One of the earliest cases was that of ED Sassoon & Co Ltd vs CIT, 26 ITR 27(SC), where it was held that the office of managing agents and all theirrights and benefits under the Managing Agency Agreement had been assignedand since the source of income itself had been assigned, the income had beendiverted by overriding title and no part of the income from the agency wouldthen become includable in the hands of the assignor.

As succinctly put in Kanga & Palkhivala's `Law & practice of income-tax', ifa person has alienated or assigned the source of his income so that it is nolonger his, he may not be taxed upon the income arising after the assignmentof the source. This principle is, of course, subject to statutory exceptions.In Raja Bejoy Singh Dudhuria vs CIT, 1 ITR 135 (PC), the assessee hadsucceeded to the family ancestral wealth on the death of his father.

Subsequently, his step-mother brought a suit for maintenance against him inwhich a consent decree was made, directing the assessee to make a monthlypayment of a fixed sum to his step-mother and declaring that the maintenancewas a charge on the ancestral estate in the hands of the assessee. Incomputing the income, the assessee claimed that the amounts paid by him tothe stepmother under the decree, should be included. The court held that theamounts paid by the assessee to the stepmother were not "income" of theassessee at all. A decree of the court by charging the appellant's wholeresources with a specific payment to his stepmother had, to that extent,diverted his income from him and had directed it to his stepmother; to thatextent, what he received for her was not his income. It was not a case ofthe application by the appellant of part of his income in a particular way,it was rather the allocation of a sum out of his revenue before it becameincome in his hands.

However, the difference between a diversion of income by an overriding titleand an application of income is very thin. There has, therefore, been muchlitigation on this issue.

In a recent decision in CIT vs Mathubhai C Patel, 238 ITR 403 (SC), theissue came up again. Here, the facts were that on death of the assessee'sfather, he inherited various assets as well as some liabilities in respectof borrowing from a bank by the father.

The father had borrowed the amount during his life time in order to meethis income-tax liabilities. Various bank shares, which were inherited hadbeen pledged for this purpose. He was also required to meet the liabilitywhich had accrued out of the inherited assets and he was obliged to payinterest to the bank on the amount due to the bank. The dividend incomewhich the assessee received from the shares pledged with the bank was soughtto be taxed during the concerned assessment year. The assessee claimed thatsince he had also paid interest to the bank on the overdraft account, thesaid amount of interest was required to be deducted from the gross receiptsin order to compute the real income earned by him. The high court held infavour of the assessee.

At the Supreme Court, it was pointed out that the high court had relied on adecision in Udayan Chinubhai vs CIT, 111 ITR 584 (Guj). This decision hadbeen reversed by the Supreme Court in CIT vs Udayan Chinubhai, 222 ITR 456(SC), wherein the court had laid down at pages 464 and 471 as under: "If aman incurs a debt, he will have to pay the debt and till the debt is paid infull, he may have to pay interest on that debt. But whether the interest isallowable as a deduction or not will depend upon the provisions of theIncome Tax Act. No question of diversion of income by overriding title canarise in a case like this. A man has to pay his debts out of his income.Merely because of the liability to pay the debts, it cannot be said that theincome from the assets that he received on partition stood diverted byoverriding title to the creditors. ... The basic principle to be borne inmind in this type of cases is that when a person pays his debts or maintainshis wife or children or any body else whom he is obliged to maintain, theexpenditure incurred in such cases will be application of the assessee'sincome and not diversion of the income at source. If he does not pay what heshould have paid and is compelled by a court order to pay, it will still notbe a case of diversion of income at source. Even if a charge is created onthe properties of the assessee for enforcing payment, the position in lawwill not change."

The Supreme Court found merit in the contention of the counsel for therevenue that a distinction had to be made between the asset being chargedwith the obligation to discharge the liability and the income from the assetbeing charged with the liability to pay interest. In the present case, thepledging of the shares was effected by the assessee's father to secure theloan advanced by the bank and it was not a case where the income from theshares had been charged with payment of interest payable on the loan.To sum up, where an assessee receives assets along with liabilities, in atestate or intestate succession, the payment of the interest in respect of aliability would not be an overriding charge on the income receivable inrespect of the assets received from the estate.

The author is a Mumbai-based chartered accountant