Real income doctrine applied to partition debts, excluding diverted interest while refusing deduction under income tax law.

Interest payable on unsecured family debts assumed on partition was treated as diverted at source because the properties were received subject to the creditors' superior claim, so that amount never formed part of the assessees' real income. The same interest was not deductible under section 12(2) of the Indian Income-tax Act, 1922, because the liability was not incurred solely for earning the income from the properties but arose from the burden attached to the assets on allotment. The court accordingly distinguished between exclusion under the real income doctrine and allowance as a statutory deduction, and held that the diverted interest had to be left out of real income but not allowed as expenditure.

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Issues: (i) Whether interest paid on unsecured liabilities taken over on partition of a Hindu undivided family was diverted by an overriding title and therefore did not form part of the assessees' real income; (ii) whether such interest was deductible under section 12(2) of the Indian Income-tax Act, 1922; (iii) whether the interest could be excluded in computing the assessees' real income.

Issue (i): Whether interest paid on unsecured liabilities taken over on partition of a Hindu undivided family was diverted by an overriding title and therefore did not form part of the assessees' real income.

Analysis: The partition arrangement and the arbitrator's awards allotted properties to the assessees subject to the obligation to discharge the outstanding family debts and liabilities assigned to them. Under Hindu law, the sons and widow remained liable for pre-partition debts not tainted by illegality or immorality, and the arrangement reflected that liability. The Court held that the assessees held the properties subject to the creditors' superior right to be paid out of the receipts, so the relevant income was diverted before it reached them in law.

Conclusion: The interest was diverted by an overriding title and was not part of the assessees' real income.

Issue (ii): Whether such interest was deductible under section 12(2) of the Indian Income-tax Act, 1922.

Analysis: Deduction under section 12(2) required expenditure incurred solely for the purpose of earning the income. The liability to pay interest on the unsecured debts was not incurred for the purpose of earning the income from the properties; it arose because the properties were received subject to the burden of those liabilities. On that footing, the claim did not satisfy the statutory test for allowance.

Conclusion: The interest was not admissible as a deduction under section 12(2).

Issue (iii): Whether the interest could be excluded in computing the assessees' real income.

Analysis: Applying the real income doctrine, the Court held that what is chargeable is only what reaches the assessee as income in law. Since the assessees received the properties subject to the creditors' superior claim and the interest burden was attached to the receipts at source, the amount never formed part of their true income. The Court also treated the position as consistent with the principle underlying section 94 of the Indian Trusts Act, 1882.

Conclusion: The interest had to be excluded while determining the assessees' real income.

Final Conclusion: The references were answered partly for the assessees and partly for the revenue, with the interest on unsecured liabilities held to be outside real income but not allowable as a statutory deduction under section 12(2).

Ratio Decidendi: Where property is received subject to a legal obligation that diverts part of the receipts to creditors before the income reaches the assessee in law, that diverted amount is not real income; but a liability not incurred solely for earning income is not deductible under section 12(2) of the Indian Income-tax Act, 1922.

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