[1983] 15 TAXMANN 116 (ART)

MINU AGARWAL
Judicial technicality and efficacy of clubbing provisions
Clubbing provisions, a peculiar feature of the Income-tax Act. were
incorporated, substantially, with a view to foil the attempts of tax avoidance.
The whole scheme of relevant statutory provisions shows the legislative
anxiety to plug loopholes even by interfering into the private affairs of an
individual. Although the judiciary, in a good number of cases, has well
responded in furthering the avowed statutory objective, but in another line of
cases, the judicial policy of going through the letters of law in interpreting
such provisions has frustrated the very object of the clubbing provisions. The
judicially evolved doctrines, like 'proximate connection' and 'subsistence of
marital relationship', etc., have opened the flood-gates for tax avoidance.
The article is an attempt to pinpoint such judicial technicalities which have,
to a considerable extent, reduced the efficacy of the clubbing provisions—
EDITOR

Perspective
1. One of the peculiar features of the law relating to income-tax is that the tax is imposed not only in respect of the income of
the assessee alone but also in respect of the income accruing or arising to certain other persons as well. Such provisions were
necessitated to control or nullify the attempts on the part of certain assessees to diversify their income by adopting income-
splitting devices as an instrument of tax avoidance. The circumstances entailing the clubbing of income are as follows:
a.transfer of income without transfer of assets [section 60];
b.income from revocable transfers [sections 61-63];
c.income from assets transferred to certain specified intimate members of family [clauses (iv ), (v), (vi) and (vii) of section
64(1)];
d.share income of spouse and minor child from the membership of a firm in which the assessee is also a partner [clauses ( i),
(ii) and (iii) of section 64(1)];
e.act of blending [section 64(2)].
Judicial response to clubbing provisions
2. These statutory provisions relating to clubbing of income reveals the legislative anxiety to plug loopholes even by
interfering into the private affairs of an individual. However, the judicial response towards the avowed statutory objective of
the clubbing provisions has not been very admirable. Although in a good number of cases the Courts have responded well in
complete tuning with the aforesaid objective of the clubbing provisions, but in another line of cases, the Courts have
responded negatively in the sense that in these cases the Courts seem to have followed the principle of strict literal
interpretation of the relevant provision. In support of its policy of going through the letters of law, the Supreme Court itself
has, repeatedly, remarked that "Section 16(3) of the 1922 Act creates an artificial income and must be construed strictly"—
see Philip John Flasket Thomas v. CIT [1963] 49 ITR 97 (SC), CIT v. Keshavlal Lallubhai Patel [1965] 55 ITR 637 (SC),
CIT v. Prem Bhai Parekh [1970] 77 ITR 227 (SC) and Smt. Mohini Thapar v. CIT [1972] 83 ITR 208 (SC). Apparently, such
a judicial approach is just and fair but, sometimes, it has led even the Supreme Court to evolve such technical doctrines
which have defeated the very object of the clubbing provisions.
Doctrine of proximate connection between income and assets transferred
3. The doctrine of 'proximate connection' as evolved by the Supreme Court in Prem Bhai Parekh's case (supra) has rendered
the word 'indirectly' occurring in the phrase "income as arises directly or indirectly" as redundant. The doctrine, undoubtedly,
appears to be sustainable where there is considerable lapse of time, say eight years, between the making of the gift or the
transfer, and any gain arising there from. For example, in CIT v. Smt. Pelleti Sridevamma [1976] 105 ITR 887 (AP), a
house was purchased out of gifted amount. After eight years, the same house was sold. The Andhra Pradesh High Court has
rightly held that the capital gains arising from the sale of such house property was not includible in the income of the donor-
assessee as there was no proximate connection between the gift and the capital gains in question.
But in clear cut cases the indulgence to the doctrine of 'proximate connection' frustrates the very purpose of the statutory
provision. In Prem Bhai Parekh's case (supra) on the retirement of the assessee from a firm, his three minor sons were
admitted to the benefits of the firm. All the three sons invested their capital in the firm out of the cash gifts made by their
father. On these facts, the Supreme Court came to the conclusion that the share income of the minor sons was not includible
in the assessee-father's income as "the connection between the gifts and the income was a remote one'. The reason put forth
by the Court was that the "income of the minors arose as a result of their admission to the benefits of the partnership".
In view of Mr. Justice Hegde, who spoke for the Court, for attracting clubbing provisions, "The connection between the
transfer of assets and the income must be proximate. The income in question must arise as a result of the transfer and not in
some manner connected with it."
It is interesting to note that Mr. Justice Hegde himself, in a subsequent case of Smt. Mohini Thapar ( supra), paid due regard
to the word 'indirectly' while allowing the clubbing of income as income indirectly arising from the assets transferred.
In Smt. Mohini Thapar's case (supra), the donee-wife purchased certain shares out of gifted amount and the balance was
invested in banks. On the question of includibility of dividend and interest income, the Supreme Court held that as there was
a proximate connection between the gift and the impugned income, they were assessable in the hands of the donor-husband.
Rejecting the contention that section 16(3)( a)(iii) of the 1922 Act was attracted only in cases of income directly springing
from the assets transferred, Mr. Justice Hegde pointed out, "Otherwise the expression 'as arises directly or indirectly' in
section 16(3)(a) would become redundant."
Accordingly, the Supreme Court came to the conclusion that "The net cast by section 16(3)(a)( iii) includes not merely the
income that arises directly from the assets transferred but also that arises indirectly from the assets transferred."
In this context, the recent pronouncement of the Supreme Court in Y.L. Agarwalla v. CIT [1978] 114 ITR 471 is worthy to
mention. Although the case was relating to the determination of status but the facts were substantially the same as those of
Prem Bhai Parekh's case (supra) .
In Y.L. Agarwalla's case (supra) on the death of karta, his three minor sons were admitted to the benefits of the firm. It was
agreed that the firm shall continue to use the capital of HUF, free of interest. The Supreme Court has rightly held that the
share income of the minors was that of HUF as the quid pro quo for admitting the minors to the firm's benefits was the
continued and interest free use of the capital lying in deceased karta's account for the firm.
Now, if we apply the same approach in Prem Bhai Parekh's case (supra) , the final outcome would certainly be otherwise
because in that case the minor sons had invested their share capital in the firm out of the cash gifts made by their father. It is
regrettable that the Supreme Court missed this very fact and decided the case on the basis of a highly technical doctrine of
'proximate connection' which has further complicated the law relating to the clubbing of income.
Accretions to transferred asset - Not includible
4. A case analysis reveals that the Courts have, surprisingly, opined that any accretion to the transferred asset could not be
regarded as assets transferred thereby rendering the inclusion of income from indirect transfer in the various clauses of
section 64(1) as meaningless. The starting point of such a judicial error is the decision of the Bombay High Court in a quite
old case of Popatlal Bhikamchand v. CIT [1959] 36 ITR 577, wherein certain shares were transferred to the son. It was held
that the bonus shares would not constitute 'assets transferred' to the son but would be accretions to the assets transferred, i.e.,
shares; hence, dividend on such bonus shares could not be clubbed with the assessee-father's income. Similarly, interest on
accumulated share profits in a partnership has been held not to be includible in the income of the respective transferor-
assessee—see, for example, CIT v. Chandanmal Kasturchand [1978] 112 ITR 296 (Bom.) and Bhaichand Jivraj Muchhala
v. CIT [1916] 102 ITR 385 (Bom.).
The correct judicial approach, it is submitted, would be to treat any accretion to the transferred asset as an indirect transfer by
the transferor-assessee to the transferee. Such an approach would be in consonance with the spirit of the clubbing provisions.
Time of accrual
5. Income is clubbed not only on the basis of receipt, actual or constructive, but also on the accrual. The determination of
time of accrual of income, especially in cases of share income of partnership, has visibly misdirected the Courts towards the
technical aspects of the legal provisions thereby frustrating the very object of clubbing provisions.
In a series of cases, the Courts have unanimously held that unless the profits and loss of the firm are ascertained at the end of
the relevant accounting year, no income can be said to have arisen, directly or indirectly, to any of the partners. Even if a
person ceases to be a partner, whether due to death, retirement or otherwise, in the mid-way, the Courts have disallowed the
apportionment of income attributable up to that time when such person was a partner of the firm. Needless to say that such a
technical judicial approach permitted a chunk of otherwise taxable share-income to go scot-free.
The case of Bhogilal Laherchand v. CIT [1955] 28 ITR 919 (Bom.) appears to be the starting point of such a judicial view.
In this case, the assessee-father formed a partnership with his sons, some of whom were minors. One of the minors attained
majority and elected to continue as a partner. After three days that son died. The accounts of the firm had to be adjusted on
the Diwali day of every year. The revenue sought to club with the father's income, the amount attributable till the date when
the deceased was a minor.
The Bombay High Court has, unfortunately, held that no income could be said to have arisen to the deceased son as prior to
the ascertainment of profit and loss of the firm on the Diwali day, it was impossible to predict whether the firm had made any
profit or it had incurred any loss. The Court had further pointed out that as the right to receive the share profit arose on the
death of the partner-son who then became a major, the share profit could not be treated as income which arose directly or
indirectly to the deceased during his minority so as to make it liable to be included in the income of his father. Chagla, CJ.,
rejecting the plea for apportionment between the profits earned till the date of minority of the deceased and the profits earned
subsequently, remarked: "We refuse to countenance the attempt on the part of the department to add a second fiction to the
fiction contained in section 16(3) which is sufficiently burdensome upon the assessee." (p. 926)
The aforesaid view of the Bombay High Court was adopted, in toto, by the Supreme Court in CIT v. Ashokbhai Chimanbhai
[1965] 56 ITR 42 . In this case, the assessee, in the capacity of karta, was a partner in a firm. Before the end of the financial
year of the firm, the partition took place, as a result of which the assessee became the full-fledged owner of the share income
of the partnership. On the question of assessability of share income in the hands of the joint family, the Supreme Court held
that the share income arose to the assessee and not to the joint family as, on the date of settlement of the accounts of the firm,
the family had no right in the share income. The Court also ruled out the possibility of apportionment of income between the
joint family and the assessee as the income accrued to the assessee in his individual capacity.
It is, however, submitted that there seems to be no logic for rejecting the plea for apportionment of income in such cases.
Clubbing provisions are in fact, related to day-to-day transactions which invite a more pragmatic and rational judicial
approach. In both the aforesaid cases, the Courts have failed to realise the net effect of their finding which had defeated the
very purpose of the relevant clubbing provisions. Had the Courts allowed apportionment of income, a chunk of chargeable
income would have rightly come within the tax-net.
Doctrine of subsistence of marital relationship
6. The word 'spouse' as appeared in section 64 of the 1961 Act and its corresponding word 'wife' under section 16(3) of the
1922 Act have received a very technical interpretation which has, to a considerable extent, reduced the impact of the relevant
statutory provisions. The Courts have expressed the view that the word spouse or wife 'predicates marital relationship'
between the transferor and the transferee. Therefore, to attract the application of clubbing provisions, it has been held that it is
necessary that the relationship of husband and wife must subsist not only at the time when income accrues or arises but also
when the transfer of assets is made. The net result of the aforesaid judicial attitude is that neither a prospective wife/husband
nor a widow is covered by the expression 'spouse' or 'wife', hence any income arising to them is outside the sphere of
clubbing provisions.
The tax-free status of the aforesaid income has, in fact, been evolved through the Supreme Court's decision in Philip John
Plasket’s case (supra).
In this case, certain shares of a company were transferred by the assessee to his prospective wife, just three days before the
marriage. The transfer was made in consideration of the marriage itself. The Supreme Court adopting a very technical stand
to the problem, held that the dividend income from such shares was not includible in the income of the transferor assessee as
the transferee was not the wife of the assessee when shares were transferred. Mr. Justice Das, who spoke for the Court, after a
careful consideration of section 16(3)(a)(iii ) of the 1922 Act, came to the conclusion:
".....it seems clear enough that the relationship of husband and wife must also subsist when the transfer of assets is made
in order to fulfil the condition that the transfer is directly or indirectly to the wife by the husband." (p. 103)
It is, however, regrettable that the Supreme Court in the case of Philip John Plasket Thomas (supra) had failed to appreciate
the very relevant fact that the assets, i.e., the shares were transferred in consideration of the forthcoming marriage and that
though the shares were transferred to the prospective wife, the income there from was arising to the legally married wife.
Such income, as a matter of fact, is sought to be taxed under the Income-tax Act through the provisions relating to the
clubbing of income. If the income fulfils the condition laid down in the relevant provision, there seems to be no justification
for allowing it to go scot-free merely on the ground of certain technicalities. In this context, it is significant to note that Mr.
Justice P.B. Mukherjee of the Calcutta High Court had adopted the right approach while deciding the case of P.J.P. Thomas v.
CIT [1962] 44 ITR 897 . In this case, on reference, the learned Judge expressed the view that the words 'husband' and 'wife'
as appearing in section 16(3)( a)(iii) of 1922 Act must mean 'legal husband and legal wife'. His Lordship had further ruled
out the notion that the relevant statutory provision itself lays down the circumstances under which a transfer would attract the
application of the clubbing provision:
". . .The section does not limit any particular time as to when the transfer of assets in section 16(3)( a)(iii ) of the Act
should take place. The word 'transferred' in that section leaves it unqualified as to the time of the transfer. The
qualifications of the word 'transferred' that appear expressly on the statute are 'directly or indirectly' and 'to the wife by
the husband'. . . ." (p. 904).
Accordingly, Mukharji, J., paying due regard to the opening words of section 16(3) of the 1922 Act, came to the conclusion:
". . .the relevant time of the relationship between husband and wife which has to be considered by the taxing authorities
is the time of computing of the total income of the individual for the purpose of assessment. ..." (p. 904)
This approach of the Calcutta High Court, however, failed to get approval by the Supreme Court in appeal in Philip John
Plasket's case (supra).
Repercussions of Supreme Court's view in various cases
7. The repercussion of the Supreme Court's view in the foregoing cases of Ashokbhai Chimanbhai ( supra) and Philip John
Plasket ( supra) has well sounded in a subsequent decision of the Gujarat High Court in Vinodkumar Ratilal v. CIT [1975]
100 ITR 564 . In this case, the assessee and his wife were partners in two firms in which their minor sons were also admitted
to the benefits thereof. The assessee died three months prior to the end of the accounting year of the firms. The Gujarat High
Court, on the authority of the above-mentioned cases, held that the share income of the wife, then a widow, was not
includible in the total income of her deceased husband as the 'marital relationship was snapped' or she ceased to be the wife
when the right to receive share income accrued to her. With regard to the share income of minors, it was pointed out that as
the minor children did not cease to be the children of the assessee on his death and since the relationship could not be said to
have come to an end by reason of the death, therefore, their share income was liable to be included in the total income of the
deceased-assessee.
It is, however, submitted that had the Court allowed the apportionment of income between the two relevant time, it would
have saved the Court from giving such an unusual finding.
Judicial technicalities
8. The case of CIT v. Jwalaprasad Agarwala [1967] 66 ITR 154 (SC) itself is an example of judicial technicality. In this
case, the assessee-father made cash gifts to his minor child who invested it as his capital in a firm and was admitted to the
benefits thereof. According to the partnership deed, it was not obligatory for any of the partners to contribute capital. The
minor was also admitted to the benefits of the two financially allied firms of the previous firm. It was a significant point that
although the assessee was not a partner in any of the three firms but he had taken active interest in the business of the firms.
Further, it was remarkable that the name of the firms contained the assessee's name. Nevertheless, the Supreme Court held
that the share income of the minor from all the three firms was not liable to be clubbed with that of the father-assessee as in
the absence of any evidence on record, it could not be said that the income arose directly or indirectly from the gift made to
the minor.
The Supreme Court, however, missed the relevant points which the Tribunal had noticed. In the first place,' the investment of
gifted amount was the sole cause for the admission of minor to the benefits of the firm. Further, the three firms were
financially inter-connected, that is why the minor was automatically admitted to the benefits of other two firms.
The recent pronouncements of the Punjab and Haryana High Court in CIT v. Daljit Singh [1981] 131 ITR 719 and the
Bombay High Court in CIT v. N.K. Pandya [1982] 138 ITR 360 , respectively, furnish the instances of lack of judicial
pragmatism in deciding cases relating to clubbing of income.
In Daljit Singh's case (supra), the assessee made certain cash gifts amounting to Rs. 50,000 to his brothers' wives and their
minor children. These gifts were made from January 6, 1968 to September 30, 1971. The brothers also made cash gifts of Rs.
30,000 to the assessee's wife from December 25, 1967 to March 21, 1970. The amount of gift was credited in her account in
firm in which all the brothers except the assessee were partners. The revenue sought to include the share and interest income
of the wife in the total income of the assessee-husband. The High Court, however, held that section 64(1) had not been
attracted as neither there was any gift or transfer of asset by the assessee to his wife nor was the assessee a partner in the firm
from which his wife's income was derived.
It is submitted that the facts of the case show that the whole transaction was in the form of cross-gifts. The relevant dates of
gifts clearly showed that there was no considerable lapse of time in making the various gifts. Further, the unequal amount of
gifts may be said to be a part of tax planning as the difference of Rs. 20,000 had well been covered by the huge interest which
the assessee's wife had earned on her credit account. Thus, in the light of the foregoing relevant points, it is submitted that in
Daljit Singh's case (supra) the interest and share income of the assessee's wife should be clubbed with that of the assessee.
The facts of N.K. Pandya's case (supra) are similar to those of Daljit Singh's case (supra). This is again a case concerning
cross-gifts. In this case, the assessee made cash gifts to his brother's wife and brother made gifts to the assessee's wife. The
amount of gift which was transferred to the assessee's wife was deposited in a firm in which the assessee was not a partner.
On these facts, the Bombay High Court has held that the share income of the assessee's wife was not includible in the total
income of the assessee as he was not the partner in the firm from which the income was arising to his wife. It is, however,
unconvincing that when the case was clearly covered by section 64(1)(iv), why the Court had insisted on examining it only
under clause (i) to section 64(1) of the Act? Had the Bombay High Court considered the case in the light of clause (iv) to
section 64(1), i.e., income arising from transfer of asset by the individual to his/her spouse, the case would have been beyond
any criticism.
Before concluding the subject-matter, it should be noticed here that despite the elaborate clubbing provisions, the above
discussed three cases of Jwala Prasad Agarwala, Daljit Singh and N.K. Pandya (supra) themselves show an infirmity in the
relevant statutory provision. At present, the share income of spouse and minor child can be clubbed with the income of an
individual-assessee only if he/she happens to be a partner in the same firm. But, in all the aforesaid three cases, the respective
assessees were not a partner in the firm wherefrom the impugned income arose to the minor child or the wife. It is, therefore,
submitted that clauses (i) and (iii) of section 64(1) be suitably amended to remove the above-mentioned infirmity, if possible
at all. Alternatively, the better course for the administrative authority would be not to invoke these clauses in such kind of
cases. Instead, clauses (iv) and (v) of section 64(1) should be applied to deal with such cases.
Conclusion - Need for a more pragmatic approach
9. A perusal of the relevant cases revealing the negative judicial response shows that the whole state of affairs is due to the
judicial indulgence for going through the letters of law rather than the substance of law. Such approach, no doubt, might be
justifiable for interpreting provisions imposing artificial liability but at the same time the object sought to be achieved should
not be disregarded. The clubbing provisions, indisputably, deal with the affairs of personal character and, therefore, they
should be given a more pragmatic treatment which would certainly produce favourable results in consonance with the object
of the clubbing provisions.
116Focus Vol.15 - Sec.IVTAXMANNovember, 1983