[1992] 64 TAXMAN 131 (ART)

TAX LITERATURE/CLUBBING OF INCOME

UNDER WHAT HEAD OF INCOME IS THE INCOME TO BE CLUBBED/TAXED

R. Raghunathan
The author has raised an interesting issue in the context of sub-section (1A) introducedinsection64oftheIncome-taxAct, 1961, by the
Finance Act, 1992. The new provision relates to the clubbing of the minor children's income with the incomes of parents. The issue raised
is whether incomes to be clubbed should be assessed as incomes from 'other sources' or these should be taxed under the head to which
these relate. The consensus of judicial opinion on this issue had been that the incomes should first be computed under respective heads in
the minor's hand and thereafter only the taxable incomes computed in accordance with the provisions of the Act, not the gross income,
should only be taxed under the appropriate heads - EDITOR
Introduction
1. An important change has been introduced in the Income-tax Act, 1961 ('the Act') by the Finance Act, 1992, in the context of clubbing of
income. The scope of the clubbing provisions has been widened to bring within its net the income accruing or arising to the minor child
during a previous year. Sub-section (1A) has been incorporated in section 64 of the Act with effect from 1-4-1993 as a consequence of
which the income accruing or arising to a minor child will be included in the hands of a parent, except where the income has been earned
by the minor child on account of manual work, or on account of any activity involving the application of his skill, talent or specialized
knowledge and experience. The income of the minor child will be included—
(i)where the marriage of his parents subsists, in the income of that parent whose income, excluding the minor's income which is sought to
be clubbed, is greater; or
(ii)where the marriage of his parents does not subsist, in the income of that parent who maintains the minor child during the previous year
under consideration.
Issue for consideration
2. An important question in this context is the head of income under which the 'included' income is to be taxed. The problem can be
examined from two angles. One view could be that the 'included' income is always to be taxed under the head 'Income from other sources'.
The other view can be that the income to be tagged should be taxed under the same head under which it would have been subjected to tax in
the hands of the person who earned such income, had it no' been for the clubbing provisions. If the former view is correct, it may affect an
assessee in many ways. The deductions to be allowed from such income will be governed by section 57 of the Act. Provisions relating to
set-off and carry forward will have to be determined depending upon the head of income. Take an imaginary situation where during the
previous year relating to the assessment year 1993-94, a minor has earned rental income from a residential building and has paid interest on
borrowings for the construction of the said building, in excess of such rental income. If this income were to be included in the hands of
minor's parent under the head 'Income from other sources' the deductions of expenditure would be governed by sections 56 and 57 of the
Act only. The net result being loss, the set off in the same year and carry forward of unabsorbed loss, if any, will be governed by sections
70 and 71 of the Act. Assuming that there is some unabsorbed loss pertaining to this item, the same will not be allowed to be carried
forward. On the other hand, if the minor's income, which is to be clubbed in the hands of the parent, is to be also taxed under the head
'Income from house property', deductions envisaged by sections 23 and 24 of the Act will have to be granted. After considering the set-off
provisions under section 70 and sub-section (4) of section 71, if there is still some unabsorbed loss under this head, the same will have to be
carried forward subject to the newly introduced provisions of section 71 of the Act. As per this section, loss arising from the head 'Income
from house property', insofar as it relates to interest on borrowings utilised for construction, shall be carried forward to the subsequent
assessment year or years without any time limit and set-off against the income under the- same head. The importance of determining the
head of income under which the clubbed income has to be taxed is, thus, very relevant.
Judicial decisions
3. The Bombay High Court in Keval chand Nemchand Mehta v. CIT [1968] 67 ITR 804 held that the 'included' income is always to be
treated as 'Income from other sources' and taxed accordingly. The author respectfully submits that this decision does not appear to be
correct. All that the relevant clubbing provisions insist is that the income of the spouse, son's wife, minor child, etc., should be assessed in
the hands of the individual or the parent, instead of in the hands of the said spouse, son's wife, minor child, etc. One of the important
consequences of this principle is that the income of the vulnerable person should be clubbed in the hands of the individual under the same
head of income under which the said income would have been assessable if it had been taxed in the hands of the vulnerable person.
In this context, one can refer to the decision of the Mysore High Court in J.H. Gotla v. CIT [1973] 91 ITR 531 , subsequently affirmed by
the Supreme Court In CIT v. J.H. Gotla [1985] 156 ITR 3231. The Mysore High Court In the course of its judgment has referred to a
decision of the Supreme Court in CIT v. S.A.S. Marimuthu Nadar [1962] 44 ITR 1 . In this case, the question was whether the assessee
was entitled to regard the income of his minor sons included in his income under section 16(3) of the Indian Income-tax Act, 1922 as his
'earned income'. The minor sons had been admitted to the benefits of partnership in the same firm in which the assessee was also a partner.
The Supreme Court was of the emphatic view that such 'included' income is to be also construed as the assessee's 'earned' income. In J.H.
Gotla's case (supra), the facts were that an individual had brought forward business loss sustained in his own business. The individual's
wife who was a partner in a firm and the minor children who had been admitted to the benefits of partnership in the same firm derived
income from business. The share income of the wife and minor children was clubbed in the hands of the husband. (The husband continued
his old business on a small scale, during the concerned years also.) The question arose as to whether losses incurred by the assessee in his
business in the earlier years brought forward, can be set off against such income. The revenue contended that set-off is not possible, since
the share income of wife and minor children clubbed under section 16(3) of the 1922 Act (corresponding to section 64 of the 1961 Act)
would not tantamount to income from a 'business carried on by him' for the purpose of carry forward and set-off under section 24(2) of the
1922 Act (which corresponds to section 72 of the 1961 Act). The Supreme Court did not favour such a contention. The Supreme Court held
that the 'individual was entitled to set off the loss in his individual business incurred in the earlier years and carried forward against the
share income of the wife and minor children clubbed in his hands, since the share income had to be regarded as business income derived
from business carried on by the assessee. It may be noted in this context that the department itself did not object to the reasoning that the
share income of wife and minor children (to be included in the hands of the husband) should be regarded as 'income from business or
profession'; the objection was that such business income cannot be construed as income from 'business carried on by him'. If the objection
had been that such share income of wife and minor children should be taxed under the head "Income from other sources', there would have
been no further possibility of set off of brought forward business loss against 'Income from other sources'. Useful reference can also be
made to the decision of the Supreme Court in CIT v. P. Doraisamy Chetty [1990] 183 ITR 559. In this case, the Supreme Court held that
share income of the assessee's wife, a loss, which had to be clubbed in the hands of the assessee, can be set off against the assessee's
income, and if the resultant net figure is still a loss, the same can be carried forward, for set-off in the subsequent years as per the
provisions of the Act.
In S.M. A. Siddique v. CIT [1984] 148 ITR 3072 (Mad.), the basic facts of the case were thus: the assessee S, with the help of borrowings,
purchased a house property in the name of his wife and minor children. On account of the clubbing provisions of section 64, S included the
income arising to his wife and minor children from the said house, under the head 'Income from house property' and claimed the deduction
of interest paid on borrowings, under section 24. The revenue did not accept such claim for deduction. When the matter came up before the
High Court, the High Court observed thus:
"The question provoked a wide range of argument on both sides with profuse citation of case law. We, however, feel that the
discussion turns within a narrow compass, and on certain basic provisions of the Income-tax Act. Under section 64(1)(iv) and (v) of the
Act, what is to be included in the assessee's total income is 'income' from assets transferred by him to his spouse and minor children.
This provision is necessarily general in character. It applies to transfers of any and every kind of income-yielding assets. The assets
may be shares and securities; they may be other movables; or they may be items of immovables such as house property; what is to be
included in the transferor's total income is the income arising from the assets transferred, whatever the nature of the assets be. Under
the scheme of the Act, 'income' is classified,' for purposes of computation, under several heads, such as income from business, income
from securities, income from house property, and so on. Hence, for the purpose of applying section 64 of the Act, the income from the
transferred assets, which has to be included in the transferor's total income, will have to be computed according as the income to be so
included falls under one or the other of the (several) heads of income. For example, if the transferred assets are securities, then the
interest income derived from the transferred securities will have to be computed in accordance with the relevant provisions in sections
19 to 21 of the Act. In this case, the assets transferred by the assessee to his wife and minor children happened to be items of house
property. It follows, therefore, that in applying section 64(1)(iv) and ( v), the income from the house properties in question will have to
be arrived at by applying the computation provisions falling under the head, 'Income from house property'. . . ." (p. 309)
In R. Ganesan v. CIT [1965] 58 ITR 411 (Mad.), one Ganesan, being assessed to income-tax in the status of an individual, gave a gift to
his wife of Rs. 75,000 for constructing a house for herself. The Madras High Court held that the income from the house had to be included
in the assessee's total Income under section 16(3). The Court, however, observed that the measure of the income to be included would be
subject to the first proviso to section 9(2) of the 1922 Act. This proviso laid down that the income from house property in the occupation of
an owner shall, in no case, exceed 10 per cent of the owner's total income. In the 1922 Act, there was no provision comparable to section
27(i) of the 1961 Act. Nevertheless, the Court held that the income from property which is transferred to the assessee's wife or minor child
which has to be included in the assessee's total income cannot exceed 10 per cent of that total income. According to the learned Judges, the
limitation under the proviso to section 9(2) was a ceiling on the income from the house property which has been transferred to the wife or
minor child without adequate consideration. The Court held that this ceiling must be applied with reference to 10 per cent of the assessee's
total income, because it was in his total income that the said property income was to be included by the application of section 16(3). The
following passage from the Court's judgment contains the basis of their reasoning:
". . .We are unable to see how insofar as the assessment of the assessee is concerned or the computation of his total income by the
application of section 16(3) of the Act, requires, any higher income in respect of the property could be brought in, than what the law by
a particular mode of computation determines as the income from that property. Whether it is in the assessment of the owner of the
property or the assessment of the assessee in respect of the income from that property by reason of section 16(3) of the Act, the mode
of determination of the income from the property is equally applicable...." (p. 419)
Computation of the income to be included
4. It may be noted that the 'included' income should not only be taxed under the same head of income under which it would have been taxed
in the hands of the other person, had it not been tagged, but also that such income to be included should first be computed with reference to
the income of the vulnerable person and then tagged. Computation should not be with reference to the income of the individual in whose
hands the income of the vulnerable person is clubbed. It is respectfully submitted that the decision in R. Ganesan's case (supra) on this
point is not fully correct. In this regard, we may also refer to the decision of the Allahabad High Court in Addl CIT v. H.L. Gulati [1982]
138 ITR 6481. In this case, the assessee gifted a sum of Rs. 50,000 and also advanced a sum of Rs. 61,000 to his wife who utilised the same
for construction of a house. The house was self-occupied. It was not denied by G, the assessee, that a portion of the income of his wife from
the house property was to be clubbed [under section 64(iii), as the provisions then stood]. However, his contention was that the income
from such self-occupied house property had to be computed first as it belonged to his wife and then only the clubbing provisions should be
applied. At that time the proviso to section 23(2) stipulated that the annual value of a self-occupied house property should be restricted to
10 per cent of the assessee's gross total income. Since his wife did not have any other income, G contended that the limit of 10 per cent
should be worked out with reference to the other income of his wife and not with reference to his own other income. The other income of
his wife being nil, the annual value under section 23(2) would be nil: consequently, no income could be tagged under section 64 in the
hands of the assessee. The Allahabad High Court agreed with the aforesaid argument.

In CIT v . S.K. Nayak [1984] 145 ITR 791-------------------------

1. 23 Taxman 14J.
2. 17 Taxman 14.
1. 11 Taxman 167.
4. 18 Taxman 495 .