India: Family Arrangement: Income Tax Perspective

1.1. Definition of Family Arrangement

Family Arrangement is an arrangement between members of a family descending from a common ancestor or near relation trying to sink their differences and disputes, settle and solve their conflicting claims once and for all to buy peace of mind and bring about harmony and goodwill in the family by an equitable distribution or allotment of assets and properties amongst members of the family.

In the case of Sk Satter Sk. Mohd. Choudhary. Gundappa Amabadas Bukate, AIR 1997 SC 998, the Apex Court relying upon the definition of Family Arrangement in Halsbury's Laws of England held that a family arrangement is intended to be generally and reasonably for the benefit of the family either by compromising doubtful or disputed rights or by preserving family property or peace and security of the family by avoiding litigation or by saving the family honour.

1.2. Components/Ingredients of Family Arrangement

The main components of a Family Arrangement in India evolved through customs and judicial pronouncement are: Family; Property; Disputes and Arrangement.

1.2.1. Family

The term Family has been defined in the Income Tax Act, 1961 ("Act") under 'explanation' to Section 10 (5) which reads as:

"Family", in relation to an individual, means—

(i) the spouse and children of the individual; and

(ii) the parents, brothers and sisters of the individual or any of them, wholly or mainly dependent on the individual;

The explanation to Section 10 (5) is an inclusive definition which lists down that spouse, children, parents, brother and sister of an individual would be considered as a Family for the purpose of the Act. Apart from the Income Tax Act, 1961, the word family has no where been defined. The courts have in addition to the aforesaid definition given a wider meaning to the word family, to exclude persons who have common tie or relation to be a part of family. In Ram Charan Das v. Girjanandini Devi AIR 1966 SC 323 and subsequently in the case of Krishna Bihari Lal v. Gulab Chand 1971 AIR 1041 SCR 27, the Hon'ble Supreme Court held that the word family had a much wider meaning. The court in Paragraph 7 held: "...the word "family" in the context of a family arrangement is not to be understood in a narrow sense of being a group of persons who are recognized in law as having a right of succession or having a claim to a share in the property in dispute."

Therefore, the requirement of existence of legal/succession of the family property has been subsequently dispensed with in the view of the aforesaid judgements and a broad interpretation thereto has been given to the term 'family' for the purpose of inter-alia, taxation and family arrangements.

1.2.2. Property

The entire purpose of having a Family Arrangement is to secure and settle the rights of a person on a family's property. For the purpose of Family Arrangement, there must be some ancestral right over the property in dispute. Subsequently, individual and self-acquired property are not taken into consideration as 'property' for the purpose of Family Arrangement, until and unless some ancestral title or claim is shown in the property.

In the case of Bansari Lal v. CGT, 1998 230 ITR 114 (P&H), the Punjab and Haryana High Court disregarded a family arrangement as being collusive, in which the property in dispute was an individual property. The court had held that mere antecedent title or claim or interest on an individual property and subsequent family arrangement would be set aside as being collusive and obtained with a view to avoid payment of tax.

1.2.3. Dispute

Generally, dispute in a family property is a prelude to Family Arrangement. The entire purpose of having an arrangement is to settle the 'dispute' to maintain the harmony of the family system. The dispute can be either in presenti or in future depending upon the nature of the dispute. In the case of Shambhu Prasad v. Phool Kumar AIR 1971 SC 1337, the Hon'ble Supreme Court had held that for a family arrangement there must a dispute in property, either actual or possible in future. Thus, a bona fide dispute, which has not arisen yet but could arise in future is sufficient to arrive at Family Arrangement.

1.2.4. Arrangement

The definition of the phrase 'Family Arrangement', has been elaborately explained by the Supreme Court in the case of Sk. Sattar Sk. Mohd. Choudhari v. Gundappa Amabadas Bukate (1996) 6 SCC 373. The Hon'ble Supreme Court held that: "...A family arrangement is a transaction between members of the same family for the benefit of the family so as to preserve the family property, the peace and security of the family, avoidance of family dispute and litigation and also for saving the honour of the family."

2. TYPES OF FAMILY ARRANGEMENT IN INDIA

Family Arrangements in India, for the purpose of taxation can be generally classified into two main types based viz. [a]. Transfer of Individual Properties/Cash/ Securities etc. amongst the Family Members and [b]. Transfer of Assets/ Business/Share of One Company to another company under a Family Arrangement.

2.1. Transfer of Individual Properties/Cash/Securities Amongst the family members

In this type of Family Arrangements, there is an inter-se transfer of properties amongst the family members. The transfer under this category can also be done in respect of shares, cash, securities, immovable properties, paintings etc. Under this type of arrangements, the individual members of the family are parties to the Family Arrangement.

2.2. Transfer of Assets/Business /Shares of One Company to Another

Much of the businesses today are operated by family members through common holding companies, as opposed to the traditional businesses which used to be operated directly by individuals. Therefore, unlike the abovementioned type of Family Arrangement, this type usually involves inter-se transfer of assets/ business/shares of one company to another in furtherance of Family Arrangement.

The authors have discussed the tax implication of the two types separately, vis-à-vis the counters of The Income Tax Act, 1961 subsequently.

3. TAX IMPLICATIONS- TRANSFER OF INDIVIDUAL PROPERTIES AMONGST THE FAMILY MEMBERS

If we consider the situation, wherein there is an inter-se transfer of properties amongst the family members for tax implication, following two main questions would fall for consideration:

Whether transfer of properties pursuant to a family arrangement would amount to 'transfer' or 'conveyance' with the meaning of Section 2 (47) of the Income Tax Act and therefore be exigible to be charged to capital gains under Section 45 of the Income Tax Act?

The authors have intrinsically discussed the aforesaid issues in the light of the provisions of Income Tax Act and Judicial Interpretations thereto.

The Hon'ble Supreme Court in Ram Charan Das v. Girja Nandini Devi AIR 1966 SC 323 had held that the transaction amongst family members to put an end to bona fide dispute would not amount to 'transfer' or creation of any interest. The court held: "...here the transaction in question is a family settlement entered into by the parties bona fide for the purpose of putting an end to the dispute among family members. InHiran Bibi v. Sohan Bibi AIR 1914 (PC) 44 approving the earlier decision inKhunni Lal v. Govind Krishna Narain ILR 33 All 356 the Privy Council held that a compromise by way of family settlement is in no sense an alienation by a limited owner of family property. The case therefore would support the conclusion that the transaction does not amount to transfer."

Again, in the case of Ziauddin Ahmed v. Commissioner of Gift Tax [1976] 102 ITR 253, four hundred shares in the tea estate concerned had been by way of family settlement transferred and the transaction had been made bona fide to put an end to the dispute amongst the members of the family of the deceased-assessee. The Hon'ble Gauhati tribunal relying on the observations of the Supreme Court in Ram Charan Das v. Girja Nandini Devi AIR 1966 SC 323, held the allocation of properties was amongst family members, for putting an end to a bonafide dispute and thus was outside the purview of 'transfer' or 'conveyance'.

Furthermore, the Hon'ble Madras High Court in the case of Commissioner of Income Tax v. KAY ARRT Enterprises 299 ITR 348, held that transfer of shares by way of family arrangement would not amount transfer and therefore would not attract capital gain tax. The court held: "the Tribunal had rightly found that the transfer of shares by way of family arrangement would not attract capital gains tax, as the same was a prudent arrangement to avoid possible litigation among the family members and was made voluntarily and not induced by any fraud or coercion and therefore, could not be doubted. The Tribunal was justified in arriving at the conclusion that the family arrangement among the assessee did not amount to any transfer and hence was not exigible to capital gains tax."

Similarly, in the cases of Hari Shankar v. Gauri Hari Singhania AIR 2006 SC 2488, Kale v. Deputy Director of Consolidation AIR 1976 SC 807, Kamal Bhandari v. ITO 155 ITD 680 (Kol) etc. the courts have reiterated the settled principle of law that transfer of property amongst the family members to settle a bonafide dispute cannot be construed as 'transfer'.

Therefore, in the view of the authors and in light of the ratio decidendi emanating from the aforesaid decisions dealing with the legal effect of family settlement, it can be deduced that since family arrangement is only in the nature of allocation, distribution, re-aligning, relinquishing, re-distribution or recognition of pre-existing rights, or even consolidating certain claims and rights between the members of the family bonafide, by putting an end to the dispute amongst themselves, the same would not be treated as "conveyance" or "transfer". In the absence of any alienation or transfer inter se, the question of capital gains does not arise

4. TAX IMPLICATIONS- TRANSFER OF ASSETS/SHARES OF COMPANIES UNDER FAMILY ARRANGEMENT

This type of transaction usually involves inter-se transfer of assets/ business/shares of one company to another in furtherance of Family Arrangement. Under this type of family settlements, technically Companies are a part of family arrangement. Therefore, the question for consideration that arises is:

Whether or not the transaction of transfer of shares/assets/property of one company to another in pursuance of a family arrangement amounts to 'transfer' and is exigible to 'capital gain tax'?

Interestingly, there is divergent judicial opinion on the aforementioned issue. As discussed above, we have plethora of judgements of The Hon'ble Supreme Court and High Courts, which have held that any transaction entered into settle a bonafide family dispute by way of family settlement would not amount to transfer. However, the Bombay High Court B.A. Mohota Textile Traders Pvt. Ltd. v. Commissioner of Income Tax Income Tax Appeal No. 73 of 2002 (Bombay) held that any transfer of shares by a "company" would not be the same as transfer by its "members" despite the fact that such transfer by the company is pursuant to a family arrangement (by way of an arbitration award) between the family members. The authors shall first discuss with the reasoning given by the Hon'ble Bombay High Court to arrive at the stark contrasting decision and shall subsequently analyse the judgment in the light of the earlier set precedents, to arrive at a conclusion.

4.1. B.A. Mohota Textile Pvt. Ltd v. Commissioner of Income Tax

In the case of B.A. Mohota Textile Traders Pvt. Ltd. v. Commissioner of Income Tax Income Tax Appeal No. 73 of 2002 (Bombay), pursuant to a family settlement (by way of an arbitration), the appellant/assessee transferred the shares held by him in a company in favour of his family members collectively in the year 1995. During the assessment proceedings in the year 1995-1996, the appellant filed return of income of Rs. 58 lakhs contending that the same was done in pursuance of family arrangement and was not exigible for any capital gain tax. However, the Assessing Officer refuted the contentions of the assessee and held that the same was liable to capital gain tax as the Company being a separate legal entity was distinct from its shareholder and was not a part of family settlement/ arrangement.

The matter subsequently reached the Hon'ble Bombay High Court which held that transfer of shares of company despite the fact that the same was done under 'family arrangement' would amount to 'transfer' and thus be exigible for capital gain tax.

The court held that once a company comes into existence under the provision of the Companies Act, it is considered as a separate legal entity and there is an existence of a corporate veil between the shareholder and the company. Therefore, the assessee could not claim any rights over the property of the Company and if any transfer of assets were done, the same would amount to 'transfer' and be exigible for capital gain tax, despite the fact that it was done under a family arrangement. The Hon'ble Court further held that the object/purpose of family settlement would restrict itself only to the members of the family and not to the Company, who is a separate legal entity and stranger to the settlement.

4.2. Whether 'Transfer' or not?

The decision of Bombay High Court in B.A. Mohota Textile Traders Pvt. Ltd. v. Commissioner of Income Tax Income Tax Appeal No. 73 of 2002 (Bombay) cannot be held to be final position of law and the matter is still pending before the Supreme Court.

In our view since family arrangement is only in the nature of allocation, distribution, re-distribution or recognition of pre-existing rights, like re-alignment of rights and is not to be treated as "conveyance" or "transfer". It is essentially in the nature of a compromise and companies can be part of such arrangement.

To support our contention we can place reliance on the decision of Punjab and Haryana High Court in the case of CIT v. Ashwani Chopra (2013) 352 ITR 620 (P&H). In that case the assessing officer found that the assessee (Group A) had received compensation from Group B at the time of partition of properties of group of M/s. Hind Samachar Ltd. and that the said amount has been kept in fixed deposits as per the orders passed by the High Court as well as by the Supreme Court. The assessing officer considered the family settlement and found that 8.56% of Rs. 24 crores of compensation is the share of the assessee and accordingly, levied long term capital gain on the said amount. The CIT (A) upheld the action of the assessing officer which was subsequently affirmed by the Tribunal.

Furthermore, reliance can also be placed on judgement of Mumbai Bench of ITAT in the case of Jayneer Infrapower & Multiventures (P.) Ltd. V. Deputy Commissioner of Income Tax, Mumbai, [2019] 103 taxmann.com 118 (Mumbai-Trib), wherein the Mumbai Bench of ITAT held that the gift of shares made by a company to group companies pursuant to family settlement is not colorable transaction and shall not be subject to capital gains. The relevant extracts of the judgement is reproduced: "that it is not correct to say that the real purpose is to divide the business amongst family members. In any case, if the transactions are not in violation of any law or unreal the same cannot be disregarded. Further, when the ultimate recipient of gifted shares sells the shares, it would be subject to capital gains tax taking the cost of acquisition with reference to that of the previous owner as provided under section 49(l)(ii) of the Act, Accordingly, it is not even a case where the assesses has been able increase its cost of acquisition with a view to pay lower capital gains in future. We also observe that if the transaction is a colourable device, no cognizance of the same can be taken and consequently there is no question of charging any capital gain arising out of these transactions."

Similarly, the High Court of Karnataka in the case of Commissioner of Income Tax & Anr. Vs. Millenia Developers (P) Ltd.: (2019) 307 CTR (Kar) 226 in relation to allowance of bad debts arising on gift of flats by the assessee company pursuant to family settlement held as under: "It can be clearly seen that the reason for entering into a family arrangement was with the hope to avoid all future disputes and litigations inter se between the members of HUF. It is for this reason; the family arrangement was entered into. Therefore, it cannot be said that it is a colorable devise and therefore, the allowance should not be granted to the assesses."

Furthermore, the Hon'ble Madras High Court in the case of Commissioner of Income Tax v. KAY ARRT Enterprises 299 ITR 348, held that transfer of shares by way of family arrangement would not amount transfer and therefore would not attract capital gain tax. The court held: "the Tribunal had rightly found that the transfer of shares by way of family arrangement would not attract capital gains tax, as the same was a prudent arrangement to avoid possible litigation among the family members and was made voluntarily and not induced by any fraud or coercion and therefore, could not be doubted. The Tribunal was justified in arriving at the conclusion that the family arrangement among the assessee did not amount to any transfer and hence was not exigible to capital gains tax."

5. CONCLUSION

As we have discussed above, from a plethora of judgements it can be said that it is a settled position of law that when there is inter-se transfer of properties/cash/ assets between the family members, such transaction does not amount to 'transfer' and cannot be exigible for capital gain tax.

However, there is a divergent opinion in cases where the company is part of the family arrangement, in the sense that there is transfer of assets/shares/properties of company under family arrangement. In the view of the author the decision of Bombay High Court should not be rendered as final position of law. Therefore, the matter is subject to litigation. However, in the view of author's family arrangement, being in the nature of allocation, distribution, re-distribution or recognition of pre-existing rights, like re-alignment of rights, should not to be treated as "conveyance" or "transfer" even in case of transfer of assets amongst the group companies under the family settlement.

© 2018, Vaish Associates Advocates,
All rights reserved
Advocates, 1st & 11th Floors, Mohan Dev Building 13, Tolstoy Marg New Delhi-110001 (India).

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