FAMILY SETTLEMENTS – PART II

We
continue with our analysis of family settlements….

Capital Gains Tax liability

Taxation
is always a key consideration in any transaction more so in a family settlement
which involves properties / assets changing hands. Under the Income-tax Act,
any profits or gains arising from the transfer of a capital asset are
chargeable to capital gains tax. Thus, the primary condition for levy of
capital gains tax is that there must be a “transfer” as
defined in section 2(47) of the I.T. Act. This primary condition must be
satisfied before a tax levy on a capital gain may come in (C.A. Natarajan
vs. CIT, 92 ITR 347 (Mad)). A family arrangement, in the interest of
settlement, may involve movement of property or payment of money from one
person to another. Several judgments have held that there is no “transfer”
involved in a family arrangement. Therefore, there is no question of capital
gains tax incidence under a family arrangement.   

The
following principles emerge from various cases:

(a) The transaction of a family settlement entered
into by the parties bona fide for the purpose of putting an end to the dispute
among family members, does not amount to a “transfer”. It is not also
the creation of an interest.

(b)  The assumption underlying the family arrangement is that the
parties had antecedent rights in all the assets and this proposition of law
leads to the legal inference that the same does not amount to any transfer of
title. Section 47 of the Income-tax Act excludes certain transfers and since
the family arrangement is not held to be a transfer, it would not require to be
listed in section 47 unlike a partition which is a transfer and had to be
specifically excluded from section 45. Since section 45 can apply only to
capital gains arising from transfers, family arrangements fall outside the
scope of section 45, in view of the legal position that a family arrangement is
not a transfer at all. 

(c) In a family settlement, the consideration for
assets received is the mutual relinquishment of the rights in joint property
and hence, cost of assets received on settlement is the cost to the previous
owner. 

(d) Even a married daughter can be made a
party to a family settlement between her paternal family members – State
of AP vs. M. Krishnaveni (2006) 7 SCC 365. If she surrenders shares
held by her pursuant to a family arrangement, then it would not be a taxable
transfer – P. Sheela, 308 ITR (AT) 350 (Bangl).

(e) In B.A. Mohota Textiles Traders (P.) Ltd.
[TS-234-HC-2017(BOM)], the Bombay High Court held that any transfer of
shares by a company would not be the same as transfer by its members even if
the transfer was pursuant to a family arrangement between the family members.

While
on the subject of income-tax, one should also bear in mind the applicability of
the provisions of section 56(2)(x) of the Income-tax Act, 1961, which treats
the value of certain property received without consideration / adequate
consideration by an individual donee as his income. The section applies to any
gift of cash, immovable property and certain types of movable property, such
as, shares, jewellery, arts and paintings, etc. While a gift between
specifiedrelatives is exempt, gifts received from other relatives is taxable.
Here an issue which arises is that whether an asset received from a non-defined
relative under a family settlement could be taxed under this section? Is not
the settlement of disputes a valid consideration for the receipt of the asset?
In this respect, the decisions in the case of DCIT vs. Paras D Gundecha,
(2015) 155 ITD 180 (Mum) andSKM Shree Shivkumar vs. ACIT(2014) 65 SOT 232
(Chen) have held that property received on family settlement is not
taxable u/s. 56(2).

Whether Registration and Stamp Duty is required?

One
of the main issues under a family settlement is that whether the instrument
which records the family arrangement between the family members requires
registration under the Registration Act, if it affects the rights or interests
in immovable properties. A natural corollary of registration is the payment of
stamp duty. Stamp duty is leviable as on rates as applicable on a conveyance.
In most states in India, the stamp duty rates on a conveyance are the highest
rates. For instance, in the State of Maharashtra, the rate of conveyance on
immovable properties is 5%. As with all principles which involve a family
settlement, the law relating to registration of family settlement instruments
have been laid down by various Supreme Court and High Court decisions. There
are no express decisions on the issue of whether stamp duty is leviable.
However, the decisions rendered in the context of the Registration Act are
equally applicable. The principles laid down by some important cases, such as, Ram
Charan Das vs. Girja Nandini Devi (1955) 2 SCWR 837; Tek Bahadur Bhujil vs.
Debi Singh Bhujil, (1966) 2 SCJ 290; K. V. Narayanan vs. K. V. Ranganadhan, AIR
1976 SC 1715; Chief Controlling Revenue Authority vs. Shri Abdul Karim Ebrahim
Balwa, (2000) 102 BOMLR 290, etc., are as under:

(a) If a person has an absolute title to the
property and he transfers the same to some other person, then it is treated as
a transfer of interest and hence, registration would be required.

(b) A family arrangement may be even oral in
which case no registration is necessary. The registration may be necessary only
if the terms of the family arrangement are reduced to 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 has already been made either for the purpose of
the record or for information of the Court for making necessary mutation. In
such a case, the memorandum itself does not create or extinguish any rights in
immovable properties and is, therefore, not compulsorily registerable. 

(c) A family arrangement, the terms of which may be
recorded in a memorandum, need not be prepared for the purpose of being used as
a document on which future title of the parties are founded. When a document is
nothing but a memorandum of what had taken place, it is not a document which
would otherwise require compulsory registration. 

(d)  A family arrangement as such can be
arrived at orally.  Its terms may be
recorded in writing as a memorandum of what had been agreed upon between the
parties. The memorandum need not be prepared for the purpose of being used as a
document on which future title of the parties be founded. It is usually
prepared as a record of what had been agreed upon so that there be no hazy
notions about it in future. It is only when the parties reduce the family
arrangement to writing with the purpose of using that writing as a proof of
what they had arranged and, where the arrangement is brought about by the
document as such, that the document would require registration as it is then
that it would be a document of title declaring for future what rights in what
properties the parties possess.  

(e) If a document would serve the purpose of proof
or evidence of what had been decided between the family members and it was not
the basis of their rights in any form over the property which each member had
agreed to enjoy to the exclusion of the others, then in substance it only
records what has already been decided by the parties. Thus, it is nothing but a
memorandum of what had taken place and therefore, is not a document which would require compulsory registration u/s. 17 of the Registration Act.

(f) Registration is
necessary for a document recording a family arrangement regarding properties to
which the parties had no prior title. In one case, one of the parties claimed
the entire property and such claim was admitted by the others and the first one
obtained the property from that recognised owner by way of a gift or by way of
a conveyance. On these facts, the Court held that the person derived a title to
the property from the recognised owners and hence such a document would have to
satisfy the various formalities of law about the passing of title by transfer.

(g) If the document itself creates an interest
in an immovable property, the fact that it contemplates the execution of
another document will not exempt it from registration u/s. 17(2)(v) of the
Registration Act.

(h) If the family arrangement agreement is required
to be registered and it is not so registered, then the same is not admissible
as an evidence under the Registration Act in proof of the arrangement or under
the Evidence Act. However, the same document is admissible as a corroborative
of another evidence or as admission of the transaction, etc. 

(i)  The essence of the matter is whether the deed
is a part of the partition transaction or merely contains an incidental recital
of a previously completed transaction.

Reorganisation of Companies and Family Settlement

Very
often a Family Arrangement also seeks to make the family controlled companies
(whether public or private) as parties thereto so as to make the arrangement
(so far as it relates to family shareholdings in such companies) to be
effective and binding. The moot point here is, when there is a family
settlement which involves reorganisation of some of the properties of one or
more companies in the Group, whether the principles of family settlement would
be applicable even to such reorganisation? 
In other words, when there is a transfer of a property from a company to
another company or to an individual as a part of a family settlement, whether
it would be correct to say that there is no transfer of the property, and
therefore direct and indirect taxes would not apply? There is not much support
on this aspect.

The
decision of Sea Rock Investment Ltd., 317 ITR 253 (Karn), dealt
with the case of a company owned by the family members which was made a party
to the family arrangement and which transferred shares held by it to various
family members. The company claimed an exemption from capital gains by stating
that it was pursuant to a family arrangement. The High Court disallowed this
stand by holding that a Company was a separate legal entity distinct from the
family members and hence, it was liable to pay tax on this ground.

In
the case of Reliance Natural Resources Ltd vs. Reliance Industries Ltd,
(2010) 7 SCC 1, the Supreme Court held that a Family Settlement MOU,
signed by the key management personnel of a listed company, did not fall within
the corporate domain. It was neither approved by the shareholders nor was it
attached to the demerger scheme which demerged various undertakings from the
listed company. The Court held that technically, the MOU was not legally
binding on the listed companies.

It
is true that a company is a separate legal entity and has an existence
independent from its shareholders and therefore, in normal circumstances, the
property of a company cannot be treated as that of its shareholders. However,
as pointed out above in various Court judgments, Courts make every attempt to
sustain a family arrangement rather than to avoid it, having regard to the
broadest considerations of family peace, honour and security. If the principles
of family settlement are confined only to the properties owned by individuals
and not to those owned through corporate entities, then it would not be
possible to use the instrument of family settlement for settling disputes between
the members of the family and it would be necessary to go through the
litigations. It is submitted that a relook may be needed at the above decisions
or else we could have a plethora of family disputes clogging the legal system.   

STAMP DUTY ON OTHER INSTRUMENTS

Sometimes,
the parties to a family settlement may implement it through other modes, such
as a Release Deed, a Gift Deed, etc. Although these are not family settlement
awards in the strict sense of the term, but in the commercial sense they would
also be a part and parcel of the family settlement. Hence, the stamp duty
leviable on such instruments is also covered below.

Release Deed

A
release deed is a document by which a person relinquishes his share or interest
in a property in favour of another person. Under Article 55 of the Indian Stamp
Act, a release attracts duty at Rs. 5. However, various states have enacted
their own amendments to this Article. Earlier, a release deed attracted only
Rs. 200. For instance, in the state of Andhra Pradesh it is 3% of the
consideration or market value whichever is higher.

The
Bombay High Court, in the case of Asha Krishnalal Bajaj, 2001(2) Bom CR
(PB) 629 held that a Release Deed is not a conveyance and only
attracted stamp duty as on a release deed. In the case of Shailesh
Harilal Poonatar, 2004 (4) All MR 479, the Bombay High Court held that
a release deed without consideration under which one co-owner released his
share in favour of another in respect of a property received under a will, was
not a conveyance. Accordingly, it was liable to be stamped not as a conveyance
but as a release deed.

To
plug this loophole, in 2005 the duty in the State of Maharashtra was increased
on such instruments to Rs. 5 for every Rs. 500 of market value of the property.
The 2006 Amendment Act has once again made an amendment in Maharashtra to
provide that if the release is without consideration; in respect of ancestral
property and is executed by or in favour of the renouncer’s spouse, siblings,
parents, children, children of predeceased son, or the legal heirs of these
relatives, then the stamp duty would only be Rs. 200. In case of any other
Release Deed, the duty is equal to a conveyance. Thus, for immovable
properties, it would be @ 5% on the market value of the property. What is an
ancestral property becomes an important issue. E.g., if a son releases his
share in a property acquired by his deceased father, so that his mother can
become the sole owner, it would not be a release of an ancestral property.

Similar
provisions are found under the Karnataka Stamp Act. The duty on a release deed
between family members, i.e., spouse, children, parents, siblings, wife of a
predeceased son or children of a predeceased child, is Rs. 1,000. 

Gift Deed

Section
2(la) of the Maharashtra Stamp Act defines an “instrument of gift” to include,
in a case where the gift is not in writing, any instrument recording whether by
way of declaration or otherwise the making or acceptance of such oral gift. The
gift could be of movable or immovable property. The term gift has not been
defined and hence, one has to refer to the definition given u/s.122 of the
Transfer of Property Act, which is “a transfer of certain existing movable or
immovable property made voluntarily and without consideration.”

An
instrument of gift not being a Settlement or a Will or a Transfer attracts duty
under Article 34 of Schedule-I to the Maharashtra Stamp Act. A gift deed
attracts duty at the same rate as applicable to a Conveyance (under Article 25)
on the Market Value of the Property which is the subject matter of the
gift.  Almost all States whether under
the Indian Stamp Act or under their respective State Acts levy duty at the same
rate as applicable to a Conveyance on the Market Value of the Property which is
the subject matter of the gift.  

The
Maharashtra Stamp Act provides for a concession to gifts within the
family. Any gift of property to a family member (i.e., a spouse, sibling,
lineal ascendant / descendant) of the donor, shall attract duty @ 3% or as
specified above, whichever is less. However, if the gift is of a residential
house or an agricultural property and is to a spouse / child or a grandchild,
then the duty is a concessional sum of Rs. 200. In such a case, the
registration fees are also Rs. 200. Thus, there is a very large concession for
a gift of two types of properties, viz, a residential house or an agricultural
land made to six relatives. Both these conditions must be satisfied for the Rs.
200 concessional duty. For a gift of any other property made to any family
member, including these six relatives or for a gift of these two properties
made to any relative other than these six relatives, the concessional duty is
3% of the market value.   

One
misconception often faced is the coverage of lineal ascendants – are females
covered? Can a grandmother, mother and son be treated as a lineal line? The
answer is yes, there is no requirement that lineal ascendancy or descendancy is
limited only to male members or to the same gender. All that is required is
relatives in a straight line. The definition under the Maharashtra Stamp Act is
not as wide as u/s. 56(2) of the Income Tax Act. The relatives covered u/s. 56
of the Income-tax Act but not under the Stamp Act are spouses of siblings;
uncles and aunts; spouses of one’s lineal ascendant / Descendant; lineal
ascendant /descendant of spouse and their spouses.

The
Karnataka Stamp Act, 1957 also provides for a concession for gifts
within the family of the donor. The duty is only a flat sum of Rs. 1,000 to Rs.
5,000 depending upon where the property is located. The definition of family
for this purpose means father, mother, husband, wife, son, daughter,
daughter-in-law, brothers, sisters and grandchildren of the donor.

The
Rajasthan Stamp Act, 1998 provides a concessional rate of 2.5% for gifts
in favour of father, mother, son, brother, sister, daughter-in-law, husband,
son’s son, daughter’s son, son’s daughter, daughter’s daughter. Further, in
case of gifts in favour of wife or daughter the stamp duty is only 1% or Rs. 1
lakh, whichever is less. stamp duty for a gift in favour of widow by her
deceased husband’s mother, father, brother, or sister or by her own mother,
father, brother, sister, son or daughter is Nil.

Epilogue

From
the above discussion, it would be obvious that our present laws relating to
income-tax, stamp duty, registration, etc., are inadequate to deal with family
settlement and, in fact, instead of facilitating the family settlement, they
may hamper it. This is all the more strange given the fact that a large number
of businesses and assets are family owned in India and hence, the possibility
of there being a family dispute is quite high! Hence, it is necessary to make
suitable amendments in various laws so as to facilitate family settlement.