Can my master thesis be a part of doctoral dissertation of the Ph.D student I worked with? I had been working on a project for my masters thesis under a doctoral student, which is eligible for a paper publication. But after finishing more than half of the project, my supervisor suddenly ordered me to start over a new project and told me to stop working on the former work, stating that a masters thesis work cannot be used in a doctoral student's dissertation even if I am given authorship in that paper.

I would sincerely like to know if what my supervisor said is true or if I am being cheated out of my masters project and thus my masters degree. Either way, can the answer please be supported by proper evidence(s) to support it? It will help me talk to my supervisor, if necessary with solid proof and even escalate it up the hierarchy if required.

I come from a Central University in India.
For both a masters' thesis and a PhD dissertation, there needs to be a core piece of work that is primarily the student's work.  Collaboration can certainly be fine, but there needs to be a core idea that is "yours" in order to get a degree out of it.

It's at least conceivable that you and the PhD student were collaborating on something that had only one degree-worthy idea in it, and therefore a tough decision had to be made.  

It's also possible that this is being used as an excuse for something unethical like cheating you out of your masters' project.  

Whether this was legitimate, or not, we can't really tell from the information given.

It does sound that the situation was, at least, not handled very well.  The supervisor has oversight of both your projects and should have prevented your projects from overlapping too much, before you wasted lots of work on something. Also, if you contributed significantly to the eventual PhD project, at a minimum you should still get credit for this (e.g. with paper authorship).