|Question And Answer|
|Subject:||What is “diversion of income by overriding title”?|
|Asked by:||Suresh Kumar|
|Answered by:||Advocate Michael Gonsalves|
|Date:||September 26, 2018|
What is the difference between “diversion of income by overriding title” and “application of income”? Please give case laws of the Supreme Court and High Courts on the issue of “diversion of income by overriding title”
The principles of “Diversion of Income by overriding title at source” have been explained in the decisions of the Hon’ble Supreme Court in (i) Commissioner of Income Tax Vs. Sitaldas Tirathdas 41 ITR 367 (SC); (ii) Raja Bejoy Singh Dudhuria Vs. Commissioner of Income-Tax 1 ITR 135 (Privy Council(; (iii) Deputy Commissioner of Income-Tax Vs. T. Jayachandran 406 ITR 1 (SC); (iv) Commissioner of Income-Tax Vs. Madras Race Club  219 ITR 39 (Mad).
CASE LAWS ON DIVERSION BY OVERRIDING TITLES
CIT Vs. Sitaldas Tirathdas 41 ITR 367 (SC)
CIT Vs. Pompie Tile Works 175 ITR 1 (Kar)
CTI Vs. Dharma Productions (P) Ltd 153 ITR 105 (Bom)
Raja Bejoy Singh Dudhuria Vs. CIT 1 ITR 135 (Privy Council)
CIT Vs. Nagarbail Salt-Owners Co-Op Society Ltd 291 CTR 287 (Kar)
DCIT, Vs. T. Jayachandran Civil Appeal No.4341 of 2018 dated 24.04.2018 (SC) (2018) 406 ITR 1 SC)
CIT Vs. Sunil J Kinariwala  259 ITR 10 (SC)
Smt. Savita Mohan Nagpal Vs. CIT  154 ITR 449 (Raj)
T. Jayachandran Vs. DCIT 263 CTR 629 (Mad)
CIT Vs. Madras Race Club  219 ITR 39 (Mad)
CIT Vs. Pandavapura Sahakara Sakkare Kharkane Ltd 174 ITR 475 (Kar)
CIT Vs. Crawford Bayley & Co. 106 ITR 884 (Bom)
CIT Vs. Nariman B Bharucha & Sons 130 ITR 863 (Bom)
Jit and Pal X-Rays Pvt Ltd Vs. CIT 267 ITR 370 (All)
CIT Vs. Varanasi Nagar Vikas 275 ITR 140 (All)
Soma Trg Joint Venture Vs CIT 398 ITR 425 (J & K)
CIT Vs. Patuck 71 ITR 713 (Bom)
In CIT Punjab, Himachal Pradesh and Bilaspur Vs. Thakar Das Bhargava  60 ITR 301 (SC), the Hon’ble Supreme Court dealing with the case of a leading Advocate who reluctantly accepted to appear in a Criminal trial on the condition that the monies or Fees paid to him will be paid for a Charitable Trust created by him.
Despite the fact that the Trust was so created out of the Fees received by him, the Hon’ble Supreme Court held that the said Fees was first taxable in his hands as Professional Fees and there was no ‘diversion of income by overriding title at source’.
The relevant extract is quoted below for ready reference:-
“The assessee, an advocate, who had been originally reluctant, agreed to defend certain accused persons in a criminal trial, on condition that he would be provided with the sum of Rs.40,000 for a public charitable trust which he would create.
When the trial was over the assessee was paid a sum of Rs.32,000 and he created a trust deed. The question was whether the sum of Rs.32,000 was the assessee’s professional income:.
Held, that on the facts, the proper legal inference was that the sum of Rs.32,000 paid to the assessee was his professional income at the time when it was paid to him and no trust or obligation in the nature of a trust was created at that time and when the assessee created a trust by executing the trust deed he applied part of his professional income as trust property.
The desire on the part of the assessee to create a trust out of the moneys paid to him created no trust; nor did it give rise to any legally enforceable obligation. The sum of Rs.32,000 was taxable in the hands of the assessee. The rule in Bejoy Singh Dudhuria’s case did not apply.”
Further explaining the background in which the case was decided by the Appellate Authority, the Hon’ble Apex Court emphasized that unless the money paid was earmarked for charity ab initio once such amount was received as his Professional Income, it would be so taxable in his hands.
The relevant extract from the body of the judgment is also quoted below:-
“In the circumstances the Appellate Assistant Commissioner rightly pointed out that “if the accused persons had themselves resolved to create a charitable trust in memory of the professional aid rendered to them by the appellant and had made the assessee trustee for the money so paid to him for that purpose, it could, perhaps, be argued that the money paid was earmarked for charity ab initio but of this there was no indication any where.”
In our opinion, the view taken by the Appellate Assistant Commissioner was the correct view. The money when it was received by the assessee was his professional income, though the assessee had expressed a desire earlier to create a charitable trust out of the money when received by him.
Once it is held that the amount was received as his professional income, the assessee is clearly liable to pay tax thereon. In our opinion, the correct answer to the question referred to the High Court is that the amount of Rs.32,500 received by the assessee was professional income taxable in his hands.”
In Provat Kumar Mitter Vs. Commissioner of Income Tax  41 ITR 624 (SC), the Assessee, who by a written instrument assigned the Shares of a Company in favour of his wife, held that the Dividends received from such Shares would continue to be taxed in the hands of the Settlor-husband, since the Assessee merely applied his income, since he has entered into a legal obligation to apply it in that way, nonetheless the Dividends will remain his income. The Privy Council decision in the case of Bejoy Singh Dudhuria Vs. Commissioner of Income-tax 1 ITR135 was held to be not applicable.
The relevant extract of the said judgment is also quoted below for ready reference:-
“The assessee was a registered holder of 500 ordinary shares of a company. By a written instrument, dated 19-1-1953 he assigned to his wife, the right, title and interest to all dividends and sums of money which might be declared or might become due on account or in respect of those shares for the term of her natural life.
However, under the terms of the instrument, the shares themselves remained the property of the assessee and it was only the income arising therefrom which was sought to be settled or assigned to his wife.
During relevant previous year assessee’s wife received dividends on those shares. In course of assessment, the ITO included dividend amount in the total income of assessee. Against the said inclusion, the assessee contended that since the settlement was for the lifetime of his wife, the third proviso to section 16(1)(c) applied and the dividend which his wife received could not be deemed to be his income under section 16(1)(c) and that in his case section 16(3) did not apply, because there was no transfer of the shares to his wife.
In this view of the matter, it is not necessary to decide the further question if a contract of this nature operates only as a contract to be performed in future which may be specifically enforced as soon as the property comes into existence or is a contract which fastens upon the property as soon as the property comes into existence or is a contract which fastens upon the property as soon as the settler acquires it. In either view, the incomes from the shares will first accrue to the settler before the beneficiary can get it.
Such income will undoubtedly be assessable in the hands of the settler despite the contract. We think that the true position is that if a person has alienated or assigned the source of his income so that it is no longer his, he may not be taxed upon the income arising after the assignment of the source, apart from special statutory provisions like section 16(1)c) or section 16(3) which artificially deem it to be the assignor’s income.
But if the assessee merely applies the income so that it passes through him and goes on to an ultimate purpose, even though he may have entered into a legal obligation to apply it in that way, it remains his income.
This is exactly what has happened in the present case. We need only add that the principle laid down by the Privy Council in Bejoy Singh Dudhuria v. Commissioner of Income-tax  1 ITR 135 does not apply to this case; because this is not a case of an allocation of a sum out of revenue before it becomes income in the hands of the assessee. In other words, this is not a case of diversion of income before it accrues but of application of income after it accrues.”
In Commissioner of Income-Tax Vs. Sunil J. Kinariwala  259 ITR 10 (SC) the Supreme Court succinctly dealt with the earlier case laws on the issue of ‘Diversion of Income by over riding title at source’ and in a case where the Assessee, a partner in a Firm having 10% share in the profits of the Firm, created a Trust by a Deed of Settlement assigning 50% of his 10% share of profits in favour of that Trust of which his other relatives were the beneficiaries and the Assessee claimed that there was a diversion at source of 50% of his share of profit of 10%, the Court negatived the said plea and held that the entire 10% share in the Partnership Firm was taxable in his hands.
The Hon’ble Supreme Court following the leading judgment in the case of Commissioner of Income-Tax Vs. Sitaldas Tirathdas  041 ITR 367 (SC) held that the true test is, where by the contractual obligation, the income is diverted before it reaches the Assessee, it is deductible, but where the income is required to be only applied to discharge the contractual obligations, it will not escape taxation in the hands of the Assessee so diverting his income.
The relevant extract of the said judgment which in the opinion of this Court covers the case in hand before us also is quoted below for ready reference:-
“The assessee was a partner in a firm having a 10 per cent. share therein. He created a trust by a deed of settlement assigning 50 per cent. out of his 10 per cent. right, title and interest (excluding capital) as a partner in the firm and a sum of Rs.5,000 out of his capital in the firm in favour of the trust. The beneficiaries were the assessee’s brother’s wife, the assessee’s niece and his mother. The question was whether 50 per cent. of the income attributable to his share from the firm stood transferred to the trust resulting in diversion of income at source.
The Appellate Tribunal held that there was no diversion of income and that section 60 of the Income-tax Act, 1961, applied. On a reference, the High Court held that on assignment of 50 per cent. of the share of the assessee in the firm it became the income of the trust by overriding title and it could not be added to the income of the assessee. On appeal to the Supreme Court:
Held: The principle is simple enough but more often than not, as in the instant case, the question arises as to what is the criteria to determine, when does the income attributable to an assessee get diverted by overriding title? The determinative factor, in our view, is the nature and effect of the assessee’s obligation in regard to the amount in question.
When a third person becomes entitled to receive the amount under an obligation of an assessee even before he could lay a claim to receive it as his income, there would be a diversion of income by overriding title; but when after receipt of the income by the assessee, the same is passed on to a third person in dis-charge of the obligation of the assessee, it will be a case of application of income by the assessee and not of diversion of income by overriding title.
The decisions of the Privy Council in Raja Bejoy Singh Dudhuria v. CIT  1 ITR 135 and P.C.Mullick v. CIT  6 ITR 206 together are illustrative of the principle of diversion of income by overriding title.
In Raja Bejoy Singh Dudhuria’s case  1 ITR 135 (PC), under a com-promise decree of maintenance obtained by the step-mother of the assessee, a charge was created on the properties in his hand. The Law Lords of the Privy Council, reversing the judgment of the Calcutta High Court, held that the amount of maintenance recovered by the step-mother was not a case of application of the income of the assessee.
In contrast, in P.C. Mullick’s case  1 ITR 135(PC), under a Will, certain payments had to be made to the beneficiaries by the executors and the trustees (assessees) from the property of the testator. It was held by the Privy Council that such payments could only be out of the income received by the assessees and there was no diversion of income at source. Whereas in the former case, the step-mother of the assessee acquired the right to get the maintenance by virtue of the charge created by the decree of the Court on the properties of the assessee even before he could lay his hands on the income from the proper-ties, but in the latter case, the obligation of the assessee to pay amounts to the beneficiaries was required to be discharged after receipt of the income from the properties.
In CIT v. Sitaldas Tirathdas  41 ITR 367, speaking for a Bench of three learned judges of this Court, Hidayatullah J. (as he then was) having considered, among others, the aforesaid two judgments of the Privy Council laid down the test as follows (page 374):
“In our opinion, 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 obligation cannot be said to be a part of the income of the assessee. Where by 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.”
In a recent decision rendered in April 2018, the Two Judges’ Bench of the Hon’ble Supreme Court in the case of Deputy Commissioner of Income-Tax, Chennai Vs. T. Jayachandran  406 ITR 1 (SC) upholding the decision of the Madras High Court reported in  263 CTR 629 (Mad) dealt with an interesting case of a Share Broker who was working on behalf of the Indian Bank and got only his Commission Income but was sought to be taxed for the gross receipts for the sale of Shares and Securities dealt with by him on behalf of the Indian Bank, held in favour of the Assessee that he was not liable to be taxed, except for his Commission Income received from the Indian Bank.
The Division Bench of the Rajasthan High Court in the case of Commissioner of Income Tax Vs. Jodhpur Co-operative Marketing Society  275 ITR 372 [Raj] dealt with a case of Co-operative Society which under the statutory obligations was liable to transfer 25% of its net profits to the specified funds and the Assessee Society claimed that such diversion was not taxable in its hands.
Even negativing this plea of the Assessee – Co-operative Society, the Court explained the concept of ‘Diversion of Income by over riding title at source’ after discussing several case laws, some of which were cited before us also, in the following manner:-
“The obligation to carry a part of net profit to a reserve fund does not envisage diversion of any part of profits in person other than society itself. There is no overriding title vesting in a third party other than the assessee to lay claim to the reserve fund independent of co-operative society.
The reserve fund remains part of the assessee-society’s corpus and is to be applied for assessee’s business only, albeit its application is being regulated by the Registrar under the provisions of the Act but the statue does not give any power even to the Registrar to utlise the reserve fund so created out of the profits of the society for any purpose other than for the purpose of the society.
Even on dissolution of the society the first obligation of the assets of the society including the reserve fund as part of the total assets and not specifically, is to the discharge of its debts outstanding and obligation towards the shareholders to pay their contribution with interest and dividend payable to them for the period such dividends are not paid. Surplus, if any, left thereafter, is to be applied according to the resolution of the general body of the members of the society only.
Therefore, there is no insignia of diversion of income through an overriding title vesting in a third party outside the corpus of the society itself so as to consider it to be a case of diversion of income by overriding title to somebody other than the assessee.
It is also to be noticed that the question of transferring any amount to the reserve fund arises only in the case the assessee society received its net profit, after paying off all its expenses”
The Division Bench of the Madras High Court in the case of Commissioner of Income Tax Vs. Madras Race Club  126 Taxman 6 (Mad), dealt with a similar controversy involved before them in the following manner:-
“The payments made are compulsory exactions, which if not complied with will result in the disqualification altogether of the person, who has subjected himself to the levy of penalty, fine or the requirement to take out a licence from participating in the assessee’s racing activity.
The power to collect these amounts is the power of the stewards and of the club generally to regulate racing and to ensure that it is carried on in an orderly fashion only with persons, who are considered competent and desirable, being allowed to take part, subject to their complying with the rules of racing.
The amount of the penalties, licence fees and fines collected are amounts which are received by the club as part of income, which it derives by conducting races. These amounts are not paid to the club by any of those, who become liable to the payment of licence fees, penalties or fines, by way of voluntary contribution from them to the benevolent fund.
The amounts are not paid by them with the intention that it be a contribution to the charitable or benevolent fund. The race club itself is under no statutory compulsion to earmark or divert any part of its income for the benefit of the jockeys, apprentices, stable boys, etc.
The race club was under no statutory obligation to create a trust fund for their benefit. The fact that the club has done so and had done so with the best of intentions, does not on that score result in what is actually the income of the club, a part of which has been applied for benevolent purposes by having those amounts credited to the benevolent fund, becoming the income of the benevolent fund even at the inception.
The income which the benevolent fund receives is by way of the amounts which the race club has allowed to be credited to that fund, the amounts so allowed by the club to be so credited being the amounts which it has collected from the jockeys, trainers and others, who are required to take out licences and pay licence fees and the penalties and fines, which it has levied and collected from those who are participants in racing but who have not complied with the rules and had therefore become liable for a penalty or fine.
The amounts received by the club by way of licence fees, fines and penalties are amounts which reach the club as part of its income and which amounts after they reach the club are applied by the club for benevolent purposes by allowing the benevolent fund to have the benefit of all those amounts.
The licence fees, penalties and fines at the time the payments were made by those, who are required to make those payments were, at the time the payments, not regarded by them as amounts, which were earmarked for charity and they did not regard those amounts as having been paid as contributions for a benevolent or charitable purpose.
The levy as also the payment was by reason of the regulatory power vested in the assessee-club to regulate racing in accordance with the rules framed by it, non-compliance with which would result in the jockeys, trainers and others being excluded from participating in racing.
The levy had direct nexus with their activity as participants in racing and the levies were designed to ensure compliance with the requirement of the rules. There was no earmarking of those amounts for the benevolent fund ab initio. The amounts collected by the club as licence fees, fines and penalties were therefore, amounts which form part of its income.
The execution of a trust deed and the inclusion of a provision in the rules of racing for crediting the sums to the benevolent fund was merely the application of a part of the income of the assessee for benevolent purpose. Creation of the benevolent fund by the trust deed and the provision made for the benevolent fund in the rules did not result in the amounts which the club was to credit to that fund being diverted at source by the overriding title of the benevolent fund to those sums.
The concept of diversion of income by overriding title is to be applied in situations which are clear and where the existence of the title in the legal or natural person in whom an overriding title is to be recognized is also certain, and the facts are such as to warrant the conclusion that the income is not that of the recipient, but in fact the income of the person in whose favour an overriding title is to be recognized.
A rule framed by an assessee for its own internal management cannot be elevated to the level of statutory rule and the decision on the part of the club to apply a portion of what it receives for benevolent purposes cannot be regarded as an instance of diversion by overriding title when the amounts received by the club and allowed by it to be used by the fund were not amounts, which had been paid voluntarily with the object of making those payments for charitable purposes. Diversion of the income took place after, and not before the income had reached the assessee. – CIT vs. Bangalore Turf Club Benevolent Fund (1984) 38 CTR (Kar) 235: (1984) 145 ITR 323 (Kar): TC 44R. 1060 distinguished”