Fatehchand Murlidhar & ANR Vs.
Commissioner of Income-Tax, Calcutta  INSC 125 (19 July 1966)
Income-tax Act (11 of 1922), s.
23(5)(a)-Scope ofPartnership Sub-partnership between a partner and strangersAgreement
to share profits and losses of partner in the Partnership--Income from the
Partnership-Whether belongs to partner or sub-partnership.
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,
(i) The new partnership constituted a sub-partnership in respect of the
assessee's share in the registered firm. (In the case of a sub partnership, 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 subpartner 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] (ii)The object of s.
23(5)(a) 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 subpartnership
and the section being applied again. [463C, F] Charandas Haridas v.
Commissioner of Income Tax,  3 S.C.R. 296, and Commissioner of Income
Tax, Bombay v. Sitaldas Tirathdas  3 S.C.R. 634, followed.
Commissioner of Income Tax, Punjab v. Laxmi
Trading Co. 24 I.T.R. 173 and Ratilal B. Daftari v. Commissioner of Income
Tax:-, Bombay, 36 I.T.R. 18, referred to.
Mahaliram Santhalia v. Commissioner of Income
Tax 33 I.T.R.
CIVIL APPELLATE JURISDICTION:Civil 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.
A.K. Sen, S. C. Mazumdar and J. Datta Gupta,
for the appellants.
R.M. 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 s. 66(1) 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 M/s 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 M/s
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 M/s 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. Murlidhar 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
/2/8 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
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
Party hereto of the Third Part-Three annas
Party hereto of the Fourth Part-Three annas
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 s. 23(5)(a) 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 M/s Fatehchand Murlidhar. The Appellate Tribunal,
agreeing with the views of the Appellate Assistant Commissioner, dismissed the
The High Court held that it was a case of
diversion of income 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
Murlidhar Himatsingka and M/s Fatehchand
Murlidhar having obtained special leave, the appeals are now before us.
The learned counsel for the appellants, Mr.
A. K. Sen, contends 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 subpartnership 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 M/s Fatehchand Murlidhar.
Mr. Hazarnavis, on the other hand, contends
that this agreement 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
s. 23(5)(a) twice.
He says that the firm of Basantlal
Ghanshyamdas was a registered firm and the 457 Income Tax Officer was bound.
under s. 23(5)(a), 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 s. 23(5)(a).
The first point that arises is whether the
agreement dated December 21, 1949, has succeeded in diverting the income from
Murlidhu's share in M/s Basantlal Ghanshyamdas to M/s 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 M/s 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
In Commissioner of lncome tax, Bombay v.
das,(1) 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
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 v. Commissioner of Income-tax, Bombay(1) 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
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 v. Commissioner of Income-tax, Madras(1) and Provat Kumar Mitter v.
Commissioner of Income-tax, West Bengal(1) 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 v.
Commissioner of Income-tax, Bombay(1) the assessee who was one of the sixteen
partners in a registered partnership had contributed Rs. 25,000/out of the
capital of the partnership, Rs. 3,45,000/-. In order to contribute this capital
of Rs. 25,000/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 v. Commissioner of
Income-tax(1) and Sitaldas Tirathdas v. Commissioner of Income-tax(1) As
pointed out by the learned counsel for the respondent, Mr. Hazarnavis, Sitaldas
Tirathdas v. Commissioner of Income-tax(1) was reversed by this Court in
Commissioner of Income-tax v. Sitaldas Tirathdas(4) Hidayatullah, J., at p. 374
of his judgment reversing the judgment of the Bombay High Court, had also
referred to Motilal Manekchand v. Commissioner of Income-tax (5) but did not
expressly dissent from this case.
In our opinion the case of Ratilal B. Daftari
v. Commissioner of Income-tax, Bombay(1) 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 v. Sitaldas
Tirathdas(3). We say so far the follow.
(1) 33 I.T.R. 390,394.
(2) 42 I.T.R. 25.
(3) 41 I.T.R. 624, (4) 36 I.T.B. Is.
(5) 31 T.T.R. 735.
(6) 41 I.T.R. 367.  3 S.C.R. 634.
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 v. Hickman (1860) 8 H.L. Cas. 268, 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 v. Laxmi Trading Company)(1) The question
then arises is whether the interest of the subpartnership 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 v. Hickman(1), 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, s. 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.
(1)24 I.T.B. 173.
(2)  8 H.L. Cas. 268.
460 The decision of this Court in Charandas
Haridas v. 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 coparceners
of the family a partial portion of the income from the managing agency was
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 visa-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 v. Commissioner of Income-tax(1) was wrongly decided. The
facts in that case were these. Mahal' Santhalia was a partner in the firm M/s
Benares Steel Rolling Nills. He was also a partner in another firm named M/s
Radhakissen Santhalia. By agreement dated April 3, 1944, between the partners
of M/s Radhakissen Santhalia, it was provided that the partnership income from
M/s Benares Steel Rolling Mills would belong not to Mahaliram Santhalia
individually but to the firm of M/s 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 M/s Radhakissen
Santhalia before it became (1)  3 S.C.R. 296.
(2) 33 I.T.& 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
between 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 v. Commissioner of
Income-tax, Madras(1):"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 (1)42 I.T.B. 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 v. Abdul Rahim(1) 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 obligation 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
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 s.
25(5)(a) of the Act it is only he who could be assessed, but there is no
warrant for this proposition. In Commissioner of Incometax, West Bengal v. Kalu
Babu Lal Chand(2) this Court mentioned with approval Kaniram Hazarimull v.
Commissioner of Income-tax(1) 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) 55 I.T.R 651. (2) 37 I.T.R. 123.
(3) 27 I.T.R. 294.
463 of the till of the Hindu undivided
family, then he must be regarded as having entered into the partnership 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 v. Commissioner of Income-tax(1) and Dhanwatav v. Commissioner of
Income-tax(1) in support of this view".
The object of s. 23(5)(a) 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 s. 23(5)(a) of the Act.
This view was taken by the Bombay High Court
in Ratilal B., Daftri v. Commissioner of Income-tax(1). 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 23(5)(a), 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
In conclusion we hold that there is nothing
in s. 23(5)(a) that prevents the income from the firm Basantlal Ghanshyamdas
being treated as the income of M/s Fatehchand Murlidhar and s. 23(5) (a) being
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.
(1)27 I.T.R. 294.
(2) 32 I.T.R. 682.
(3)36 I.T.R. 18.