Gift shares are taxable

When a partner decides to gift a part of his share in the partnership firm, an interesting question arises with respect of the implications of such a gift. The tax department refuses to recognise such a gift and takes the stand that the entire share of profits should be taxable in the hands of the partner despite the gift being made, in view of the provisions of section 60. This point was considered by the Gujarat High Court in CIT v Jayantilal D Patel [2007] (162 Taxman 385).

The facts in this case were that the assessee was deriving income, inter alia, by way of a partnership share in the firm, in which he had a 60% share in the profit and loss of its business. The assessee created a trust for the benefit of his children and executed a deed of assignment whereby he gifted 50% of his partnership share in the firm to the trust.

For the assessment years 1979-80 to 1982-83, the assessee claimed a deduction of 50% out of the profits from his 60% share in the firm, on grounds that as per the deed of the assignment, the income had been diverted in favour of the trust, and as such was not liable to be included in his total income.

The Assessing Officer observed that the amount in question had accrued to the assessee first and then further entries were passed to transfer 50% of the profits in favour of the trust, and only 50% of the share of profit had been transferred, without transferring the source of the income producing asset, namely, a share in the partnership firm, comprising of all the concomitant rights.

The Assessing Officer accordingly held that it was a case of application of income after its accrual and not a case for diversion of income at source and, therefore, by virtue of provisions of section 60, the assessee was not entitled to deduct it from his assessable income, but the same was taxable as income in his hands. The Commissioner (Appeals) allowed the assessee?s appeal on the grounds that the assignment of a 50% share was not by way of application of income but by way of diversion of income on account of overriding the title. On appeal, the Tribunal confirmed the order of the Commissioner (Appeals).

The Gujarat High Court held that the facts showed that the transfer was not revocable. For the purpose of applying section 60, the only question that requires to be answered is whether there is no transfer of the assets from which the income arises.

If the answer is in the affirmative, all income arising to any person by virtue of such a transfer would be chargeable to income tax as the income of the transferor, and would be included in the total income of the transferor. In the instant case, there was no dispute that the transfer of the 50% share of the assessee?s share in partnership had been gifted to the trust, the constitution of which, under the deed of trust, dated June13, 1978, was not challenged.

The gift of the one-half share had been accompanied by a gift of a cash amount of Rs 3,000, out of the amount standing to the credit of the donor in the partnership firm.

The gift was complete by way of delivery and acceptance. The Tribunal had found as a matter of fact that the transaction had been subjected to charge under the Gift Tax Act and that was based on the assessment order dated October 8, 1982 under the Gift Tax Act. The transfer was of the right to share profits, i.e., right to receive profits and liability to contribute to the losses. Therefore, it could not be stated that there was no transfer of the asset, from which the income by way of the share in the profits arose to the transferee. The income-producing asset stood transferred.

Provisions of section 60 could not be attracted to the facts of the instant case. It was not even the case of the revenue that there was an intrinsic or inseparable interconnection between the contributions of capital and right to receive profits. However, even if such a contention could be raised by the revenue, the same stood answered by the decision of Gujarat High Court in CIT v Nandiniben Narottamdas (140 ITR 16).

While assessing the partners individually, the status of the partner, the capacity of the partner, and the obligation of the partner have to be borne in mind, independent of the partner?s status and relations vis-?-vis other partners of the firm. The instant case was a classic one of such a mixed approach, while framing an assessment of the partner in his individual capacity.

Whatever may be the obligations of the partner qua the other partners of the firm, or against a third party as a partner of the firm under the general law of partnership, what an assessing officer is required to look at is whether the income lawfully accrues to him and is taxable in his hands. At that stage, revenue is not required to look at his capacity or obligations qua the partnership firm or other partners of the firm. Legally there is a distinct taxable entity under the Income-tax Act, viz., a partnership firm, and the revenue cannot be permitted to import the general principles of partnership law at this stage.

To conclude, once Legislature has provided for a particular legislative scheme under the Income-tax Act, the revenue cannot ignore the same on the specious plea that under the general law, partnership is nothing but a compendious name of persons who have come together to conduct a business. There is a dichotomy when one looks at the scheme of the Income-tax Act as against the scheme under the partnership law. The same has to be borne in mind when one is called upon to decide the legality of action of the assessing officer, while assessing an individual who may be a partner in a firm.

?The author is an advocate of the Supreme Court