred for commercial expediency and in order to facilitate business, qualifies for the deduction under the section, and that payment to employees in expectation of creating impetus or encouraging them to put in selfless work for the employer is a payment made out of commercial considerations and commercial expediency, deductible under the section. Attention was called to the passage in Lindley on Partnership, Thirteenth Edition, at page 455, to the following effect: "Sometimes it is agreed that if a partner dies the surviver shall pay an annuity, or a share of the profits, to his widow. A clause of this sort will not make the widow a partner or liable as a partner by virtue only of her participation in profits; and after her husband's death she can, if the articles arc properly framed, enforce payment of the provision intended for her."; and to the passage in Kanga's Income Tax Vol. I at page 511. Dealing with the amendments effected to S.10(a)(v) by the Finance Act, 1968, and the amendments introduced by the Taxation Laws (Amendment) Act, 1970, the learned author has noted that these cover any expenditure which results directly or indirectly in the provision of any benefit or perquisite, whether convertable into money or not, to an employee. There can be no quarrel with the propositions stated in the passages cited. There can be no quarrel with the propositions stated in the passages cited. But the test, in the first instance, has to be satisfied whether the deduction is from out. of the income after it has accrued to the assessee, or constitutes an expenditure incurred by the assessee solely and exclusively for earning the income. On this, the passages in question offer no guidance. 3. Turning to the terms of the Partnership Deed, clause 18 which we have extracted, says that the wife or the children of the deceased partner, in the contingency contemplated by the clause, shall be entitled to the gratuity at the rate of 10 per cent of the average annual share of income of the partner concerned ..................." This is subject to the ceiling of Rs. 50,000 under the provision. There is the further provision that the payment is to be in four equal half yearly instalments, the first being not later than six months after the date of death or occurrence of disability. The payment is to be treated as an outgoing from the Firm's income in the year in which the payments were made. The provisions, taken as a whole, leave no doubt in our mind that that they provided only for a diversion or appropriation of the income after it has accrued to the assessee, and therefore cannot amount to an expenditure incurred wholly and exclusively for earning the income. The terms of the clause in the Partnership Deed arc strongly in favour of the Revenue and against the assessee. 4. We may then refer to the line of cases relied on by counsel for the Revenue. He cited the decisions of the Supreme Court in Commissioner of Income Tax, Bombay City II v. Sitaldas Tirathdas 41 ITR 367, K. A. Ramachar and another v. Commissioner of Income Tax Madras 42 ITR 25; Commissioner of Income Tax, West Bengal III v. Imperial Chemical Industries (India) P. Ltd. 74 ITR 17. The decision in Murlidhar Himatsingka and another v. Commissioner of Income Tax, Calcutta 62 ITR 323 was relied on by both counsel for the assessee and counsel for the Revenue in support of their respective stand points. 5. In Commissioner of Income Tax v. Sitaldas Tirathdas 41 ITR 367 the Supreme Court considered the question of diversion of income by overriding title. The assessee Sitaldas Tirathdas of Bombay had several sources of income. 5. In Commissioner of Income Tax v. Sitaldas Tirathdas 41 ITR 367 the Supreme Court considered the question of diversion of income by overriding title. The assessee Sitaldas Tirathdas of Bombay had several sources of income. For the years 1953-54 and 1954-55, his total income was computed at Rs. 50,375 and Rs. 55,160. Deductions were claimed from this income in respect of a sum of Rs. 1,350 in the first assessment year, as amounts required to be paid under a decree, for maintaining the assessee's wife and children. The decree was in a suit for maintenance allowance, separate residence and marriage expenses for the daughters, filed on the original side of the Bombay High Court, which resulted in a consent decree, allowing maintenance at Rs. 1,500 per month against the assessee. For the year ending 31st March 1953 only one payment was made, which after deduction of Rs. 150 per month as rent for the flat occupied by the wife and children, was struck at Rs. 1.350 for purposes of deduction under the Income Tax Act. For the second year, the amount was worked out for the whole year at Rs. 1,500 per month. The claim was disallowed by the Income Tax Officer and by the Appellate Assistant Commissioner; but was allowed by the Tribunal. The Revenue went up in appeal to the Supreme Court. The Supreme Court noticed that the High Court had observed that the test for deductibility was the same, even though there was no specific charge upon the property, so long as there was an obligation upon the assessee to pay, which could be enforced in a Court of law. Reference was made to Bejoy Singh Dudhuria's case 1 ITR 135 which was regarded as having sanctioned the principle that unless a charge is created for the payment of the amount in respect of which deduction is claimed, there is no overriding title for the said amount. It was observed by the Supreme Court that the charging section of the Income Tax Act, 1922 (S.3) subjected to charge 'all income' of an individual, which means what reaches the individual as income. As the decree of the Bombay High Court charged the assessee's resources with a specific payment to his stepmother, it, to that extent, diverted this income from him and directed it to his stepmother. As the decree of the Bombay High Court charged the assessee's resources with a specific payment to his stepmother, it, to that extent, diverted this income from him and directed it to his stepmother. To that extent, therefore, what the assessee received was not his income but the received for her. Therefore, it was not the application of part of his income in a particular way, but rather the application of a sum out of his revenue before it come into his hand. After noticing the other cases on the point, namely P. C. Mullick's case 6 ITR 206, Diwan Kichan Kishore's case 1 ITR 143, including the decision of the Madras High Court in V. M. Raghavalu Naidu and Sons case 18 ITR 787 the Supreme Court observed: "These are the cases which have considered the problem from various angles. Some of them appear to have applied the principle correctly and same, not. But we do not propose to examine the correctness of the decisions in the light of the facts in them. In our opinion, the 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 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 become 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 on 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 when it is payable. 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 when it is payable. In our opinion, the present case is one in which the wife and children of the assessee who continued to be members of the family received a portion of the income of the assessee, after the assessee had received the income as his own. The case is one of application of a portion of the income to discharge an obligation and not a case in which by an overriding charge the assessee became only a collector of another income. The matter in the present case would have been different, if such an overriding charge had existed either upon the property or upon its income, which is not the case. In our opinion, the case falls outside the rule in Bejoy Singh Dudhuria's case (1933 (1) ITR 135) and rather falls within the rule stated by the Judicial Committee in P. C. Mullick's case (1938 (6) ITR 206)." 6. In K .A. Ramachar and another v. Commissioner of Income Tax, Mad. 42 ITR 25, the position was restated by the Supreme Court. Reference was made to the three cases which had a direct bearing on the question, namely, Provat Kumar Mittar's case 41 ITR 624; Bejoy Singh Dudhuria's case 1 ITR 135 and Sitaldas Tirathdas's case 41 ITR 367. Examining the facts of the case in the light of the principle of the decision noticed it was held that there was no diversion of income by an overriding title before it occurred to the assessee and hence the deduction cannot be sustained. In Commissioner of Income Tax, West Bengal III v. Imperial Chemical Industries (Indian) P. Ltd. 74 ITR 17 the matter was again examined and the principle was restated, in the same way as in Sitaldas Tirathda's case 41 ITR 367. See again the principle of the decision in Poona Electric Supply Co. Ltd. v. Commissioner of Income Tax, Bombay City I 57 ITR 521. See again the principle of the decision in Poona Electric Supply Co. Ltd. v. Commissioner of Income Tax, Bombay City I 57 ITR 521. Examining the case from the point of view of the principles stated, we are of the opinion, that the income had reached, the hands of the assessee, and that thereafter alone there was diversion of the income for payment to the widow of the erstwhile partner. It does not therefore qualify for deduction under S.37. 7. Counsel for the assessee relied on Commissioner of Income Tax, Kerala v. Travancore Sugar and Chemicals Ltd. 88 ITR 1 at page8 for the proposition that a charge is not necessary to create an overriding title for the amount, as counsel for the Revenue would stress in the instant case, and that even in the absence of a charge, an overriding title for the amount may well arise. Our attention was called to the observations at page 8. We could not find any such, proposition specifically laid down on the said page. On the other hand, in the decision of the Supreme Court in Murlidhar Himatsingka and another v. Commissioner of Income Tax, Cal. 62 ITR 323 it is stated at page 328 as follows: "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 the judgment in the above case Sitaldas Tirathdas v. Commissioner of Income Tax (1958 (33) ITR 390, 394) the High Court of Bombay had observed. 'It is not essential that there should be a charge, it is quite sufficient if 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." It is quite academic in the instant case to consider whether the presence or absence of a charge is necessary before there can be an overriding title for the amount in respect of which the claim for deduction is made. On the nature of the provision, and the term of the clause, we are satisfied that there was only a diversion of the income after it had reached the assessee and not an incurring of an expenditure for the purpose of earning the income. 8. We answer the question referred in the affirmative, that is, in favour of the Revenue and against the assessees. There will be no order as to costs.