Meaning of Family Settlement/Arrangement

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.

Krishna Bihari Lal V. Gulabchand, 1971 AIR 1041, SCR 27 (Supreme Court of India)

Under this case it was held that the word ‘family’ has a wider meaning. It cannot be confined to a group of persons who by law has the right of succession. In a matter of family arrangement, the word ‘family’ is to be seen in a much wider sense.

  • The following principles emerge from various decisions of the Supreme Court and High Courts:
  • The family settlement must be a bona fide one, so as to resolve family disputes and rival claims by a fair and equitable division or allotment of properties between the various members of the family.
  • The said settlement must be voluntary and should not be induced by fraud, coercion or undue influence.
  • The family arrangement may be even oral; in which case no registration is necessary.
  • It is well-settled that registration would be necessary only if the terms of the family arrangement are reduced into writing. Here also, a distinction should be made between a document containing the terms and recitals of a family arrangement made under the document and a mere Memorandum prepared after the family arrangement had already been made either for the purpose of the record or for information of the Court for making necessary mutation.
  • The members who may be parties to the family arrangement must have some antecedent title, claim or interest, even a possible claim in the property which is acknowledged by the parties to the settlement. Even if one of the parties to the settlement has no title but under the arrangement the other party relinquishes all its claims or titles in favour of such a person and acknowledges him to be the sole owner, then the antecedent title must be assumed and the family arrangement will be upheld, and the Courts will find no difficulty in giving assent to the same.
  • Even bona fide disputes, present or possible, which may not involve legal claims, are settled by a bona fide family arrangement which is fair and equitable, the family arrangement is final and binding on the parties to the settlement.

Family Arrangement

Appointing Advisor/Arbitrator:

  • The process of reaching an acceptable settlement is, however, usually difficult, and is facilitated by a third person such as advisor/lawyer or arbitrator.
  • In order to settle such existing disputes or avoid any potential litigation among the family members, such families arrive at a “family arrangement” either by way of a mutually agreed deed for family settlement or in the form of an arbitration award or a court decree.
  • The family arrangement and settlement may be entered among the family members as per the suggestions given by Arbitrator/Conciliator or it can be advised by the independent advisors. The Advisor can give report on how the family assets, properties or shares in the business entities should get distributed among the family members. There is also needed to check rights and obligations of the third parties on the family arrangement. The advisor provides independent documentation according to which family members should act or settle the disputes.

Taxation Aspects:

  • Family arrangements can be categorised into:
    • Inter-se transfer of properties or cash settlement between family members; or
    • Transfer of assets or businesses or shares of operating company from a common holding company to respective family members who manage and control such businesses or companies.
  • Family Arrangement would be considered if and only if the same has been done so as to avoid future litigations / disputes within the family. Such an arrangement should not be used as a vehicle to avoid tax or to provide maximum benefits to a particular person.
  • Section 47 Transactions not regarded as transfer includes:

(iii) any transfer of a capital asset under a gift or will or an irrevocable trust

  • As per Explanation to section 56(2)(vii), “relative” means,—

in case of an individual—

  • spouse of the individual;
  • brother or sister of the individual;
  • brother or sister of the spouse of the individual;
  • brother or sister of either of the parents of the individual;
  • any lineal ascendant or descendant of the individual;
  • any lineal ascendant or descendant of the spouse of the individual;
  • spouse of the person referred to in items (B) to (F); and

Transfer between individual family members

Transfer of property between the individual family members pursuant to a bona fide family arrangement entered into between the individual family members cannot be treated as a “transfer” u/s. 2(47) of the I.T. Act  and therefore, any capital gains which may arise in the hands of the transferor shall not be taxed as capital gains tax u/s 45 of the Act.

When it cannot be treated as a “transfer” which is liable to capital gains tax u/s 45 of the Act, other deeming fictions such as section 50C or 50CA of the Act (to compute the fair market value of unlisted shares and land or building as deemed consideration) should not be triggered despite the fact such transfer is at a lower valuation than the fair market value.

Transfer of Shares of Companies under Family Arrangement:

As per the HIGH COURT OF MADRAS in case of CIT v. AL Ramnathan [2003] 128 TAXMAN 87 (MAD.)

FACTS

The assessee was an HUF. A dispute arose in the family and an interim agreement was entered under which the assessee’s side was to receive Rs. 8 lakhs and certain lands and in return they were required to transfer half of their shareholding in M, L and C to the other side subject to full settlement later. The final agreement was drawn up later. By virtue of that agreement, the rights between the parties were settled. The assessee claimed that the agreement should be taken as supplement to the earlier partition and, thus, it did not amount to a transfer under section 47 or, in the alternative, it was a family arrangement not amounting to transfer so that capital gains from the above transaction could not be assessed to tax. The assessee further contended that the consideration paid was not only for the transfer of assets but also to avoid continuous friction and to buy peace and, as such, the amount had to be excluded from the capital gains. The ITO rejected the contentions of the assessee and took the view that the transactions amounted to transfer of title in respect of which capital gains was exigible to tax. On further appeal to the Commissioner (Appeals), the Commissioner (Appeals) upheld the order of the ITO. On second appeal to the Tribunal, the Tribunal found that the transaction was only a family arrangement and family arrangement involved in the instant case appeared to be bona fide one inasmuch as it had been shown to have been made voluntarily and was not induced by any fraud or collusion and the conduct of the parties referred to by the revenue was consistent with the bona fide arrangement, particularly when it was arrived at in the presence of panchayatdars. It, therefore, held that the family arrangement was a bona fide one and it was effected to solve the family dispute and, hence, did not give rise to capital gains.

HELD

It is the settled law that when parties enter into a family arrangement, the validity of the family arrangement is not to be judged with reference to whether the parties who raised disputes or rights or claimed rights to certain properties had in law any such right or not.

A perusal of the records established that a dispute arose in that family and the family arrangement was arrived at in consultation with the panchayatdars and, accordingly, realignment of interest in several properties had resulted. The family arrangement was arrived at in order to avoid continuous friction and to maintain peace among the family members.

The family arrangement is an agreement between the members of the same family intended be generally and reasonably for the benefit of the family either by compromising doubtful or disputed rights or by preserving the family property or the peace and security of the family by avoiding litigation or by saving its honour. So, the family arrangements are governed by principles which are not applicable to dealings between strangers and the family arrangement among them is for the interest of the family, for the harmonious way of living. So, such realignment of interest by way of effecting family arrangement among the family members would not amount to transfer.

In the instant case, the Tribunal was perfectly justified in taking the view that the transaction in question being a family arrangement, did not amount to transfer and, therefore, there was no chargeable capital gain arising from that transaction. So, the transaction of the assessee did not amount to transfer and there was no chargeable capital gain arising from that transaction.

  • In the case of ACIT v. Bilakhia Holdings P. Ltd. the court held that the shares that are transferred pursuant to a family arrangement is for a consideration and is not voluntary. Thus, it cannot be considered to be a gift. In this case, three brothers of the same family by a deed agreed to transfer shares of the companies held by the them to Bilakhia Holdings Limited(“taxpayer”) to consolidate holdings and avoid any further disputes. However, the three brothers were also the directors of the taxpayers not just this, they also held equal stake in the taxpayer. The brothers then transferred loans worth millions to the company which were given to them by others. The company recorded such loans by credit to the capital account reserves. The taxpayer then sold a few is such shares received under the settlement deed. For calculating the capital gains on shares of these shares , the company took the shares as gifts and took the cost and holding period of the earlier owners and offered long term capital gains to them. The company then showed the gain on the sale of shares to be transferred to capital reserved instead of going through profit and loss accounts.
  • When the case came up before the tribunal the company contended that there was no requirement of natural love, care and affection for a gift to exist as defined under section 122 in Transfer of Property Act, 1882. The company argued that the consideration in Section 122 is something valuable and capable of being expressed in money or money’s worth. In the case of the taxpayer, it could not be denied that the no consideration in money was paid by the taxpayer. The family arrangement was entered into by the three brothers by their own free will. Consequently, the shares were transferred to the company. Hence, the binding nature of such arrangements cannot deem the transfer to be voluntary. The company also contended that the members who had transferred their shares have reflected it as gifts in their accounts. Thus, shares received as a gift are not investment and hence gains on sale of these shares cannot be put through profit and loss account.
  • Tax department contended that the company cannot show natural love and care which is a prerequisite for a receiving any valuable object as gift. The consideration for such a transfer was to the parties was to attain peace and settle disputes. The transfer could not be said to be one without consideration. Such transfer was also not voluntary as it was under a binding agreement. Therefore, as the transfer did not satisfy both requirements of gifts, it could not be held as a gift under law. The receipt of shares by the company was nothing but buying of shares on lower prices.

The Tribunal held that family arrangements were undoubtedly binding and such transfers under agreements cannot be regarded as one being without consideration. The arrangement was done in order to consolidate the holdings of the three brothers and hence, the consideration of transfer can be measured in money or money’s worth. Family disputes being settled in monetary terms by using such arrangements leads to the result that said transfer was with consideration and the transfer was not voluntary as the agreements is binding and enforceable on all parties. No tax avoidance in garb of arrangements:

However, family arrangements cannot be entered into just to avoid taxation on transfer of property.

  • In the case of Bansari Lal Aggarwal v. CGT, the High Court refused to accept the family arrangement arrived at between the husband on the one side and wife & four son on the other as collusive one effected with a view to avoid payment of tax. In the said case, property owned by the assessee was an individual property. He had a wife and four sons had only lent money to him to buy the said property. The assessing officer held that by the mere creation of an antecedent title, claim or interest of the five persons in the individual property of husband and consequently, the family arrangement decree obtained by the parties concerned shall be set aside on the ground of being collusive, obtained with a view to avoid payment of tax.

As per Mumbai Bench of ITAT in the case of Jayneer Infrapower & Multiventures (P.) Ltd. V. DCIT, [2019] 103 taxmann.com 118 (Mumbai-Trib),

  • As long as a donor company is permitted by its memorandum/articles of association to make a ‘gift’, it can do so. Transfer of shares without consideration by way of gift are valid, permissible and genuine and there is no requirement of a gift deed. They are exempt from provisions of capital gain by virtue of provisions of section 47(iii).
  • Residuary head of income under section 56(1) can be resorted to only if none of specific head is applicable to income in question and that it comes into operation only if preceding heads are excluded. Where benefit that accrued to assessee was in capital field and could be brought to tax only under head capital gain, provisions of section 56(1) could not have been resorted to.

The Hon’ble Madras High Court in the case of CIT 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.” 

The High Court in Commissioner of Gift Tax (CGT) v. K N Madhusudan, has held that the word ‘transfer’ in section 45 does not include partition or family settlement as defined in the Income Tax Act. The facts recorded in the family settlement are akin to a partition and hence cannot be taxed. Family members under the scheme of arrangement have an anterior title to the property which is a subject matter of partition or a family arrangement. Thus, under family settlement there is an adjustment of shares, crystallization of respective rights in the family properties and therefore it cannot be construed as a transfer in under the Taxing statutes. Thus, as there is no transfer in the eyes of law, there is no capital gain and therefore no capital gain tax can be levied on such transfer. 

Thus, as per various judicial pronouncements it can be said that the transfer of assets among the members of a family, for the purpose of settling an existing or even a perceived dispute, does not amount to a transfer as contemplated under the income tax laws. Thus, under a family arrangement or partition, any property transferred cannot be taxed under capital gains. Such giving away of property under a scheme of family arrangement cannot be construed as ‘transfer’ for capital gain purposes. Therefore, there is no liability to pay capital gain tax under Section 45 of the Income-tax Act, 1961.

However, there are some opinions of the courts where the company is a part of family arrangement and there is transfer of assets/shares/properties of the company under family arrangement. Thus, the matter is not finally upheld as not attracting capital gains tax. 

Section 56(2)(x) where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,—

 (a)  any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;

(b)  any immovable property,—

(A) without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property;

(B) for a consideration, the stamp duty value of such property as exceeds such consideration, if the amount of such excess is more than the higher of the following amounts, namely:—

 (i)  the amount of fifty thousand rupees; and

(ii)  the amount equal to 13[five] per cent of the consideration: 

The Explanatory Memorandum to the Finance Bill, 2017 explained the rationale of the section 56(2) as under:

“Widening scope of Income from Other Sources

Under the existing provisions of section 56(2)(vii), any sum of money or any property which is received without consideration or for inadequate consideration (in excess of the specified limit of Rs. 50,000) by an individual or HUF is chargeable to income-tax in the hands of the resident under the head “Income from other sources” subject to certain exceptions. Further, receipt of certain shares by a firm or a company in which the public are not substantially interested is also chargeable to income-tax in case such receipt is in excess of Rs. 50,000 and is received without consideration or for inadequate consideration. The existing definition of property for the purpose of this section includes immovable property, jewellery, shares, paintings, etc. These anti-abuse provisions are currently applicable only in case of individual or HUF and firm or company in certain cases. Therefore, receipt of sum of money or property without consideration or for inadequate consideration does not attract these anti-abuse provisions in cases of other assessees. In order to prevent the practice of receiving the sum of money or the property without consideration or for inadequate consideration, it is proposed to insert a new clause (x) in sub-section (2) of section 56 so as to provide that receipt of the sum of money or the property by any person without consideration or for inadequate consideration in excess of Rs. 50,000 shall be chargeable to tax in the hands of the recipient under the head “Income from other sources”. It is also proposed to widen the scope of existing exceptions by including the receipt by certain trusts or institutions and receipt by way of certain transfers not regarded as transfer under section 47.”

From the perusal of the provisions and clarifications issued by the Board, it emerges that the provisions u/s. 56(2) are enacted –

1. For curbing bogus capital building and money laundering

2. To act as anti-abuse provisions and were introduced as a counter evasion mechanism to prevent laundering unaccounted income,

It is specifically clarified that these provisions are not intended to tax the transactions entered into in the normal course of business or trade. 

As per the HIGH COURT OF GAUHATI in case of Ziauddin Ahmed v. Commissioner of Gift-tax [1976] 102 ITR 253 (Gauhati)

FACTS

The deceased-assessee owned 425 shares of a company in his own name. In year 1959, certain family arrangements were devised as a result of which certain shares were transferred by the assessee and his children to other children at an agreed consideration. 425 shares belonging to the assessee were transferred for consideration of Rs. 3,00,050. The GTO found that the consideration for which 425 shares had been transferred by the assessee was much smaller than the market value of those shares on the date of the transfer. The GTO further found that the consideration was lower than even the face value of those shares. He further took note of the fact that the consideration for the other shares of the same company belonging to the minor son and other children of the assessee was much more than the market value of those shares.

The GTO held that the difference between the market value of the shares and the value at which the actual transfer was made, represented deemed gifts in the hands of the assessee. This order was confirmed by the AAC though he reduced the quantum of gift by taking a smaller market value of the shares.

On further appeal, it was argued before the Tribunal that there was no element of gift in the transfers which had to be made under force of circumstances by the assessee. Alternatively, it was argued that the sale of 100 shares belonging to the minor son which were transferred at a price much more than the market price should have been taken into consideration while computing the quantum of the taxable gift. The Tribunal rejected the contention of the assessee and held that the assessee was chargeable to deemed gift under section 4(1)(a).

On appeal:

HELD

To attract the provision of clause (a) of sub-section (1) of section 4, some property has to be transferred for consideration, but the consideration is found to be inadequate. If that be so, the amount by which the market value of the property at the date of the transfer exceeds the value of the consideration shall be deemed to be a gift made by the transferor.

From the findings of the Tribunal in the instant case it was found that the allocation of 425 shares belonging to the deceased assessee was made by way of family arrangement to settle existing and future disputes amongst the members of the family of the deceased assessee and it had also been found by the Tribunal that there was some arbitration and the shares were transferred at an agreed consideration and such agreed consideration for 425 shares belonging to the deceased-assessee was Rs. 3,00,050. Applying the observations of the Supreme Court in Ram Charan Das v. Girja Nandini Devi AIR 1966 SC 323, the allocation of 425 shares in the tea estate concerned had been by way of family settlement 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 and, therefore, this transaction was not a transfer. In order to bring a case within the scope of section 4(1) (a), first there must be a transfer for consideration and such consideration must be found to have been inadequate consideration. Therefore, the provisions of section 4(1)(a) were not attracted to the facts and circumstances of the present case and there was no deemed gift taxable in the hands of the assessee.

B.A. Mohota Textiles Traders (P.) Ltd. [TS-234-HC-2017(BOM)],

Assessee-company was under control and management of members of a family. Family settlement through Court required assessee-company to transfer shares held by it in another company in favour of certain family members. Assessee claimed that since transfer of shares was done in pursuance of family arrangement/settlement, no capital gains would be attracted.

The Bombay High Court 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. Therefore, while noting that any inter-se transfers between the family members pursuant to a family arrangement would not be considered as “transfer”, any transfer by a company (having a distinct identity) would nonetheless be considered as “transfer” and therefore, be exigible to capital gains tax u/s 45 of the Act on the difference between the consideration charged and the cost of acquisition (as indexed). 

Glebe Trading Pvt. Ltd. Vs ITO (ITAT Delhi)

Facts

The taxpayer is an investment company. During the Assessment Year (AY) 2014-15, the taxpayer had received shares of various companies as gift without paying any consideration as a part of internal family realignment amongst members of the family of late O.P. Jindal. Mrs. Arti Jindal holds 99.9 per cent shares of the taxpayer company. The AO observed that 99.6 per cent of shareholding of the taxpayer company was transferred to P R J Holdings Private Trust as gift. The AO held that the transaction of gift of shares held by Mrs. Arti Jindal to PRJ Holding Private Trust was not valid and was a sham and void transaction. It was undertaken to avoid tax. Accordingly, the AO made additions in the hands of the beneficiary. However, no addition was made in the hands of the taxpayer.

Tribunal’s Decision

The AO did not make any addition in the hands of the taxpayer but held that the benefit arose to the taxpayer through receipt of shares from various companies and the same was taxable under Section 2(24)(iv) of the Income-tax Act, 1961 (the Act) in the hands of Mrs. Arti Jindal as the beneficiary.

On one hand the AO stated that there was a benefit to the taxpayer and on the other hand he stated that the transaction of gift of shares held by Mrs. Arti Jindal to PRJ Holding Private Trust was not valid and was a sham and void transaction which was undertaken to avoid tax. But from the MOU submitted by the taxpayer it was evident that it was a family arrangement. Internal family realignment amongst the members of the family of Late Shri O.P. Jindal cannot be treated as gift or perquisite.

The AO by lifting the corporate veil, without providing any cogent reasons, and without appreciating that the beneficiary never obtained any benefit from this transaction at any time cannot assume that the said transaction was sham and bogus.

Thus, the observations made by the AO in the assessment order were without any jurisdiction. Further, the AO overstepped the provisions of Section 2(24)(iv) and made ‘nil’ assessment in the case of taxpayer and commented on the third party which is not permissible under the Act.

In case of genuine family arrangement, in order to purchase peace, resolve disputes and keep harmony in the family, certain amount is paid or property is given to family member(s), such receipt cannot be considered as receipt without consideration in the hands of recipient [Dy. CIT v. Paras D Gundecha [2015] 62 taxmann.com 170/155 ITD 880 (Mum. – Trib.)]. In family settlement, only existing interest or rights in the common asset or property gets realized, therefore, the provision of Clause (x) pf section 56(2) would not apply in such cases.

Therefore, owing to adequacy of consideration, albeit non-monetary, any receipt of property pursuant to a family arrangement should not trigger provisions of section 56(2)(x) of the Act. However, if such receipt is by a company (and not an individual family member), then such receipt may be subject to tax u/s 56(2)(x) of the Act on the lines of what was held by the Bombay High Court in the case of B.A. Mohota Textiles (P.) Ltd., as discussed above.

It is proposed under Family Settlement Agreement to transfer shares of the Private company to the relatives. As the shares are transferred to family members in pursuant of family arrangement, it shall not be treated as transfer for the purpose of capital gains tax and in the hands of recipient also it will not get taxed under Income from other Sources u/s. 56(2)(x).

Further, irrespective of Family arrangement, transfer of shares or any property among the family members being covered under the definition of relative as per section 56(2) and the shares are given as gift then transferor is not taxed under capital gains tax and transferee is also not taxed u/s. 56(2)(x).

As regards tax in the hands of the recipient under Section 56(2)(x) of the Income Tax Act, it must be noted that this provision is an anti-abuse rule which was introduced to cover property which is transferred under the garb of a gift for inadequate consideration. Since family settlements have been judicially recognised as a valid means of arranging a family’s affairs, the anti-abuse rule should not be triggered. It has been established that the Gift Tax Act 1958 – the abolition of which made way for the insertion of the anti-abuse rules in Section 56(2) of the Income Tax Act – excluded family settlements and partitions from its scope. In any case, Section 56(2) contains a carve-out for gifts made to family members (i.e., ‘relatives’, as defined in the provision). The applicability of the anti-abuse rule may need to be tested where the recipient family member falls outside the defined scope of ‘relatives’.

Tax implications u/s. 2(22) of I.T. Act,1961

(22) “dividend” includes—

(e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits ;

As per the ITAT CHENNAI BENCH, SKM Shree Shivkumar v. ACIT [2014] 48 taxmann.com 346

Where pursuant to family settlement, assessee received certain amount and assets from a company in which he had substantial interest, provisions of section 2(22)(e) could not be applied to amount so received.

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