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Income‑tax Reference No. 54 of 1956, decided on 12th February 1957.
S. 16(1)(c)‑Scope and effect of the first and third provisos‑Irrevocable trust in favour of wife and son‑Trustees permitted to advance loans to themselves-- Settlor himself taking loans as trustee‑Assessment of income as settlor's income‑Legality‑Proper procedure.
The assessee made a trust settling shares worth about 6 lakhs of rupees in trust for his wife and his son. The income was to go to both the wife and the son, after his wife to the son, and after the son to his wife and children, and if he did not have issue, it was to go to charity. He appointed himself, his wife and his son and two others as trustees, he himself being the managing trustee. The trustees were empowered to give loans to any persons, includ ing the trustees, and in fact the settlor himself took loans. The income‑tax authorities held that the case fell under the third proviso to section 16(1)(c) of the Income‑tax Act and therefore the income from the trust was liable to be taxed as income of the settlor in the settlor's hands:
Held, that, as the trust was on the face of it an irrevocable one, the third proviso to section 16(1)(c) had no application at all ; the case was covered by the first proviso to section 16(1)(c), but, as the Department had not made any attempt to bring the case under the first proviso, the assessment as it stood could not be upheld:
By these applications made under section 66 (1) which are consolidated as they involve an identical question of law, Shri Abbay L. Khatau, legal representative of late Shri Laxmidas M. Khatau, hereafter referred to as the assessee, requires the Appel late Tribunal to refer to the High Court a question of law which is said to arise out of the Tribunal's order under section 33(4) in I.T.A. Nos. 741 to 744 of 1954‑55. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid orders of the Tribunal, we hereby draw up a statement of the case and refer it to the High Court .of Judicature at Bombay under section 66(1) of the Indian Income‑tax Act, 1922. Both the parties agree that all the relevant facts have been correctly stated.
2. The relevant assessment years are 1949‑50 to 1952‑53, both inclusive. The account years relevant to them are Samvat Years 2004 to 2007 respectively. On 18th January 1948, i.e. during the Samvat Year 2004, a trust settlement was made by Laxmidas Mulraj Khatau. The trustees were the said Laxmidas, his wife, Bai Jayabai, his son Abbay, and his brother, Chandra kant Mulraj. The trust property consisted of shares worth about 6 lakhs of rupees. There was a supplementary deed of 18th October 1948, under which further property was added to the trust property. It is not necessary to notice it in any greater detail. Clause 2 of the trust settlement dated 18th October 1948, provides that the trustees "shall pay every six months the residue of such income hereafter called the net income 3/4th thereof to the said Abbay Laxmidas Mulraj Khatau and the balance to Bai Jayabai." Clause 4 of the trust settlement deals with powers of the trustees to make investment, the material portion of which is as follows:
"The trustees shall be entitled to invest the trust property and/or the funds and/or the income if any belonging to the trust for the time being in such investments as they in their discretion think proper or in keeping in deposits with any bank or banks and/or in depositing with or lending to any person including any trustee or trustees etc,":
Clause 15 provides that "the trustees shall during the lifetime of the settlor act in accordance with the opinion of the settlor." Clause 16 provides that the settlor during his' lifetime "shall be the Managing Trustee who shall have all powers of management of the trusts and trust properties." A copy of the trust settlement is Annexure, marked "A" and forms part of the case.
3. During Samvat years 2004 to 2007, the position in regard to the trust income and loan given to Laxmidas, the settlor, by the trustees is as follows:
| Asst. year | Year | Trust income | Advance or loan to settlor Mr. L.M. Khatau. | Advance or loan by Mr. L.M. Khatau. | Cash and bank balance at the end of year. |
|
|
| Rs. | Rs. | Rs. | Rs. |
| 1949‑50 S.Y. | 2004 | 11,454 | 28,604 | ‑‑‑ | 16,454 |
| 1950‑51 | 2005 | 78,651 | --- | 6,521 | 23,412 |
| 1951‑52 | 2006 | 51,625 | 21,347 | ‑‑‑ | 5,072 |
| 1952‑53 | 2007 | 46,911 | 37,347 | --- | 25,849 |
4. In view of these provisions of the trust settlements dated 18th January 1948, and the above facts, the assessee claimed before us, as he claimed before the Income‑tax authorities, that the provisions of section 16(1)(c) did not apply 3/4th of the net income of the trust payable to Abbay and that the third proviso to section 16 (1) (c) had no bearing on the issue involved and even if it had, the settlor did not derive any direct or indirect benefit from the trust income. The amounts involved are Rs. 12,495, Rs. 76,429, Rs. 49,870 and Rs. 47,459 respectively for these four assessment years. On the other hand, the Department's contention was that the income was not saved from the mischief of the substantive part of section 16(1) (c) inasmuch as the condi tion "from which income the settlor derives no direct or indirect benefit" mentioned in the third proviso to that section was not satisfied. For reasons given in the Tribunal's main order in I. T. A. No. 741 of 1954‑55 relating to the assessment years 1949‑50, the Tribunal rejected the assessee's contention by relying upon the Bombay High Court decision in the case of Sir Kikabhai Premchand ((1948) 16 I T R 207). A copy of the said order is annexure marked "B" and forms part of the case.
5. On these facts, the following question of law arises:
Whether on a true construction of the settlement dated 18th January 1948, the sums of
| Rs. 12,495
Rs. 76,429
Rs. 49, 870
Rs. 47,459
|
are properly brought to tax in the hands of the assessee in view of the provision of section 16(1)(c) of the Indian Income‑tax Act, for the assessment years:
| 1949‑50
1950‑51
1951‑52
1952‑53
|
"The appellant claimed that the provisions of section 16(1)(c) did apply to the 3/4th of the net income of the trust payable to Abbay. On the other hand the Department's contention is that this income is not saved from the mischief of the substantive part of section 16(1) (c) inasmuch as the condition from which income the settlor derives no direct or indirect benefit' mentioned in the third proviso to that section is not satisfied. Section 16 (1) (c) does not apply to the case of income arising to any person by virtue of a settlement where the conditions mentioned in the third proviso concur, i.e., are simultaneously satisfied. One of the conditions is that the settlor should derive no direct or indirect benefit from the income. In contending that this condition is not satisfied in the present case, the Department strongly relies upon the decision of Bombay High Court in Sir Kikabhai Premchand's case. From page 212 of that volume it appears that clause 8 in the material trust settlement gave power to the settlor (underlined[Here printed in italics.] by us) to make a loan to any person including himself with or without security or howsoever the settlor shall determine as if he were absolutely entitled to such moneys'. Interpreting this clause; the Chief Justice observed as follows:
Under this clause it would be competent to the settlor to make a loan of a part of the income of the trust estate to himself without security and I should think even without interest.'
It is contended by the Department that in view of clauses 15 and 16 of the trust settlement, the settlor has power to override the decision of all the trustees and hence during his lifetime under clause 4 it would be competent to the settlor in keeping in deposit with or lending to himself the trust income for the time being, inasmuch as either the word trustee' or the word person' occurring in the phrase in depositing with or lending to any person including any trustee' appearing in clause 4 would cover Laxmidas, the settlor. As a matter of fact in this particular case, as the above table shows, trust income was deposited or lent without interest to the settlor, though the High Court held in Kikabhai's case. (1) that it was not necessary for the purpose of the third proviso to section 16(1)(c) that a loan was actually made without interest to the settlor, or that he actually derived any benefit direct or indirect from the trust income. We would, therefore, uphold the Department's contention.
It only remains to add that Mr. Kapadia for the assessee brought to our notice the decision given by the Bombay High Court in the case of Mathuradas Mangaldas, not yet reported. In that case the trust was created by the karta of a Hindu undivided family. Dealing with the Com missioner's contention that under a settlement "the trustees might make loans to themselves and that too without interest,' the High Court observed that the benefit would be derived by the trustees and not by the settlor and in this sense, the case of Sir Kikabhai Premchand (1) was distinguished. In the present case the settlor is admittedly an individual and we are unable to distinguish the present case from that of Sir Kikabhai Premchand.
The appeal fails and is dismissed."
R. J. Kolah with B. A. Palkhivla for the Assessee.
G. N. Joshi with Advocate‑General for the Commissioner.
‑This is one of those rare cases where the Taxing Department has misfired, and the facts are very simple. Laxmidas Khatau, who is being assessed to tax through his legal representative, made a trust deed on the 18th January, 1948, and briefly the provisions of the trust deed are that he settled a sum of about Rs. 6 lakhs in trust for his wife and his son. The income was to go to both the wife and the son, after his wife to the son, and after the son to his wife and children, and if he did not leave any wife or issue then it was to go to charity. There is a provision in this trust deed that the trustees are authorised to lend moneys to any of the trustees‑and the settlor was one of the trustees ‑and the trust deed also provides that the settlor would have an overriding vote in case of difference of opinion between the trustees, and there fore it seems to be the position that it would be open to the settlor by his, overriding vote to get the trustees to lend trust moneys to him ; and the Tribunal as a matter of act finds that this did happen after the trust was executed. But the Tribunal took the view that this particular provision constituted a direct or indirect benefit to the settlor and their case was that the case fell under the third proviso to section 16(1)(c) and therefore the income from this trust was liable to tax in the, hands of the settlor.
Now, before the Income‑tax Officer, the Appellate Assistant Commissioner and the Tribunal, emphasis was placed by the Department upon the third proviso and the Tribunal's finding also is that the case falls under the third proviso of sec tion 16(1)(c). What was completely overlooked was the proper interpretation of clause (c) of section (16) (1). The first part of clause (c) deals with a trust which is either revocable or not revocable, and the second part deals with a revocable trust, and the first proviso introduces a legal fiction and constitutes what is an irrevocable trust in fact into a revocable trust for the purpose of this clause. The third proviso deals with revocable trusts and it is in favour of the assessee that although the trust is revocable and although it falls in the second part of clause (c), if it is not revocable for a period exceeding six years then clause (c) would not apply to such a trust. But the assessee would be prevented from taking advantage of the third proviso if it is shown that the settlor derives any direct or indirect benefit. Therefore, it is clear that it is for the assessee to claim protection of the third proviso and as and when he claims protection of the third proviso it would be for the Department to satisfy the Tribunal that he is not entitled to that protection because he derives direct or indirect benefit. But as far as the Department is concerned, it must bring the case within clause (c) itself. Here we have a trust which is on the face of it irrevocable, no power of revocation is reserved to the settlor, and it is con ceded that the case of the Department does not fall under the first part of clause (c) but it falls under the second part of clause (c). Now, the second part of clause (c) only applies to revocable trusts, it does not apply to irrevocable trusts, and therefore in order to succeed the Department, must bring the case within the first proviso of clause (c) so as to convert an irrevocable trust into a revocable trust by a legal fiction. In order to convert what in fact is an irrevocable trust into a revocable trust, it must satisfy the conditions laid down in the first proviso, but strangely enough no attempt whatsoever has been made by the Department to bring the case within the first proviso of section 16(1)(c). At no stage has the Department contended that what is in fact an irrevocable trust has become revocable by the legal fiction introduced by the first proviso. Through some misunderstanding, which it is difficult to understand, the Department has all the time urged that the case fell under the third proviso. As we have already pointed out, the third proviso would only apply if we were dealing with a revocable trust and where the assessee con tended that the revocation being beyond six years he came within the exemption. But how the Department can claim to come under the third proviso it is difficult to understand. Whatever the position might be as the Department has not tried to bring this case under the first proviso as the matter stands we cannot decide this reference on the presumption that the first proviso applies. If the first proviso does not apply, then it is clear that this being an irrevocable trust it does not fall under the second part of sec tion 16(1)(c).
We must, therefore, answer the question submitted to us in the negative. Commissioner to pay the costs.
Question answered in the negative.
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