Semester VI

Law of Taxation LB - 604

“On a lighter note it is said that the living cannot escape Death and Tax”.

Statute: Income Tax Act 1961

Topic 1 – Introduction

 Introduction Concept of – Tax,

 Cess, Surcharge;
 Types of taxes: Direct Taxes, Indirect Taxes;
 Definition of Income [Section 2(24)] –
 Application of Income or diversion by overriding title
 Capital Receipt v. Revenue Receipt - Tests to distinguish (with special reference to
‘Salami’);
 Assessee; Previous Year (section 3);
 Assessment year;
  Basis of charge (Receipt, Accrual, and Arisal);
 General Scheme of Income Tax Act, 1961

To understand any Act one should understand the objective of the act. The aim of tax statute
is to levy tax and generate revenue that is used by the state to meet the public expenditure.
Income tax act aims to levy and collect tax on direct source of income or simply put income
which is earned by a person as Salary, Business or profession, Capital gains, House Rent
income or any other source in his hands.

Income Tax is a tax of direct nature levied by the central government ony. The person
earning the income or receiving the money has to pay his share of tax from the same.
Whereas in case of indirect tax like GST, Customs, the receiver of money like restaurant
owner, telecom provider charges GST from their customers thus the receiver of money
directly do not pay the tax.

Article 265 of the Constitution of India provides that "no tax shall be levied or collected
except by the authority of law". Therefore, no tax can be levied or collected in India, unless it
is explicitly and clearly authorised by way of legislation. The Income-tax Act, 1961 (ITA) was
enacted to provide for levy and collection of tax on income earned by a person.

The Constitution of India → Schedule VII → Union List → Entry 82 has given the power
to the Central Government to levy a tax on any income other than agricultural income, which
is defined in Section 10(1) of the Income Tax Act, 1961. The Income Tax Law consists of
Income Tax Act 1961, Income Tax Rules 1962, Notifications and Circulars issued by Central
Board of Direct Taxes (CBDT), Annual Finance Acts and judicial pronouncements by the
Supreme Court and High Courts.

According to the Income Tax Act(IT Act)Sec 4, every person, whose total income exceeds
the maximum amount not chargeable to tax, shall be chargeable to income tax at the rate or
rates prescribed in the Finance Act.

The IT Act defines the term "person" Sec 2(31) to include an individual, an HUF, a
company, a firm (including LLP), an AOP or a BOI; a local authority and every other artificial
juridical person.

Article 270 of the Constitution describes a cess. Cess may be in the nature of a tax or a
fee but it is imposed for a specific purpose, as identified in the charging legislation. A tax is a
compulsory contribution collected by the government from the public at large and is to be
used for a public purpose. On the other hand, a fee is imposed by the government for a
specific facility or service being provided or rendered.

Name of some of the main cess used in India-

Education Cess,Road cess or (fuel Cess),Infrastructure Cess,Clean Energy Cess,Krishi

Kalyan Cess,Swachh Bharat Cess,Education and Health Cess (From FY 2018-19)Can be
spent for the specified purpose only.

As per section Article 271 of the Constitution of India, the Centre may at any time increase
the taxes and duties by a surcharge for its own purposes. Thus, the proceeds collected from
any such surcharge would form part of the Consolidated Fund of India. It applies to
taxpayers with higher income. The amount recovered in the form of surcharge also reaches
the Consolidated Fund of India (CFI), and it can be spent for any purpose, just like the
normal tax.

The IT Act provides an inclusive definition of the expression "income". Therefore, income
includes not only those things which this definition explicitly declares, but also all such things
as the word signifies according to its natural import. Therefore, before arriving at a
conclusion as to the tax implications of a receipt of money, it is imperative to determine
whether or not such a receipt amounts to income under the IT Act. There will be no
incidence of income tax if a receipt of money does not amount to income. For instance, it is
important to distinguish a capital receipt from a revenue receipt because, while all revenue
receipts are taxable under the IT Act, unless specifically exempted, a capital receipt cannot
be taxed as income, unless otherwise provided for by the statute.

Definition of Income Sec 2(24)

Section 2(24)

“Income" includes-

(i) profits and gains;

(ii) dividend;

[(iia) voluntary contributions received by a trust created wholly or partly for charitable or
religious purposes or by an institution established wholly or partly for such purposes 8[or by
an association or institution referred to in clause (21) or clause (23), or by a fund or trust or
institution referred to in subclause (iv) or sub-clause (v) of clause (23C) of section 10].

Explanation.-For the purposes of this sub-clause, "trust" includes any other legal obligation;]

(iii) the value of any perquisite or profit in lieu of salary taxable under clauses (2) and
(3) of section 17;

[(iiia) any special allowance or benefit, other than perquisite included under sub-clause
(iii), specifically granted to the assessee to meet expenses wholly, necessarily and
exclusively for the performance of the duties of an office or employment of profit;

(iiib) any allowance granted to the assessee either to meet his personal expenses at the
place where the duties of his office or employment of profit are ordinarily performed by him
or at a place where he ordinarily resides or to compensate him for the increased cost of
living;]

(iv) the value of any benefit or perquisite, whether convertible into money or not, obtained
from a company either by a director or by a person who has a substantial interest in the
company, or by a relative of the director or such person, and any sum paid by any such
company in respect of any obligation which, but for such payment, would have been payable
by the director or other person aforesaid;
[(iva) the value of any benefit or perquisite, whether convertible into money or not, obtained
by any representative assessee mentioned in clause (iii) or clause (iv) of sub-section (1) of
section 160 or by any person on whose behalf or for whose benefit any income is receivable
by the representative assessee (such person being hereafter in this sub-clause referred to
as the "beneficiary") and any sum paid by the representative assessee in respect of any
obligation which, but for such payment, would have been payable by the beneficiary;]

(v) any sum chargeable to income-tax under clauses (ii) and (iii) of section 28 or section 41
or section 59;

[(va) any sum chargeable to income-tax under clause (iiia) of section 28;]

[(vb)] any sum chargeable to income-tax under clause (iiib) of section 28;

[(vc ) any sum chargeable to income-tax under clause (iiic) of section 28;]

[(vd)] the value of any benefit or perquisite taxable under clause (iv) of section 28;

[(ve) any sum chargeable to income-tax under clause (v) of section 28;]

(vi) any capital gains chargeable under section 45;

(vii) the profits and gains of any business of insurance carried on by a mutual insurance
company or by a co-operative society, computed in accordance with section 44 or any
surplus taken to be such profits and gains by virtue of provisions contained in the First
Schedule;

[(viii) Omitted by the Finance Act, 1988, with effect from April, 1988. It was inserted by the
Finance Act, 1964, w.e.f 1-4-1964.]

[(ix) any winnings from lotteries, crossword puzzles, races including horse races, card
games and other games of any sort or from gambling or betting of any form or nature
whatsoever;]

[(x)any sum received by the assessee from his employees as contributions to any provident
fund or superannuation fund or any fund set up under the provisions of the Employees' State
Insurance Act, 1948 (34 of 1948), or any other fund for the welfare of such
employees;] interest in the company or a relative of the director or the other person.”

The word “ income includes” used in the section is an inclusionary provision and not
exhaustive.

The word 'income' is of the widest amplitude and it must be given its natural and
grammatical meaning. The definition of income in section 2(24) is inclusive. The purpose of
the definition is not to limit the meaning of 'income' but to widen its net and the several
clauses therein are not exhaustive of the meaning of income; even if a receipt did not fall
within the ambit of any of those clauses, it might still be income if it partook the nature of
income. The words "other games of any sort' were of wide amplitude and their meaning was
not confined to mere gambling or betting activities. Assuming that the
expression "winnings" had acquired a particular meaning viz. receipts from activities of a
gambling or betting nature only, it did not follow that monies received from non-gambling or
non-betting activities were not included within the ambit of income. The assessee
participated in a car rally and won a prize. The car rally was a contest, if not a race and the
assessee entered the contest to win it. What he got was a return for his skill and endurance.
It was "income" construed in its widest sense. Though it was casual in nature, it was
nevertheless income.

(1) CIT v. G.R. Karthikeyan, 1993 Supp (3) SCC 222

Concept of income in relation to S2(24)(ix) – Question before the Apex court was whether
prize money from car rally(for testing skill and endurance of participant i.e. minimum no of
violations of the rally rules) was covered under the definition of income?

The Court observed: -

Upto assessment year 1972-73 receipt of a casual nature were exempted from tax. Finance
Act of 1972 enlarged the concept of income by including winnings from lotteries, betting etc.
Therefore a single transaction may result in income for IT purpose.

Sec 10(3) – receipts of casual nature not being winnings from lotteries, to the extent such
receipts do not exceed one thousand rupees. – indicates income.

Held:

(i) words ‘other games of any sort’ are of wide amplitude not limited to games of gambling
nature alone.

(ii) Assuming expression winnings had acquired a particular meaning, namely receipts from
the activities of a gambling/betting nature alone, it did not follow that money from non
gambling or non betting were not included in the word income.

(iii) The rally was a contest, if not a race, and assesse entered the contest to win it. What he
got was a return for his skill & endurance but there was some earning. Hence declared
income in its widest sense.

The following citations were also discussed and used as a precedent.

Kamakshya Narayan Singh v CIT – Income is a word difficult & impossible to define in any
precise general formula

Gopal Saran Narain Singh v CIT – Anything which can properly be described as income is
taxable under the act

Navinchandra Mafatlal v CIT – “the definition of income as given in 2(24) is inclusive and
its purpose is not to limit the meaning of income but to widen its net.” Several clauses there
in are not exhaustive of the meaning of income. Its meaning should be same as that of
income occurring in Entry 82, List I, Seventh Schedule of the Constitution of India.

Bhagwan Das Jain v Union of India - Income includes not merely what is received or what
comes in by exploiting the use of property but also what one saves by using it oneself or that
which can be converted into income

In US & Australia – income used in wide sense so as to include capital gain. Its natural
meaning embrace any profit received.
State of Bombay v R.M.D. Chamabaugwala – All crossword puzzles are not of a gambling
nature.

State of AP v K Satyanarayana – Even in card games there are some games which are
games of skill without an element of gamble.

Capital Receipt vs Revenue Receipt - Test to distinguish (with spl ref to 'Salami');

Revenue Receipts

Revenue receipts are money earned by a business through its day to day operational
activities. These are recurring in nature and directly affects the profit and loss of the
business. Thus, the disclosure of revenue receipts are required to be made in the income
statement of the company or organization.

In general terms, we can say that revenue receipts do not create any liability for the business
nor does it reduces the assets. It simply suggests that goods or services have been
delivered to the clients and in return, income has been received. Ultimately it is a source of
cash inflow which leads to an increase in the total revenue of a company.

Examples of Revenue Receipts

Some examples of receipts which are of routine nature i.e. revenue receipts in an
organization are,

Money received for services provided to customers

Rent received

Discount received from suppliers, vendors or creditors

Dividend received

Interest earned

Commission received

Bad-debts recovered(if any)

Revenue earned by the sale of scrap material or waste etc

Some Important features of Revenue Receipts-

Benefits from revenue receipts can be taken for a short period of time i.e one accounting or
financial year

As benefits from revenue receipts are for a short period of time, thus another feature comes
that it is recurring in nature

Revenue receipts come directly from the operational activities of a business

It directly affects the profit and loss of business. As when revenue is received by a company
it will either increase the profit or will contribute towards loss.

Disclosure is made under Trading and Profit or Loss account and not in the Balance Sheet.

Capital Receipts?

Capital receipts are cash inflow in business arising from financial (capital) activities and not
the operating activities of the business. These are receipts resulting from activities which are
occasional or not of routine nature. Capital Receipts are not the regular or main source of
income for an organisation. Thus it either creates a liability or reduces the assets for the
business entity. And, because of its capital nature such receipts are shown in the balance
sheet of a company and not the income statement or Profit and Loss account.

These receipts are recorded on an accrual basis (means recording an income for which you
have got the rights to receive but the actual receipt has not yet occurred). Also, since capital
receipts are non-recurring in nature, they can not be used for the distribution of profit, unlike
revenue receipts.

Types of Capital Receipts

Capital receipts are divided into three groups-

1. Borrowings

2. Recovery of Loans and

3. Other Capital Receipts

Difference between the Revenue Receipts & Capital Receipts

Revenue Receipts Capital Receipts

Revenue receipts are generated Capita receipts are

1
from the operational activities of generated from the financial
.
the business. activities.

2 It affects the profit and loss of the It has no impact on the profit
. business. and loss of a business.

3 Revenue receipts are recurring in Capital receipts are non-

 . nature. recurring in nature.

In
It is the amount received from the
Capital receipts result from
4 sale of normal day to day
any loan, disinvestment,
. products or services of the
insurance claim etc.
company

5 Affect the Income Statement of Capital receipts affect the

. the company. Balance sheet.

Profit distribution is not

6 Through revenue receipts
available through capital
. distribution of profit is done.
receipts.

7 It includes Sale of products of It includes the sale of fixed or

. business financial assets.

Capital receipts can not be

8 Revenue receipts are one of the
used for creating reserve
. sources for creating reserves
funds in the business.

The Member for the Board of Agricultural Income Tax, Assam v. Smt. Sindurani
Chaudhurani (1) this Court defined as salami as follows:

The indicia of salami are (1) its single non-recurring character and (2) payment prior to the
creation of the tenancy. It is the consideration paid by the tenant for being let into possession
and can be neither rent nor revenue but is a capital receipt in the hands of the landlord.

Maharaja Chintamani Saran Nath Sah Deo Vs. The Commissioner Of Income-Tax, Bihar &
Oriss Air 732 1961 Scr (2) Sc1871

HEADNOTE:
In 1945 the appellant who was a Zamindar granted licences to different parties to prospect
bauxite. Under the licence the licensee had the right to enter upon the land to
prospect, dig and prove all bauxite lying in or within the land and to take away and
appropriate samples of bauxite in reasonable quantities not exceeding 100 tons in the
aggregate. In consideration of the premium paid, the licensees could, at their option,
after giving necessary notice and on payment of a further sum, get a mining lease for a
term of thirty years. The income-tax authorities were of the view that the licensees were not
granted any interest in land and that the amounts received by the appellant from the
licensees were revenue receipts and, therefore, assess-able to income-tax.Held, that on its
true construction the transaction of 1945 did not amount merely to a grant of the use of the
capital of the licensor but was really a grant of a right to a portion of the capital.
Accordingly, the amounts received by the appellant were capital receipts and, therefore, not
liable to income-tax.

In Raja Bahadur Kamakshya Narain Singh of Ramgarh v. Commissioner of Income-tax,

Bihar & Orissa (1) the payments by way of premium were held to be capital receipts. In that
case large payments by way of royalty for granting various mining leases were received by
the assessee. The leases were for a period of 999 years for mining coal with liberty to
search for, work, make merchantable and carry away the coal there found and with power to
dig and sink pits. In consideration of these rights the lessees paid a sum by way of salami
(premium) and an annual sum as royalty on the amount of coal raised subject to minimum
annual royalty. The lessor had the right to reenter in case of failure to pay the royalty. It was
contended by the assessee there that the sums received as salami and royalty were capital
receipts representing the price of the minerals removed. It was held that salami was a single
payment paid for the acquisition of the right to enjoy the benefits granted by the lease and
was a capital asset and that the two other forms of royalty-both minimum and per ton-flowing
from the covenants in the lease were not on capital account and fell within the meaning of
other income under s.12 of the Act. Lord Wright said at p. 190:- "The salami, has been,
rightly in their Lordships' opinion, treated as a capital receipt. It is a single payment made for
the acquisition of the right of the lessees to enjoy the benefits granted to them by the lease.
That general right may properly be regarded as a capital asset, and the money paid to
purchase it may properly be held to be a payment on capital account. But the royalties are
on a different footing."

In Commissioner of Income-tax, Bihar & Orissa v. Raja Bahadur Kamakshya Narain

Singh (1) a coal company had been given by the Court of Wards a prospecting licence in
respect of certain coal bearing lands with the option of renewal and also to take a mining
lease on certain terms and conditions. The prospecting licence was subsequently extended
on four occasions. When the assessee attained majority he claimed that the giving of the
licence was ultra vires the Court of Wards but there was a settlement between the licencee
and the assessee by which the latter agreed to accept the various prospecting licences, their
extensions and leases in consideration of which he received by way of salami Rs. 5,25,000
and capital lump sum of Rs. 40,000 and some other payments in lieu of cesses. The
question arose whether the amounts were capital or revenue and it was held that the amount
of Rs. 5,25,000 received as salami and the amounts received as cesses were capital
receipts and therefore not taxable. Manohar Lal, A. C. J., held that the amount was received
by way of settlement and not by way of salami but S. K. Das, J. (as he then was) held that
salami was a lump sum payment for rights which were being given to the licensee, namely,
the right to prospect for a certain number of years and also the right to get mining leases and
therefore salami in question was undoubtedly a capital receipt.

CIT, Assam etc v Panbari Tea Co. Ltd

In the Panbari Tea (1) case certain tea estates had been leased out for a period of 10 year.
The lease was executed on a consideration of a sum of Rs. 2,25,000 as and by way of
premium or salami and an annual rent of Rs. 54,000 to be paid by the lessee to the lessor.
The payments were to be made by installments. This Court declined to assume that the
parties had camouflaged their real intention and fixed a part of the rent in the shape of
premium and it was observed that no material had been placed either direct or circumstantial
to disbelieve the description given in the lease deed to the amount as premium and to hold
that it was not in fact premium but was only rent

Prev Year (Section 3) - Previous Year (PY)

You should be able to infer this yourself. The word previous is a big give away. Yeah you are
right – this is the year for which your income is being assessed in the Assessment Year. A
short form of this is PY which stands for Previous Year.

assessment year

the year in which you are doing the assessment and filing of your income for any financial
year which has passed by or just ended is called Assessment Year.

Date wise, both FY and AY are from April 1st to next year’s March 31st but it is the activity
that you do and refer to in these 12 months that help you refer to them as financial year or
assessment year.

Assessee - Section 2(7) of Income Tax

As per S. 2(7) of the Income Tax Act, 1961, unless the context otherwise requires, the term
“assessee” means a person by whom any tax or any other sum of money is payable under
this Act, and includes-

(a) every person in respect of whom any proceeding under this Act has been taken for the
assessment of his income or assessment of fringe benefits or of the income of any other
person in respect of which he is assessable, or of the loss sustained by him or by such other
person, or of the amount of refund due to him or to such other person;

(b) every person who is deemed to be an assessee under any provision of this Act;

(c) every person who is deemed to be an assessee in default under any provision of this Act.

1. Normal Assessee

An individual who is liable to pay taxes for the income earned during a financial year is
known as a normal assessee. Every individual who has earned any income earned or losses
incurred during the previous financial years are liable to pay taxes to the government in the
current financial year.

All individuals who pay interest/penalty or who are supposed to get a refund from the
government are categorised as normal assessees. Say, Mr A is a salaried individual who
has been paying taxes on time over the past 5 years. Then, Mr A can be considered as a
normal assessee under the Income Tax Act, 1961.

2. Representative Assessee

There may be a case in which a person is liable to pay taxes for the income or losses
incurred by a third party. Such a person is known as representative assessee.

Representatives come into the picture when the person liable for taxes is a non-resident,
minor, or lunatic. Such people will not be able to file taxes by themselves. The people
representing them can either be an agent or guardian.

Consider the case of Mr X. He has been residing abroad for the past 7 years. However, he
receives rent for two house properties he owns in India. He takes the help of a relative, Mr Y,
to file taxes in India. In this case, Mr Y acts as a representative assessee. If assessing
officer plans to investigate the tax filing, Mr Y will be asked to provide the necessary
documents as he is the guardian of the property and represents Mr X.

3. Deemed Assessee

An individual might be assigned the responsibility of paying taxes by the legal authorities and
such individuals are called deemed assessees. Deemed assessees can be:

The eldest son or a legal heir of a deceased person who has expired without writing a
will.
 The executor or a legal heir of the property of a deceased person who has passed on his
property to the executor in a writing.

The guardian of a lunatic, an idiot, or a minor.

The agent of a non-resident Indian receiving income from India.

For example, Mr P owns a commercial building from which he earns rent income. He has
prepared and signed a will stating the property should be handed over to his niece after his
death. Upon his death, his niece will be considered as the executor of the property, i.e.
deemed assessee. She will be responsible for paying tax on the rental income thereon.

4. Assessee-in-default

Assessee-in-default is a person who has failed to fulfil his statutory obligations as per
the income tax act such as not paid taxes to the government or not file his income tax return.

For example, an employer is supposed to deduct taxes from the salary of his employees
before disbursing the salary. He is, then, required to pay the deducted taxes to the
government by the specified due date. If the employer fails to deposit the tax deducted, he
will be considered as an assessee-in-default.

Application of Income or diversion by overriding title -

diversion of income by transfer of overriding title at source” should normally have the support
of

1)the statutory requirements or

2) some decretal binding character of Courts of law and

3) even though the private contractual obligations can also bring about such “diversion of
income at source” but in this last sphere of private contractual obligations, the Courts and
the Income Tax Authorities have to examine such aspects carefully in comparison to the
above two other categories of statutory requirements and the Court decrees and then
examine the real purport and object of such private arrangements and Contracts.

DIVERSION OF INCOME

-- Income never reaches to the assessee as his own income. By virtue of an obligation, the
income is diverted at source before it reaches the assessee.

-- here the obligation is on the source of income.

--There is an overriding title by virtue of which diversion of income takes place.

-- In case of diversion, the income is not included in the income of the assessee.

APPLICATION OF INCOME
-- income reaches to the assessee as his own income and is subsequently applied to discharge
an obligation

-- here the obligation is on the receipt of incoem ie. after income reaches to the assessee.

--There is no over riding title in this case.

-- In case of application, income is included in the income of assessee

(2) CIT v. Sitaldas Tirathdas (1961) 2 SCR 634 (case of application of income)

The respondent sought to deduct a sum of Rs. 1,350 in the first assessment year and a
sum of Rs. 18,000 in the second assessment year on the ground that under a decree
he was required to pay these sums as maintenance to his wife and his children. This
was disallowed by the Income Tax Officer. The matter reached till the Supreme Court.

The Supreme Court made a distinction between the amount which a person is obliged to
apply out of his income and an amount which by the nature of an obligation cannot be said
to be the part of the income of the assessee. When the income does not reach the hands of
the assessee due to diversion under an obligation, it is deductible. But on the other
hand when 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. The first kind of
payment is exempted u/ IT Act but not the second one. The second one is a case
of application of income which has been received. 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. On the facts and
circumstances of the case it was held that it was a mere case of application of income to
discharge an obligation. The wife and children of the assessee who continued to be
members of the family received a portion of the income of the assessee only after the
assessee had received the income as his own. Therefore there was no diversion of
income by an overriding charge.

(3) CIT v. Sunil J Kinariwala (2003) 1 SCC 660(case of application of income)

The assessee a partner in a firm created trust – by settlement deed assigned to it

a specific percentage of his right, title and interest (excluding capital) in the firm. The
question was what is the criteria to determine, when does the income attributable to an
assessee get diverted by overriding title created in favor of a third party.Court held – no
overriding title in favor of the trust

(4)Bejoy Singh Dudhuria v. CIT, Bengal (diversion of income)

The step mother and the Raja had entered into a compromise decree whereby a sum
of Rs. 1, 100 per month was to be paid to her for her maintenance. This amount
was declared as a charge upon the properties in the hands of the Raja by the Court. The
Raja sought to deduct this amount from his assessable income. This was disallowed by the
High Court of Calcutta. He went on appeal to the Judicial Committee.

The Judicial Committee held that the amount which the Raja paid to his step-mother did
not constitute his income. This was a case of diversion of income by overriding title, as
the Court had created a charge on the whole resources of the Raja with a specific
payment to his step-mother. To that extent it was not his income. Further it was observed
that it is not a case where the appellant is applying his income in a particular way rather it is
the allocation of a sum out of his revenue before it becomes income in his hands. It is
submitted that given the facts and circumstances of the case it was correctly held that the
case was of diversion of income by overriding title. The assessee never received the sum
of Rs. 1, 100 in his hands. Even if he received it was not for himself. He was acting as a
mere collector of that income which was to be paid to his step-mother. Thus, he was like a
conduit pipe between his step-mother and the resources which generated the income.

Additional case citations

Diwan Kishen Kishore v CIT

There was an impartible estate governed by the law of primogeniture, and under
the custom applicable to be family, an allowance was payable to the junior member. Under
an award given by the Deputy Commissioner acting as arbitrator and according to the will of
the father of the holder of the estate and the junior member, a sum of Rs. 7,200 per year
was payable to the junior member. This amount was sought to be deducted, which was
disallowed. The appellants argued that the payment which was made was necessary and
obligatory payment, and therefore the deduction should be allowed. Due to the distinctive
nature of the estate, the junior member is not entitled to separate his share and collect his
income directly. Hence in lieu of his share a separate allowance is given to him.
That allowance therefore, cannot form the part of the income of the assessee.

It was held it was not a case of application of income. Since, the junior member cannot
claim himself to be a member of the coparcenary with the assessee, the assessee was
merely acting as a collector of the allowance on his behalf. The Court further substantiated
its decision by pointing out the fact that the junior member cannot legally claim an increase
in the allowance even if the income of the estate materially increases.

Case should be distinguished from instances where an allowance is given by the head of the
Hindu coparcenaries to its members by way of maintenance. In that situation the income
generated by the resources of the Hindu joint family comes to the hands of the karta of
the family which he distributes among the coparceners as per their needs. Unless there is a
partition in the family, the coparceners who receive separate maintenance, still remain the
members of the joint Hindu family. Therefore, providing maintenance allowance to them is a
case of application of income.

P.C. Mullick and Another v. Commissioner of Income Tax, Bengal

The testator appointed the appellants as executors and directed them to pay Rs. 10,000 out
of the income on the occasion of his addya sradh. The executors paid Rs. 5,537 for such
expenses, and sought to deduct the amount from the assessable income. The Judicial
Committee disallowed the deduction. It held that whatever payments were made, were done
once the income had reached the hands of the assessee and in pursuance of the obligation
imposed upon them by the testator. This was not the case of diversion of income. It is
submitted that the decision of the Judicial Committee in the above case rightly brings out the
intention of the drafters of the Act. The Act is not concerned about how one spends his
money, that is, the Act is indifferent to the destination of the income. What is of material
concern is that whether the income has reached the hands of the assessee or not. Once it is
in the hands of the assessee it is liable for tax.

CIT v Bhagyalakshmi & Co – 2 members of HUF together held 10 annas share in a firm – on
partition in the family of the said members was divided among various members of the family
– thereafter a fresh partnership deed was executed in which the said two persons were
however shown as having the same proportion of share in the firm. They claimed that they
were liable to pay tax only on respective shares shown in the partnership deed.

Murlidhar Himatsingha v CIT – One of the partners in a partnership firm constituted a sub
partnership firm with his two sons and a grand son. The deed of sub partnership provided
that the P/L of partner in main firm belonged to the sub partnership and shall be borne and
divided in accordance with the shares specified therein. Question arose: whether share of
the partner in the main firm, who had become a partner in the sub partnership could be
assessed in his individual assessment. It was held that there was an overriding
obligation which converted the income of the partner in the main firm into the income of the
sub partnership and therefore the income attributable to the share of the partner had to be
included in the assessment of the sub partnership.

In Raja Bejoy Singh Dudhuria v. Commissioner of Income Tax, Bengal, the step mother and
the Raja had entered into a compromise decree whereby a sum of Rs. 1, 100 per month was
to be paid to her for her maintenance. This amount was declared as a charge upon the
properties in the hands of the Raja by the Court. The Raja sought to deduct this amount
from his assessable income. This was disallowed by the High Court of Calcutta. He went on
appeal to the Judicial Committee. The Judicial Committee held that the amount which
the Raja paid to his step-mother did not constitute his income. (discussed in case
above)
The Supreme Court in Moti Lal Chhadami Lal Jain v. Commissioner of Income
Tax, observed that what is of cardinal importance is the nature of obligation by reason of
which the income becomes payable to a person other than the one entitled to it. Where
the obligation flows out of an antecedent and independent title, it effectively diminishes the
total income of an individual and so it would be a case of diversion. Whereas when the
obligation is self imposed or gratuitous, it is only a case of application of income.

From the above observation of the Apex Court, it is submitted that there is a difference
between an amount which a person is obliged to apply out of the income and an amount
which by the nature of the obligation cannot be said to be the part of the income.

K A Ramachar – The assessee a partner in a firm executed three deeds of settlement in

favour of his wife, married daughter and a minor daughter, assigning to each of them 1/4th of
his share in the firm’s profit. Assessee contended that the amounts covered by the
settlements could not be included in his total income for the purpose of assessment to
income tax. Court held that under law of partnership it was the partner and the partner
alone who was entitled to the profits and that a stranger, even if he were an assignee
did not have and could not have any direct claim to the profits. The claim of the
assesee was negatived on the ground that what was paid was in law a portion of his income,
as such the amounts have to be included in his total income.