Transactions Not Regarded as Transfer for Capital Gain Purpose

Omkhar

TRANSACTIONS NOT REGARDED AS TRANSFER FOR CAPITAL GAIN PURPOSE UNDER INCOME TAX ACT, 1961

No stone is left unhurt when the law makers are Indians. In the sense that no kind of income goes untaxed under the Indian Income Tax law. The Income Tax Act, 1961 is a freakish machine with 5 eyes, no income goes unnoticed from these eyes. Compared here is the five heads of income ranging from Salaries to Other Sources. The fourth eye, Capital Gains, need an extra spectacle to be watchful of, as this head involves higher degree of technicalities as compared to other heads of income.

Brief

It is explicable that any transaction that falls under section 2(47) and involving a Capital Asset that falls under section 2(14) attracts tax as Capital Gain tax. Section 2(47) cover transactions of almost all sort anyroad. Withal, the drafters of the Income Tax law had overtly termed certain transactions as those not regarded as Transfer under section 2(47) of the Act and this is dealt with in section 47 of the Income Tax Act, 1961. And on those transactions, no Transfer as per section 2(47) take place as a result of which section 45, which is the charging section of Capital Gain tax is not attracted.

The Act has incisively classed the section into those applicable for each of the persons as defined under section 2(31) of the Act, in the sense that several transactions are marked as not regarded as Transfer for each kind of persons under the Income Tax Act, 1961.

B.Transactions not regarded as Transfer

There are around 25 such transitions not assuming the shape of Transfer and as a result, not attracting section 45. Taking a drive over the transactions:

Sl	Clause u.s. 47	Transaction [u.s. 47]	Transferor [u.s. 2(47)]	Transferee [u.s. 2(47)]	Capital Asset involved [u.s. 2(14)]	Cost in the hands of Transferee [u.s. 49]
1	(i)	Distribution in total or partial partition of a HUF.	HUF	Any Person (member of HUF)	Any Capital Asset.	Cost in the hands of the Transferor HUF.
2	(iii)	Transfer of Capital Asset under a Gift or Will or Irrevocable Trust	Individuals	Any Person	Any Capital Asset barring Shares/Debentures/Warrants allotted to the Transferor individual under an ESOP.	Cost in the hands of the individual Transferor.
3	(iv)	Transfer by a Holding Company to its 100% Subsidiary Company.	Holding Company	Subsidiary Indian Company	Any Capital Asset.	Cost to Previous Owner.
4	(v)	Transfer by a 100% Subsidiary Company to its Holding Indian Company.	100% Subsidiary Company	Holding Indian Company	Any Capital Asset.	Cost to Previous Owner.
5	(vi)	Transfer by an Amalgamating Company to an Amalgamated Company in a scheme of Amalgamation	Amalgamating Company	Amalgamated Indian Company	Any Capital Asset.	Cost to the Previous Amalgamating Company.
6	(via)	Transfer between two Foreign Companies on Amalgamation; wherein such Transfer does not attract Capital Gain Tax in the Country of Incorporation of the Amalgamating Foreign Company.	Amalgamating Foreign Company	Amalgamated Foreign Company	Shares of any Indian Company [Domestic Company].	Cost to Previous Amalgamating Foreign Company
7	(viaa)	Transfer by a Banking Company to Banking Institution in a scheme of Amalgamation sanctioned u.s. 45(7) of Banking Regulation Act, 1949	Banking Company u.s. 5(c) of Banking Regulation Act, 1949	Banking Institution u.s. 45(15) of Banking Regulation Act, 1949	Any Capital Asset.	Cost to the Transferor Banking Company
8	(vib)	Transfer in a scheme of Demerger	Demerged Company	Resulting Indian Company	Any Capital Asset	Cost to the Demerged Company [subj. to sec. 49(2C)].
9	(vic)	Transfer in a scheme of Demerger; wherein such Transfer does not attract Capital Gain Tax in the Country of Incorporation of the Demerged Foreign Company.	Demerged Foreign Company	Resulting Foreign Company	Shares of any Indian Company [Domestic Company].	Value by which the Original Cost of Acquisition of Shares in the Demerged Company exceeds Cost of Acquisition of Shares of the Resulting Company.
10	(vica)	Transfer during business succession of Co-operative Banks in a scheme of Business Reorganisation	Predecessor Co-operative Bank u.s. 44DB	Successor Co-operative Bank u.s. 44DB	Any Capital Asset. (see also item E(2) below)	Cost to Predecessor Co-operative Bank
11	(vicb)	Transfer in a scheme of Business Reorganisation of Co-operative Banks	Any Shareholder	Predecessor Co-operative Bank	Shares in the Predecessor Co-operative Bank	Cost of Acquisition of the Shares of Predecessor Co-operative Bank
12	(vid)	Resulting Company issuing/Transferring to the Shareholders of Demerged Company in consideration of Demerger.	Company	Any Person	Shares of Resulting Company	Based on the Purchase Consideration settled among.
13	(vii)	Transfer by Shareholders in a scheme of Amalgamation; wherein the Amalgamated Company is a Domestic Indian Company.	Any Shareholder	Amalgamating Company	Shares held in the Amalgamating Company	Cost of Acquisition of the Shares of Amalgamating Company
14	(viia)	Transfer referred to u.s. 115AC(1) outside India.	Non-resident	Non-resident	Bonds & GDRs referred to u.s. 115AC
15	(viii)	Transfer of land prior to 01-03-1970.	Any Person	Any Person	Urban Agricultural land
16	(ix)	Transfer made to Government, University, National Museum, National Art Gallery, National Archives, and any other Institutions of National importance as notified by the Central Government	Any Person	Government, University, National Museum, National Art Gallery, National Archives etc.	Work of Art, Archaeological, Scientific or Art Collection, Books, Manuscripts, Drawings, Paintings, Photographs, Printings.
17	(x)	Conversion into Shares and Debentures of a Company in any form and manner	Any Person	Any Person	Bonds, Debentures, Debenture Stocks, Deposit Certificates, into Shares or Debentures of that Company.	Cost of that portion of old Asset that is converted.
18	(xa)	Conversion into Shares and Debentures of any Company as per Foreign Currency Exchangeable Bonds Scheme, 2008	Any Person	Any Person	Bonds u.s. 115AC(1) into Shares, Debentures.	Cost of that portion of old Asset that is converted.
19	(xii)	Transfer under a scheme prepared and sanctioned u.s. 18 of Sick Industrial Companies (Special Provisions) Act, 1985	A Sick Industrial Company, managed by its Workers Co-operative	Any Person as decided u.s. 18 of Sick Industrial Companies (Special Provisions) Act, 1985	A land
20	(xiii)	Conversion of a Partnership Firm into a Company [subj. to certain conditions – see below]	Partnership Firm	Company	All the Assets and Liabilities immediately prior to conversion	Cost to Previous Partnership Firm
21	(xiiia)	Transfer of Membership Rights in a Recognized Stock Exchange, consideration for which is by way of acquisition of Shares and clearing or trading rights on Demutualisation or Corporatisation of Stock Exchange.	Any Person	Any Person	Membership Rights of a Recognized Stock Exchange.	Cost shall be NIL.
22	(xiiib)	Conversion of an Unlisted Company [whether Public or Private] to a Limited Liability Partnership	Unlisted Company	LLP	All the Assets and Liabilities immediately prior to conversion	Cost to Previous Unlisted Company
23	(xiv)	Conversion of a Sole Proprietary Concern into a Company [subj. to certain conditions – see below]	Sole Proprietary Concern	Company	All the Assets and Liabilities immediately prior to conversion	Cost to Previous Sole Proprietary Firm
24	(xv)	Lending under an arrangement or agreement with the Borrower as per guidelines laid by RBI.	Any Person	Any Person	Any securities as per RBI guidelines	Value at which Transfer takes place.
25	(xvi)	Transfer in a transaction of Reverse Mortgage as notified under Reverse Mortgage Scheme, 2008	Individuals	Any Person	A Residential house Property

C. Special issues in case of Transactions not regards as Transfer for Companies

1. Clause (iv) and (v) of section 47 tenders certain Transfers between Holding and Subsidiary Companies as not amounting to Transfer u.s. 2(47).

Wherein Capital Gain is not attracted on such transactions, section 47A(1) prescribe certain conditions on which the transactions shall not be considered as Transfer and if such conditions are not complied with, Capital Gain gets levied u.s. 45. If the Assets transacted between the Holding and Subsidiary Companies fall under any one of the following, then the exemption granted shall stand withdrawn and the transaction shall be chargeable to Capital Gain Tax in the previous year in which the original Transfer between the group Companies took place; and section 155(7B) gets attracted for the rectification of Assessment of the initial year of Transfer;

a. within 8 years of Transfer, such Capital Asset is converted into Stock-in-Trade of the business of the Transferee Company;

b. within 8 years of Transfer, the subsidiary Company no more is a 100% subsidiary of the Holding Company, i.e., the Holding Company ceases to hold whole of the Share Capital of the Subsidiary Company.

1. Transfer of Indian Company’s Shares by a Foreign Amalgamating Company to a Foreign Amalgamated Company is not considered as Transfer only if:

a. At least 1/4^th of the Shareholders of the Transferor Company become the Shareholders of the Transferee Company;

b. The Amalgamating Company should not have paid Capital Gain tax in its Country of incorporation.

1. Section 49(2C) and 49(2D) prescribe Cost of Acquisition of Shares of Resulting Company and Demerged Company in the hands of Shareholders in case of transactions in a scheme of Demerger (item 8 and 9 above) respectively

a. Cost of Acquisition of Demerged Company’s Shares:

b. Cost of Acquisition of Demerged Company’s Shares after Demerger

Original Cost of Acquisition of Shares in Demerged Company	xxx
Less: Cost of Acquisition of Resulting Company’s Shares u.s. 49(2C)	xxx
Cost of Acquisition of Shares of Demerged Company immediately after Demerger	xxx

4. Section 47(xiii) and 49(xiv) grant the transactions of Transferring any Capital Asset on conversion of a Partnership Firm or a Sole Proprietary Concern into a Company (as in items 23 & 23 above) as not amounting to Transfer, but only on certain conditions being complied with:

a. All the Assets and liabilities of the predecessor organization become the Assets and liabilities of the successor Company.

b. No other consideration or allotment shall be paid to the proprietor or partners apart from allotment of Shares in the successor Company.

c. The sole proprietor or all the partners of the predecessor organization should become the Shareholders of the Company immediately after Conversion. And in case of Conversion from a Firm, the ratio of Shareholding of the erstwhile partners should be the same as their Capital Account balances immediately before the Conversion.

d. For a period of five years next to conversion, the aggregate Shareholding of erstwhile partners or the sole proprietor should not plummet below 50% of total voting power.

If even any one of the conditions as laid above are not complied with, section 47A(3) does not kibosh from slaying the benefit granted u.s. 47(xiii) and 47(xiv), i.e., all the conditions need to be complied with so as to come under the canopy of the above sections.

D. Judicial Dictums relating to section 47

1. The word ‘gift’ u.s. 47(iii) has the same meaning u.s. 2(xii) r.w.s 4 of the Gift Tax Act which gives an extended meaning of ‘gift’ by also including any Transfers of property for inadequate consideration. Consequently, where any Transfer of property takes place for inadequate consideration and the resultant deemed gift was taxable under the then Gift Tax Act (u.s. 56 now), the same could not be subjected to Capital Gains Tax since it would constitute a ‘gift’ within the meaning of section 47(iii). [Sanjiv V. Kudva v. CIT [1981] 127 ITR 354 (Kar. HC); Buragadda Satyanarayana Murthi v. ITO [1974] 96 ITR 57 (AP); Contrary view taken in Shiv Shankar Lal v. CIT [1974] 94 ITR 433 (Delhi HC)]

2. Section 47 deems to cover under its clause (vii) only the Transfer of Shares of the Amalgamating Company to it and not the allotment of Shares in the Amalgamated Company. Allotment of Shares in the Amalgamated Company to the Shareholders of the Amalgamating Company in a scheme of Amalgamation is an Extinguishment u.s. 2(47) and hence is chargeable to Capital Gain Tax. [CIT v. Mrs. Grace Collis [2001] 248 ITR 323 (SC)].

3. While granting exemption u.s. 47(vii) on Transfer of Shares held in an Amalgamating Company during a scheme of Amalgamation (item 13 in table above), the court had held that if the Consideration paid to the Shareholders on such Amalgamation consists something more that the Shares in the Amalgamated Company, then benefit granted under this section shall stand to be reclaused; consideration contemplated is only Shares and not bonds/debentures. And the full value of Shares received shall be taken as Gross Consideration for Capital Gain purpose u.s. 45. The combined reading of section 2(42A), 47(vii) and 49(2) leaves no room for doubt that the ‘consideration’ contemplated under sub- clause (a) of section 47(vii) is nothing but Share or Shares only in the amalgamated Company. It is not necessary to add or read the word ‘only’ in that sub-clause. If besides the Share or Shares in the amalgamated Company, the Shareholder of amalgamating Company is allotted something more, say bonds or debentures, in consideration of the Transfer of his Share or Shares in the amalgamating Company, he cannot get the benefit of section 47(vii). Composite consideration is not contemplated by section 47(vii)(a) [ITO v. Gautam Sarabhai Trust [1988] 173 ITR 216 (Guj. HC)].

4. Whenever a Holding Foreign Company received Assets on the voluntary liquidation of its wholly owned Subsidiary Company, the transaction shall fall outside the ambit of section 47(v) and the transaction shall be taxed as Capital Gains u.s. 46(2). The cost of the Assets obtained from the liquidated Company has to be compared with the cost of acquisition of Shares held by the Holding Company in the Subsidiary Company for computation of Capital Gains. [CIT v. Brahmi Investments Private Limited 286 ITR 66 (Guj. HC)].

5. Provisions of section 47(v) (see item 3 and 4 above) would apply to only Capital Assets alone and not to Stock-In-Trade. This means if Stock-In-Trade are Transferred from Holding to its 100% Subsidiary or vice-versa, then the Transfer shall be chargeable under Chapter IV-D as Profits and Gains from Business or Profession as Capital Asset u.s. 2(14) excludes Stock-In-Trade. [CIT v. Simpson General Finance Co. Ltd. [1998] 96 Taxman 172 (Mad. HC)].

6. The Conversion of a Partnership Firm into a Company under Part IX [Joint Stock Company] of the Companies Act is not a Transfer and hence, is not chargeable to tax as Capital Gains. [in re Texspin Engg. & Manufacturing Works 263 ITR 345 (Bom. HC)].

7. The language employed in section 47(iii) will apply only to actual Transfers and not deemed Transfers. Hence section 47(iii) shall not apply to such deemed Transfers and Capital Gain Tax shall apply to such Transfers. [CIT v. Bharani Pictures [1981] 129 ITR 244 (Mad.); CIT v. Tibruz Mustafa Bilgen [1986] 157 ITR 723 (Mad.); CIT v. Jankut Mustafa Bilgen [1986] 157 ITR 728 (Mad.); ITO v. Buragadda Satyanarayana [1977] 106 ITR 333 (AP)].

8. Merely because Transfer of Shares held in a wholly owned Indian Company by one Foreign Company to one of its another Foreign Subsidiary abroad does not fall into the clutches of section 47(iv) as the Transferee subsidiary Company is not an Indian Company and its being an Indian Subsidiary is the very crux of the benefit based on which the transactions cannot be regarded as Transfer, it cannot be termed that the Transfer of Shares would fall outside the ambit of exemption accorded u.s. 47 and shall hence be taxed as Capital Gains. Such a transaction cannot be made to tax as Capital Gains. [Vanendurg Group B.V. v. CIT 289 ITR 464 (AAR)].

E. Other important Sections in the Income Tax Act involving Section 47

1. Section 43C speaks about the Cost of Acquisition of Stock-in-Trade in certain special situations:

a. In case of Acquisition made during Amalgamation of two Companies, the Cost of Acquisition shall be the sum total of Cost to the Amalgamating Company and the Cost of improvement and Expenses incurred for the Transfer.

b. In case of Acquisition made during Total or Partial Partition of HUF or as Gift or Will or Irrevocable Trust, the Cost of Acquisition shall be the sum total of Cost to the Previous Owner and the Cost of Improvement and Expenses incurred on such Transfer.

1. Section 44DB supplements the matter granted u.s. 47(vica) by drafting out the conditions to be complied with, in order to fall under this section. Further as a business re-organisation can take shape in the nature of Amalgamation or Demerger, the section further carves out separately, the conditions to be complied with to fall into the ambit of section 47(vica) in those two situations

a. If the Re-organization is in the nature of Amalgamation,

i. All the Assets and Liabilities of the Amalgamating Co-operative bank immediately before the re-organisation should be Transferred to the Successor Co-operative bank on the re-organization.

ii. Members in the Amalgamating Co-operative bank holding at least 3/4^th of Voting Rights have to become the members in the successor Amalgamated Co-operative bank.

iii. Shareholders in the Amalgamating Co-operative bank holding at least 75% of the Shares shall have to become the Shareholders in the Amalgamated Co-operative bank.

b. If the Re-organization is in the nature of Demerger,

i. All the Assets and Liabilities of tihe Demerging Co-operative bank(s) immediately before the re-organisation should be Transferred to the Resulting Co-operative bank(s) on the re-organization.

ii. All the Assets and Liabilities that are Transferred are to be made at their Book Values appearing immediately before Demerger.

iii. In consideration of Transfer, the Resulting Co-operative Bank has to issue its membership on a proportionate basis to the members of the De-merged Co-operative Bank.

iv. The Shareholders of the De-merged Co-operative bank holding at least 3/4^th of the value of Shares of De-merged Co-operative Bank shall have to become the Shareholders of the Resulting Co-operative Bank.

v. The De-merged Co-operative Bank should be undertaken by the Resulting Co-operative Bank on a Going Concern basis.