This Article is written by Sidharth M of Govt Law College, Thiruvananthapuram
Abstract
This article explores the concept of diversion of income by overriding titles, which is a tax avoidance scheme that involves transferring income or assets to another party through a legal document known as an overriding title. This article also examines how this scheme works, the legal and ethical implications of its use, and the potential consequences for individuals or companies who engage in it. It also emphasizes the importance of complying with tax laws and consulting with qualified professionals for legitimate tax planning strategies. By understanding the intricacies of this complex tax avoidance strategy, individuals and companies can avoid costly legal penalties and ensure compliance with tax regulations.
Introduction
Diversion of income by overriding titles refers to a tax avoidance scheme where an individual or company transfers their income or assets to another party through a legal document known as an overriding title. This is done in order to reduce the amount of tax that would be payable on the income or assets.
In this scheme, the individual or company creates an overriding title, which is essentially a legal document that transfers the right to receive income or assets from one party to another. The overriding title can be in the form of a lease, license, or other legal agreement that allows the income or assets to be diverted to another party.
The use of overriding titles to divert income is considered to be an aggressive tax planning strategy, and may be illegal in some jurisdictions. Tax authorities are typically very vigilant in monitoring these types of schemes, and individuals or companies who engage in them may face legal consequences and heavy penalties.
It’s Important to note that while tax planning is legal, it’s important to ensure that any strategies used are legitimate and compliant with the law. If you’re unsure about the legality of a tax planning strategy, it’s best to consult a qualified tax professional for advice.
How this Works?
Diversion of income by overriding titles is a tax avoidance scheme that works by transferring income or assets to another party through a legal document known as an overriding title. Here’s how it typically works:
- An individual or company creates an overriding title, which is a legal document that transfers the right to receive income or assets from one party to another.
- The overriding title is usually structured as a lease, license, or other legal agreement that allows the income or assets to be diverted to another party.
- The individual or company then pays the income or assets to the other party, who may be a related party, such as a family member, or an unrelated party, such as a shell company.
- By doing this, the individual or company can reduce their tax liability, as the income or assets are no longer directly attributed to them.
However, it’s important to note that using overriding titles to divert income is often considered to be an aggressive tax planning strategy, and may be illegal in some jurisdictions. Tax authorities are typically very vigilant in monitoring these types of schemes, and individuals or companies who engage in them may face legal consequences and heavy penalties.
It’s Important for individuals and companies to understand the potential risks and consequences of using this tax avoidance strategy, and to ensure that they comply with tax laws and regulations. Consulting with a qualified tax professional is highly recommended for legitimate tax planning strategies that comply with the law.
Legal Usage
The use of diversion of income by overriding titles can be legal if it’s done for legitimate business purposes and in compliance with tax laws and regulations. For example, a business may use an overriding title to lease property to another party, which allows them to receive rental income through the lease. As long as the lease agreement is negotiated at arm’s length and the terms are fair and reasonable, this type of transaction would be considered legal and legitimate according to the Judgement of Padmashree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010)(1) Case.
However, using an overriding title for the sole purpose of reducing tax liabilities or avoiding taxes is often considered to be an aggressive tax planning strategy and may be illegal. Tax authorities closely scrutinize such transactions to determine whether they are legitimate business transactions or simply a means of avoiding tax obligations.
It’s important for individuals and companies to consult with a qualified tax professional to ensure that any tax planning strategies they use are compliant with tax laws and regulations. If in doubt, seeking legal advice from a qualified professional can help to avoid any potential legal or financial consequences.
About the Case – Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom)
In Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom), the Bombay High Court held that the principle of diversion of income by overriding title can be applied only when there is a legal obligation to divert the income. The case involved a university that made voluntary donations to its trust, and the trust, in turn, used the donations for charitable purposes. The university claimed that these donations were a legitimate diversion of income by overriding title, and, therefore, they were not taxable.
However, the court held that the donations made by the university were voluntary and not made under any legal obligation. Therefore, these donations could not be treated as a diversion of income by overriding title, and they were taxable as the income of the university. The court also observed that a diversion of income by overriding title must be made under a genuine and legal obligation, and not merely a voluntary payment or transfer of income.
Overall, the case of Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom) reinforces the principle that the diversion of income by overriding title is only applicable when there is a legal obligation to divert the income.
Legal Consequences
The legal consequences of using diversion of income by overriding titles can be severe. In most jurisdictions, tax authorities are authorized to challenge the validity of transactions that they deem to be tax avoidance schemes, and may impose financial penalties, interest charges, and even criminal charges.
If an individual or company is found to have engaged in diversion of income by overriding titles for the sole purpose of reducing tax liabilities, they may be subject to penalties for tax evasion, which can include significant fines, imprisonment, and reputational damage. Additionally, they may be required to pay back taxes owed, along with interest charges and penalties.
In some cases, individuals or companies may also face civil lawsuits from other parties who were harmed by their actions. For example, if an individual transferred assets to another party using an overriding title, creditors of the individual may challenge the validity of the transfer, and may seek to recover the assets as happened in the Case CIT v. Shoorji Vallabhdas & Co. (1962)(2).
About the Case – CIT v. Shoorji Vallabhdas & Co. (1962) 46 ITR 144 (SC).
In this Case, the Supreme Court of India considered the question of whether income diverted by overriding title could be taxed as the income of the assessee. The case involved a partnership firm, which had entered into an agreement with a company, under which a portion of the profits of the firm was diverted to the company.
The Supreme Court held that if the owner of the income deliberately creates a diversion of income by overriding his legal obligation to receive that income, then the income will be taxed as his own income. The court further observed that if the diversion of income is made voluntarily and without any legal obligation, then it would not qualify as a diversion of income by overriding title.
The court also held that the principle of diversion of income by overriding title is not limited to cases of voluntary gifts or donations. It can also be applied in cases where there is a legal obligation to divert the income. The court noted that the diversion must be a real and bona fide arrangement, and not a mere pretense or sham.
Overall, the case of CIT v. Shoorji Vallabhdas & Co. (1962) established the principle that income diverted by overriding title can be taxed as the income of the assesse, but only if the diversion is made with the intention of creating a legal obligation to divert the income.
Why this Scheme is in a rise?
Using diversion of income by overriding titles as a tax avoidance strategy can have serious legal consequences for individuals and companies. If tax authorities determine that an overriding title was used to avoid taxes, the individual or company may face penalties, interest, and fines. In some cases, they may even face criminal charges for tax fraud.
Additionally, the use of overriding titles for tax avoidance purposes may result in the re-characterization of the transaction by tax authorities. For example, if an overriding title is used to transfer income from a business to a related party, the tax authorities may re-characterize the transaction as a dividend or a salary payment, which may result in a higher tax liability for the business.
In extreme cases, the use of overriding titles for tax avoidance may also result in the loss of reputation and damage to a company’s brand. This can have significant long-term consequences for the business, including loss of revenue and reduced customer loyalty.
It’s important for individuals and companies to understand the potential legal consequences of using this type of tax avoidance strategy.
Prevention
In India, the Income Tax Act provides provisions to prevent the diversion of income by overriding titles. These provisions are designed to ensure that the person who earns the income is the one who is taxed on it, regardless of who may have legal title to it.
One of the key provisions in this regard is Section 60 of the Income Tax Act, which provides that any income arising to an individual shall be deemed to belong to that individual, even if the income is paid or credited to someone else.
Additionally, Section 64 of the Income Tax Act provides that if any income is transferred without adequate consideration to a spouse or minor child of an individual, such income will be deemed to belong to the individual and will be taxed as his or her income.
Furthermore, Section 61 of the Income Tax Act provides that any income arising to an individual from assets transferred by him or her to another person without adequate consideration will be deemed to belong to the transferor and will be taxed accordingly.
These provisions are meant to prevent individuals from transferring their income to others in an attempt to avoid taxation. It is important for individuals and businesses to comply with these provisions to avoid any penalties or legal action by the Income Tax authorities.
Conclusion
Income tax is an essential source of revenue for the government to finance public goods and services such as infrastructure development, healthcare, education, public transportation, and other essential services. Income tax is a progressive tax system, meaning that individuals with higher incomes pay a higher percentage of their income as tax than those with lower incomes.
Paying income tax is not only a legal obligation but also a social responsibility. It helps to ensure that the government has sufficient funds to carry out its responsibilities towards the public. When people pay their taxes, they contribute to the growth and development of the country, which benefits them and the society as a whole.
Apart from fulfilling the civic duty of paying taxes, there are several benefits of paying income tax, such as it provides individuals with a sense of security and peace of mind, as they become eligible for various social security schemes and other government benefits. Paying taxes also helps individuals establish their credibility and financial stability, which may be useful when applying for loans or credit in the future.
In summary, paying income tax is not only a legal obligation but also a social responsibility. It is essential for the economic and social development of a country and helps to ensure that the government has sufficient funds to provide essential public goods and services.
Case laws mentioned
1.Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom)
2.CIT v. Shoorji Vallabhdas & Co. (1962) 46 ITR 144 (SC)
Reference
1.https://www.taxmanagementindia.com/visitor/detail_manual.asp?ID=1288#:~:text=Diversion%20of%20income%20by%20overriding%20title%20means%20that%20the%20income,subject%20to%20a%20legal%20obligation%20.
2.https://itatonline.org/archives/catchwords/diversion-of-income-by-overriding-title/
3.https://www.casemine.com/search/in/Diversion%2Bof%2Bincome
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