Income Tax Law relating to Family Settlements

A family settlement is an agreement where family members mutually work out how a property should get distributed among themselves. All the parties should be related to each other and have a claim to a share of the disputed property. The latter need not be limited to real estate, but can also cover movable assets like jewellery or money in bank accounts. A family settlement is usually used to settle common property or joint property that the family owns as opposed to individual or self-acquired property.

Family settlement is not addressed exactly by the legal provisions contained in the Income-tax Act, 1961. It is more so governed by the general law. The courts have interpreted at regular intervals. The concept of family settlement evolved because of such court decisions. In a nutshell, family settlement is court made law and is tax-free because of such decisions and the absence of legal provisions to tax those settlements.

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. This is like re-alignment of rights. In the process, some of the pre-existing rights of one of 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.

Family arrangement or settlement should not be entered into with an object of escaping tax. It then becomes a fraud. It should not be made with a view to circumvent provisions of law relating to stamp duty or provide an advantageous position with regard to stamp duty and registration costs. It must not be in the nature of extinguishing or limiting the rights of a family member who is not a consenting party to the arrangement.

Family Settlement

The term ‘family settlement’ has wider meaning than "partition" which is applicable for HUFs. A family settlement or arrangement would mean an arrangement between the members of the same family to amicably settle present disputes and avoid any possible future disputes. The title to the asset or property is not the bed rock for making a family settlement.

Halsbury’s Laws of England, Volume 18, 4th Edition deal with family arrangement in paras 301 to 312. It defines family arrangement as under:

“A family arrangement is an agreement between the 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.”

Memorandum of Family Settlements.

Irrespective of the fact that, ‘Family Settlements’ have not been defined under any Indian statute, the courts nonetheless recognises and upholds its validity. In simple terms, family settlements can be described as transaction between members of the same family for their mutual benefit, so as to maintain and preserve the property, peace and security, thus avoiding any future discourses and court cases and ultimately saving the honour of the family. Similarly, a Memorandum of Family Settlements refers to a written document which states the arrangement between family members and acts as a record of the mutual agreement regarding the terms of the division of property.

Ingredients of family arrangement

The courts have held that under a family arrangement, there is no transfer of property by one member to another and it is just an arrangement by which each member takes the share of family property by virtue of his/her antecedent title. As to whether a transfer falls within the ambit of a family arrangement (and, therefore, out of the tax net), the courts have consistently evaluated three ingredients: family, property and dispute.

(1)  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 generally 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. Also, the existence of legal/succession right to the family property is not a prerequisite to determine whether a person is a family member.

Family has been defined under Income Tax Act, 1961 in Explanation 1 to Section 10(5)

Family in relation to individual means:
(i)  The spouse and children of the individual

(ii) The parents, brothers, sisters of the individual or any of them wholly or mainly dependent on the individual.

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.

Cousin of members of the same family can be party to the Family Arrangement

Common tie of relationship is enough to bring a person within the fold of ‘family’. Whenever there is legal claim by any person against near relations, then all such persons shall stand included within fold of a family. It is not necessary that the parties to the arrangement should all belong to one family. The Apex Court further held that the word “family” in the context of family arrangement is not to be understood in a narrow sense of being a group of persons who are recognized in law as having a right of succession or having a claim to share in the property in dispute. – [Krishna Bihari Lal v. Gulabchand and others 1971 AIR 1041, SCR 27 (SC)]

(2)  Property

The family arrangement should be for working out the rights in the family property. Typically, common property or joint property in the family is considered for the purpose of family arrangement. Individual or self-acquired properties are generally 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. Thus, there must be an ancestral title in the property for Family Arrangement.  

In case of Bansari Lal Aggarwal v. CGT, the Punjab and Haryana High Court disregarded 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. Wife and four sons had only lent money to husband to buy the said property. Mere creating 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 was set aside on the ground of being collusive, obtained with a view to avoid payment of tax. – [Bansari Lal Aggarwal v. CGT (1998) 230 ITR 114 (P&H)] 

(3)  Disputes

Normally a dispute in a family leads to a family arrangement. The word ‘arrangement’ means to come to an agreement about, to settle the dispute. The very nature of the word ‘arrangement’ suggest the existence of either the actual dispute or the prosperity of the persons concerned to raise the dispute in future.

However, family dispute is not necessarily a prelude to the family arrangement. Though conflict of the legal claims in presenti or in future of generally a condition for the validity of the family arrangement, it is not necessarily so. Even the possibility and/or plausibility of bona fide disputes, which may not involve legal claim, will suffice to arrive at a valid family arrangement.

In the case of Shambhu Prasad v. Phool Kumar, the Court observed by holding that there must exist a dispute, actual or possible in future, in respect of each and every item of property and amongst all members arrayed by one against the other. It would suffice if it is shown that there were actual or possible claims by parties in settlements whereof the arrangement as a whole has been arrived at, thereby acknowledging title in one to whom a particular property falls on the assumption (not actual existence in law) that he had an interior title therein. In the present case, the property was purchased by father out of his own money. The adopted son could not have claimed any share in such property. In spite of this position, the Apex Court held that – “But, as stated earlier, a dispute or contention, the settlement of which can constitute family arrangement, need not be one which is actually sustainable in law.” – [Shambhu Prasad v. Phool Kumar AIR 1971 SC 1337 (SC)]

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.

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

In the case of S. K. Sattar S.K. Mohd. Vs. Gundappa Ambadas, the Court described ‘family arrangement’ as a transaction between members of the same family for the benefit of the family so as to preserve the property, peace, and security of the family, avoidance of family dispute and litigation and for saving the honour of family. Such an arrangement is based on the assumption that there was an antecedent title in the parties and the agreement acknowledges and defines what title is. – [S.K. Sattar S.K. Mohd. Vs. Gundappa Ambadas (1996) 6-SCC-373 (SC)]

In the case of Roshan Singh v. Zile Singh, the Supreme Court held that parties to a Family arrangement set up competing claims to the properties and there was an adjustment of the rights of the parties. By family arrangement it was intended to set at rest competing claims amongst various members of the family to secure peace and amity. The compromise was on the footing that there was antecedent title of the parties to the properties and the settlement acknowledged and defined title of each of the parties. – [Roshan Singh v.  Zile Singh AIR 1988 SC 881 (SC)] 

Parties in General

Any members of a family may be parties to a family arrangement. Thus, agreements between husband and wife, parent and child, legitimate or illegitimate, uncle and nephews or nieces, coheiresses and brothers have all been supported as family arrangements (see para 309 of Halsbury’s Laws of England).

To constitute a valid family arrangement:

(i)     The transaction should be one which is for the benefit of the family generally.

(ii)    The consideration for arrangement may be the preservation of family, property, preservation of peace and honour of the family or the avoidance of litigation.

(iii)    It is not essential that there should be a doubtful claim, or disputed right to be compromised. If there is one, the settlement may be upheld if it is founded on a reciprocal give and take and there is a mutuality between the parties, in the one surrendering his right and in the other forbearing to sue. In such cases, the Court will not too nicely scrutinize the adequacy of the consideration moving from one party to the other.

(iv)    In any case, if such an arrangement has been acted upon, the courts will give effect to it on the ground of estoppel or limitation and the like.

(v)     A family arrangement may also be upheld if the consideration moves form a third party.

(vi)    If it appears to the Court that if one party has taken undue advantage of the helpness of the other and there is no sacrifice of any right or interest, the agreement is unilateral and devoid of consideration.

(vii)   The consent of the parties should be freely given to the arrangement end gross inadequacy of consideration may be determining factor in judging whether the consent was freely given.

(viii)  If the agreement involves or implies injury to the person or property of one of the parties, the courts retain inherent power to prevent injustice being done.

Binding effect and the essentials of a Family Settlement

The concept of Family Settlement was considered by the Supreme Court in detail in the case of Kale v. Dy. Director of Consolidation AIR 1976 SC 807 and the Supreme Court explained the binding effect and the essentials of a family settlement in a concretised form and reduced the concept of Family Settlement into the following propositions:

(1)  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;

(2)  The said settlement must be voluntary and should not be induced by fraud, coercion or undue influence:

(3)  The family arrangement may be even oral in which case no registration is necessary;

(4)  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 in formation 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 therefore does not fall within the mischief of section 17(2) of the Registration Act and is, therefore, not compulsorily registrable;

(5)  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;

(6)  Even if bonafide disputes, present or possible, which may not involve legal claims are settled by a bona fidefamily arrangement which is fair and equitable the family arrangement is final and binding on the parties to the settlement.

 

 

Essential Conditions

An imperative pre-requisite in a family arrangement is that :

1. There should be a family dispute or rival claims which require to be settled by an equitable division or allotment of property between the claimants who are necessarily family members belonging to the same family.

a.       The dispute could relate to any aspect, but is usually relates to the rights or claims in respect of property, assets, enjoyment of rights in respect of properties, claims, shares, possible claims, family feuds, refusal to recognise rights of family members, etc.

b.       It could relate to any aspect which may threaten the rights of any member or the family as a whole, if the disputes are prolonged or escalated or in the nature of creating situations or circumstances that the members are not able to meet eye to eye.

c.        It could be a genuine dispute or a controversy, rival claims, assertions and denials. It is unfortunate that many disputes revolve around the sheer ego of the persons involved. The law says that these disputes are not in the best interest of the members of the family.

2. The family arrangement should be for the benefit of the family in general.
3. The family arrangement must be bonafide, honest, voluntary and it should not be induced by fraud, coercion or undue influence.
4. The family members must have interest, claim or an antecedent title.
5. The parties to the family arrangement must have antecedent title, claim or interest. Even if a possible claim in the property which is acknowledged by the parties to the settlement will be sufficient for the same.
6. The consideration for entering into family arrangement should be preservation of family property, preservation of peace and honour of the family and avoidance of litigation

The Supreme Court in Ramcharandas v. Girjanandinidevi AIR 1966 SC 323 provided the following insights into family settlement:

(a)     Family settlement between the members of the family to put an end to the dispute among themselves is not a transfer. It is also not a creation of interest.

(b)     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.

(c)      Every party who takes benefit under it need not necessarily have a legal claim to a share in the property.

(d)     All that is necessary is to show that the parties are related to each other in some way and have a possible claim to the property or even a semblance of claim on some other ground, say affection.

(e)     The word ‘family’ is not to be understood in a narrow sense of being a claimant to have share in the property in dispute.

Even without registration a written document of family settlement can be used as corroborative evidence

Even without registration a written document of family settlement / family arrangement can be used as corroborative evidence as explaining the arrangement made thereunder and conduct of the parties

It was held that a family arrangement, in the form of a document that mentioned the list of properties which were partitioned, though not registered, would operate as a complete estoppel against the parties to such a family settlement. It was held that even without registration a written document of family settlement/family arrangement can be used as corroborative evidence as explaining the arrangement made thereunder and conduct of the parties. – [Thulasidhara v. Narayanappa 2019 SCC OnLine SC 645 (SC)]

 

It was held that once family settlements are reduced in writing, they require registration. However, if the same are not registered, the contents thereof can be used to corroborate the existence of an arrangement between the families, as also to explain the conduct of the parties. – [Satish Kumar Batra v. Harish Kumar Batra and Ors. (RFA 776/2016) on 09.02.2018 (Del.)] 

 

Family arrangement /settlement in respect of immovable property worth more than Rs. 100, when orally made, no registration is required and is admissible in evidence but when reduced in writing same has to be registered- but even if unregistered, same can be used as corroborative evidence. [Sections 17 & 49 of the Registration Act, 1908]

In respect of joint family immovable property worth more than Rs 100, when family arrangement/settlement has been orally made, no registration is required and would be admissible in evidence but when reduced in writing, registration is essential, without which it is not admissible in evidence. But even without registration, written document of family settlement can be used as corroborative evidence as explaining the arrangement made thereunder and conduct of the parties. – [Subraya M.N. v. Vittala M.N. And Others (2016) 8 SCC 705 (SC)]

Family settlement could also be made orally which could be reduced later on in writing as memorandum of understanding - It is only to prove what was agreed upon and the document written as memorandum of understanding could be registered for declaring what rights and in which of those properties, the parties possess rights

In Tek Bahadur Bhujil v. Debi Singh Bhujil and others, a Bench consisting of 4 Hon’ble Judges, it was pointed out by this Court that a family arrangement could be arrived at even orally and registration would be required only if it was reduced into writing. It was also held that a document which was no more than a memorandum of what had been agreed to did not require registration. This Court had observed thus :

“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 in writing with the purpose of using that writing as 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.” – [Tek Bahadur Bhujil v. Debi Singh Bhujil and others (1966) AIR 1966 SC 292]

Examples of a valid family settlement

(a) A father has started a business in which he is later on joined by his two sons. All the assets and business interests are jointly owned by the family. After several years, disputes arise between the two sons as to who is in command and who owns which property. This leads to a lot of bad blood and ill-will within the family. In order to buy peace and avoid unnecessary litigation, the father, the two sons and their families effectuate a family settlement under which all the businesses and properties are equally divided between the two brothers’ families. This is a valid family settlement and would be recognised in a court of law.

(b) A father and son are joint in business. The son has played an active role in the business and in creating the wealth. After many years, the two develop a bitter dispute over various issues with the result that the son wants to opt out of the business. The son gives up all his rights and interest in the family properties and in return for the same the father pays him some money. This is a valid family settlement.

(c) There are two brothers and two operating companies, which are located in separate offices. The shares of these operating companies are held through investment companies. The offices, in turn, are owned by a property company, the shares of which are held by the two brothers. As a part of the family settlement, it has been decided to give one operating company to each brother and also to give the respective office to the respective brother. This is a valid family arrangement.

(d) A family settlement is purported to have been executed by all the family members of a particular family. However, the married daughter has not signed the family settlement MOU. In such a case, it cannot be said that the family settlement would bind the daughter – Sneh Gupta vs. Devi Sawarup (2009) 6 SCC 194.

It may so happen that a family of four brothers may carry on the business jointly and the business may be registered in the name of one such brother. The other brothers may not have a legal title or right to claim the net worth of the business yet by means of family settlement the assets standing in the name of one such brother could be divided and allocated among the brothers.

[A] Cases wherein genuineness of family settlement vis-à-vis genuineness of transactions was accepted

It was held that where the assessee had received property from his brothers on account of Family Settlement and Release Deed was also executed in which it was nowhere recorded that the assessee paid any consideration to his other three brothers, there being no commercial transaction, provisions of section 56(2)(vii)(b) of the Act were not attracted. – [Govind Kumar Khemka v. ACIT (2020) 118 ITD 586 : 113 taxmann.com 5 (ITAT Delhi)]

Assessing Officer on noticing that there was a credit of Rs. 5 crores asked the assessee to explain the source of credit to which the assessee explained that it was received on family settlement. After going through the document submitted by the assessee titled “Recording of Family Settlement” that the assessee had relinquished his share in family business and in lieu thereof he received Rs. 5 lcrores, the Assessing Officer held that provisions of section 2(47)(v) of the Act stood attracted and accordingly framed the assessment. The Commissioner of Income-tax (Appeals) after apprising the facts of the case noted that genuine Family Settlement was done with a view to settling the issue(s) between the assessee, his brother and mother and therefore through family settlement deed, the family business was settled and all disputes were settled in the presence of their family Guru. The Commissioner of Income-tax (Appeals) thus, on appreciation of evidences and material, held that family settlement was genuine and was done under circumstances to settle all disputes between family members. The Tribunal held that the Commissioner of Income-tax (Appeals) was justified in holding that no capital gain tax was attracted in this case and so the addition by the Assessing Officer was unjustified. The Tribunal followed number of precedents in this case. (Related Assessment Year : 2008-09 – [DCIT v. Arvind Kapoor - Date of Judgement : 10.02.2016 (ITAT Agra)]

It was held that where the assessee received a property with clause in his mother’s Will providing overriding title in favour of his three sisters, payment made by assessee to his sisters for acquiring absolute title in property would be reduced as expenditure while computing capital gain on sale of said property. – [ACIT v. Kamlakar Moghe (2015) 378 ITR 561 : 64 taxmann.com 413 (2016) 236 Taxman 439 (Bom.)]

The ITAT Mumbai Bench in the case of DCIT v. Paras D. Gundecha noted that the assessee, in this case, received certain sum from his brother’s wife, ‘N’ and claimed the said sum to be exempt under section 56(2)(v) of the Act. In her statement, ‘N’ stated that she gave the amount to the assessee because of family settlement deed arrived at among family members. The Assessing Officer added the amount to the income of the assessee. The Tribunal Court held that since the assessee received the sum out of family settlement, the same was not taxable, as by way of settlement only respective shares were determined. – [DCIT v. Paras D. Gundecha (2015) 155 ITD 880 : 62 taxmann.com 170 (ITAT Mumbai)]

The Andhra Pradesh and Telangana High Court in the case of P. Shankaraiah Yadav (HUF) v. ITO explained the concept of family settlement by observing as under at para.10 of its judgment-

“The family arrangement is a typical legal phenomenon that does not fit into those which are specifically recognised under law. The transfer of immovable or movable property, as the case may be, does take place under the arrangement but it is substantially different from the one that is contemplated under the Transfer of Property Act or the Sale of Goods Act. No formal registered document is executed and the nature of consideration is not amenable to any legal analysis. The purport of the family arrangements was explained by the Supreme Court in  Kale v. Dy. Director of Consolidation AIR 1976 SC 807, in such a way that is difficult to put it in any different words. The relevant portion reads:

“Before dealing with the respective contentions put forward by the parties, we would like to discuss in general the effect and value of family arrangements entered into between the parties with a view to resolving disputes once for all. By virtue of a family settlement or arrangement members of a family descending from a common ancestor or a near relation seek to sink their differences and disputes, settle and resolve their conflicting claims or disputed titles once for all in order to buy peace of mind and bring about complete harmony and goodwill in the family. The family arrangements are governed by a special equity peculiar to themselves and would be enforced if honestly made. In this connection, Kerr in his valuable treatise Kerr on Fraud at page 364 makes the following pertinent observations regarding the nature of the family arrangement which may be extracted thus:

‘The principles which apply to the case of ordinary compromise between strangers do not equally apply to the case of compromises in the nature of family arrangements. Family arrangements are governed by a special equity peculiar to themselves, and will be enforced if honestly made, although they have not been meant as a compromise but have proceeded from an error of all parties, originating in mistake or ignorance of fact as to what their rights actually are, or of the points on which their rights actually depend.”” - The issue was decided in favour of the assessee. – [P. Shankaraiah Yadav (HUF) v. ITO (2015) 371 ITR 386 : 232 Taxman 757 : 59 taxmann.com 263 (AP&T)]

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

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 the given case, on piercing the corporate veil with respect to the two private limited companies, viz., SKM Animals Feeds & Foods (India) Ltd. and SKM Siddha & Ayurvedic Medicines (India) (P) Ltd., the entire intermingled transactions can be seen only as the family settlement arrived at through arbitration award amongst Hindu family members. Further there are no transfers of assets with respect to the public limited company SKM Egg Products Exports (India) Ltd. Therefore, considering the facts and circumstances of the case the provisions of section 2(22)(e), 2(24)(iv) or section 56(2)(vi) cannot be invoked. Accordingly, the addition made by the Assessing Officer in the case of the assessee which is further sustained by the Commissioner (Appeals) on account of deemed dividend under section 2(22)(e) and income from other sources under section 56(2)(vi) is hereby deleted. – [SKM Shree Shivkumar (2014) 65 SOT 232 : 48 taxmann.com 346 (ITAT Chennai)]

It was held that where family members of assessee were holding shares in different business concerns and assessee under a family arrangement had transferred his share held in a firm in favour of a family member, there was no transfer involved attracting the provisions of section 2 (47)(v) of the Act in the instant case. – [CIT v. R. Nagaraja Rao (2013) 352 ITR 565 : (2012) 207 Taxman 236 : 21 taxmann.com 101 (Karn.)]

Family settlement - Amount of owelty i.e. compensation deposited to settle inequalities in partition, represents immovable property and would not attract capital gain tax

During the course of assessment proceedings, the Assessing Officer found that the assessee (Group A) had received compensation from Group B at the time of partition of properties of group of 'H' Ltd and that the said amount had been kept in fixed deposits as per the orders passed by the High Court as well as by the Supreme Court. The Assessing Officer considered the familysettlement and found that 8.56 per cent of Rs. 24 crores of compensation was the share of the assessee and, consequently, levied long term capital gain tax on the said amount. On appeal, the Commissioner of Income-tax (Appeals) set aside the order of the Assessing Officer and the order of the Commissioner of Income-tax (Appeals) was confirmed by the Tribunal. The matter reached the Punjab and Haryana High Court. The High Court held as under—

"The payment of Rs. 24 crores to Group A is to equalize the inequalities in partition of the assets of 'H' Ltd. The amount so paid is immovable property. If such amount is to be treated as income liable to tax, the inequalities would set in as the share of the recipient will diminish to the extent of tax. Since the amount paid during the course of partition is to settle the inequalities in partition, it is deemed to be immovable property. Such amount is not an income liable to tax. Thus, the amount of owelty i.e., compensation deposited by Group B, is to equalize the partition represents immovable property and will not attract capital gain

With regard to the argument that the assessee is liable to tax being interest on cash, suffice it to say, that such question or fact does not arise from the orders of the Tribunal. Consequently, it is held that the amount of compensation paid to the assessee to settle inequalities in partition, thus, a provision of owelty, represents immovable property and is not an income exigible to tax.” [In favour of assessee] (Related Assessment year : 2007-08)  - [CIT v. Ashwani Chopra (2013) 352 ITR 620 : 213 Taxman 490 : 30 taxmann.com 299 (P&H)]

KEY NOTE

“Owelty” means the difference which is paid or secured by one coparcener to another, for the purpose of equalizing a partition: a lien created or a pecuniary sum paid by order of the Court to effect an equitable partition of property (as in divorce) when such a partition in kind would be impossible, impracticable, or prejudicial to one of the parties. In other words, it is a payment to balance (both) sides involved in a dispute.

Whether amount received by assessee on transfer of various shares in course of family arrangement would not result in any capital gains within meaning of Act as it did not amount to transfer - Therefore, assessee would not be liable to pay any capital gains tax on amount-in-question

One Pal group consisted of two families, namely, ‘R’ Pal and ‘M’ Pal. As there were disputes between two families of group matter was referred to an arbitrator as per which an arrangement was made.  Consequent to differences between the two-family groups, a situation had developed requiring the two-family groups to identify their interests with clear understanding that they would not dabble in the affairs of the other family group. The assessee, daughter of R had to handover shares and other securities etc., in companies to M Group. From that point of view, the assessee being a member of R Group, had to be roped in and she had to abide by the award of the arbitrator for the sole purpose of ensuring peace between the two-family groups. Notwithstanding the fact that the assessee was a married woman, and became a member of husband’s family by virtue of marriage, the antecedence with R’s family remained intact and family ties were not severed. She being part of R’s family and carrying that name still as a daughter of the family, with a view to ensure peace and amity for her parents, had to necessarily surrender her interest in A Ltd., by giving away the shares at the price determined by the arbitrator. The Tribunal based on these facts held that “the amount received by the assessee on transfer of various shares in the course of the family arrangement would not result in any capital gains within the meaning of the (Income-tax) Act as it did not amount to transfer”. (Related Assessment year : 1996-97) – [Mrs. P. Sheela v. ITO (2009) 120 ITD 159 (ITAT Bangalore)]

Re-arrangement of shareholdings in company to avoid possible litigation among family members is a prudent arrangement necessary to control company effectively by major shareholders to produce better prospects and active supervision and in case of such rearrangement of share holding it cannot be held that there is transfer of shares liable to capital gains tax

There was a transfer of shares in the assessee-firm which consisted of partners, who were family members. in that, certain new shares were acquired in exchange of old shares, as also some consideration was paid in cash. According to the assessees, the transfer was consequent to a family arrangement. But the Assessing Officer, after analyzing the facts of the case and the legal aspects on the same, concluded that there was indeed a transfer involved and, thus, subjected the transaction to capital gains tax. The Tribunal held that the re-arrangement of shareholdings in the company to avoid possible litigation among family members was a prudent arrangement necessary to control the company effectively by the major shareholders to produce better prospects and active supervision as otherwise there would be continuous friction and there would be no peace among the members of the family and held that such family arrangement could not be held as transfer which was exigible to capital gains tax.

Held that the law on the point involved is well settled by the decisions of the Apex Court in Maturi Pullaiah v. Maturi Narasimham AIR 1966 SC 1836, and in Kale v. Dy. Director of Consolidation AIR 1976 SC 807 which are followed by this Court in CIT v. R. Ponnammal (1987) 164 ITR 706 :  (1986) 54 CTR 319 (Mad.) and in CIT v. AL. Ramanathan (2000) 245 ITR 494 : 159 CTR 255  (Mad.). In view of the settled proposition of law, the Tribunal was justified in arriving at the conclusion that the family arrangement among the assessees did not amount to any transfer and, hence, was not exigible to capital gains tax. Accordingly, no substantial question of law arose. (Related Assessment year : 1996-97) - [CIT v. Kay Arr Enterprises (2008) 299 ITR 348 : 215 CTR 244 (Mad.)]

Reconstitution of partnership firm pursuant to family settlement – Word ‘otherwise’ used in section 45(4) takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner - By memorandum of family settlement, dated 30-1-1997, it was agreed between parties thereto that business of six firms as set out therein would be distributed in terms of family settlement as parties desired that various matters concerning business and assets thereto be divided separately and partitioned - Pursuant to said family settlement, there was a deed of reconstitution of various partnerships as set out in family settlement - Assessing authority assessed partnerships for capital gains under section 45(4) - Tribunal held that business continued to be run and there was no dissolution of firm and, consequently, section 45(4) was not attracted - Assessing Officer was justified in assessing partnerships for capital gains under section 45(4)

It was held that, after amendment of Finance act in 1988, subsection (ii) of section 47 was removed. Hence the exemption given earlier for transfer of assets at the time of dissolution or otherwise was no more applicable. Hence the asset given by the firm to its partner at the time of dissolution or otherwise will be chargeable to tax in the hands of the firm.

Word ‘otherwise’ used in section 45(4) takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner. By memorandum of family settlement, dated 30.01.1997, it was agreed between parties thereto that business of six firms as set out therein would be distributed in terms of family settlement as parties desired that various matters concerning business and assets thereto be divided separately and partitioned. Pursuant to said family settlement, there was a deed of reconstitution of various partnerships as set out in family settlement. Assessing authority assessed partnerships for capital gains under section 45(4). Tribunal held that business continued to be run and there was no dissolution of firm and, consequently, section 45(4) was not attracted. Assessing Officer was justified in assessing partnerships for capital gains under section 45(4). In this case, the taxpayer was a partnership firm constituted by family members and during reconstitution, various assets belonging to the firm were given to the retiring partners through a family arrangement. The High Court held that the gains arising out of the said arrangement is taxable. (Related Assessment year : 1997-98) - [CIT v. A.N. Naik Associates (2004) 265 ITR 346 : 136 Taxman 107 (Bom.)]

Assessee-lady settled her self- acquired immovable property on her minor children by registered settlement deed, which did not refer to family dispute and was also witnessed by her husband - During assessment proceedings she filed affidavit stating that this was done by her because of her husband having extra-marital relations with other ladies and his second marriage - It was assessee’s moral and legal obligation to support minor children and in view of her husband having deserted her, alienation of property by her was to be construed as family settlement and not a transfer so as to attract section 64(1)(v)

Section 64(1)(v) - Transfer of assets - For benefit of spouse or minor child - Through a family, settlement deed dated 26.06.1971, the assessee-lady settled her-self acquired immovable property in favour of her three minor children. She filed an affidavit before the tax authorities on 28.03.1988 stating that she had done so in view of her husband having extra-marital relations with other ladies and who had subsequently married a second time. The AAC accepted her affidavit and excluded the income from said properties from her total income and also from her wealth.

Aggrieved, the revenue in its appeal to the Tribunal contended that the income was includible in the assessee’s total income under section 64(1)(v), inasmuch as (a) the said section provided for both direct and indirect transfers;(b) the conditions precedent for making of family settlement were not fulfilled as the deed of settlement did not provide or suggest any dispute for which the family settlement was made; (c) the husband was a witness to the deed which showed that the dispute was fictitious; and (d) the AAC had erred in accepting the affidavit filed after along time. The transfer, according to the revenue, was a simple gift and could not be considered as a family settlement.

Held : The existence of a family dispute is sine qua non for the purpose of family settlement. The record and documents revealed that the assessee was deserted by her husband. She was apprehending breach of family peace. Therefore, she was concerned with the well-being of her three minor daughters. She was also not in a position to repose faith in her husband. In the light of her husband’s alleged adulterous relations, it was quite natural on the part of the assessee to take care of her minor children. She had not only a moral obligation but also a legal obligation to support the minor children. In those circumstances, alienation of property through a deed of settlement could only be construed as a family settlement. Section 64(1)(v) was not applicable in the facts and circumstances of the case, since it was not a transfer within the ratio of the decision of the Andhra Pradesh High Court in CGT v. Gandhi Subba Rao (1987) 63 ITR 305 (sic). The order of the AAC excluding the income of the property in question from the total income of the assessee did not, therefore, call for interference and was to be sustained. [In favour of assessee] (Related Assessment year : 1981-82) - [ITO v. Smt. Jagrani Bai (1990) 34 ITD 54 (ITAT Hyderabad)]

Surrender of a portion of the properties bequeathed to the assessee by her father in favour of her minor son amounted to only a family arrangement and there was no transfer as under section 64(iii)

Section 64(iii) [as it stood prior to 01.01.1971] of the Income-tax Act, 1961 - Transfer of assets - For benefit of spouse or minor child - On facts mentioned under heading ‘Transfer of property’ surrender of portion of properties bequeathed to assessee by her father in favour of her minor son did not amount to a transfer of assets within meaning of section 64(iii) and, therefore, inclusion of income from surrendered properties was improper and should be deleted. - [CIT v. R. Ponnammal (1987) 164 ITR 706 : (1986) 28 Taxman 26 (Mad.)]

Assessee had received certain properties by way of a family settlement which was arrived at to save peace and honour of family and to avoid unnecessary litigation by various claimants to such property - Settlement was arrived at following assessee’s claim in a suit that she had succeeded by inheritance to the impugned property by virtue of the relevant law - Later assessee sold some of the jewellery received by way of family settlement - It could not be said that assessee had received properties sold by way of succession/inheritance so as to attract provisions of section 49(1)(iii) for purposes of computation of capital gains

The assessee was the wife of S, who had a brother P. The assessee and S had no issue during P's lifetime. His wife A, out of love and affection, made a will on 09.12.1965 in favour of two of her sister's sons, of all her immovable and movable properties in equal shares. P died on 27.11.1966, A died on 11.07.1975 and S expired on 10.11.1977. On the death of A, the assessee filed a suit against the two sons of A's sister claiming that the properties left behind by A would devolve upon her in accordance with law as she was sister-in-law of A whose husband had already died. However, on 20-9-1978, the assessee and the two brothers, the beneficiaries of the will, moved an application for compromise decree in order to save peace and honour of the families and to prevent unnecessary litigation which was ruinous to all concerned and in order to arrive at a settlement which was beneficial to all. The Court approved the compromise settlement. The assessee received some assets, including jewellery later on sold, on the basis of the settlement arrived at through the Court. According to the ITO the assets acquired by the assessee, including the jewellery sold, were by succession/inheritance or devaluation and attracted the provisions of section 49(1)(iii) for purpose of determination of capital gains. In appeal, the AAC held (i) that the properties left behind by A were not received by the assessee under the Hindu Succession Act, 1956, but were, in fact, received by way of family settlement which was recognised as one of the modes which gave proper title to a person and, therefore, the cost of jewellery to the assessee had to be taken at the market value pertaining on the date of the acquisition of the assets, and (ii) that since the jewellery was sold immediately after acquisition there was no material change in their cost and no capital gain could arise from the sale thereof. On second appeal the revenue contended that (i) the assessee's rights flowed from her vested interest under the provisions of the Hindu Succession Act and as such those rights could not be compromised in a family settlement, and (ii) that the members who arrived at the settlement cannot be called members of a family in view of the provisions of section 2(41).

HELD : The two brothers with whom the settlement was arrived at were the sons of A’s sister. They together constituted a family and apparently had antecedent rights to the properties of the deceased as the assessee was claiming right, title and interest over the properties because of her close relationship and the two brothers were staking their claims on the basis of the will of the deceased dated 09.07.1965. The settlement was, therefore, nothing but a family settlement and the rights of the parties accrued and were finally settled on account of that settlement. To such facts, the provisions of section 2(41) are not applicable in view of the judgment of the Supreme Court in Ram Charan Das v. Girja Nandini Devi AIR 1966 SC 323. In that decision it was also laid down that in a family settlement each party takes a share in the property by virtue of the 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, a claim to a share in the property.

The rights of the parties prior to approval of family settlement by the Court were inchoate. None of the parties could claim an asbolute right, title and interest in the properties left by A due to disputes and counter claim. Apparently, none of the parties was able to exercise the right, title and interest over the properties left by A and, therefore, the dispute was taken up before the Court where there was no adjudication upon rights of the parties on the merits because before that contingency happened the parties arrived at a family settlement, 'to save the peace and honour of the families and in order to prevent unnecessary litigation'. It was under the family settlement that the rights of the parties to the ownership of the properties left by A became final. Thus, the date of acquisition by the assessee had to be taken with reference to the family settlement and not with reference to any other right which was in an unsettled state earlier. Since the properties were received in view of and by way of family settlement, the date of acquisition for the purpose of computation of capital gains on sale of jewellery would be with reference to the family settlement.

The will of A was made as far back as 09.07.1965. Thereafter, there were natural events upon which no one could claim to have control whatsoever - the events were deaths of S, P and finally the death of the testator ‘A’ on 11.07.1975. All these natural events culminated into a position from where the assessee claimed her rights to the properties testated in the will dated 09.07.1965 by A. On such facts, a settlement followed in the way and to the extent described above. To such a settlement, allegation that it was an artificial device to defraud the revenue could not but be described as flights of fanciful imagination. Even if the ITO had a right to look behind the family settlement, there was nothing for him but to recognise family settlement which has approved by the Court and could not be impeached by the revenue.

Since the family settlement was binding on the parties and the assessee received the properties including the jewellery sold under the settlement, the conclusion drawn by the AAC that the assessee did not acquire the property by way of the means mentioned in section 49 was fully justified. [In favour of assessee] – [ITO v. Smt. Sharda Seshadri (1986) 16 ITD 615 (ITAT Delhi)]

Where as per civil court’s decree assessee was entitled only one-third of house property in question, ITO could not tax two-thirds of income from that property in hands of assessee merely on basis that assessee had invested two-thirds of cost of such property, in absence of challenge to decree and finding that decree was collusive

Section 23 of the Income-tax Act, 1961 - Income from house property - Annual value - The assessee and his wife jointly purchased a plot and constructed a house property thereon. The assessee’s case was that he had thrown his share in the common hotchpot of his HUF consisting of himself, his wife and son and later by family settlement as decreed by a civil court he became entitled to 1/3 of the property in question and as such 1/3 of income alone could be included in his hand. The ITO, however included 2/3 share of the income in his hand on the basis of investment made by the assessee and his wife for the construction of the property which worked out to be 78 : 22. It was undisputed that the civil court decreed that assessee was entitled to only 1/3 share of the property. The ITO however held that the decree was collusive and brought to tax 2/3 share of income on the hands of assessee. The Tribunal held that the decree of the Civil Court was binding on the Revenue unless the same was challenged and found to be collusive and that no challenge having been brought about by the revenue, though it had suspected the genuineness of the decree, it could tax only 1/3rd of the income in the hands of the assessee. (Related Assessment years : 1972-73, 1974-75 and 1976-77) – [T. S. Madan v. ITO (1982) 13 TTJ 575 (ITAT Chandigarh)]

[B] Cases wherein genuineness of family settlement vis-à-vis genuineness of transactions was not accepted

It was held that where huge volume of shares in a public limited company was transferred by assessee to another company without any consideration, without any proper documentation being executed as per law and giving it a nomenclature of ‘gift’, as assessee had not demonstrated by way of documentary evidence genuineness and validity of transaction, the matter had to be remanded to the Assessing Officer. The Tribunal noticed that “There was no proof of any family settlement arrived at when the transferee was a party. Neither there was any family arrangement that had been brought to the notice of the authorities nor had the assessee declared that what had been received by it in lieu of that transfer of shares. The assessee had failed to establish its relation with G (the donee) as well as not executed any gift deed or family settlement, in order to establish the genuineness of the transfer. Merely stating that the transfer was effectuated in lieu of a family realignment was not acceptable without supportive documents in the eyes of law. The assessee had not demonstrated by way of documentary evidence or in any of the manner to prove the genuineness and validity of transaction.” – [Gagan Infraenergy Ltd. v. DCIT (2018) 94 taxmann.com 301 (ITAT Delhi)]

Transfer of shares by a family managed limited company, even if through a family arrangement, is liable to capital gain tax

Transfer (Family arrangement) - 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. Since assessee was separate legal entity being incorporated as limited company, transfer of shares by assessee-company would amount to transfer and would be covered within meaning of section 2(47) so as to be assessable to capital gain tax. [In favour of revenue] (Related Assessment year : 1995-96) – [B.A. Mohota TextilesTraders (P) Ltd. v. DCIT(Special Range) (2017) 248 Taxman 490 : 82 taxmann.com 397 (Bom.)]

Relinquishment of right over property in case of a family settlement falls under definition of ‘transfer’ and exigible to capital gains tax

The assessee submitted before the Tribunal that "she got 40 per cent of the said property from her father through gift deed dated 02.12.2006. She referred to the gift deed and pointed out what was given by her father was in a particular share of the property i.e., 40 per cent share in the overall property. Thus, this property could not have been divided to receive share because her younger brother had received 60 per cent of the share of the said property, through the same gift deed. Therefore, the assessee had released her share in favour of her brother through deed dated 14.02.2007 which should be construed as family settlement and cannot be called a transfer and therefore, money received in the family settlement has to be treated as exempt." The Departmental Representative for the Revenue submitted that the Assessing Officer had clearly given a finding that the assessee’s brother had given an affidavit through which it has been stated that he had paid a sum of Rs. 30 lakhs as full and final settlement for the said property and it was argued that it was a clear case of transfer of right to property and not case of family settlement and in the case of family settlement, the assessee would have got alternative property or some other right and not simple case.

It was held that release/relinquishment of right over family property against receipt of a sum would be covered by definition of ‘transfer’ in section 2(47)(i) and where share in property is released against receipt of cash, instrument of release cannot be called a family settlement and would be covered by term ‘transfe’ and exigible to capital gains tax. [In favour of revenue] (Related Assessment year : 2007-08) – [Mrs. Lalitha Rathnam v. ITO (2013) 35 taxmann.com 371 : 59 SOT (URO) (ITAT Chandigarh)]

Payment to brothers for vacating house, who were allowed to stay in assessee’s house out of natural love and affection, cannot be deducted while computing capital gain. Further such payment also did not come within family arrangement - Assessee owned a flat wherein he allowed his brothers to stay with him - Assessee sold said flat for Rs. 22 lakhs and while computing capital gains, claimed deduction of Rs. 12 lakhs allegedly paid to his brothers to get flat vacated - In absence of any legal right of assessee’s brothers in said flat, alleged payment of Rs. 12 lakhs to them was inadmissible as deduction in computing capital gains - In absence of any bona fide dispute present or possible among members of family, it would be incorrect to construe aforesaid payment as family arrangement so as to be an allowable deduction

The assessee sold a flat which was his personal property for Rs. 22 lakhs. In the relevant assessment year 1987-88, he claimed a deduction of Rs. 12 lakhs out of the said amount while calculating capital gains on the ground that he had paid that amount to get the flat vacated from his three brothers who had been living with him in the flat for a long time. The amount of Rs. 12 lakhs was also alleged to have been paid in terms of a family settlement. The Assessing Officer rejected the claim of the assessee, but the Commissioner (Appeals) allowed the claim. On the revenue’s appeal:

Held : There is no provision in the law by which it could be said that the brothers of the assessee had acquired a legal right in the premises on the strength of uninterrupted stay in the flat. If a person allows his relation to stay in his house, he only provides him a licence to use the house. This licence does not confer any right in the property.

A right is a legally protected interest, infraction of which can be challenged in a Court of law. Law prescribes remedy against the violation of any legal right. This idea is inculcated in the well-known legal maxim -’UBIJUS IBI REMEDIUM’(wherever there is right, there is remedy).

In a situation like the instant case, no Court of law could allow any claim to the brothers of the assessee. They were not the owners of the house. They were not the tenants. The assessee had allowed them to stay out of natural love and affection. There was absolutely no evidence that the assessee had taken any money for allowing them to stay. In these circumstances, it could not be said that a ‘right’ was generated in favour of the assessee brothers.

In the instant case, the payment made to the brothers was at best a personal obligation. The amount, therefore, could not be deducted while computing the capital gains. Further, the payment could not be construed as a family arrangement. The conflict of legal claim in praesenti or in futuro is generally a condition for the validity of a family arrangement. There should be at least a bona fide dispute present or possible. Members of a joint Hindu family may, to maintain peace and to bring about harmony in the family, enter into such a family arrangement. In the instant case, the core of the dispute was not explained. The flat was not family property. It was the personal property of the assessee. It was only an arrangement to reduce the tax burden. When the factum of dispute itself was dubious, there was no sanctity of the award. In this view of the matter, the order of the Commissioner (Appeals) was set aside. [In favour of revenue] (Related Assessment year : 1987-88) – [ITO v. Narendra Kapadia (1996) 58 ITD 329 (ITAT Mumbai)]

A company, PSM, had two groups of shareholders managing affairs as directors also - Pursuant to sale agreement in respect of certain property between said company and purchaser, each group claimed a share in part of price receivable under said agreement - Eventually, by virtue of an arbitration award, first group to which assessee belonged, transferred its shares at a rate less than face value to shareholders of second group and got one of properties belonging to said company - Two groups of shareholders though related to each other, there being nothing common among them in matter of enjoyment of properties belonging to company as members of family, transaction in question could not be said to be family arrangement so as to say there was no transfer within meaning of section 2(47) so as to exclude applicability of section 45 - Assessee having thus transferred her shares on cash payment and received a share in property transferred by company, was liable to capital gains in respect of consideration received including share of value in property after deducting therefrom original cost of those shares

The existence of a family dispute is a sine qua non for the purpose of family settlement. Further a family arrangement is made by the parties belonging to the same family in a bona fide manner so as to put an end to various disputes amongst themselves in respect of the properties in which their interest is common. But such interest can not be determined in species and severality. There should be an antecedent title in the properties belonging to the family before a family arrangement could be made amongst the various claimants to the title. In the instant case, so far as the assessee was concerned, her family consisted of herself, her husband and her daughter. Admittedly she had no dispute with her husband and her daughter. She was the absolute owner of 321 shares and the second group to whom the shares were transferred had no antecedent title in these shares. The two groups of shareholders, though related somehow, belonged to altogether different families and there was nothing common amongst them in the matter of enjoyment of properties as members of the family. There was a third party too, i.e., a company which was a distinct legal entity and, as per laws governing companies, distinct shares were held by different members of the group in their own rights and such shares were their individual properties, which were capable of being transferred without any pre-condition or hindrance, legal or otherwise. Further, the company being a corporate entity, was in no way concerned with the disputes amongst the shareholders. One group of shareholders imputed certain charges as regards mismanagement of the company; beyond that there was nothing to show the existence of family dispute or the possibility of a family dispute The smooth functioning of the company was dictated by its memorandum of association and articles of association and not by the conduct of its shareholders. In the absence of a dispute, it could not be concluded, even if the corporate veil was penetrated, that the arrangement was made to secure peace and harmony amongst the members. There was no supporting evidence. Thus, the transfer of shares by the assessee was not covered by the alleged family arrangement and was squarely covered by ‘transfer’ as contemplated under section 2(47).

The fact that the ITO assessing the other two shareholders of the first group had not taxed in their hands the capital gains on the said transfer on the basis of a family arrangement, had no relevance. If another ITO assessing the other two members of the family did not correctly appreciate the facts of the case, that should not help the assessee whose case had been discussed threadbare by the authorities below. The issue raised here had to be adjudicated de hors any other proceedings to which recourse might have been taken by the revenue. The proceedings under the Income-tax Act and the Gift-tax Act were distinct proceedings and it was the company in whose hand gift tax had been levied and that was not tantamount to double taxation so far as the assessee was concerned. Hence, the findings of the Commissioner (Appeals) were upheld. (Related Assessment year : 1982-83) - [Kusumben Kantilal Shah v. ITO (1996) 56 ITD 476 (ITAT Ahmedabad)]

SLP dismissed against impugned order of High Court holding that consideration received on settlement of case of property usurped by relatives was taxable as capital gain

Family settlement - Assessee was a Power of Attorney holder to an NRI, namely, LMP. An immovable property owned by LMP along with other co-owners was usurped by her relatives. Pursuant to settlement in a civil suit filed by LMP and other co-owner for same, LMP received certain amount as consideration towards her share in property. A reopening notice under section 148 was issued to assessee on ground that aforesaid amount received by LMP was taxable as capital gains. Assessee contended that impugned reopening was barred by limitation; and, secondly, there was a family settlement in which impugned amount in question was received and same was ineligible to capital gain tax. High court by impugned order held that reassessment notice issued against assessee within 6 years from end of relevant assessment year 1999-2000, was well within period of limitation and merely because dispute regarding immovable property involved some family members and such dispute was ultimately settled by filing consent terms, same could not be styled as a family settlement and on such basis, it could not be held that consideration received as a result of such settlement did not constitute capital gain. SLP against said impugned order was to be dismissed. [In favour of revenue] (Related Assessment year 1999-2000 – [P. P. Mahatme v. ACIT (2021) 279 Taxman 325 : 126 taxmann.com 176 (SC)]

No tax if assessee received property on account of family settlement - Where assessee had received property from his brothers on account of Family Settlement and Release Deed was also executed in which it was nowhere recorded that assessee paid any consideration to his other three brothers, there being no commercial transaction, provisions of section 56(2)(vii)(b) were not attracted

Assessee during year filed its return of income declaring total income of Rs. 1.28 crore. Assessing Officer on perusal of Memorandum of Family Settlement (MFS) noted that assessee had acquired Bungalow at New Delhi, due to relinquishment of rights in said property by three brothers of assessee for Rs. NIL. Assessing Officer noted that assessee had got sanctioned a bank loan of Rs. 15 crore and disbursement was made by bank of Rs. 12 crore, Rs. 4 crore to each of three brothers and this meant that brothers were paid a sum against relinquishment of their rights in property. Thus, taking into consideration that property had been purchased by assessee from brothers for Rs. 12 crore and there being difference of Rs. 28 crore, in stamp value determined by Registrar for this property, Assessing Officer made addition of difference under section 56(2)(vii)(b). Commissioner (Appeals) confirmed addition under section 56(2)(vii)(b). On appeal, it was found that in pursuance of Family Settlement, assessee and his three brothers had distributed various properties among themselves and necessary rights and title were transferred in favour of each brother which would show that parties had entered into genuine transaction. Further, Release Deed was also executed, in which it was nowhere recorded that assessee paid any consideration to his other three brothers. Moreover, loan as considered by authorities below of Rs. 12 crore received by assessee had been received after execution of aforesaid Release Deed and thus, there was no question of parting with any consideration for execution of Release Deed. Thus, there being no commercial transaction in distribution of property, provisions of section 56(2)(vii)(b) were not attracted. [In favour of assessee] (Related Assessment year : 2015-16) – [Govind Kumar, Khemka v. ACIT (2020) 113 taxmann.com 5 (ITAT Delhi)]

Family members intended to maintain peace in the family and therefore, the family arrangement was arrived at which was bona fide one. Hence, the transaction did not constitute gift within the meaning of Section 2(xii) and 4(1)(a) of the Gift-tax act, 1958

Assessee along with her son carried on business and acquired certain properties jointly with her son. She executed a partition deed with a view to settle dispute with her son. She along with her son also executed lease deed in respect of properties in favour of her husband and two daughters for a sum of Rs. 16,000 per annum. GTO held that by partition deed property absolutely belonging to assessee was allotted to her son which involved a ‘gift’ and lease amount fixed was much lower than annual income of property and brought transaction to gift-tax. Assessee pleaded that that was a family arrangement. Tribunal held in favour of assessee. Tribunal was right in holding that transaction by which a self-acquired property of assessee was alienated in favour of her son by way of partition was only a family arrangement and was, therefore, outside purview of Gift-tax Act. Tribunal rightly held that transaction by which assessee leased out properties to her husband and two daughters at a lease rent which was far below annual income of property was only a family arrangement and was outside purview of Act. (Related Assessment year : 1988-89) – [Commissioner of Gift Tax v. D. Nagrirathinam (2004) 266 ITR 342 (2003) 129 Taxman 822 (Mad.)]

Income-tax implications

Transfer between individual family members cannot be treated as a “transfer” under section  2(47) of the Income Tax Act

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” under section 2(47) of the Income Tax Act and therefore, any capital gains which may arise in the hands of the transferor shall not be taxed as capital gains tax under section 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.

Word ‘transfer’ does not include partition or family settlement - Where family members of assessee were holding shares in different business concerns and assessee under a family arrangement had transferred his share held in a firm in favour of a family member, there was no transfer in instant case

Family members of assessee were holding apart from personal properties, family properties and shares in different business concerns. Disputes arose between assessee and other family members . Thereupon a family arrangement was made between assessee and other family members, whereby assessee had resigned from a partnership firm and transferred his share of profit and loss in said firm to a family member for a consideration of ₹ 35,000 being capital balance of firm.

The Karnataka High Court held that the word ‘transfer’ does not include partition or family settlement as defined under the Act. It is well settled that a partition is not a transfer. What is recorded in a family settlement is nothing but a partition. Every member has an anterior title to the property which is the subject matter of a transaction, that is, partition or a family arrangement. So there is adjustment of shares, crystallization of the respective rights in the family properties and, therefore it cannot be construed as a transfer in the eye of law. Consequently, the Tribunal on a proper consideration of the entire material on record has categorically held that the transaction in question is a family arrangement. When there is no transfer, there is no capital gain and, therefore, there is no liability of the assessee to pay capital gain tax. Therefore, the appeal filed by the revenue was dismissed. (Related Assessment year : 1993-94) – [CIT v. R. Nagaraja Rao (2012) 207 Taxman 236 : 21 taxmann.com 101 (Karn.)]

Section 56(2) does not apply to “Family Arrangement”

It will not attract any income-tax as the arrangement is among the members of the family.

Section 56(2) of Income-tax is applicable for transfer of assets between persons with inadequate consideration or without consideration. However, the said section 56(2) does not apply to “Family Arrangement”.

Hon’ble Supreme Court in Ramcharandas v. Girjanan Devi AIR 1966 323 held as under:

(i) To put an end to dispute amongst the members of the family is not a transfer. It is also not a creation of interest.

(ii) In family settlement each party takes a share in the property by virtue of an independent title which is in fact admitted by other parties.

(iii) Each Party need not have a legal claim to be share in the property.

(iv) It is necessary to show that the parties are related to each other in some way and a possible claim on property or possible claim on some other ground.

(v) Apex Court in Kale v. Dy. Director of Consolidation AIR 1976 SC 807

It laid down two important aspects of family arrangement, they are:

It must be bona fide one to resolve the family dispute and rival claims by fair and equitable division or allotment of properties amongst various members of the family. Settlement must be fair and voluntary free of coercion or fraud.

No tax on transfer of property under family settlement - Where assessee had received property from his brothers on account of Family Settlement and Release Deed was also executed in which it was nowhere recorded that assessee paid any consideration to his other three brothers, there being no commercial transaction, provisions of section 56(2)(vii)(b) were not attracted

Family settlement of property - Assessee during year filed its return of income declaring total income of Rs. 1.28 crore. Assessing Officer on perusal of Memorandum of Family Settlement (MFS) noted that assessee had acquired Bungalow at New Delhi, due to relinquishment of rights in said property by three brothers of assessee for Rs.NIL. Assessing Officer noted that assessee had got sanctioned a bank loan of Rs. 15 crore and disbursement was made by bank of Rs. 12 crore, Rs. 4 crore to each of three brothers and this meant that brothers were paid a sum against relinquishment of their rights in property. Thus, taking into consideration that property had been purchased by assessee from brothers for Rs. 12 crore and there being difference of Rs. 28 crore, in stamp value determined by Registrar for this property, Assessing Officer made addition of difference under section 56(2)(vii)(b). Commissioner (Appeals) confirmed addition under section 56(2)(vii)(b). On appeal, it was found that in pursuance of Family Settlement, assessee and his three brothers had distributed various properties among themselves and necessary rights and title were transferred in favour of each brother which would show that parties had entered into genuine transaction. Further, Release Deed was also executed, in which it was nowhere recorded that assessee paid any consideration to his other three brothers. Moreover, loan as considered by authorities below of Rs. 12 crore received by assessee had been received after execution of aforesaid Release Deed and thus, there was no question of parting with any consideration for execution of Release Deed. Thus, there being no commercial transaction in distribution of property, provisions of section 56(2)(vii)(b) were not attracted. [In favour of assessee] (Related Assessment Year : 2015-16) – [Govind Kumar Khemka v. ACIT (2020) 181 ITD 586 : 113 taxmann.com 5 (ITAT Delhi)]

In the case of individual properties, there can be a valid family settlement, therefore, such a settlement will not fall within the ambit of Section, 64

In the case of individual properties, whether in respect of Hindus or other communities, there can be a valid family settlement. The other family members can have claims in the estate either on account of rights of maintenance or otherwise and in settlement of such claims a family arrangement can be arrived at which will be considered to be one for a valid consideration and, therefore, such a settlement will not fall within the ambit of Section, 64 of the Income Tax Act, 1961. Such a transaction is clearly with and for a valid consideration. Obligations regarding maintenance are to be found under the general law and specifically, under the Hindu Adoption and Maintenance Act, 1956 and if any settlement takes place in this connection, it will be for a valid and valuable consideration.

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Transfer of shares was for equalization of wealth of the family members which had monetary connotation, the same cannot be said to be voluntary

Family arrangement was to equalize the holdings between the respective families of three brothers. Therefore, it cannot be said that consideration for transfer of shares cannot be measured in terms of money or monies worth. The equalization of wealth has only monetary connotation. To avoid disputes cannot be said to be without monetary consideration as it is common knowledge that family disputes ruin the family financially. The family disputes are being settled in monetary terms by resorting to arbitration and in case such settlements is not done, matter travels to the court and the family suffers heavily not only mentally but also financially. There is a proverb according to which it is said that a person who wins a case actually looses it as by the time matter is settled in his favour he is already a ruined person. Thus, it cannot be said that the consideration for transfer of shares was not for monetary consideration.

Further the transfer was in pursuance of family arrangement, the same was not voluntary as the family arrangement was enforceable and binding on the parties. The argument made on behalf of the assessee that since the family arrangement was voluntary the subsequent action of the parties to the arrangement was also be considered voluntary. But it was held that the argument advanced by assessee devoid of any merit because if this argument of the assessee is accepted then what was the need of signing enforceable binding family agreement in the first place. - [In favour of revenue] (Related Assessment year : 2002-03) - [Addl. CIT, Vapi v. Bilakhia Holdings (P) Ltd. (2014) 49 taxmann.com 91 (ITAT Ahmedabad)]