In this article, Diksha Chaturvedi of BVPU discusses the Capital gain tax on family arrangements and settlements.
Introduction
There are various forms of Indian businesses and one such is Family owned business. It is the oldest form of business. The ownership and management of this kind of business is in the hands of family members only. The business passes from generation to generation and because of this rights of family members are extinguished. So for this family arrangement is done.
What is Family Arrangements?
Family arrangement is a transaction between the members of family for the future benefit of family members. This arrangement is done by the descending ancestors who try to settle the differences, disputes and conflicts and maintain peace and harmony in the family and to bring goodwill in the family by equally distributing all the assets and properties among family members.
The object of family arrangement is to preserve the goodwill and property of the family by recognising that it is not good to indulge in fights and disputes. Every family has some or the other kind of disputes. Majority of these disputes relates to family’s property. Thus to solve these matters in an amicable manner courts have taken steps towards it.
Ingredients of Family Arrangement:
-
Family:
- Family has been defined under Income Tax Act, 1961 in explanation 10(5)
Family in relation to individual means:
- The spouse and children of the individual
- The parents, brothers, sisters of the individual or any of them wholly or mentally dependent on them.
However the term ‘family’ has not been defined under any law. But according to the courts it has to be understood in a wider sense. A common tie or relation is enough to consider that person as the member of a particular family. To determine whether a person belongs to the family or not it is not required that there should be an existence of legal/succession right to the family property.
Case law: 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.
-
Property
Family arrangement is done for the rights of a person on a family’s property. The property is either joint or common. Individual and self-acquired property is not taken into consideration until some ancestors claim is shown in that property.
Thus, there must be an ancestral title in the property for Family Arrangement.
Case Law: Bansari Lal v. CGT, 1998-148 CTR All 533, 229 ITR
(Punjab-Haryana High Court) Under this case the family arrangement was disregarded by the court as it was collusive in nature. The dispute was between the husband on one side and his wife and four sons on the other side. Property of dispute was an individual property. Wife and four sons had only lent money to husband to buy the property. Mere creating an antecedent title, claim or interest of five persons in the individual property of the husband and eventually the family arrangement decree was set aside on the ground of being collusive , obtained with a view to avoid payment of taxes.
-
Disputes
Dispute is prelude to the family arrangement. Existence of the word ‘arrangement’ suggests that there is a dispute or prosperity of a person which can create dispute in family in future. However a pre-existing dispute is always not necessary. It can occur in future because of legal claims. The possibility of bona fide disputes, which may not involve legal claim, will be a valid family arrangement.
Case Law: Shambu Prasad V. Phool Kumar, 1971 AIR 1337, 1971 SCR 181 (Supreme Court of India)
Under this case court said that there must be a dispute whether actual or possible in future. In this case the property was purchased by the father from his own money thus the adopted son has no claim in the property. In spite of this, Supreme Court held that “ As stated earlier, a dispute, the settlement of which can constitute family arrangement, need not to be one which is actually sustainable in law.”
-
Arrangements:
The word ‘arrangement’ means to come to an agreement regarding a dispute. Under the process of arrangement, the parties are not warned by any court of law. The arrangement is not arrived strictly by following law of inheritance. The person with no right to inherit particular property can also get a share in an arrangement.
Case Law: S.K. Sattar S.K. Mohd. V. Gundappa Ambadas, 1996 (Supreme Court Of India)
Under this case ‘family arrangement’ was described as transaction between the members of a family for the future benefit of family members. It is done to preserve peace and harmony in the family and to avoid any legal dispute.
What is Capital Gain Tax?
Any profit or gain acquired from a capital asset is known as Capital gain. This gain or profit is tax chargeable from the year in which the transfer of capital asset take place. Therefore, Capital gain Tax is a tax charged on the profits made by selling Capital assets.
Capital Gains include:
- Stock in trade.
- raw materials
- Personal effects that are movable. It does not include jewellery, archaeological collections, drawings, paintings, sculptures or any art work held for personal use.
- Agricultural land.
- 6.5 percent Gold Bonds, National Defence Gold Bonds and Special Bearer Bonds.
- Gold Deposit bonds under Gold Deposit Scheme.
Exemptions of Capital Gain Tax
Under Long-term Capital Gains
- Profit on sale of residential house (Section 54): Must belong from Hindu Undivided Family.
- Ownership of property for at least 3 years
- The assessee must have purchased a new house one year before or two years after the sale of original house. But if he is building a new house then after 3 years of the sale.
- If the capital gained is equal to or more than the actual value of the house. But if the value of house is less than capital gain, then tax of 20% is levied on the difference of the value.
Capital gain is invested in long term specified assets of NHAI or Rural Electrification Corporation (Section 54EC)
- Profit from Long term capital asset.
- It is compulsory to invest capital gain in assets like bonds of NHAI or REC (3-year lock-in period or 6 months from the date of sale of asset).
- The investment made should not be less than the capital gain.
- New asset must remain in possession for a minimum of 3 years.
Profits from the sale of an asset other than a residential house (Section 54F)
- Must belong from Hindu Undivided Family.
- Capital gain must be from a sale of an asset (not a residential house)
- The assessee must have purchased a new house one year before or two years after the sale of original house. But if he is building a new house then after 3 years of the sale.
- The value of new house cannot be less than the value of asset sold. Only the part in which capital gain is invested will be exempted. Apart from that it will be taxable.
The amount should be kept in Capital Gains Scheme 1988 account if it is not invested. - The assessee should not be having more than one residential house at the time of sale of asset. He cannot buy another house in 2 years or construct one till 3 years.
Under Short-term Capital Gains
Short term capital gain on transfer of agricultural land (Section 54B):
- The capital gain should be invested in purchase of agricultural land.
- The purchase has to be made from 2 years of the date of transfer.
- If the value of capital gain is higher than the value of land, then the difference amount will be taxed but if the gain is less than the value of land,then no tax will be charged.
Taxation Aspect Of Family Arrangements
Transfer under Section 2(47) and Section 45(4) of the Income Tax Act, 1961.
The court has held that, property which comes under the purview of family arrangement cannot be taxed under capital gains. When property is given in a Family Arrangement, then this arrangement cannot be considered 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.
Under the case B.A. Mohota Textile Traders Pvt. Ltd vs. DCIT (Bombay High Court) it was contented that no capital gains would be attracted as there was no transfer. It was working out of family arrangement.
The realignment of interest by way of family arrangements among the family members has not construed a transfer. No liability of capital gain tax should arise in such cases. It is a settled law that validity of family arrangement is not to be judged with reference to whether the parties who raise disputes or claim a right of certain property, had in law any right or not. Commissioner of Income Tax vs. A. L. Ramanathan, 1998 (Madras High Court)
Moreover, ‘transfer’ in section 45 does not include family arrangement. The family arrangement refers to partition which cannot be taxed. Thus, under family arrangement there is settlement of shares, distribution of rights and therefore it cannot be construed as transfer under taxing statutes. If there is no transfer, there is no capital gain and thus, no capital gain tax can be levied on it.
CGT Vs. K.N. Madhusudhan (Karnataka High Court)
- Case where Tax can be levied on a transfer.
Capital Gain from Transfer of Securities under Section 45(2A) of Income Tax Act, 1961.
As per section 45(2A) of the Act, if any person has in the previous year transferred his interest in securities to another person and if there is any gain or profit arising from transfer, then it shall be chargeable to tax as it is the income of the beneficial owner not the income of the depository.
Is Family Arrangement a ‘Transfer’?
Usually the terms ‘Transfer’ and ‘Family Arrangements’ are considered as same but in reality, they differ from each other. The point of difference are:
Registration:
-
- In case of Transfer of Property it is necessary to register your property by law with the Registrar u/s 17 of the Indian Registration Act, 1908. If a document related to the property is not registered then u/s 49 of Indian Registration Act, 1908 the document will not have any bearing on the property and the law does not recognize any rights on the property by the person.
- But in case of Family Arrangement registration is not necessary. Registration would be necessary only if the terms of the family arrangement are made in writing. There is a difference between a document containing the terms of a family arrangement and a mere memorandum prepared after the family arrangement. In such a case, preparing memorandum will not create any rights in the property. Thus it won’t fall under the purview of section 17 of the Registration Act and is, therefore not compulsorily registrable –Kale v. Dy. Director AIR 1976 SC 807.
Oral/ Written:
- In case of Transfer of Property u/s 9 of Transfer of Property Act, 1882 ‘A transfer of property may be made without writing in every case in which a writing is not expressly required by law.’ But to file a suit in court it is advisable to have a written document.
Family Arrangement can be arrived orally. Its terms may be recorded in writing as a memorandum of what had been agreed upon between the parties. Memorandum is usually prepared to record what had been agreed upon so that there be no confusion in future.
Stamp duty:
- In case of Transfer of Property Act, stamp duty is payable. But in case of Family Arrangement, if the arrangement is registered one, then stamp duty is payable (the amount of stamp duty depends on value of the property) and if the arrangement is written in the form of memorandum of family arrangement, no stamp duty is payable.
Conveyance:
- A family arrangement is not treated as a conveyance. It is only in the nature of allocation, distribution, re-distribution or recognition of pre-existing rights. In the process, some of the pre-existing rights of one or more members may even be extinguished by their consent. So long as it meets the other requirements of a valid family arrangement, this is also recognised. The matter to be considered is the recognition of a claim or a right and not the transfer of the same even though there could be relinquishment by one or more members or acknowledgement of rights of others by one or more members.
- In case of Transfer of Property it is necessary to register your property by law with the Registrar u/s 17 of the Indian Registration Act, 1908. If a document related to the property is not registered then u/s 49 of Indian Registration Act, 1908 the document will not have any bearing on the property and the law does not recognize any rights on the property by the person.
Gift under Section 2(xii) and Section 4(1) of the Gift Tax Act, 1958
In the case of CGT vs. Nagrita Thiram (Madras High Court), the assessee was the owner of a half a share in the building which consisted of ground floor and first floor along with a residential house and a building. There was a dispute between the assessee and her son. When Panchayat Dars intervened, the assessee executed the deed of partition to settle the dispute with her son. As per the deed, one property was completely allotted to the son who was belonging to the assessee. Gift tax was levied on the said property according to the value of the property. The tribunal held that only to resolve the dispute this family arrangement was made which does not constitute gift within the meaning of Sec. 2(xii) and 4(1)(a). The court upheld the decision by the tribunal on the ground that the family arrangement was a bona fide one. Hence, the transaction did not constitute gift within the meaning of Sec. 2(xii) and 4(1) (a) of the Gift-Tax Act.
Conclusion
Thus, Family arrangement is a settlement done with peace. These arrangements are done to settle the disputes related to property among the family members. As the arrangement made is not a transfer but merely a settlement done to resolve the disputes so taxes are not levied on it. No capital gain tax or a gift tax is levied. Indian courts have consistently held a family arrangement to merely represent the working out of the rights in the common property, between the family participants and, hence, not a taxable transfer. According to me it is the best way to resolve a family dispute in a peaceful manner without going through the legal process. It is helpful in the case of illiterate members or not well off members of a family or who have no means to bear expenditure of legal process/advice
Reference:
