APPLICATION

&
DIVERSION
OF INCOME

Submitted by:
Nisha
00616503812
VII Sem., Sec. B
B.A. LL.B. (H)

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 CONTENTS

S.NO. TOPICS PAGE NO.

1. Introduction 3

2. Diversion of income 3

3. When diversion of income holds good 8

4. Application of income 12

5. Difference between diversion of income and application 14

of income
6. Conclusion 17

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INTRODUCTION

There are certain fundamental concepts which play a very elementary role in the computation
of income tax. One such concept is application of income. Closely related to it is another
fundamental concept called diversion of income by overriding title. These two concepts have
been a constant source of litigation and have knocked the doors of the Supreme Court and
various High Courts on numerous occasions.

In case of diversion of income by overriding title, the income before coming to the hands of
the assessee is diverted from the source itself and hence is not liable for tax. But in case of
application of income the transaction is overlooked and the assessee in whose hands the
income accrues becomes liable for tax. The distinction between these two concepts assumes
importance as it helps in determining the liability of an individual to income tax. Once the
income has accrued or arisen, the Income Tax Act (herein after referred as Act) is not
concerned about what happened to it thereafter. In other words the Act is oblivious to the
destination or disposal of the income.

DIVERSION OF INCOME

The concept of application of income cannot be fully appraised without understanding the
concept of diversion of income by overriding title. The following case laws would throw light
on the matter. In Raja Bejoy Singh Dudhuria v. Commissioner of Income Tax 1, Bengal, the
step mother and the Raja had entered into a compromise decree whereby a sum of Rs. 1, 100
per month was to be paid to her for her maintenance. This amount was declared as a charge
upon the properties in the hands of the Raja by the Court. The Raja sought to deduct this
amount from his assessable income. This was disallowed by the High Court of Calcutta. He
went on appeal to the Judicial Committee.

The Judicial Committee held that the amount which the Raja paid to his step-mother did not
constitute his income. This was a case of diversion of income by overriding title, as the Court
had created a charge on the whole resources of the Raja with a specific payment to his step-
mother. To that extent it was not his income. Further it was observed that it is not a case
where the appellant is applying his income in a particular way rather it is the allocation of a

1
(1933) 35 BOMLR 811
Page | 3
sum out of his revenue before it becomes income in his hands. It is submitted that given the
facts and circumstances of the case it was correctly held that the case was of diversion of
income by overriding title. The assessee never received the sum of Rs. 1, 100 in his hands.
Even if he received it was not for himself. He was acting as a mere collector of that income
which was to be paid to his step-mother. Thus, he was like a conduit pipe between his step-
mother and the resources which generated the income.

The assessee in Commissioner of Income Tax, Bombay v. C.N. Patuck 2, got a consent decree
divorce from his wife. As a result of the compromise the assessee made certain arrangements
for his two unmarried daughters. The decree contemplated a tripartite agreement between the
firm of Messrs Patuck and Sons, the assessee himself and his two daughters. The agreement
stated that the allowance would be paid out of the remuneration and profits payable to the
assessee from the partnership firm. In the event of the partnership firm being dissolved or in
the event of the retirement of the assessee from the said partnership or in case of his death the
payment of the sums mentioned in this clause shall constitute a first charge on the share of
the assessee. During the accounting year the assessee share of profits in the firm and his
salary according to the statement of the case were first credited to his account and then the
assessee made the payment to his daughters direct, though the receipts obtained from his
daughters mentioned that the payments were made by the firm.

The assessee claimed that the amount paid to his daughter did not constitute his income at all
and was not liable to tax. He claimed that the amount was at source diverted and ceased to be
his income, because of the overriding title created in his daughter.. On the other hand the
department contended that the profits were first paid to the assessee and then the assessee
himself distributed the profits to his two daughters. The whole arrangement was merely made
so as to ensure to the two daughters their maintenance. The Court decided in the favour of the
assessee. The decision of the Court was based on three grounds. Firstly, the very fact that the
parties contemplated security for payment of the debt or obligation by the assessee in favour
of his two daughters would give rise to a charge the moment the property which was to be a
security for the payment is specified.

Secondly, if it were merely a case of the discharge of a personal obligation by the assessee in
favour of his two daughters, then there is no reason why a tripartite agreement should be
entered into. The fact that they were made parties to the agreement and agreed themselves to
2
1969 71 ITR 713 Bom
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pay to each of the daughters the amounts of the maintenance due to them out of the
remuneration and the one-third share in the profits of the partnership, clearly shows that it
was the intention of the parties that the source or the profits should be bound. Therefore that
part of the profits could never become the income of the assessee.

Finally, the daughters could claim their maintenance directly from the two partners out of the
profits and to that extent they would have a title superior to that of their father in the profits..
The researcher agrees with the decision of the Court. What one has to see is whether the
income has actually reached the hands of the assessee or not? Once it has reached in his
hands there can be no diversion. But when he acts as a mere collector of the income or due to
some charge the income gets diverted, he cannot be taxed for that amount.

In Diwan Kishen Kishore v. Commissioner of Income-tax 3, there was an impartible estate

governed by the law of primogeniture, and under the custom applicable to be family, an
allowance was payable to the junior member. Under an award given by the Deputy
Commissioner acting as arbitrator and according to the will of the father of the holder of the
estate and the junior member, a sum of Rs. 7,200 per year was payable to the junior member.
This amount was sought to be deducted, which was disallowed. The appellants argued that
the payment which was made was necessary and obligatory payment, and therefore the
deduction should be allowed. Due to the distinctive nature of the estate, the junior member is
not entitled to separate his share and collect his income directly. Hence in lieu of his share a
separate allowance is given to him. That allowance therefore, cannot form the part of the
income of the assessee.

It was held it was not a case of application of income. Since, the junior member cannot claim
himself to be a member of the coparcenary with the assessee, the assessee was merely acting
as a collector of the allowance on his behalf. The Court further substantiated its decision by
pointing out the fact that the junior member cannot legally claim an increase in the allowance
even if the income of the estate materially increases.

This case should be distinguished from instances where an allowance is given by the head of
the Hindu coparcenaries to its members by way of maintenance. In that situation the income
generated by the resources of the Hindu joint family comes to the hands of the karta of the
family which he distributes among the coparceners as per their needs. Unless there is a

3
(1933) 11 I.T.R. 143
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partition in the family, the coparceners who receive separate maintenance, still remain the
members of the joint Hindu family. Therefore, providing maintenance allowance to them is a
case of application of income.

The Supreme Court in Moti Lal Chhadami Lal Jain v. Commissioner of Income Tax4,
observed that what is of cardinal importance is the nature of obligation by reason of which
the income becomes payable to a person other than the one entitled to it. Where the
obligation flows out of an antecedent and independent title, it effectively diminishes the total
income of an individual and so it would be a case of diversion. Whereas when the obligation
is self imposed or gratuitous, it is only a case of application of income.

From the above observation of the Apex Court, it is submitted that there is a difference
between an amount which a person is obliged to apply out of the income and an amount
which by the nature of the obligation cannot be said to be the part of the income.

The issue in Gallotti Raoul v. Assistant Commissioner of Income Tax 5 was whether the social
charges which the French nationals are liable to contribute compulsory be deducted from
salary and then be taxed or the gross salary without adjustment of the social charges be
taxed?

The argument which was put forth by the appellants was that the amount that was contributed
by the employer to the social security was similar to a primary charge existing on the income
and therefore an overriding title existed on the salary income of the employees. On the other
hand it was contended by the respondent that since the contributions were made only after the
receipt of income, it was a case of application of income.

The Supreme Court held that the since the affiliation was compulsory in nature, it made the
social security organization an earning partner alongside of the assessee. In other words, the
assessee earns not only for himself but also for the social security organization. Therefore on
the amount which had to be contributed towards the social security organization, the assessee
had no right over it at all and thereby no domain on it. The researcher is of the opinion that
the Court had aptly decided the above case. This is because, even before the assessee could
claim his salary, the social security charge is set apart for being handed over to the social

4
1991 SCR (2) 237
5
1997 61 ITD 453 Mum
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security organization and thereby the employee never has the chance of even touching it. It is
rightly an instance of diversion of income.

In the case Jit & Pal X-Ray Pvt. Ltd. Vs. CIT6, an assessee purchased a business as a
going concern subject to the condition of payment of a percentage of profits to the vendor’s
wife. The amount of profits so paid should be regarded not as application of income but as
diversion of income at source by overriding title. Therefore, such amount of profit cannot be
taxed in the case of the assessee.

In a case where, partnership firm making payment to the spouse of the deceased partner, the
Bombay High Court in CIT Vs. Nariman B. Bharucha & Sons 7 has held that such payment
are in the nature of diversion of income at source by overriding title. Hence, it cannot be
taxed in the hands of partnership firm. Similarly, where a firm utilized the capital of retired
partner, such retired partner is eligible for share of profit u/s 37 of the Indian Partnership Act,
1932 until his share is paid to him. The Allahbad High Court in CIT Vs. Varnasi Nagar Bika
(2005) 275 ITR 140 (All) has held that the firm is entitled to claim the amount so paid to the
retired partner applying the concept of diversion of income by overriding title.

A co-operative society deducted certain amounts at prescribed rates from the cane price
payable to members pursuant to instruction issued by the Director of Sugar and credited to
certain funds such as Chief Minister’s Relief Fund, Hutment Fund, Area Development Fund
and Cane Development Fund. The assessee society exercised dominion over these funds and
was expected to utilize them in accordance with the guidelines issued by the by Government
for which the Director of Sugar acted in a supervisory capacity to oversee proper utilization.
In such cases, the concept of diversion of income at source by overriding of title does not
apply and the entire income is assessable in the hands of society. S. Sahakari Sakhar
Karkhana Ltd. Vs. CIT8.

Diversion of Income is an obligation to apply the income in a particular way before it is

received by the assessee or before it has arisen or accrued to the assessee results in diversion
of income. The source is charged with an overriding title, which diverts the income.
Therefore the essentials are the following:

6
(2004) 267 ITR 370 (All)
7
130 ITR 863
8
(2004) 270 ITR 1 (SC)
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 i. Income is diverted at source,
ii. There is an overriding charge or title for such diversion, and
iii. The charge / obligation is on the source of income and not on the receiver.

Examples of diversion by overriding title are –

(i) Right of maintenance of dependents or of coparceners on partition

(ii) Right under a statutory provision
(iii) A charge created by a decree of a Court of law.

When diversion of income holds good

With most people keen on avoiding paying tax on income earned, they resort to several
devices. One such method is to transfer a part of the income directly to reserves.

Some tax-payers indulge in accounting jugglery by taking a part of the receipts directly to the
credit of reserve fund in the balance-sheet without routing such amount to the profit and loss
account, in the hope that it may escape the attention of the tax officer to whom the accounts
are submitted along with the return of income.

Very often, this method is adopted where a statute requires the creation of a reserve fund.

Taking advantage of this statutory provision, a legal entity, be it a company, co-operative

society, etc., takes the view that such amount required to be transferred to the reserve fund
does not constitute its taxable income, on the ground that there is an overriding title (or
overriding claim) for such amount in this case, the statutory requirement of a reserve fund.

This principle of diversion of income by overriding title is undoubtedly sanctified by judicial

authorities.

However, the scope of this principle has to be clearly understood so that it does not become a
tool for evading tax on income received by an assessee.

Diversion arises where income is applied in a particular manner under statutory or contractual
obligation or under the provisions of a document under which the company is constituted,
such as memorandum or articles of association.

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In principle, if a person has alienated or assigned the source of his income so that it no longer
remains his income, he cannot be taxed on income arising after assignment of the source.

The reason is that it is not the income of the assessee at all.

In Raja Bejoy Singh Budhuria v. C.I.T. (1 I.T.R. 135; PC), the assessee had succeeded to the
ancestral estate on the demise of his father.

Subsequent to such succession, his stepmother, who had a legal right to maintenance out of
the estate of her husband, brought a suit of maintenance against him, and the the Court
decreed that the assessee had to pay a fixed monthly sum to the stepmother.

It was declared that the maintenance was a charge on the ancestral estate in the hands of the
assessee.

The question that arose before the Privy Council was whether the assessee was liable to be
assessed as an individual in respect of the amount of maintenance payable to the stepmother;
to that extent, what he diverted to her was not his income.

It was not a case of application by the appellant of part of his income in a particular way.

In Provat Kumar Mitter v. C.I.T. (41 I.T.R. 624; SC), the assessee, who was a registered
holder of 500 ordinary shares in a limited company, assigned to his wife, by a deed of
settlement, the right, title and interest to all dividends and sums of money that might be
declared or may be due and payable in respect of those shares for the term of her natural life
and covenanted to deliver and endorse over to her any dividend warrant or other document of
title to such dividends or sums of money and to instruct the company to pay such dividends
and sums of money to her.

The assessee claimed exclusion of dividends on the aforesaid 500 ordinary shares on the
ground of transfer by diversion of income by overriding title.

The Supreme Court repelled the contention by holding that the deed of assignment was, in its
true nature, only a contract by the assessee to transfer, or make over, to his wife in future all
dividends that may be declared in respect of the shares.

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Hence, the income continued to accrue to the assessee and was assessable in the hands of the
assessee as his income, even though it was ultimately payable to his wife under the terms of
the deed.

It was a case of application of income after it had accrued and not a case of diversion of any
sum of money before it became the income of the assessee nor was it a case where the
assessee had received the income for someone else.

In K. A. Ramachar v. C.I.T. (42 I.T.R. 25; SC), though the deed of settlement was
irrevocable, each of the beneficiaries of the settlement was entitled to receive one-fourth of
the share in the profits of the firm for eight years from the date of the settlement.

The assessee's claim that those amounts were payable to the wife and children of the settlor
under the obligation arising under the irrevocable deed of settlement was negatived on the
ground that, on the facts, the effect of the deeds of settlement was that the profits were first to
accrue to the assessee and then be applied for determination of the share payable to the
beneficiaries.

A stranger, even if he were an assignee, did not and could not have any direct claim to the
profits.

The dispositions were, in law and in fact, portions of the assessee's income after it had
accrued to him, and tax was payable by him at the point of accrual.

The difference between "application of income after it reaches the assessee" and "diversion of
income by overriding title before it reaches the assessee" was explained by the Supreme
Court in C.I.T. v. Sitaldas Tirathdas (41 I.T.R. 367):

"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."

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In C.I.T. v. Imperial Chemical Industries (India) P. Ltd. (74 I.T.R. 17; SC), the Court held
that the payment of amounts by the respondent to the outgoing agents was not by an
overriding title created either by act of the parties or by operation of law, and it could not be
said that the amount of compensation paid to the outgoing agents did not form part of the
respondent's income.

In C.I.T. v. Jodhpur Co-operative Marketing Society (275 I.T.R. 372), the assessee, a co-
operative society, claimed that Rule 68 of the Rajasthan Co-operative Societies Rules, 1966,
framed under the Rajasthan Co-operative Societies Act, 1965, required the society to transfer
twenty-five per cent of its net profits to a reserve fund.

Hence, the said amount was deductible under Section 37 of the Income-tax Act, 1961, for the
assessment year 1989-90.

The Assessing Officer and the Commissioner (Appeals) disallowed the claim of the assessee,
but the Tribunal held that the amount transferred to the reserve fund was business expenditure
and, therefore, an allowable deduction.

On appeal, the Rajasthan High Court held that neither did the reserve fund go to any party
other than the assessee itself nor was there any obligation to provide for such reserve before it
became part of the net income earned by the society.

The obligation to carry a part of its net profit to a reserve fund did not envisage diversion of
any part of the profits to a person other than the society itself.

There was no overriding title vesting in a third party other than the assessee to lay claim to
the reserve fund independent of the co-operative society.

To sum up, the essence of the principle of diversion of income by overriding title is that
income must reach a person other than the assessee by reason of a pre-existing title to it.

Even if a tax-payer incurs a legal obligation to apply a part of his income, it would still
remain his taxable income unless the very source of the income is assigned to the third party.

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APPLICATION OF INCOME

A cursory perusal of the S.60 of the Act will make it clear that unless there is transfer of the
assets from which the income arises, the income arising from that asset will be included in
the income of the transferor for computation of tax. The issue in Life Insurance Company v.
Commissioner of Income Tax9, Bombay City was whether, under S.28 of the Life Insurance
Corporation Act, 1956 the surplus which is statutorily payable to the Central Government, is
a permissible deduction from the surplus disclosed for the inter-valuation period ended March
31, 1963 or not?

The appellant contended that this was a case of diversion of income by an overriding charge
in so far as a part of the surplus was compulsorily required to be paid to the Central
Government. The Apex Court did not found any substance in the argument of the
Corporation and held that the statutory obligation that has been imposed on the Corporation
comes into effect only when the income accrues to the Corporation and not before that. Since
the obligation has to be discharged only after the income has been received by the
Corporation, there was no question of any overriding charge so as to result in diversion of
any income to the Central Government. The researcher also sees in line with the Apex Court
judgment. It is only a question of application of income. S.28 operates only after the surplus
has reached the hands of the Corporation and therefore there is no diversion of any income by
an overriding charge. In other words, S.28 provides for the manner in which the surplus is to
be distributed after it has been properly determined.

The respondent in Commissioner of Income Tax, Bombay v. Sitaldas Tirathdas 10 sought to

deduct a sum of Rs. 1,350 in the first assessment year and a sum of Rs. 18,000 in the second
assessment year on the ground that under a decree he was required to pay these sums as
maintenance to his wife and his children. This was disallowed by the Income Tax Officer.
The matter reached till the Supreme Court.

The Supreme Court made a distinction between the amount which a person is obliged to
apply out of his income and an amount which by the nature of an obligation cannot be said to
be the part of the income of the assessee. When the income does not reach the hands of the
assessee due to diversion under an obligation, it is deductible. But on the other hand when the

9
1967 SCR (1) 943
10
1961 SCR (2) 634
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income is required to be applied to discharge an obligation after such income reaches the
assessee, the same consequence in law does not follow. The first kind of payment is
exempted under the Income Tax Act but not the second one. The second one is a case of
application of income which has been received. 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. On the facts and circumstances of the
case it was held that it was a mere case of application of income to discharge an obligation.
The wife and children of the assessee who continued to be members of the family received a
portion of the income of the assessee only after the assessee had received the income as his
own. Therefore there was no diversion of income by an overriding charge.

The testator in P.C. Mullick and Another v. Commissioner of Income Tax 11, Bengal
appointed the appellants as executors and directed them to pay Rs. 10,000 out of the income
on the occasion of his addya sradh. The executors paid Rs. 5,537 for such expenses, and
sought to deduct the amount from the assessable income. The Judicial Committee disallowed
the deduction. It held that whatever payments were made, were done once the income had
reached the hands of the assessee and in pursuance of the obligation imposed upon them by
the testator. This was not the case of diversion of income. It is submitted that the decision of
the Judicial Committee in the above case rightly brings out the intention of the drafters of the
Act. The Act is not concerned about how one spends his money, that is, the Act is indifferent
to the destination of the income. What is of material concern is that whether the income has
reached the hands of the assessee or not. Once it is in the hands of the assessee it is liable for
tax.

The appellant in Provat Kumar Mitter v. Commissioner of Income Tax12, West Bengal had
under a contract 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 for the term of her natural
life. In assessing the assessee the Income Tax Officer included the dividend paid to his wife
as his income. It was contended by the assessee that the dividend which his wife received
could not be deemed to be his income.. The department argued that since the shares
continued to stand in the name of the assessee and the dividends had been declared in his
name, the transfer of the dividend to the beneficiary was only an application of the dividend

11
 (1938) 40 BOMLR 780
12
1961 SCR (3) 37
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income and, therefore, the assessee could not claim exemption from being taxed on it as a
part of his own income.

The Court rejected the contention of the assessee and said that since the assessee did not
assign the shares to his wife he therefore, retained the right to participate in the profits of the
company. He did not part with that right. So the dividend accrued to him which was later
given to his wife as per the contract. Therefore it was a case of application of income.The
researcher opines that Act is not concerned with the ultimate destination of the income. What
is to be seen is that in whose hands income accrues. Once the income is in the hands of the
assessee, he is liable for tax. In other words 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.

An application of income is an obligation to apply income, which has accrued or has arisen or
has been received amounts to merely the apportionment of income. Therefore the essentials
of the concept of application of income under the provisions of the Income Tax Act are:

(i) Income accrues to the assessee

(ii) Income reaches the assessee
(iii) Income is applied to discharge an obligation, whether self-imposed or gratuitous.

DIFFERENCE BETWEEN DIVERSION OF INCOME AND

APPLICATION OF INCOME

Section 4, the charging section in the Income-Tax Act, has lead to a major controversy —
over the concept of application of income and its diversion by overriding title, that is.There is
a plethora of decisions on the subject and, as early as 1961, the Supreme Court had laid
downthe principles in  CIT vs Sitaldas Tirathdas (1961 41 ITR 367 SC).                                   

Despite this, such issues as whether income that is transferred by overriding title escapes the
clutches of tax, or whether it is a case of receiving the income and applying it for a particular
purpose, keep surfacing .The law is, by and large, settled, treating the income which is
received and applied for any purpose as taxable in the hands of the recipient. Recently, the

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Supreme Court had to deal with a situation of overriding title versus application of income in
the CIT vs Sunil J Kinariwala (2003 126 Taxman 161 SC) case.

Facts, issues

The assessee, a partner in Kinariwala R. J. K. Industries, Ahmedabad (a partnership firm),

was having 10 per cent share therein. On December 27, 1973, he created a trust, `Sunil
Jivanlal Kinariwala 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 Rs 5,000 out of his
capital in the firm in favour of the said trust. There were three beneficiaries of the trust — the
assessee's brother's wife, the assessee's niece and the assessee's mother.

In the assessment year 1974-75, he claimed that as 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 same could not be included in his total income for the purpose of his assessment.
The income-tax officer (ITO) rejected the claim on the view that it was a case of application,
not diversion, of income at source. He also found that Section 60 of the Act was attracted, as
only income without transfer of asset was settled.

Against the order of assessment, the assessee appealed before the Appellate Assistant
Commissioner of Income-tax (AACIT), who allowed the appeal directing that a sum of Rs
20,141, which stood transferred to the trust under the settlement, be excluded from the total
income of the assessee. However, on appeal by the Revenue, the Tribunal reversed the
AACIT's order. The High Court, relying on the judgments in CIT vs Bhagyalakshmi & Co
(1965 55 ITR 660) and Murlidhar Himatsingka vs CIT (1966 2 ITR 323), held, inter alia, that
on assignment of 50 per cent share of the assessee in the firm, it became the income of the
trust by overriding title and it could not be added in the total income of the assessee. The
Revenue took the matter to the Supreme Court.

Decision

The Supreme Court held that the assessee's share of income assigned in favour of the trust
would have to be included in the assessee's total income. The court reasoned that, under the

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Act, it is the total income of an assessee, computed under the provisions of the Act, that is
assessable to income-tax.

So much of the income which an assessee is not entitled to receive, by virtue of an overriding
title created in favour of a third party, would get diverted at source and the same cannot be
added in computing the total income of the assessee.

There is thin dividing line between diversion and application of income. While application of
income may be of little consequence, diversion of income has to be examined carefully. To
decide whether a particular payment is a diversion or application of income, one must
determine whether the amount sought to be diverted reaches the assessee as his own income
or not. That is, it has to be seen whether the disbursement of income by the assessee was a
result of fulfilment of an obligation on him or whether income was applied to discharge an
obligation after it reached the assessee. Where, because of an obligation, income is diverted
before it reaches the assessee, it is not taxable.

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.

The first kind of payment can be excused, but not the second. The latter is merely an
obligation to pay another portion of one's income which has been received and is since
applied.

The former 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 short, this is one issue where legislative amendment cannot help. It has to be decided only
with reference to the facts of the case.

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CONCLUSION

Income emanates from a source. Income is got through receipt or accrual or it is deemed to
accrue. Under the Income Tax Act, once the income has come into existence it is liable for
tax. Taxable event is the source generating the income. When I earn income, I set apart it for
certain things. It may arise under a contractual obligation or statutory obligation or
involuntary/voluntary disposition. It is not every obligation under which an income is applied
is taken into account while computing tax. The emphasis is on the nature of the obligation. If
the nature of obligation is such that the income gets diverted before it reaches the hands of
the assessee due to operation of law or due to creation of charge, then such amounts are
deductible while computing the tax liability of the individual. Rational behind this is that
presence of an independent title effectively slices away a part of the corpus of the right of the
assessee to receive the entire income. On the other hand if the obligation is self imposed, it is
a mere application of income.

Due to the ingenuity of the people, S.60 has been provided in the Act. The section tries to
curb the mischief whereby individuals try to escape tax liability by transferring the income.
Unless and until the source has been assigned to someone else, it will not fall within the
domain of diversion of income. The test is to see precisely at what time the transfer had taken
place. If transfer had taken place after the accrual of income then it is an application of
income. But if transfer has taken place after the assignment of source then it is not application
of income. There exists 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. All this has to be seen in the broader context of the Act
that the Act is nonchalant about the destination or disposal or what happened to the income
once it has accrued in the hands of the assessee.

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