Judgment:
Ratnam, J.
1. The assessee, an individual, was a partner in the firm of Messrs. Premier Match Works, as per the terms of a deed of partnership dated April 1, 1974. Thereunder, the brother of the assessee, S. K. Pandia Nadar, the assessee, the two sons and daughter-in-law of S. K. Pandia Nadar, were the partners, having made their contributions to the capital in the sums of Rs. 9,000, Rs. 33,000, Rs. 6,000, Rs. 6,000 and Rs. 6,000, respectively. The share of profits of the firm payable to them under the terms of the deed of partnership was fixed at 15%, 55% and 10% each to the other three partners. On June 24, 1974, S. K. Pandia Nadar, one of the partners of Messrs. Premier Match Works and the brother of the assessee, executed a deed of trust constituting a trust of the name of Lalitha Trust and appointing S. S. Sankaralingam and Bhuvaneswari as trustees for the benefit of the two minor daughters. Shyamala and Sharmila, of the assessee through his first wife, Lalitha. A sum of Rs. 11,200 was paid by S. K. Pandia Nadar to the trustees with a direction that the net income from the trust fund and such other amounts as may form part of the trust should be enjoyed by the two beneficiaries, Shyamala and Sharmila, in equal shares. Subsequently, on October 1, 1974, there was a reconstitution of the firm, Messrs. Premier Match Works, in that Lalitha Trust, represented by the trustees, was taken in as a partner in the firm. As per the terms of the partnership deed dated October 1, 1974, the profit-sharing ratio was also refixed at 15% to S. K. Pandia Nadar, 35% to the assessee, 10% each to the two sons and daughter-in-law of S. K. Pandia Nadar and 20% to Lalitha Trust. Represented by its trustees. By this process, the share of profits of the assessee which was earlier 55% was reduced to 35% and, on a reallocation of the share of profits as per the deed of partnership dated October 1, 1974, Lalitha Trust became entitled to a share of 20% of the profits of the firm with no liability for losses. In the course of the assessment proceedings for the assessment years 1975-76 and 1976-77 relating to the assessee, it was found that the share or profits of the trust amounted to Rs. 33,566 and Rs. 36,274, respectively. The Income-tax Officer applied the Provisions of section 64 of the Income-tax Act, 1961 (hereinafter referred to as 'the Act'), on the conclusion that the minor daughters of the assessee had been admitted to the benefits of the partnership firm in which the assessee was a partner and that the trust was only an artificial cloak concealing the real owner and beneficiary of the income and there was a direct connection between the trust and the beneficiaries and clubbed the income of the minors with that of the assessee for both the assessment years. On appeal by the assessee, the Appellate Assistant Assistant Commissioner took the view that the minor children cannot be treated as having been admitted to the benefits of the partnership as found by the Income-tax Officer but that, by the application of clause (iv) for the assessment year 1975-76 and clause (v) for the assessment year 1976-77 of section 64(1) of the Act, there was a transfer by the assessee to the trustees of lalitha Trust, of the assessee's right to share in the profits of the firm, Messrs. Premier Match Works, without consideration and that would constitute a direct transfer resulting in the arising of income from the transferred assets for the benefit of the minor children of the transferor, i.e., the assessee. In the result, the Appellate Assistant Commissioner upheld the clubbing, applying section 64 of the Act. On further appeal by the assessee to the Tribunal, it found that the creation of Lalitha Trust was not by the assessee, but by the brother of the assessee, S. K. Pandia Nadar, another partner of the firm, and the assessee had not transferred any of his assets either directly or indirectly to the Lalitha Trust so as to attract the application of section 64 of the Act justifying the clubbing of the income of the trust with the share income of the assessee in the firm of Messrs. Premier Match Works. Ultimately, the Tribunal deleted the addition of the share income of Lalitha Trust in the assessment of the assess for the two assessment years in question. That is how the following common question of law, as reframed, under section 256(1) of the Act, at the instance of the Revenue, has been referred to this court for its opinion :
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the sum of Rs. 33,566 and the sum of Rs. 36,274 being the share income belonging to the minor daughters of the assessee should not be clubbed in the hands of the assessee for the assessment years 1975-76 and 1976-77, respectively, under section 64(1)(iv)/64(1)(v) of the Income-tax Act. 1961 ?'
2. Learned counsel for the Revenue contended that the right of a partner to a share in the profits of a firm is property capable of transfer and a redistribution of the share of profits between one partner and other partners would involve a transfer of that right leading to a diminution in the interest of a partner and, at the same time, correspondingly increasing the share of the other partners and that was tantamount to a transfer by the assessee of assets, either directly or indirectly, in favour of the minor children of the assessee otherwise than for adequate consideration, justifying the clubbing of the income of the minors with that of the assessee. Strong reliance in this connection was also placed upon the decision reported in CGT v. V. A.M. Ayyar Nadar : [1969]73ITR761(Mad) . On the other hand, learned counsel for the assessee submitted that a consideration of the mechanics of the transfer involved would disclose that there was no transfer of assets either directly or indirectly by the assessee to his minor children and, in the absence of a nexus between the transfer of the asset by the assessee and the arising of income to the minors, the provisions of section 64 of the Act cannot be applied. It was also further submitted that a redistribution of the profit-sharing proportion was brought about by the event of the agreement between the partners on October 1, 1974, reconstituting the firm and that cannot be attributed to any act of transfer either directly or indirectly on the part of the assessee without consideration. Attention was drawn by learned counsel in support of this to the decisions in CIT v. Prem Bhai Parekh : [1970]77ITR27(SC) , CGT v. Ali Hussain M. Jeevaji : [1980]123ITR420(Mad) and CIT v. Prahladrai Agarwala : [1989]177ITR398(SC) . Reference was also made to Circular No. 204, dated July 24, 1976 - [1977] 110 ITR 21 explaining the scope of clauses (iv) and (v) of the amended sub-section (1) of section 64 of the Act.
3. Section 64 of the Act creates an artificial income and liability to tax and the inclusion of the income of one in that of another stems from a transfer or assets by the individual without consideration to the spouse or minor children or for their benefit and unless the case falls squarely within the provisions of section 64(1)(iv) and (v) of the Act, no clubbing is possible. It is also well-established the assets and the arising of income and in its absence clubbing is not permissible and section 64 should receive a strict construction. In this case, the brother of the assessee, S. K. Pandia Nadar, created Lalitha Trust by the execution of a deed of trust and making available to the trustees a sum of Rs. 11,200 towards the corpus of the trust. Neither the creation of the trust nor the contribution of Rs. 11,200 to it by S. K. Pandia Nadar can, in any manner, be attributed to the assessee or any act on his part. In other words, the assessee has not transferred any asset in favour of his minor children or for their benefit without consideration. The requirement of a direct transfer of assets by the assessee to his minor children or for their benefit is, therefore, absent. Whether there was an indirect transfer by the assessee of assets in favour of his minor children or for their benefit may now be considered. Under the deed of partnership dated April 1, 1974, the share of profits of the assessee was 55% and that share had been reduced to 35% under the terms of the partnership deed dated October 1, 1974, reconstituting the firm taking in Lalitha Trust as a partner and making available to it a 20% share in the profits of the firm. We gather from the order of the Income-tax officer that the object of the trust was to invest the sum of Rs. 11,200 belonging to the trust for purposes of yielding income and the trustees were, therefore, at liberty to invest that amount in whatever manner they liked to secure the objects of the trust and the trustees invested the amount as capital contribution of the trust in the firm in order to enable the firm to admit the trust as a partner in the firm. Viewed thus, the reduction in the share of profits of the assessee from 55% to 35% is not relatable to any act of transfer on the part of the assessee, for, there is no transfer as such by the assessee of 20% share of the profits in favour of Lalitha Trust. It is in this connection that it has to be borne in mind that the reduction in the share of profits from 55% to 35% can at best be attributed to an act of the firm at the time when Lalitha Trust was taken in as a partner in consideration of the capital contribution made by it and not the assessee. Even assuming that the assessee had relinquished his interest in his share of profits to the extent of 20%, that would at best be a surrender in favour of the firm and not in favour of minor children of the assessee and, at the time of the reconstitution of the firm, in consideration of the capital furnished by the trust for becoming partner in the firm, the trust had been allotted 20% share of the profits. Looked at from the point of view of the requirements of section 64 of the Act, there is, in this case, no transfer of assets by the assessee in favour of his minor children or for their benefit either directly or even indirectly.
4. We may now make a brief reference to the decision to which our attention was drawn. CGT v. V. A.M. Ayya Nadar [1969] 73 ITR 71, considered the nature of distribution of profits by way of realignment for purposes of deemed gift under section 4 of the Gift-tax Act. Considering the wide scope of the definition of 'gift' as including any transaction entered into by any person with intent thereby to diminish directly or indirectly the value of his own property and to increase the value of the property of any other person, it was held that the diminution in the share of profits of one partner and the corresponding increase in the value of quantum of shares of another partner would involve a transfer of property amounting to a gift chargeable to tax. That decision has to be understood as having been rendered with reference to the provisions of the Gift-tax Act relating to deemed gifts and, in the absence of a similar provision in the Act, the principle of that decision cannot, in our view, be applied. We may also point out that section 63 of the Act occurring in Chapter V defining 'transfer' for purposes of sections 60, 61 and 62 of the Act is not wide enough as that found in the Gift-tax Act nor has that been made applicable to section 64 of the Act. Though, under section 2(47) of the Act, a 'transfer' would include the extinguishment of rights, it had earlier been pointed out that the extinguishment in this case was not at the instance of the assessee in favour of the minor children or for their benefit. Therefore, the reliance placed upon the decision in CGT v. V. A.M. Ayya Nadar : [1969]73ITR761(Mad) does not, in any manner, assist the Revenue. CIT v. Prem Bhai Parekh : [1970]77ITR27(SC) , relied on the learned counsel for the assessee, lays down, though with reference to section 16(3)(a)(iv) of the Indian Income-tax Act, 1922, that, before an income can be held to come within the ambit of section 16(3)(a)(iii) or (iv) of the Indian Income-tax Act, 1922, it must be proved to have arisen directly or indirectly from a transfer of assets made by the assessee in favour of his wife or minor children and the connection between the transfer of assets and the income must be proximate and the income must arise as a result of the transfer and not in some manner connected with it. Further, on the facts of that case, it was held that the connection between the gifts made by the assessee and the income of the minors from the firm was a remote one and it could not be said that the income arise directly or indirectly from the transfer of the assets and the income arising to the minor sons of the assessee by virtue of their admission to the benefits of partnership in the firm could not be included in the total Income of the assessee. This decision emphasises the need for a nexus between the transfer of assets and the arising of income and it would not be sufficient for the application of section 64 of the Act that some remote connection is either made out or found. What we find in this case is that there is no nexus whatever between the so called transfer of assets and the arising of income to the minor children of the assessee. Earlier, we had pointed out that there was no transfer at all, either directly or indirectly and there is, therefore, no question of any nexus between the transfer which had not taken place and the arising of income to the minor children. Even as regards the reduction in the share of profits of the assessee from 55% to 35% such reduction may, at best, be stated to be in some remote manner connected with the minor children of the assessee, in that, as a result of the admission of Lalitha Trust as a partner in the firm, on the trust contributing the capital, the 20% of the share of profits had been made available to it, but that result had not been brought about owing to the transfer of assets by the assessee and the connection between the transfer of assets and the income, on the facts of this case, is not proximate. We may now refer to circular No. 204, dated July 24, 1976, explaining the scope of the amended provisions in clauses (iv) and (v) of sub-section (1) of section 64 of the Act [1977] 110 ITR 21. It is seen that Explanation 3 had been inserted for purposes of clauses (iv) and (v). Where the assets transferred by an individual to his spouse or minor child, without adequate consideration, are invested by the spouse or minor child in a business to then 'such part of the income arising form the said business to the spouse or minor child as is proportionate to the portion of investment representing assets transferred by the individual without adequate consideration, will be included in the assessment of the individual. The Explanation was intended to get over the decision of the Supreme Court in CIT v. Prem Bhai Parekh 3 cannot be applied, for, as found earlier, there has been no transfer of assets by the assessee to his minor children and there is no investment of those assets by the minor children in a business. The investment in this case is towards the capital contribution and that to by the trust and not by the minor children, though it may be that the trust was for the benefit of the minor children. Thus, Explanation 3 would not, in any manner, affect the position in this case with reference to the requirements regarding the clubbing as laid down in CIT v. Prem Bhai Parakh : [1970]77ITR27(SC) . We may now refer to CGT v. Ali Hussain M. Jeevaji : [1980]123ITR420(Mad) . There also the question that arose was whether the relinquishment of shares by the two partners would constitute gifts liable to tax under the Gift-tax Act. It was found that there was a transfer by the two partners in the firm to their sons for consideration and the consideration consisted of accumulation of the share of profits till such accumulation amounted to Rs. 20,000 which should be treated as capital brought in by the two incoming partners. It was held that contribution of capital, rendering of service, sharing in future liabilities and losses would all constitute consideration for the admission of new partners into the firm. On the principle of this decision, even on the assumption that the assessee had indirectly transferred his share of profits to the extent of 20% in favour of Lalitha Trust and for the benefit of his minor children, it was for consideration in the shape of capital contribution by the trust and that would, therefore, negative the applicability of section 64 of the Act. Again, in CIT v. Prahladrai Agarwala : [1989]177ITR398(SC) , the Supreme Court had occasion to consider the scope of section 64(1)(iii) of the Act. There. The assessee made a gift to his wife and mother who became partners in a firm in which the other partners were the assessee's grand-father, his brother and a stranger. The wife contributed the amounts received by gift as capital to the firm and the question arose as to whether the share of profits of the wife in the firm could be included in the total income of the assessee under section 64(1)(iii) of the Act. The High Court held that the share of profits arose to the wife of the assessee because of the profits made by the firm and, although it might have had connection with the gifts, it did not arise as a result of the gift but the income arose because the other partners agreed to take the wife of the assessee as a partner and she was allowed to contribute to the firm and the admission of the wife of the assessee was not in consequence of the gifts and that, therefore, the connection between the share of profits and the gifts by the assessee to his wife was to remote to justify the application of section 64(1)(iii) of the Act. The Supreme Court pointed out that the wife of the assessee became a partner because of her capital contribution, but it was upon agreement by the remaining partners that she became a member of the partnership and the mere contribution of the capital would not automatically entitle her to be a partner in the firm and it was only the event of agreement that brought the assessee's wife into the firm as a partner. We are of the view that the same principle would be appllicable in this case, for, it is not the reduction in the share of profits of the assessee from 55% to 35% that brought Lalitha Trust as a partner, but it was upon a agreement by the partners that the trust should become a member of the firm and it was that agreement that made the trust a partner of the firm and not any transfer, directly or indirectly, by the assessee of his assets to the minor children or for their benefit. We, therefore, hold that the Tribunal was quite right in deleting the addition of the share income of Lalitha Trust from the assessment of the assessee for the assessment years in question. We answer the question referred to us in the affirmative and against the Revenue. The assessee will be entitled to the costs of this reference. Counsel's fee one set, Rs. 500.