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Petitioner: K.V. KUPPA RAJU and, others VS Respondent: GOVERNMENT OF INDIA and others
Court Name: karnataka High Court Judge(s): V. K. Singhal, T. N. Vallinayagam Title: K.V. KUPPA RAJU and, others vs GOVERNMENT OF INDIA and others Case No.:Writ Petitions Nos. 27324 of 1992, connected with Writ Petitions Nos. 31467,
JUDGMENT
Reported As: 2002 PTD 1764 Result: Petition dismissed Judgment JUDGMENT V.K. SINGHAL, J.---The validity of section 64(1A) of the Income Tax Act, 1961, has been assailed in these petitions. The provisions of section 64(1A) are as under: "64(1A) In computing the total Income of any individual, there shall be included all such income as arises or accrues to his minor child: Provided that nothing contained in this subsection shall apply in respect of such income as arises or accrues to the minor child on account of any- (a) manual work done by him; or (b) activity involving application of his skill, talent or specialized knowledge and experience." The Full Bench of the Madras High Court in the, case of K.M. Vijayan v. Union of India (1995) 215 ITR 371 upholding the validity of section 64(1A) held that it was not violative of Articles 14 and 19 of the Constitution of India. Before us the competence of the Legislature is not challenged and the challenge is only on the following points: (a) that there is a hostile discrimination between the income of the minor which is clubbed with the income of his/her father/mother, and the income of that minor which is not so clubbed. In a case where the income is clubbed it is liable to higher' rate of tax and, therefore, the provisions are discriminatory; (b) there is no nexus of the object sought to be achieved in clubbing the income of the minor with either of the parents;
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(c) that the provisions are against the Directive Principles of State Policy inasmuch as a special status has been given to the minor. Reliance is placed on the memorandum accompanying the Finance Bill which reads as under (see (1992) 194 ITR (St.) 170, 179): "MEASURES AGAINST TAX AVOIDANCE Clubbing of minors' income. Section 64 of the Income-tax Act provides that in computing the total income of anx individual, there shall be included all such income as arises directly or indirectly to a minor child of such individual from,---- (i) the admission of the minor to the benefits of partnership in a firm, (ii) assets transferred directly or indirectly to the ,minor child by such individual otherwise than for adequate consideration, and (iii) assets transferred directly or indirectly by such individual to any person or association of persons otherwise than for adequate consideration, to the extent to which income from such assets is for the immediate or deferred benefit of such individual's minor child. In reality as well as in law, the minor children cannot administer their property nor can they take decisions on the disposal of income arising therefrom. These responsibilities fall on the parents, who, for all practical purposes, treat and use this income as part of their own income. Exclusion of minor children's income from the income of their parents also leads to tax avoidance. The existing provisions of section 64 with regard to clubbing of minors' income have also led to litigation between Income-tax Department and the assessee. The Bill, therefore, seeks to amend section 64 of the Income-tax Act to provide that all income of a minor is to be included in the income of his parent. However, the income derived by the minor from manual work or from any activity involving his specialized knowledge or experience will not be included in the income of his parent. It is also being provided that the income of the minor will be included in the income of that parent whose total income is greater. Where the marriage of the parents does not subsist, the income of the minor will be includible in the income of that parent who maintains the minor child in the relevant previous year. The Bill also seeks to insert a new clause (32) in section' 10 of the Income-tax Act so as to provide that in case the income of an individual includes income of his minor child in terms of section 64 of the Act, such individual shall be entitled to exemption of one thousand five hundred rupees in respect of each minor child if the income of such minor, as includible under section 64, exceeds that amount. However, where the income of any minor so includible is less than one thousand five hundred rupees, .The aforesaid exemption shall be restricted to the income so included in the total income of the individual. This provision is proposed to provide relief to the individual in whose total income the income of the minor child is to be included." Recommendations of the Chokshi Committee; In its final report, the Direct Tax Laws Committee examined the provisions of section 64 in great detail and made the following recommendations: "1-11.2. As regards the provisions of section 64, they are principally aimed at clubbing the income of a spouse or minor child of the taxpayers in the circumstances specified therein under the amendments made by the Taxation Laws (Amendment) Act, 1975, the clubbing has been extended, in certain circumstances, to the income of the son's wife or the son's minor child, apart from further tightening up of the provisions for clubbing the income of the spouse or minor child. It has been recognized that one of the methods of tax avoidance is the diversion of income to the spouse or minor children by taxpayers. With a view to preventing such avoidance, section 64(1) enumerates seven different contingencies for clubbing the income. One of the suggestions made to us was that these provisions could be considerably simplified by the introduction of the concept of a family comprising husband, wife and minor children, as a taxable unit. The concept of the family as a unit of assessm ent has been discussed for almost the last ten years, when a suggestion to this effect
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was contained in the Budget Speech. We have carefully examined this suggestion. This concept, in our, view, has far reaching implications and repercussions on the independent status of women and their right to hold property and earn income under our law. It may also be detrimental to the interests of a large number of middle class families where women have to work to supplement the family income. It may be urged that these aspects could be taken into consideration if provisions were made to exclude various categories of incomes from particular sources and incomes from what is popularly known as streedhan from the scope of joint tax liability. Any such Scheme to our mind would be far from simple in operation and would not be a better alternative to the Scheme of clubbing of income in specified circumstances as contained in the present section 64(1). Moreover, in the context of the Hindu undivided family being a separate taxable unit, further complications would arise in evolving yet another separate taxable unit. It would considerably distort the law in regard to the Hindu undivided family as a taxable unit where the law has evolved and is now reasonably well-settled by several judicial pronouncements. In view of these and other considerations we are not in favour of substituting the present provisions for clubbing of incomes under section 64(1) by the adoption of a family as a unit of assessment. 1-11.3. One of the circumstances under which the income of a minor child is clubbed with that of its parent is the income from the admission of the minor to the benefits of partnership in a firm. Prior to the amendment made in 1976, such clubbing only operated if the minor was admitted to the benefits of a partnership in which either parent was a partner. It was observed that the advantage of admitting minors to the benefits of partnership had unfortunately been misused widely. It was even suggested at one stage that the Partnership Act should be amended to prevent the admission of minors to the benefits of partnership. It was also observed that the clubbing provision was easily avoided by the admission of minors to the benefits of partnerships in which neither parent is a partner. Having observed the large scale misuse of this facility, section 64 was amended to provide for clubbing of the income of the minor from admission to the benefits of any partnership with the income of the parent irrespective of whether or not either parent was a partner in the same firm. I-11.4. Our attention has been drawn to instances where the new provisions are being circumvented by the interpolation of a trust for the benefit of minors and the trustees of such trusts entering into partnerships. According to this device, a trust is created for the benefit of minors with express power to the trustees to utilize the trust funds by way of investment in business enterprises and partnerships. The legal position under partnership law is that partnership is the relationship between the persons who are named as partners and the fact that a partner is in turn accountable for his share of income to any third party is irrelevant to the partnership. The introduction of a trust takes advantage of this position under the partnership law and seeks to avoid the clubbing under section 64(1). It is appropriate that the adoption of such a devoice is countered and the underlying provisions of the section are given proper effect. We, accordingly, recommend that where a minor receives income as a beneficiary under a trust and such income is derived from the profits and gains of business carried on by the trustees in partnership with others, such income of the minor should be added to the income of the parent. The clubbing provision in section 64 should be extended to cover such cases. 1-11.5. It would follow from the recommendations made in the earlier paragraph that the device of a trust which is used to avoid the clubbing of the income of a spouse under the circumstances presently contained in section 64 should likewise be countered. Accordingly, we recommend that if the spouse is a beneficiary under a trust and the trustees join a partnership with the individual, the clubbing provisions as presently contained in section 64(1)(i) and Explanation 1 should become applicable..
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1.11.6. The provisions for aggregating income of the spouse under clause (i) of section 64(1) have led to a dispute in regard to the treatment of losses which may fall to the share of the spouse from the partnership. The Gujarat High Court in Dayalbhai Madhavji Vadera v. CIT (1966) 60 ITR 551, has ruled that the section contemplates inclusion of income and, accordingly, the share of loss arising to the spouse cannot be set off against the total income of the other spouse. The Karnataka High Court in Dr. T.P. Kapadia v. CIT (1973) 87 ITR 511, has dissented from this view and has held that income in this section includes a loss. On general principles, income from membership in a firm would include a loss and the context of clause (i) of subsection (1) doe's not warrant the contrary construction. The liability to assessm ent cannot alternate from year to year between the individual and the spouse depending on whether there is a profit or a loss. Besides, in the absence of other income , the right to carry forward the loss in a running business would be completely lost if the individual is to be vicariously liable when there is a profit and the loss is to remain a dead loss in the assessment of the spouse. Apart from the construction of the, existing provisions, in the interest of equity as well, it is appropriate that income referred to in section 64 should include losses. Accordingly, if the income which is subject to clubbing under the section is negative amount, such negative amount should be available for set off In the income of individua1 in whose hands the clubbing has to be given effect to. We, accordingly, recommend that income referred to in section 64(1) of the Act should include loss." An Expert Group to rationalize and simplify income-tax law had given the following report (see (1997) 224 ITR (St.) 169, 218): "SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX: New provision.---Taxation is now regarded as an important cost factor and so it is a common practice to undertake tax planning basically to ensure that while tax is reduced or totally avoided the transactions are structured within the legal framework of the law to minimize costs. While tax avoidance by taking advantage of law as distinguished from evasion is generally considered legitimate, the line between the two has tended to become thin. Hence, Many tax systems in the world now contain provisions defining unacceptable tax planning. These provisions have come to be known as anti-avoidance provisions which cover cases other than those of sham transactions amounting to outright tax evasion. The Ramsay doctrine which was also taken note of by the Supreme Court in the celebrated McDowell's case, explains a tax avoidance Scheme as one where steps having no commercial purpose apart from the avoidance of a liability to tax are inserted in a composite transaction made up, of a pre-ordained series of transactions. While dealing with the relevant anti-avoidance provisions, Barwick, C.J., observed; 'if the actual transaction into which the parties have entered involves the taxpayer any liability to tax or does not afford the taxpayers some benefit in taxation, such as a deduction, and that transaction is cast into another form which, if effective, would relieve the taxpayer of tax, wholly or partially, the intention with which that form of transaction is chosen can properly be said to be an intention 'to alter the incidence of the income-tax'.' (italics added Mullens v. FCT 6 Australia Tax Report 504). The Group also took note of the need to see that an anti-avoidance provision is not given a literal interpretation and that an arrangement having the 'purpose or effect' of attracting a tax avoidance or tax deduction consequence must pass an objective purpose test and also the predication test propounded by Lord Denning in Newton v. Commissioner of Taxation of the Commonwealth of Australia (1958) AC 450, 466; 'In order to ring the arrangement within the section you must be able to predicate -by looking at the overt acts by which it was implemented-that it was implemented in that particular way so as to avoid tax. The Group also had occasion to go through the various anti-avoidance provisions contained in the Income-tax Acts of other countries, in particular those of Australia, New Zealand, Malyasia, U.K. And
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Singapore. Though these provisions are more or less similar, there are shades of difference. Extracts of these provisions are given in an 'Annexure' to this report. After reviewing all the laws concerned, the Group has taken the view that section 33 of the Singapore Income-tax Act with a few changes will be best suited to our conditions. It may be noted that an Expert Group was set up in Singapore some time in 1988 to review the anti-avoidance laws of other countries and to propose a suitable provision to that effect. The proposed provision is as under: Subsection (1): Where the Assessing Officer is satisfied that the purpose or effect of any arrangement is directly or indirectly- (a) to alter the incidence of any tax which is payable by or which would otherwise have been payable by any person; (b) to relieve any person from any liability to pay tax or to make a return under this Act; or (c) to reduce or avoid any liability imposed or which would otherwise have been imposed on any person by this Act; he may, without prejudice to such validity as it may have in any other respect or for any other purpose, disregard or vary the arrangement and make such adjustments, as he considers appropriate, including the computation or recomputation of gains or profits, or the imposition of liability to tax, so as to counteract any tax advantage obtained or obtainable by that person from or under that arrangement. Subsection (2): In this section, 'arrangement' means any Scheme, trust, grant, understanding, covenant, agreement, disposition, transaction and includes all steps by which it is carried into effect. Subsection (3): This section shall apply to any arrangement made or entered into, orally or in writing, whether, before or after the commencement of this Act but, shall not apply to any arrangement carried out for bona fide commercial reasons and had not as one of its main purposes the avoidance or reduction of tax. Proviso: Provided that the Assessing Officer cannot take any action under this section without the previous approval of the Commissioner. It is suggested that the Board may issue clear instructions that the provision should not be invoked in case of ordinary commercial transactions including normal claims of expenses and allowances, and involving transactions of tax mitigation where the reduction in tax is derived from the provisions of the Act and not through any 'arrangement'. For example, contributions to provident fund, donations to recognized charity which an assessee makes with a view to obtain the benefit of incentive provisions would not be covered by the anti-avoidance law. The Board may clarify the correct import of these provisions having regard to the caveats indicated above, qualifying these provisions." The Budget Speech of the Finance Minister was to the following effect (see (1992) 194 ITR (St.) 1. 17): "60. It is said that the child is the father of man, but some of our taxpayers have converted children into tax shelters for their fathers. The tax law provides for clubbing of income from gifts given by parents but this does not apply to other income, including income from other gifted assets, and the practice of cross gifting is widely used to evade clubbing. The Chelliah Committee has recommended that in order to plug this loophole, which accounts for a substantial leakage of Revenue, the income of a minor child should be clubbed with that of the parent. There is merit in this suggestion and I propose to accept it. Recognising, however, the existence of a number of child prodigies, especially child artistes in our country, I propose to exclude their professional income, as also any wage income of minors, from the purview of such clubbing. The practice of clubbing the income of minor children with that of the parent for tax purposes is in vogue in a number of countries."
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It is submitted that the tax avoidance necessarily involves overt acts on the part of the assessee and the earlier proviso contained in section 64(1) had covered all possible situations whereby the income of a parent could be diverted to 'a minor. The new provisions of section 64(1A) now covers all income of the minor (with the exception of earned income) irrespective of the fact whether there is a nexus between the earning of such income and the overt act of the parent. The provisions of section 64(1A) did not distinguish between avoidance and acceptable income. It is submitted that if the income of minor is clubbed with the parent then such income is liable to be taxed at a higher slab and a larger slice of the estate of the minor goes in taxes, Reliance is placed on the judgment given in the case of Hbeper v. Tax Commission (284 US 206-221), where it was observed that a husband cannot, consistently with the due process and equal protection clause of the 14th amendment, be taxed by a State on the combined total of his and his wife's incomes as shown by separate returns, where her income is her separate property and, by reason of the tax being graduated, its amount exceeded the sum of the taxes which would have been due had their separate incomes been separately assessed. The directive principles enshrined under Article 45 of the Constitution of India contemplated free and compulsory education and other Articles of the Constitution provide for the welfare particularly for the minor which cannot be whittled down by causing a burden on the minor as observed in Unni Krishnan (J.P.) v. State of A.P., AIR 1993 SC 2178; (1993) 1 SCC 645. Section 64(1A) was inserted by the Finance Act, 1992, from April 1, 1993, i.e., the assessment year 1993-94. The validity of this provision was challenged before the Patna High Court in the case of Syed Ashori Hadi Ali Augustine Imam v. Union of India (1994) 209 ITR 746, it was observed that the provisions of section 64(1A) are for the purpose of checking the evasion of tax and the Legislature is competent to enact such a provision for imposition of tax. The provisions were held intra wires entry 82. List I of the Seventh Schedule and not violative of Article 14 of the Constitution. It was also observed that there is inherent complexity in fiscal adjustment of diverse elements, permitting a large discretion to the Legislature in the matter of classification so long as it adheres. To the fundamental principles underlying the said doctrine. The provisions of section 64(1A) were considered machinery provisions relating to computation of income. The Full Bench of the Madras High Court in the case of K.M. Vijayan v. Union of India (1995) 215 ITR 371, also examined the validity of section 64(1A) in this matter it was alleged that there is no attempt at classification in the provisions of section 64(1A) and lack of classification itself created inequality and is violative of Article 14 of the Constitution of India. It was observed that in order to pass the test of permissible classification under Article 14, the classification must not be arbitrary, artificial or evasive but must be based on some real and substantial distinction bearing a just and reasonable relation to the object sought to be achieved by the Legislature. There is no palpable arbitrariness in section 64(1A) and hence it does not offend Article 14 of the Constitution of India. The provisions for clubbing the property of the wife (other than judicially separated wife) with the property of her husband were also upheld in the case of Jeet Singh v. State of U.P. (1993) 1 SCC 325. In Howard de Walden (Lord) V. IRC (1942) 1 All ER 287 (CA), at page 289, Lord Greene observed: "For years a battle of manoeuver has been waged between the Legislature and those who are minded to throw the burden of taxation off their own shoulders on to those of their fellow subjects. In that battle, the Legislature has often been worsted by the skill, determination and resourcefulness of its opponents, of whom the present appellant has not been the least successful. It would not shock us in the least to find that the Legislature has determined to put an end to the struggle by imposing the severest of penalties. It scarcely lies in the mouth of the taxpayers who plays with fire to complain of burn fingers." The validity of the provisions of section 16 of the Act of 1922 and the provisions of sections 64/65 of the Act have also been upheld in the following cases.
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Provisions Citations Section 16(3)(a)(i) and (ii) of the 1922 Act corresponding to section 64(l) (i) and (ii)Balaji v. ITO (1961) 43 ITR 393 (SC); S. Srinivasan v. CIT (1967) 63 ITR 273 (SC); Smt. Shreekunwarded Daga v. T.G. Trivedi, ITO (1972) 85 ITR 451 (Bom.) and EN. Narasa Reddy v. ITO (1960) 39 ITR 629 (AP). Section 16(3)(a)(iv) of the 1922 Act, corresponding to section 64(1)(iv)G.K. Devarajulu Naidu v. CIT (1963) 48 ITR 756 (Mad.). Section 64(1) (iii)
Section 64(I)(A)K. Krishnaveni v. AAC of I.T. (1985) 151 ITR 83 (Mad.) Syed Askari Hadi Ali Augustine Imam v.Union of India (1994) 209 ITR 746 (Patna). In B.M. Amina Umma v. ITO (154) 26 ITR 137 (Mad.), the provisions of section 16(3)(a)(ii) admission of a minor to the benefits of partnership in which his parent is a partner was held not violative of Article 14 of the Constitution. In Ganga Sugar Corporation Ltd. v. State of U.P. (1980) 45 STC 36 (SC), it was observed (page 50): "It is well-established that the modern State, in exercising its sovereign powers of taxation, has to deal with complex factors relating to the objects to be taxed, the quantum to be levied, the conditions subject to which the levy has to be made, the social and economic policies which the tax is designed to subserve, and what not. In the famous words of Holmes, J., in Bain Peanut Co. v. Pinson (1930) 282 US 499, 510; `We must remember that the machinery of Government would not work if it were not allowed a little play in its joints'...Fine-tuning to attain perfect equality may be a fiscal ideal but, in the rough and tumble of work-a-day economics, the practical is preferred to the ideal, provided glaring caprice or gross disparity does not make the levy arbitrary or frolicsome. Article 14 is not intellectual chess unrelated to actual impact or the wear and tear of life but even handed justice with some play in the joints." In Punjab Distilling Industries Ltd. v. CIT (1965) 57 ITR 1 (SC), it was observed that tax can be evaded…
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