Dear Ritesh Jha,
In my opinion, the transfer of income from firm by a partner to a sub partner will be treated as exempt in the hands of sub partner.
In this regard, there is a wonderful article on this topic published in the Financial Express, date 11-11-2007, which has been reproduced for your reference.
With effect from April 1, 1993, the income of a partnership is subject to tax in the hands of the firm. The share of an individual partner has been exempted under section 10(2-A). Diversion of income by overriding title to sub-partnership confers upon it the attributes of a partner in so far as it relates to such income for the purpose of the Income-Tax Act, 1961, irrespective of the provisions of the Indian Partnership Act, 1932. A sub-partnership has been recognised in India and registered as a partnership firm under the Income-Tax Act though the term has not been defined in the Indian Partnership Act, 1932.
A partnership firm cannot become a partner in another partnership firm for the purpose of the Indian Partnership Act, 1932 since a firm is not a person under this Act and is, therefore, not eligible to enter into an agreement. However, the position is otherwise in so far as the Income-tax Act is concerned. A "person" has been defined in section 2(31) which, amongst, others includes a firm.
In Muralidhar Himatsingka v CIT (62 ITR 323), the Supreme Court held that a sub-partnership is, as it were, a partnership within a partnership; it pre-supposes the existence of a partnership to which it is sub-ordinate. An agreement to share profits only constitutes a partnership between the parties to the agreement. If, therefore, several persons are partners and one of them agrees to share the profits derived by him with a stranger, this agreement does not make the stranger a partner in the original firm. The result of such an agreement is to constitute what is called a sub-partnership, that is to say, it makes the parties to it partners inter se; but it in no way affects the other members of the principal firm.
In CIT v Sunil J Kinariwala (259 ITR 10), the Supreme Court held that when a third person becomes entitled to receive the amount under the obligation of an assessee, even before he could lay a claim to receive the income, there would be a diversion of income by an overriding title. In Muralidhar Himatsingka's case, it was held that there was an overriding obligation which converted the income of a partner in the main firm into the income of the sub-partnership. Therefore, the income attributable to the share of the partner had to be included in the assessment of the sub-partnership.
That was on the principle that a partner in the sub-partnership had a definite enforceable right to claim a share in the profits accrued to or received by the other partner in the main partnership because on entering into a sub-partnership, such a partner changes his character vis-à-vis the sub-partners and the income-tax authorities. Further, a sub-partnership creates a superior title and results in diversion of the income from the main firm to the sub-partnership before the same becomes the income of the concerned partner. In such a case, even if the partner receives the income from the main partnership, he does so not on his behalf but on behalf of the sub-partnership.
There is a clear distinction between a case where a partner of a firm assigns his share in favour of a third person and a case where a partner constitutes a sub-partnership with his share in the main partnership.
Whereas in the former case, in view of section 29(1) of the Indian Partnership Act, the assignee gets no right or interest in the main partnership, except to receive that part the profits of the firm referable to the assignment and to the assets in the event of dissolution of the firm, in the latter case the sub-partnership acquires a special interest in the main partnership.
Section 10(2-A) provides that the income of a person being a partner of a firm which is separately assessed as such would not be included while computing the total income of such person. Section 10(2-A) in its literal sense means that the income of a partner of a firm which is separately assessed to tax would not be reassessed in his hands. In fact, the pre-requisite for income of a person to be exempt under the provisions of section 10(2-A) is that he must be a partner of a firm which is separately assessed.
The following are the principles relating to diversion of share of income of a partner at source by overriding title. A sub-partnership is a partnership within a partnership in respect of the share of a partner in the main partnership. Formation of a sub-partnership does not affect the position of the partner in the main partnership though its character changes vis-à-vis the sub-partnership and the income-tax authorities.
The superior title of the sub-partnership diverts at source the share of income of the concerned partner in the main partnership before it becomes the income of the partner. Assessment of a share of income of a partnership in the hands of a partner has to be apportioned as per provisions of the Income-tax Act and, thereafter, the income-tax authorities are required to determine whether it would be assessable in the hands of that partner or in the hands of the sub-partnership.
The diversion of income of a partner in the main partnership at source to the sub-partnership by overriding obligation created by sub-partnership converts the income of a partner into the income of the sub-partnership, thus vesting an enforceable right upon the sub-partnership to claim a share in the profits accrued to, or received by, a partner. The right to receive profits and bear losses becomes the asset of the sub-partnership. A sub-partnership which is in receipt of the share of profit of a partner in the main partnership, has to be deemed to be a partner in the main partnership for the limited purpose of section 10(2-A) of the Income tax Act.
Hope the above article would be useful.
Regards,
Rohan Thakkar
TaxTMI 
TaxTMI 
