The article specifically answers the question of whether Family arrangements involving realignment of assets of a Company solely owned by family members would still be taxable under the provisions of Section 56 of the Income Tax Act, 1961?
Before delving into the aspect of taxability of the question at hand, it is pertinent to understand what a Family arrangement is in the eyes of the law. Where there is no specific definition or statutory explanation of the said concept, it has evolved over time and the Indian Judiciary has further refined it whilst keeping in mind the spirit behind such an arrangement. Typically, a family arrangement would involve the working out of the management and/or ownership rights in the common family property, either following or in anticipation of a dispute or to maintain harmony amongst the interested members.
Family Arrangements – Meaning
As per the Halsbury’s Law of England, a family arrangement is, “an agreement between members of the same family, intended to 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.”Meanwhile, the Black’s Law Dictionary defines a family settlement as, “an informal agreement among family members usually to distribute property in a manner other than what the law provides for.”
Generally, the realignment could take one of the two forms that is, a mere separation of management rights with common ownership, or separation of ownership along with management rights. While mere reallocation of management rights should not give rise to tax implications, a reallocation of ownership in the family property, say, shares or immovable property, could be seen as a transfer and, hence, may act as a potential tax trigger for the parties involved in that arrangement.
Is Family arrangement a Transfer?
Under the Income Tax Act (“Act”), a transfer of capital asset gives rise to capital gains in the absence of any specific exemptions provided under the Act. The provisions of the Act require a taxpayer to admit the capital gains arising out of the transfers executed in a particular year and pay the necessary taxes thereupon. While transfers pursuant to inheritance or will are specifically exempted u/s 56, the Act does not explicitly mention or exempt family arrangements. However, the Indian Courts have consistently taken a position that, a bona fide family arrangement should not be regarded as a transfer but a mere working out of the rights of the family members in the common family property, which always existed.
The uncertainty with regard to a Family arrangement is whether it pertains to transfer of property or not. The same was answered by the Hon’ble Apex Court in Ramcharandas V/s. Girjanandinidevi, AIR 1966 SC 323, wherein it observed; “Such family settlement between the members of the family bonafide to put an end to the dispute amongst themselves is not a transfer. It is also not a creation of an interest. In a family settlement, each party takes a share in the property by virtue of independent title which is admitted to that extent by the other parties. Every party who takes benefit under it need not necessarily be shown to have under the law claim to share in property. All that is necessary to show is that the parties are related to each other in some way and have a possible claim to the property or a claim or even a semblance of a claim on some other ground as, say, affection”.
Thus, a family arrangement is not a transfer as provided u/s 2(47) of the Act and is a mere realignment of the interests that provides a family member with the exclusive share/ownership of a particular family property that was jointly owned previously, all by virtue of his/her antecedent title. It wouldn’t be incorrect to state that, there is no transfer of property by one member to another and consequently, no new right or interest is created for the person receiving the property. In the eyes of IT Act, any arrangement that is not a transfer as defined u/s 2(47) and does not involve creating of new rights or interest shall fall beyond the Tax net.
Ingredients of a valid Family arrangement
The Courts have consistently evaluated and arrived at a three-ingredient rule to ascertain if an arrangement constitutes a Family arrangement, and the three ingredients being: Family, property and, disputes:
a. Family: A family arrangement necessarily needs to be among family members, and not with outsiders. The term “family" has not been defined under any law. However, the Courts have held that the term has to be understood in a wider connotation. A common tie of relation is enough to bring a person within the fold of a family. It is relevant to note that it suffices if parties are related to one and other and they have even a semblance of a claim on a distant ground, say, affection;
b. Property:The family arrangement should be for working out the rights in the family property. Typically, a common property or joint property in the family is considered for the purpose of family arrangements and self-acquired properties are not considered unless antecedent title, claim or interest in the property is shown to be in existence. In essence, an antecedent title of the participants in the subject property is the guiding factor for evaluating a bona fide family arrangement;
c. Dispute: Generally, a dispute is a prelude to a family arrangement. However, a pre-existing dispute is not always necessary, thus a bona fide arrangement in anticipation of a plausible dispute and to maintain harmony has also been held to be a valid family arrangement.
Thus, the legal position of taxability of family arrangements may be better understood by the key judgement of the Apex Court in the case of Ram Charan Das v. Girja Nandini Devi (AIR 1965 SC 323) wherein it was held that “a bona-fide family settlement amongst family members to put an end to disputes between themselves would not amount to ‘transfer’ and it is also not the creation of an interest. In a family settlement, each party would take a share in the property by virtue of independent title which is admitted to the extent by the other party. All the members of the family have a sole right for equitable division of properties. If any dispute arises, it may involve family arrangement which is nothing but a device by which disputes or foreseeable disputes between the family members as to their respective property rights are settled. The settlement only defines pre-existing joint-interest as separate interest and hence, there would be no conveyance.”
There are a plethora of cases that have explained the nature of a family arrangement and why it does not amount to “transfer”, however a family arrangement is neither explicitly mentioned u/s 47 of the Act, nor is it listed in the exceptions as provided u/s 56(2) of the Act. The reason for the above instance is that the family arrangements can be carried out for a variety of properties which may involve various parties and entities. Where the arrangements are so distinct and unique in nature, the taxability of these arrangements have to ascertained on a case-to-case basis. While the position of the taxability of family arrangements carried out for the jointly owned properties is settled, this article intends to clarify the prevalent law pertaining to family arrangements involving the assets of jointly owned companies.
Family arrangements involving jointly-owned Companies: Can the Corporate veil be lifted/ pierced?
It is general practise for families to run businesses together, as a consequence of which they run jointly funded companies and also own various properties for commercial use. In such cases, at the time of settlement, each member shall have the right to equitable division and thus, shall take an exclusive and separate share in all the jointly-owned properties and Companies run by the family. It is a settled position of law, that immovable properties owned by families may be settled by an oral or written instrument evidencing a family understanding regarding the rights of the interested persons, however, the question is how are the settlements carried out in the cases of the properties held by the jointly-owned companies and how are these settlements perceived by the law.
According to Section 1 of the Companies Act, 2013 a company is a juristic person and has a separate legal personality which is distinct from its shareholders. Consequently, companies cannot be a party to family arrangements owing to its independent existence. Keeping that in mind, one may wonder how the assets and properties held by a Company could be settled in the favour of its shareholders without receiving any consideration, ie., in the form of a family arragement?
It is established that Companies can affect a transfer only through a sale deed, as they cannot execute gifts or settlements in favour of other persons, thus, to effectuate a family settlement involving the Company-owned properties, a sale deed would have to be executed. It is pertinent to mention that, in this context the sale deed should be seen as an instrument to realign the rights of the recipient and not as a tool to aid transfer of title, therefore, in such a situation, the consideration mentioned in the sale deed shall merely cover the conveyance charges and not the actual consideration as the same is for effecting a family arrangement. However, such transactions may alarm the radar of Section 56(2)(vii) of the Income Tax Act, which states two instances firstly, where an individual or HUF receives any immovable property without any consideration, he shall be liable to the extent of the stamp duty, secondly, when an individual or HUF receives any immovable property for a consideration which is less than the stamp duty value, the difference would be treated as “income from other sources”. In the eyes of IT Act, the sale deed effectuating such a family arrangement would be taxable, however, the Appellants have time and again couched on a concept known as the “lifting of the corporate veil”in order to aid the understanding of the true nature of the transactions and the parties involved therein.
Lifting or piercing of the corporate veil would mean ignoring the fact that a company is a separate legal entity, thus, it would disregard the separate identity of the company and look behind for the true owners who are in control of the company. It is relevant to note that the above concept is applied only in cases where the assets of the companies solely owned by family members are the subject-matter a family arrangement. The Hon’ble Kolkata High Court in the case of Shaw Wallace & Co. v. CIT (119 ITE 399) permitted the lifting of Corporate veil to prevent injustice and to understand the true nature of the transactions and the parties involved.
Judicial Pronouncements
Over the years, various judicial decisions on this matter have paved way to lay down the circumstances under which the corporate veil may be pierced. Firstly, the Company should be solely owned by the family and the entire shareholding should be held by the interested family members. Secondly, each shareholder and director of the Company should provide their free consent to such an arrangement and lastly, the transfer should be in pursuance of a settlement of properties amongst the family members only. However, to further understand and substantiate the above laid proposition, it is pertinent for one to look at the judicial approach towards the said issue.
The above proposition was upheld and applied by the Hon’ble ITAT, Chennai Bench, in the case of ACIT v. Anitha Kumaran (ITA No. 1164/Chny/2019) when they came across an issue where the Appellant contended that the provisions of section 56(2)(vii) wouldn’t apply to her when she received an immovable property from their family-owned company, named M/s Gay Travels Private Limited as a full and final settlement of her share in the family properties under the will of her late father. In pursuance of the above, a sale deed was executed for a consideration of Rs. 10,00,000/- which was much lesser than the estimated stamp duty of the transferred property. The Appellant submitted relevant documents and made submissions to establish that the Company was solely owned by the family members and the transfer was affected only after acquiring free consent of the shareholders and directors of the Company. The Tribunal pierced the corporate veil with respect to the private limited company, viz., M/s GTPL and comprehended that the intermingled transactions were a result of the family settlements arrived at through an understanding among the family members.
Furthermore, in the case of SKM Shree Shivkumar v. ACIT (ITA No.2278/Mds/2012 & 1965/Mds/2011) it was held that when there is any distribution of assets pursuant to family arrangement or HUF partial /total partition, such transactions will not amount to ‘transfer’ of asset attracting tax liability in the hands of the recipient under the provisions of the Act. In that case, on piercing the corporate veil with respect to the two private limited companies viz. M/s. SKM Animals Feeds and Foods (India) Ltd. and M/s. SKM Siddha and Ayurvedic Medicines India Pvt. Ltd., it was held that the entire intermingled transactions could be seen only as the family settlement arrived at through Arbitration Award amongst Hindu family members. Further there would be no transfer of assets with respect to the public limited company M/s. SKM Egg Products Exports (India) Ltd. Finally, it was held that the provisions of section 2(22)(e), 2(24)(iv) or Sec.56(2)(vi) could not be invoked and the Assessing Officer's addition was deleted. This decision was arrived at after considering various binding judicial precedents of higher judicial authorities.
It is pertinent to mention that the above concept comes to play only when the company is entirely owned by the family members. The Hon’ble Bombay High Court was posed with an issue on similar lines in the case of B.A Mahota Textile Traders Pvt. Ltd. v. DCIT (ITA No. 73 of 2002) wherein an Assessee company transferred the shares it held in other corporate entities pursuant to an Arbitration award amongst the family members, however, it is relevant to highlight that in the instant case, the family held only 80% shareholding in the Assessee company, and it was not the case that it was a family-owned company. The Hon’ble Court held that the transfer of shares would give rise to capital gains and the same shall be taxed in the hands of the Assessee Company. Thus, this case reiterated the pre-requisites in case the corporate veil had to be pierced and the transaction had to be seen from the lens of a family arrangement.
Conclusion
At present, there is no precise and specific law that governs the family arrangements involving distinct parties and properties, thus, the principles laid down by the Hon’ble Courts in the judicial pronouncements act as the guiding factor while determining the validity and taxability of such arrangements. The Courts have taken the view that the transactions requiring the settlement of the Company owned assets or immovable’s in the favour of a shareholder by virtue of a family arrangement could be a suitable circumstance under which the corporate veil can be lifted and the true nature of the transactions can be understood, provided that, the ingredients to constitute a valid family settlement involving Company owned assets be present to facilitate the pierce.
Thus, it is ample clear from the precedents that family arrangements involving realignment of the assets of a Company, solely owned by family members could be carried out by facilitating the piercing of corporate veil, and the same would not be taxable, under the provisions of Section 56 of the Income Tax Act, 1961, if found to satisfy all the required ingredients.
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