2006 (4) TMI 55 - HC - Income Tax

Transfer of assets - AO contended that the entire income arising to the assessee on account of his share In the profit of the firm included in his total income and no deduction will be allowed on the income diverted in the favour of trust - Held that AO contention was not correct and allowed the deduction

Summary

Issues Involved
1. Whether the Appellate Tribunal is right in law and on facts in directing the Income-tax Officer to exclude 50 per cent. share of profit of Biren Nandish Trust from the income of the assessee.
2. Whether the Appellate Tribunal is right in law and on facts in holding that the provisions of section 60 of the Income-tax Act cannot be invoked.

Detailed Analysis

Issue 1: Exclusion of 50% Share of Profit from Income of the Assessee

The assessee, an individual with a 60% share in the profits and losses of the firm M/s. Jayantilal & Co., created the "Biren Nandish Trust" and assigned 50% of his partnership share to this trust. The assessee claimed a deduction of 50% of his share in the firm's profits, arguing that the income had been diverted to the trust and should not be included in his total income.

The Assessing Officer (AO) observed that the share of profit initially accrued to the assessee and was subsequently transferred to the trust. The AO concluded that the transactions amounted to a mere transfer of the share in the profit of the firm without transferring the income-producing assets, thus considering it an application of income rather than a diversion of income before accrual. Consequently, the AO included the entire income in the assessee's total income.

The Commissioner of Income-tax (Appeals) (CIT(A)) reversed the AO's decision, holding that the transfer was a diversion of income by overriding title, not an application of income. The Income-tax Appellate Tribunal (ITAT) upheld the CIT(A)'s decision, noting that the deed of assignment clearly transferred both the right to receive profits and the liability to share losses, thus constituting a diversion of income at source.

The High Court, referring to the terms of the deed of assignment, found that the transfer included the right to share in the profits and losses and the assets of the firm upon dissolution. The court concluded that the income-producing apparatus had been transferred, and thus, the provisions of section 60 of the Act were not applicable. The court upheld the ITAT's decision to exclude the 50% share of profits from the assessee's income.

Issue 2: Applicability of Section 60 of the Income-tax Act

Section 60 of the Income-tax Act states that all income arising to any person by virtue of a transfer shall be chargeable to income-tax as the income of the transferor if there is no transfer of the assets from which the income arises. The AO argued that since the capital account remained in the assessee's name, there was no transfer of the income-generating asset, making section 60 applicable.

The CIT(A) and ITAT disagreed, holding that the transfer of the partnership share was valid and effective, as it included the right to receive profits and the liability to share losses. The High Court affirmed this view, stating that the right to receive profits and contribute to losses constituted the income-producing apparatus. The court also noted that the gift had been accepted under the Gift-tax Act, further validating the transfer.

The court referenced its previous decision in CIT v. Nandiniben Narottamdas, which dealt with a similar issue and concluded that the transfer of the right to receive profits and contribute to losses amounted to a transfer of the income-producing asset. The court found that the provisions of section 60 were not attracted, as there was a valid and effective transfer of the asset.

Conclusion

The High Court concluded that the ITAT was correct in directing the exclusion of the 50% share of profit from the income of the assessee and in holding that the provisions of section 60 of the Income-tax Act could not be invoked. The court answered both questions in the affirmative, in favor of the assessee and against the Revenue. The reference was disposed of with no order as to costs.