P L D 1967 Karachi 662 (PLP)

WAHIDUDDIN AHMED, J.-In this reference under section 66(1) of the Income-tax Act, 1922 the following questions: (I) Whether having regard to the partnership agreement the assessee (each partner) is entitled in his personal assessment to a deduction of his proportionate share in respect of the sum of Rs. 25,337 paid to Mrs. McLaren, widow of the deceased partner ? (2) Whether on the facts and in the circumstances of the case, the assessee (the firm) is entitled to a deduction of Rs. 25,337 paid to Mrs. McLaren by virtue of the provisions of the partnership deed and the Supplementary deeds"" have been referred to this Court for its opinion. The facts which give rise to this, reference are that for the assessment year 1959-60 the Income-tax Officer while assessing the income of the firm refused to exclude the sum of Rs. 25,337 paid to Mrs. McLaren, widow of the deceased partner Mr. McLaren which was claimed as an expenditure under section 10(2)(xvi) of the aforesaid Act. this amount was payable to the widow of the deceased partner in terms of clause 15(c) of the agreement dated 31st October 1952, which provided as under "(c) Death of a partner.--There shall be payable to his widow or if he leaves no widow surviving him, to his executors and administrators, the sum of 1,900 per annum for a period of five years from the date of his death, if at the date of his death he was an Active Partner, or for the remainder, if any of a period of five years from the date on which he became a Sleeping Partner, if at the date of his death he was a Sleeping Partner." At this stage it may be mentioned that in April, 1953 the partners executed another deed and its clause 22 provided as under:- Clause 22 of the Agreement dated 29th April 1953 "Upon the taking of any other partner into the firm it shall be made a condition that such other partner shall agree to join in the liability for all payments to be made under . . . . Clause 15 of the Partnership Agreement." It is also not disputed that the assessee's firm continued to be bound by the above-mentioned terms under the Partnership Agreement operative in the relevant assessment year.

2. The firm originally consisted of three partners, namely, Messrs R. G. Chapman, J. P. Bray and Mr. A. McLaren. Later on some more partners joined the assessee's firm on the basis of the above-mentioned terms. During the period under con sideration there were five partners of the firm, namely, Mr. R. G. Chapman, Mr. J. P. Bray, Mr. J. P. Patel, Mr. M. J. McNulty and Mr. Bhaimia. The case of the fifth partner is not before us as he did not challenge the assessment order before the Income-tax Appellate Tribunal. On 8th May 1957, Mr. MCLaren died. After his death his widow Mrs. McLaren was paid a sum of Rs. 25,337 in consequence of the legal commitment by the assessee's firm under the terms of the various agreements of the partnership. The assessee's firm sought to claim ex clusion of this amount from the income of the firm under section 10(2)(xvi) of the Income-tax Act. The Income-tax Officer by order dated 9th January 1961 rejected this claim on the ground that the payment appeared to be more in the nature of help or discharge of moral obligation towards a widow and it could not be co-related with the business. The claim of the partners far the exclusion of this amount from their income was also rejected on the ground that no overriding title or legal enforceable charge existed and the amount in question, being purely an ex gratis payment, is not an admissible deduction. On these findings the learned Income-tax Officer added back this amount to the income of the assessee's firm and its partners.

3. On a direct appeal to the Income-tax Appellate Tribunal by the assessee's firm and its four partners, the Tribunal by order dated 3rd August 1962 dismissed the appeal of the assessee's firm on the ground that the payment of the above amount appear to be more in the nature of help and out of sympathy towards the widow and it could not be co-related with the business of the firm.

4. The Tribunal accepted the appeal of the four partners on the ground that only so much of their respective income could be assessed which actually reached their hands. It further held that the partners got their share of income from the firm after deduction of the amount payable to Mrs. McLaren in view of the clear stipulations in the various agreements which were in the nature of overriding title created for the widow. The Department being aggrieved by this order applied under section 66(1). It is in these circumstances that question No. 1 has been referred to this Court. The second question has been referred at the instance of the assessee's firm which claimed that the amount in question was an expenditure falling under the provisions of section 10(2)(xvi) inasmuch as the business of the firm could not be successfully continued without its payment as no new partner would join it without such an arrangement.

5. In support of the first question Mr. S. A. Nusrat, the learned counsel for the Department, has contended that the view of the Tribunal that the payment made to Mrs. McLaren was in he nature of overriding title created for the widow under the terms of the Partnership Agreement is erroneous, because the language of the above clauses clearly shows that the partners agreed to make ex gratis payment to the survivor of the deceased partner in appreciation of the services rendered by him and its character in the final analysis remained that of a moral obligation. In support of his contention the learned counsel has relied on a decision of the Supreme Court of India in K. A. Ramachar and another v. Commissioner of Income-tax, Madras ((1961) 42 I T R 25). In that case the assessee, who was a partner of the firm, executed three irrevocable deeds of settlement on September 22, 1947, in favour of his wife, a married daughter and a minor daughter, assigning to each of them one-fourth of his share of the profits in the firm payable to him during a period of 8 years from the date of the settlement to be enjoyed by them absolutely and exclusively. It was held by the Indian Supreme Court that the tenor of the deeds of settlement showed that the profits were first to accrue to the assessee and were then made for payment to the bene ficiaries. It was further held that under the law of partnership it was the partner and the partner alone who was entitled to the profits. A stranger, even if he were an assignee, did not have and could not have any direct claim to the profits. According to the view taken in that case it was held that the dispositions were in law and in fact portions of the assessee's income after it had accrued to him at the point of accrual. On this reasoning it was held that the amounts had therefore to be included in the assessee's total income. Mr. Nusrat, the learned counsel for the Department bad contended that the amounts pail to Mrs. MCLaren were paid out of the income which accrued to the partners and therefore the Tribunal fell into an error in allowing it on the ground thaw it was paid on the basis of some over riding title and a charge on the income of the firm.

6. The question therefore for consideration is whether the payment made to Mrs. McLaren was out of the income of the partners or the payment was made on the basis of obligations which created an overriding title and charge on the income of the firm. In this connection it will be noticed that as far back as 1933 the Judicial Committee in Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax, Bengal ((1933) 1 I T R 135) has taken the view that in a case in which a portion of the income had been diverted by an overriding title from the person who would have received it otherwise it can never become income in the hands of the assessee. In that case there was a charge for maintenance created against the assessee and the Privy Council observed at page 138 as under:- "But their Lordships do not agree with the learned Chief Justice in his rejection of the view that the sums paid by the appellant to his step-mother were not "income" of the appellant at all. This in their Lordships opinion is the true view of the matter. When the Act by section 3 subjects to charge "all income" of an individual, it is what reaches the individual as income which it is intended to charge. In the present case the decree of the Court by charging the appellant's whole resources with a specific payment to his step-mother has to the extent diverted his income from him and has directed it to his step mother; to that extent what he receives for her is not his income. It is not a case of the application by the appellant of part of his income in a particular way, it is rather the allocation of a sum out of his revenue before it becomes income in his hands." This case has throughout been followed is the Sub-Continent as a guiding authority. Even the Indian Supreme Court in Commissioner of Income-tax, Rombay. City II v. Sitaldas Tirath das ((1961) 41 I T R 367). following the above decision of the Privy Council, has laid down the following test for determining such questions:- "The true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obliga tion cannot be said to be a part of the income of the assessee. Whereby the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an .obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it does so, not as part of his income, but for and on behalf of the person to whom it is payable." Thus what is to be seen is whether in the present case the amount in dispute by any overriding title was diverted before it reached the assessce.

7. It is not disputed that the respondent partners are carrying on the professional business of accountants under the name and style of M/s. A. F. Furguson & Co. and in the original agreement entered into on 31st October 1952, a provision was made in the agreement of partnership to pay a specified sum to the widow of a deceased partner. In fact in 1953 the partners entered into another agreement dated 29th April 1953, which provided that all new partners in the firm shall be accepted on condition that such other partners shall agree in the liability for all payments to be made under the original Partnership Agreement. The contention of Mr. Nusrat that the payment made to Mrs. McLaren is in the nature of a moral obligation or an ex gratia payment made to his survivor in appreciation of the services rendered by the late partner has not in the least impressed us. It appears to us that the above-mentioned clause is to the nature of providing compensation to a deceased partner for the goodwill earned by the assessee's firm by the joint efforts of the partners. Mr. Ali Athar, the learned counsel for the respondent, has referred us to an English decision in Mackintosh (Mrs. V. O.) v. The Commissioners of Inland Revenue (14 Tax Cas. 15) in which a similar clause was under considera tion. In interpreting such clause Rowlatt, J. observed that by incorporating such a clause in the agreement what partners had really done was this - "When the partnership was dissolved the right to the use of the name, and the goodwill, and these established grade marks, whatever they may be, were all assets of the partner ship and ought to have been valued. But these were left in the partnership. The late partner had an interest in them in a way. You might say his executors were obliged to sell them, but what really happened was that they released their right-I think it is more accurate to say-to have these assets valued or included in the liquidation of the partnership. That is really what they did. How is it expressed? I think that really throws a good deal of light upon it; in fact I am not certain it is not the principal thing one has to go upon. The remaining partners may continue the use of the firm name on payment of a quarterly sum for this privilege for five years, after which it may be enjoyed without further payment. I think they are treating it not as paying by instalments for a thing they 'have got once for all, but I think they are treating it as paying for the use as they are using it, but that is only to go on for five years. I think it is a payment in the nature of income for the use of the firm name, the goodwill and rights, a payment concurrent with the enjoy ment of the thing for which the payment is made, running on year after )ear and therefore prolonging the interest of the deceased partner in the income, although it is merely securing an income for a period of five years. That is the best conclusion I can come to upon a question which I am bound to say is a very narrow one." This seems to be the intention in the present case also. According to the law of partnership, after a partner dies, the partnership firm stands dissolved. In the present case the partners of the assessee firm made a contrary provision, instead of having the firm dissolved on the death of a partner and making him entitled to get some compensation in lieu of goodwill and reputation of the firm, provided that for a certain period the retiring partner's widow or his executors will be entitled to have a fixed sum of amount in lieu of it. In these circumstances there is no the slightest doubt in our mind that the above-mentioned clauses in the Partnership Agreement are in the nature of overriding title. Both the firm and partners are bound to carry out the obligations set out in the above-mentioned agreement o partnership. It is obligatory on them first to discharge the obligation of the deceased widow and thereafter to distribute the profits between the partners: This, therefore, clearly is a case in which the income of the partners is diverted before it reached them and the assessee's partners on the principle enunciated in the above decisions were entitled to claim deduction for the above amount from the income of the assessee firm divisible between them. In that view of the matter, we are satisfied that the learned Income-tax Tribunal was perfectly justified in accepting the contentions of the assessee's partners in the appeal before them. We would, therefore, answer the first question in the affirmative against the Department.

8. Coming to the second question it w ill be noticed that the assessee firm's case is that the amount in dispute is in the nature of an expenditure connected with the affairs of the business and, therefore, they were entitled to claim its exemption under section 10(2)(xvi) of the Income-tax Act. Mr. Ali Athar, the learned counsel for the assessee firm frankly conceded that the view taken by the Income-tax Tribunal on this aspect of the question is correct. On the facts of the present case it is not possible to hold that the amount in question is in the nature of an expenditure wholly for the benefit of the business. We would, therefore, answer this question in the negative.

9. In the result, subject to the above remarks, the above questions are answered. Parties however are directed to bear their own costs. S. Q. References answered.