1. Facts of the Case
The assessee ‘A’ is a partner in a firm. By executing a settlement deed, A assigned 10% of his share in the profits (excluding capital) from the partnership to a trust created by him. A did not transfer his right as a partner but merely settled a portion of his right to future profits. In his income tax return, A excluded this 10% of profits and claimed that it constituted a diversion of income at source, and therefore, not taxable in his hands.
2. Issues in the Case
- Whether the assignment of a portion of partnership profits to a trust amounts to diversion of income at source or application of income?
- Is the assessee legally justified in excluding this income from his total income under the Income Tax Act, 1961?
- Does the trust become a separate taxable entity for this share, or is the income still taxable in the hands of the partner (A)?
3. Legal Principles Covered
A. Diversion of Income vs. Application of Income
- As per judicial precedent, diversion of income means income is diverted before it reaches the assessee, due to an overriding title.
- In contrast, application of income occurs after the income has accrued to the assessee. In such cases, the income remains taxable in the hands of the assessee, regardless of what he does with it later.
B. Relevant Judicial Precedent
- CIT v. Sitaldas Tirathdas (1961) 41 ITR 367 (SC): The Supreme Court held that where the assessee voluntarily assigns part of his income to another (e.g., to a relative or trust), there is no overriding title and it amounts to application of income, hence taxable in the assessee’s hands.
- CIT v. Murlidhar Jhawar & Purna Ginning Pressing & Mfg. Co. (1966) 60 ITR 95 (SC): Income that accrues to the assessee first and is then given away is not diverted, and is taxable in the hands of the assessee.
C. Position Under Income Tax Act
- Under the Income Tax Act, 1961, income of a partner from a firm is taxed under Section 28(v) as “Profits and gains of business or profession”.
- If a partner assigns or settles his share of profits after accrual, it is still taxable in his hands.
- The trust in this case, though created validly, receives income after accrual to the partner, which makes it application of income.
4. Possible Judgement
Based on the facts and the legal principles:
- The income in question (10% share of profit from the firm) accrued to A, and the assignment was a voluntary act.
- The settlement deed does not create an overriding title in favour of the trust before the income accrued.
- Therefore, the income was not diverted at source; it was only applied after accrual.
- Accordingly, the entire profit (including 10%) remains taxable in the hands of A, under Section 28(v) of the Income Tax Act.
