IMPLICATIONS UNDER TAX LAWS OF FAMILY ARRANGEMENT, NOMINATION AND WILL

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1 December 15, 2010 IMPLICATIONS UNDER TAX LAWS OF FAMILY ARRANGEMENT, NOMINATION AND WILL Balkrishna V. Jhaveri Nishith Desai Associates For discussion purpose only Advocate, High Court

2 DEFINITION OF FAMILY ARRANGEMENT BY HALSBURY S LAW OF ENGLAND Halsbury s Law of England define a family arrangement as an agreement between members of the same family, intended to be generally and reasonably for the benefit of the family either by compromising doubtful or disputed rights or by preserving the family property or the peace and security of the family by avoiding litigation or by saving its honour. 2

3 THE ESSENTIALS OF A FAMILY ARRANGEMENT In the landmark decision of Kale vs. Deputy Director of Consolidation (AIR 1976 SC 807) the Supreme Court laid down the following essentials of a valid family arrangement: (i) The family arrangement should be for the benefit of the family in general. (ii) (iii) (iv) The family arrangement must be bonafide, honest, voluntary and it should not be induced by fraud, coercion or undue influence. The purpose of the family arrangement should be to resolve present or possible family disputes and rival claims not necessarily legal claims by a fair and equitable division of the property amongst various members. 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. (v) 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. 3

4 The Landmark decision of the Supreme Court in Kale vs. Deputy Director of Consolidation (AIR 1976 SC 807) Lachmandas was the tenant & tenure holder of the agricutural land of 38 acres who died in 1948 leaving behind him three daughters Tikia Har Pyari Ram Pyari Kale (son) Under the U. P. Tenancy Act, 1939, the unmarried daughter inherits the property. - U. P. Consolidation of Holdings Act, Their Lordships held: The principles which apply to the case of ordinary compromise between strangers, do not equally apply to the case of compromise in the nature of family arrangements. Family arrangements are governed by a special equity peculiar to themselves and will be enforced if honestly made. 4

5 Continued. The object of the arrangement is to protect the family from long drawn litigation or perpetual strifes which mar the unity and solidarity of the family and create hatred and bad blood between the various members of the family. To-day when we are striving to build up an egaritarian society and are trying for a complete reconstruction of the society, a family arrangement by which the property is equitably divided between the various contenders so as to achieve an equal distribution of wealth instead of concentrating the same in the hands of a few is undoubtedly a milestone in the administration of justice. That is why the term family has to be understood in a wider sense so as to include within its fold not only close relations or legal heirs but even those persons who may have some sort of antecedent title, a semblance of a claim or even if they have a spes successions so that future disputes are sealed for ever and the family instead of fighting claims inter se and wasting time, money and energy on such fruitless or futile litigation is able to devote its attention to more constructive work in the larger interest of the country. 5

6 FAMILY ARRANGEMENT IS NOT A TAX PLANNING TOOL TO AVOID TAXATION ON DISTRIBUTION OF PROPERTIES. 6

7 FAMILY DISPUTE IS A PRELUDE TO FAMILY ARRANGEMENT Sahu Madhav Das vs. Mukund Ram (AIR 1955 SC 481) Dispute may be present or future. The threat of eruption of dispute is a good cause for a family arrangement. The test is whether the arrangement really removes the cause of dispute and makes the family more secure and happier. The example: K Venugopal vs. CIT (248 ITR 251, Mad.) K. Venugopal, the assessee, gave a sum of Rs. 3,40,000/- to his minor son pursuant to the family settlement. Interest was earned by the minor on the said amount. The question arose whether the interest income is taxable in the hands of the assessee u/s. 64(1)(v) of the I.T.Act, 1961? 7

8 List of some of the decisions where the courts have held that the claim of a family arrangement is not tenable as the assessees have failed to prove that there was a dispute among the members of the family 1. Income Tax Officer vs. Narendra S. Kapadia (1996) 58 ITD 329 (Mum.) 2. Gift-tax Officer vs. Shamjibhai Khimjibhai Patel (1994) 51 ITD 484 (Ahd.) 3. Kusumben Kantilal Shah vs. Income-tax Officer (1996) 56 ITD 476 (Ahd.) 4. CIT vs. Mrs. Bibijan Begum (1996) 221 ITR 836 (Gau) 5. Ashok Soi vs. Deputy Commissioner of Income-tax 74 ITD 235 (Delhi) 8

9 FAMILY IN A FAMILY ARRANGEMENT HAS A WIDER MEANING The Supreme Court in Ram Charan Das vs. Girja Nandini Devi (AIR 1996 SC 323, 329) held that: Court give effect to a family settlement upon the broad and general ground that it s object is to settle existing or future disputes regarding property amongst members of a family. The word family in this context is not to be understood in the narrow sense of being a group of person who are recongnised in law as having a right of succession or having a claim to a share in the property in dispute. -- CIT vs. Sea Rock Investment Pvt. Ltd. (317 ITR 253, Kar.) -- Pannalal Silk Mills Pvt. Ltd. vs. DCIT (44 ITD 458,Bom.) -- Kusumben Kantilal Shah vs. ITO (56 ITD 476, Ahd.) 9

10 ANTECEDENT TITLE, CLAIM OR INTEREST EVEN A POSSIBLE CLAIM Kale vs. Deputy Director of Consolidation (AIR 1976 SC 807) CED vs. Chandra Kala Garg (148 ITR 737, All.) Chunni Lal died in 1962 S.D.Garg (son) Chandra Kala S1 S2 Garg (wife) CIT vs. R. Ponnammal (164 ITR 706, Mad.) 10

11 WHETHER THE FAMILY ARRANGEMENT AMOUNTS TO A TRANSFER Hiran Bibi vs. Sohan Bibi (AIR 1914 PC 44) Sahu Madho Das vs. Mukund Ram (AIR 1955 SC 481) Ram Charan Das vs. Giraj Nandini Devi (AIR 1966 SC 323 at 329) Roshan Singh vs. Zile Singh (AIR 1988 SC 881) Kay Arr Enterprises vs. JCIT (99 TTJ 411, Chennai). Approved by the Madras High Court in 299 ITR 348. The assessee firm and the members of the family of Shri K. Rajgopal transferred shares of M/s.Lakshmi Mils Ltd. and M/s. Lakshmi Card Clothing Mfg. Co. Ltd. in favour of Shri G.K. Sundaram and Shri Narayanaswamy and the members of their families. The members of the families of Shri G.K. Sundaram and Shri Narayanaswamy transferred shares of M/s. Vijayeshwari Textile Mills Ltd. in favour of Shri K. Rajgopal and the members of his family. 11

12 WHETHER THE FAMILY ARRANGEMENT AMOUNTS TO A TRANSFER Continued Mrs. P. Sheela vs. Income-tax Officer (120 ITD 159, Bang.) Definition of the term transfer prior to its amendment by the Finance Act, 1987, w.e.f Insertion of the clauses (v) and (vi) to section 2(47) w.e.f Insertion of section 45(4) w.e.f CIT vs. A.N.Naik Associates (265 ITR 346, Bom.) Contrary decision of the Appellate Tribunal in the case of ACIT vs. Goyal Dresses (126 ITD 131, Chennai). After referring to the decision of the Bombay High Court in A.N.Naik Associates (supra), the Tribunal adopted the favourable view of the Kerala High Court in CIT vs. Kunnamkulam Mill Board (257 ITR 544) where the Court held that section 45(4) is not attracted in the case of retirement. The Tribunal also relied on the decision of the Madras Bench of the Tribunal in DCIT vs. G.K. Enterprises (131 Taxman 181) 12

13 CONCLUSION In a case of bone fide family arrangement which complies with the essentials of the family arrangement fully in letters and spirit, would not amount to transfer of a property as it amounts to mutual adjustment of rights among the members of the family. However as held by the Bombay High Court if a property of the firm is given to the retiring partner section 45(4) gets attracted as it deems transfer of a property to the retiring partner. A company is a legal entity and therefore, it cannot be a party to the family arrangement and hence the property of the company cannot be distributed pursuant to the family arrangement. 13

14 Cost of acquisition and the period of holding of the property in the hands of receiving member at the time of its sale CIT vs. Shanti Chandran (241 ITR 371, Mad.) The Madras High Court held that the family arrangement is analogous to partition and therefore, as provided in section 49 the cost of acquisition in the hands of the assessee is the cost incurred by the previous owner. Followed in ACIT vs. Baldev Raj Charla (121 TTJ 366, Delhi) Applicability of Clubbing provisions u/s. 64(1) Under the valid family arrangement there is no transfer as every one receives the property pursuant to antecedent title in the properties considered in the family arrangement and therefore, the clubbing provisions are not applicable. 14

15 Valid Family Arrangement does not give rise to gift u/s.2(xii) and 4(1) of the Gift-tax Act or taxable u/s. 4(1) of the Wealth-tax Act CGT vs. D. Nagrirathnam (266 ITR 342, Mad.) CWT vs. Santokh Singh (252 ITR 707, Del.) In the case of Banarasi Lal Aggarwal vs. CGT (230 ITR 114, P&H) the Court held the interest free loan given by the wife and sons to the assessee do not give them interest in the property and there was no antecedent title, claim or interest of the wife and sons in the property and hence the 3/4 th share given by the assessee to the wife and sons would amount to gift. 15

16 REGISTRATION OF THE FAMILY ARRANGEMENT AGREEMENT Section 17(1)(b) of the Registration Act,1908, lays down that a document for which registration is compulsory should by its own force, operate or purport to create, declare, assign, limit or extinguish either in present or in future any right, title or interest in an immovable property. Kale vs. Deputy Director of Consolidation (AIR 1976 SC 807) 16

17 NOMINATION Meaning Role of the nominee Appointment of minor as Nominee Nomination by Joint Account Holder Supreme Court decision in the case of Smt. Sarbati Devi & Anr. vs. Smt. Usha Devi (AIR 1984 SC 346) Latest decision of the Bombay High Court in the case of Harsha Nitin Kokate vs. The Saraswat Co-operative Bank Ltd. & Ors. [(2010) 5 Taxmann.com 43, Bom.] 17

18 Latest decision of the Supreme Court dated 15 th November, Nominee of bank account does not get succession rights The Supreme Court (SC) has clarified that the nominee of a depositor in a bank does not get ownership of the money in the account after death of the depositor. The nominee gets exclusive right to receive the money lying in the account. The money in the account will form part of the estate of the deceased depositor and devolve according to the rules of succession. In this case, Ram Chander vs Devender Kumar, one son was the nominee of his mother. After her death, he claimed he was the owner of the money in the account, to exclusion of his brother. The same rule will apply to government savings and other investments. 18