1. Partnership firm — accumulated profits of wife and minor sons — interest paid on accumulations — inclusion in appellant's income under Section 16(3)(a)(i) and (ii), Income-tax Act. (Para 1 )
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1966 Supreme(SC) 255
SUPREME COURT OF INDIA
J.C. SHAH, V. RAMASWAMI AND V. BHARGAVA, JJ.
S. Srinivasan, Erode, Appellant
Versus
The Commissioner of Income-tax, Madras, Respondent.
Civil Appeal No. 556 of 1965. dated 4-10-1966.
Advocates appeared
Mr. A. K. Sen, Senior Advocate, (Mr. R. Gopalakrishnan. Advocate, with him), for Appellant: Mr. S. T. Desai. Senior Advocate (M/s. A. N. Kirpal and R. N. Sachthey Advocates, with him), for Respondent.
Advocates:
A.K.SEN GUPTA, A.N.KIRPAL, R.GOPAL KRISHNAN, R.N.SACH, S.T.DESAI
A.K.SEN GUPTA, A.N.KIRPAL, R.GOPAL KRISHNAN, R.N.SACH, S.T.DESAI
Interest on accumulated partnership profits credited to a spouse or minor child is includible in the assessee's income under Section 16(3)(a) of the Income-tax Act, as it arises indirectly from their status as partners or beneficiaries, and cannot be classified as independent loans or deposits.
Headnote:(A) Constitution of India - Art. 19(1)(f) and (g) - Income-tax Act - Section 16(3)(a)(i) and (ii) - Validity of provisions - Provisions of Section 16(3)(a)(i) and (ii) do not impose any unreasonable restriction on the fundamental rights of the assessee and are, consequently, valid. (Para 2)
(B) Income-tax Act - Section 16(3)(a)(i) and (ii) - Interest on accumulated profits - Whether interest credited to the accounts of a spouse or minor children on accumulated profits from a partnership firm is includible in the income of the assessee - Accumulated profits remaining in the hands of the firm cannot be equated with deposits or loans - Since profits were earned due to membership or admission to benefits of the firm, interest on such accumulations arises indirectly from that capacity and is includible in the assessee's income. (Para 3)
Facts of the case:
A senior partner in a firm had his spouse and two minor sons as partners or beneficiaries. Profits accruing to the spouse and minors were accumulated in the firm's accounts. Subsequently, the firm decided to pay interest on these accumulated profits. The tax authorities included this interest in the senior partner's taxable income under the relevant sections of the Income-tax Act, which was challenged by the appellant.
Findings of Court:
The court found that the accumulated profits were not loans or deposits but were funds that the partners allowed the firm to use because of their interest in the firm. Consequently, the interest earned on these funds is income derived indirectly from their status as partners or persons admitted to the benefits of the partnership.
Issues: (i) Whether the provisions of Section 16(3)(a)(i) and (ii) of the Income-tax Act offend the fundamental rights guaranteed under the Constitution; (ii) Whether interest credited to a spouse and minor children attributable to past profit accumulations is includible in the assessment of the assessee under Section 16(3)(a)(i) and (ii).
Ratio Decidendi: Interest on accumulated profits earned by a spouse or minor child from a partnership firm is includible in the income of the assessee because such interest arises indirectly from their capacity as a partner or a person admitted to the benefits of the partnership, and such accumulations cannot be treated as independent loans or deposits.
Result: Appeal dismissed.
Legal Category Hierarchy
Table of Contents
2. Constitutional validity of Section 16(3)(a)(i) and (ii) — whether interest on accumulated profits of wife and minor sons is includible in appellant's income. (Para 1 )
3. Accumulated profits not equated to deposits or loans — interest paid due to status as partners or admitted persons — income arises indirectly from partnership capacity. (Para 3 , 4 , 5 , 6 )
4. Interest on accumulated profits of partners or persons admitted to partnership benefits is income derived indirectly from the partnership and includible under Section 16(3)(a)(i) and (ii). (Para 3 , 6 )
5. Appeal dismissed — High Court's findings upheld. (Para 6 )
6. Whether Section 16(3)(a)(i) and (ii) of the Income-tax Act violates fundamental rights under Article 19(1) of the Constitution?
No, the provisions do not impose any unreasonable restriction on the fundamental rights of the assessee under Article 19(1)(f) and (g) and are therefore valid. (Para 2 )
7. Can accumulated profits of a partner or person admitted to partnership benefits be treated as deposits or loans advanced to the firm?
No, accumulated profits remaining with the firm cannot be equated with deposits or loans unless there is a specific arrangement or contract to convert those accumulations into deposits or loans. (Para 3 )
8. Is interest paid by a firm on the accumulated profits of a partner's wife or minor children includible in the partner's income?
Yes, such interest arises indirectly from their capacity as partners or persons admitted to the benefits of the partnership and is includible in the assessment of the partner under Section 16(3)(a)(i) and (ii). (Para 3 , 6 )
Judgment
BHARGAVA, J. : The appellant is a senior partner in A firm in which the two other partners are his wife and a stranger, In addition, two minor sons of the appellant were admitted to the benefits of the partnership. Under the deed of agreement constituting the partnership, the shares in the profits of all the five persons were defined. There was also specification of the shares in which losses were to be shared by the three partners. There was a clause in the deed of partnership that "if the firm requires any sum for meeting the expenses for its management and if any of the partners has and is willing to give such amount, he may advance (such amount) as loan. He may receive interest for such sum at the rate of 12 annas per cent per mensem. The firm earned profits which were distributed in accordance with their shares between the three partners and the two minors who were admitted to the benefits of the partnership. The amounts of profit falling to the share of the wife of the appellant and his two minor sons were allowed to accumulate in the accounts of the partnership for a number of years. Up to the beginning of the previous year relevant to the assessment year 1957-58, the profits that were accumulating in the accounts to the credit of the wife and the two minor sons of the appellant were kept without any interest. With effect from the previous year in question, the partnership decided to allow interest at 9 per cent per annum on these accumulated profits, so that, during this previous year the amounts to the credit of these three persons increased on account of two additions in each case. There was addition of further profit falling to their share and there was added interest on the opening balance of the accumulated profits in the accounts of each one of these three persons. All these amounts added to the accounts during the previous year in respect of share of profits as well as interest on accumulated profits were added to the income of the appellant for purposes of assessment under S. 16 (3) (a) (i) and (ii) of the Income-tax Act. These additions were challenged by the appellant on two different grounds. The first ground was that the provisions of S. 16 (3) (a) (i) and (ii) were ultra vires as being beyond the legislative powers of the Parliament. The second ground was that, even on the application of these provisions, at least the amount added to the income of the appellant in respect of the interest credited in the accounts of his wife and minor sons was not justified in law. Both these objections were over-ruled by the Income-tax Officer. On appeal. the Appellate Assistant Commissioner upheld the decision of the Income-tax Officer on the first point, but decided the second point in favour of the appellant and held that the interest earned by his wife and minor son from the firm could not be included in the income of the appellant for purposes of charging it with income-tax. The Income-tax Appellate Tribunal, on further appeal, again upheld the decision on the first question, but, on the second question, partly rejected the claim of the appellant. The Tribunal held that the amount of interest credited to the amount of the minors in respect of capital provided by their grand-father and grant-mother had to be excluded from the total income of the assessee, while the interest earned on the accumulated profits was rightly included in the income of the appellant. Thereupon, at the request of the appellant, the following two questions were referred by the Tribunal for the opinion of the Madras High Court :-
"(i) Whether the provision of Section 16 (3) (a) (i) and (ii) offends Cls. (f) and (a) of Art 19 (1) of the Constitution of India ?
(ii) Whether interest credited by the aforesaid firm to the assessee s wife and minor children attributable to past profit accumulations only is includible in the assessment of the assessee under S. 16 (3) (a) (i) and (ii) ?"
The High Court answered both the questions against the appell
