The Hindu Business Line : No joy in simply transferring assets

Income transferred to any entity without transferring the underlying asset remains the income of the transferor and must be assessed in his hands, as rightly provided by Section 60 of the Income-Tax Act, says H. P. Ranina.

WHEN YOU transfer income to a charitable trust, to an individual or to any entity without transferring the assets, the income may still be regarded as the income of the transferor and assessed in his hands, though it is applied in a particular manner under a legal obligation.

Section 60 of the Income-Tax Act provides that in all such cases the income should be assessed as the income of the transferor.

In C.I.T. v. Sunil J. Kinariwala (259 I.T.R. 10; SC), the assessee created a trust by a deed of settlement assigning half of his right, title and interest as a partner in the firm.

The Supreme Court drew a distinction between a case where a partner assigns his share in favour of a third person, and a case where a partner constitutes a sub-partnership, and held that in the former case there is no diversion of income by overriding title and the share of the income of the assessee assigned to the trust has to be clubbed with the income of the transferor.

The Supreme Court reiterated its earlier view in Murlidhar Himastingka v. C.I.T. (62 I.T.R. 323) that 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 partner concerned.

Thus, 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; it is a case of transfer of the asset of the firm itself to which Sections 60 and 63 have no application.

In short, retention of the property from which the income arises is an essential condition for the applicability of Section 60 (Banyan v. C.I.T.; 222 I.T.R. 831) and C.I.T. v. Manharlal (231 I.T.R. 89).

The Bombay High Court in C.I.T. v. M. D. Kanoria (137 I.T.R. 137) held that Section 63(b), defines the word `transfer' to include any settlement, trust, covenant, agreement or arrangement.

If any document of the nature mentioned in Clause (b) exists, it would be considered to be a transfer.

In Dalmia Cement Ltd. v. C.I.T. (237 I.T.R. 617), the Supreme Court held that Section 60 applies only to a case where income accrues to the transferee but the income-earning asset or source of income remains with the transferor.

Recently, the Madras High Court had occasion to consider this point in C.I.T. v. A. Radhakrishnan (2005; 144 Taxman 315).

The facts in this case are that the assessee was the owner of a building comprising residential rooms with other facilities.

He claimed that by a gift deed he gifted the income from the said mansion to an educational and charitable trust and, therefore, no part of the income from the said mansion was chargeable to tax in his hands.

However, the Assessing Officer referring to Section 60 brought to tax the said income.

On a reference, the High Court held that the principle laid down by the Supreme Court in the case of Dalmia Cement Ltd. was squarely applicable to the facts and circumstances of the instant case.

This was apparently because, apart from the fact of transfer of income to the educational and charitable trust, there existed an agreement in respect of the relevant assessment years in favour of the trust to manage the property in question.

It was authorised to receive the rent from that property and utilise the same for the purpose of the educational and charitable institution.

The revenue's contention that the agreement was only for ten years and that would not by itself constitute an absolute transfer was not accepted as there is no provision which requires an absolute transfer either under Section 60 or 63, which defines the word `transfer'.

Hence, the transfer was not hit by the provisions of Section 60, even though the property with which the lodging business was done had not been transferred by the assessee to the trust.

All income arising to any person by virtue of a transfer of assets (it may be settlement, trust, arrangement or any other kind of transfer) is deemed to be the income of the transferor and taxable in his hands:

if the transfer is revocable;

if it contains any provision for the direct or indirect retransfer of the whole or any part of the income or assets to the transferor; or

if in any way it gives the transferor a right to reassume power, directly or indirectly, over the whole or any part of the income or assets.

There is one case which forms an exception to the above rule embodied in Section 61.

That section does not apply to the case of income arising to any person by virtue of a transfer where all the following conditions concur:

the transfer should not contain any provision for the direct or indirect retransfer of the whole or any part of the income or assets to the transferor (Ramji v. C.I.T.; 13 I.T.R. 105; and C.I.T. v. Jitendra; 50 I.T.R. 313);

the transfer should not in any way give the transferor a right to reassume power, directly or indirectly, over the whole or any part of the income or assets (Subrumania v. A.G. ITO; 53 I.T.R. 764); and

the transferor should derive no direct or indirect benefit from the income.

Section 61 does not apply at all to income arising to any person by virtue of a transfer that fulfils all the above conditions.

But the Section would apply as and when the power to revoke arises to the transferor, though the power may not be actually exercised.

The wording of Sections 61 and 62 is sufficiently wide to exclude some part of the income arising under a settlement from the operation of section 61 while the rest of the income may fall within the purview of that section (Gulabbai v. C.I.T.; 69 I.T.R. 238).

Thus, income arising to one person under a settlement may be taxed as his income; while income arising to another person under the same settlement may be deemed to be the income, and taxed in the hands, of the settlor.

For the purposes of Section 63(a) a transfer, settlement, etc. is revocable, even if the power of revocation is not absolute or unqualified.

Likewise, a sale which provides for retransfer to the vendor in certain contingencies would still be revocable within the meaning of Section 63(a) (Tarunendra v. C.I.T.; 33 I.T.R. 492).

Again, it is not necessary that the power of revocation should be exercisable by the settlor himself.

Where a trust deed contained a provision to the effect that in certain circumstances a beneficiary would forfeit all interest in the trust properties and in such a case the interest forfeited would vest in the other beneficiaries.

And, further, the deed empowered the settlor to cancel the forfeiture and declare that such a beneficiary would continue to be entitled to his share.

It was held that the right to cancel the forfeiture was not a right to reassume power over the income or assets and did not make the trust revocable under Section 63(a).

Section 63(b) defines "transfer" in wide terms as including any settlement, trust, covenant, agreement or arrangement. In Kohiyar v. C.I.T. (51 I.T.R. 221) two settlors were held to have created by a single deed two separate trusts.

Sections 60 to 63 do not apply to dispositions not amounting to a transfer under the general law or as defined in this clause.

Surrender of a life interest has been held to be covered by the English statute which referred to "settlement or disposition" (I.R. v. Buchanan; 37 T.C. 365 (CA), 34 I.T.R. 173).

Such a surrender is a disposition but not a settlement and, therefore, it is not covered by this Clause.

The word "transfer" both in its ordinary meaning and extended meaning under Section 63(b) applies to a bilateral or multilateral act but not to a unilateral act like relinquishment or surrender.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)

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