1964 (10) TMI 11 - SC - Income Tax

Partition deed distinguishes individual vs. HUF profits - Court rules in favor of individual's tax liability

The High Court held that profits accrued to Ashokbhai individually after the partition deed, not to the Hindu undivided family (HUF). The court determined ... Accrual of income - right to receive - dormant profits - time of accrual of profits in partnership - partnership accounts - beneficial interest - partition of Hindu undivided familyAccrual of income - time of accrual of profits in partnership - right to receive - partnership accounts - beneficial interest - partition of Hindu undivided family - Whether the five annas share of the profits of Messrs. Amrit Chemicals for the calendar year 1955 accrued to the assessee (the Hindu undivided family) and was chargeable to tax in its hands. - HELD THAT: - The Court held that income accrues or arises only when a right to receive it comes into existence and not merely because profit is embedded in gross receipts from trading transactions. In a partnership where the deed stipulates that accounts are to be made up at stated intervals, the partner's right to his share of profits arises on the contingency (making up of accounts) specified in the partnership agreement. The partnership deed in this case fixed the accounting period as the calendar year and required accounts to be adjusted only on December 31; hence the share of profits for calendar year 1955 became vested only on settlement of accounts at year end. Although the partition deed executed on November 12, 1955 disrupted the Hindu undivided family and transferred to Ashokbhai the beneficial ownership of the five annas share thereafter, the decisive question is who had the right to the profits on the date those profits were ascertained. On December 31, 1955, when the profits for the calendar year accrued by virtue of the partnership covenant, Ashokbhai (having ceased to represent the joint family by the partition) alone had the right to the share; the assessee had no subsisting interest in those profits. The Court applied the principle from earlier decisions that dormant or embedded profit in gross receipts does not equate to accrual of taxable profit unless and until a legal right to demand the profit exists, and rejected the revenue's contention that profits of a firm automatically accrue day-to-day to individual partners irrespective of the partnership accounting provisions.The five annas share of the profits for calendar year 1955 did not accrue to the Hindu undivided family and was not chargeable to tax in its hands; the High Court's negative answer was upheld.Final Conclusion: The appeal is dismissed: profits of the partnership for calendar year 1955 accrued only when accounts were made up on December 31, 1955, and on that date the beneficial interest was vested in Ashokbhai individually following the partition, not in the Hindu undivided family, so the share was not taxable in the assessee's hands. Issues Involved:1. Determination of the accrual of profits to the Hindu undivided family (HUF) or individual after the partition.2. Taxability of the share of profits from a partnership firm.3. The timing of the accrual of profits for tax purposes.4. The impact of the partition deed on the tax liability of the HUF.Issue-wise Detailed Analysis:1. Determination of the Accrual of Profits to the HUF or Individual After the Partition:The primary issue was whether the share of profits from Messrs. Amrit Chemicals for the year 1955 accrued to the Hindu undivided family (HUF) or to Ashokbhai in his individual capacity. The HUF was disrupted by a deed dated November 12, 1955, and the property was divided. The deed stated that Ashokbhai would become the full owner of the five annas share in the partnership firm from January 1, 1955. However, the High Court held that Ashokbhai became the owner of the share only from November 12, 1955, and not before. Therefore, the profits which accrued on or after December 31, 1955, belonged to Ashokbhai individually and were not liable to be included in the taxable income of the HUF.2. Taxability of the Share of Profits from a Partnership Firm:The Income-tax Officer included Rs. 21,051 received by Ashokbhai as the five annas share in the profits of the firm in the computation of the total income of the HUF. The Appellate Assistant Commissioner and the Tribunal held that the profits for the year 1955 should be apportioned between the HUF and Ashokbhai. The Tribunal submitted a case to the High Court, which agreed with the revenue authorities that Ashokbhai had become the full owner of the five annas share in the firm from November 12, 1955. However, it upheld the alternative contention that no part of the share of profits which accrued to Ashokbhai on December 31, 1955, was liable to be included in the income of the HUF.3. The Timing of the Accrual of Profits for Tax Purposes:The judgment discussed whether profits in a trading venture carried on by a firm accrue to the partners from day to day or when the accounts are made and a right to receive the profits arises under the partnership deed. It was held that under the Income-tax Act, income is taxable when it accrues, arises, or is received. The court referred to the principle that profits do not accrue from day to day but are determined by the method of accounting at the end of the accounting year. The right to receive profits or income arises only when the accounts are made up, and the right to claim the profits is determined.4. The Impact of the Partition Deed on the Tax Liability of the HUF:The court held that the beneficial interest of the HUF in the profits of Messrs. Amrit Chemicals ceased only on the execution of the deed of partition on November 12, 1955. Therefore, the profits for the year 1955 were to be apportioned between the HUF and Ashokbhai. However, since the right to the profits arose on December 31, 1955, Ashokbhai alone was the owner of those profits, and the HUF had no interest in them. The revenue authorities could not claim that the profits should be apportioned between the HUF and Ashokbhai for tax purposes.The court concluded that income becomes taxable on the footing of accrual only after the right of the taxpayer to the income accrues or arises. In the case of an agreement that makes profits receivable at or on the happening of a contingency, the fact that the profits are the result of transactions spread over a period covering a time before the contingency does not make the receipt liable to be paid to persons other than those entitled to receive it on the date it is actually received or becomes receivable.Conclusion:The High Court was right in answering the question in the negative, as the profits accrued to Ashokbhai individually after the partition deed, and the HUF had no interest in those profits. The appeal was dismissed.