24 March 2015 EY Tax Alert Mumbai Tribunal rules on legality and taxability of certain gift transactions by corporates Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Mumbai Income Tax Appellate Tribunal (Tribunal), in the case of KDA Enterprises Pvt. Ltd. [1] (Taxpayer), on the issue of possibility of an Indian company making a transaction of a gift and the tax consequences in the hands of the recipient Taxpayer. In this case, the Taxpayer received, as gift from four companies (Donors), their entitlement to receive dividends from Reliance Industries Ltd. (RIL). The Tribunal agreed that the governing Indian laws regulating corporate entities and the transaction under consideration recognize that a valid gift transaction can be entered into between two Indian corporate entities. Furthermore, the provisions of the Indian Tax Laws (ITL) subject only receipts in the nature of income to tax, unless expressly provided otherwise in the ITL. Therefore, the amount of gift so received by the Taxpayer, being a capital receipt, is not taxable under any provisions of the ITL, as no specific provisions are present in the ITL to tax the same. [1] ITA No. 2662/M/2013
Facts of the case Taxpayer The Taxpayer was a company engaged in the business of investment. During the tax year under consideration, the Donors, which were shareholders of RIL, gave irrevocable instruction to RIL to pay dividend directly to the Taxpayer. There was no consideration flowing from the Taxpayer to the Donors for the same. The dividends received from RIL were credited to capital reserve account in the books of the Taxpayer, on the basis that such gift was in the nature of capital receipt and, hence, not required to be credited to the P&L account. This view was also accepted by the statutory auditors of the Taxpayer. Dividend RIL profit for the purpose of Minimum Alternate Tax (MAT). It was further submitted that a transfer of property made voluntarily and without consideration is a valid gift as per the Transfer of Property Act (TPA), even though the gift is between corporate entities. Additionally, since the parties were corporate entities, there was no requirement to satisfy the condition of natural love and affection amongst the parties. The Tax Authority included the amount of gift in the Taxpayer s total income and taxed the same as income from other sources. The Tax Authority also contended that the whole scheme was a camouflage to evade tax and to devoid the Government of its funds. Even if the alleged transaction was not taxed as income from other sources, it should be considered as unexplained cash credit and taxed accordingly. Gift Donors Aggrieved, the Taxpayer filed an appeal before the First Appellate Authority. The First Appellate Authority agreed with the Taxpayer. Aggrieved by the order of the First Appellate Authority, the Tax Authority filed an appeal before the Tribunal. The gift transaction was authorised by the Memorandum of Association (MoA) and Articles of Association (AoA) of the Taxpayer, as well as the Donors, and both the parties passed board resolutions for making/receiving such a gift. This receipt of gift was considered as not taxable by the Taxpayer, being in the nature of a capital receipt. The Tax Authority contested this view. The Taxpayer submitted that the gift transaction was a capital receipt which was made and received in accordance with the governing provisions of the Companies Act. Hence, no addition can be made in computing the total income of the Taxpayer on account of this receipt, either under the normal tax provisions or for arriving at the book Tribunal s ruling On the meaning of gift under the TPA The Tribunal held that the transaction of the gift is valid under the TPA as there is voluntary transfer of a moveable property without consideration. Furthermore, it noted that the provisions of the TPA allow corporates to transfer any property under a gift. On requirements of a valid gift The three essentials of a valid gift transaction i.e., delivery of the gift, donative intent of the Donors to gift and acceptance by the Taxpayer were duly fulfilled. This was evidenced by the receipt of dividend in the Taxpayer s bank account, the resolutions passed by the Donors indicating the intention to transfer the dividend from RIL and the
resolution passed by the Taxpayer for due acceptance of the gift. Furthermore, corporates are competent to make and receive gifts and natural love and affection are not necessary requirements. The only requirement for a company to make gifts is to have the requisite authorization in the MoA/AoA, which was satisfied in the present case. Additionally, the specific provisions present under the ITL, the TPA and the erstwhile Gift Tax Act do recognize the possibility of the gift transaction between corporate entities. On taxability of gifts under the ITL For a receipt to be taxable under the ITL, it must necessarily be in the nature of income or its taxation specifically provided for in the statute. Any other receipt that is not in the nature of income is not taxable under the ITL. Additionally, this income is taxable only if it falls under any of the specified heads of income. The gift transaction is not in the nature of salary or income from house property. The Taxpayer is also not engaged in the business of receiving gifts from corporate bodies, to be considered as income from business. It has no relation to capital asset to be considered as a capital gain for the Taxpayer. Only revenue receipts that are in the nature of income can be taxed under the residuary head of income from other sources. The gift transaction under consideration was treated as non-taxable capital receipt in the hands of the recipient Taxpayer. Though, presently, there is a provision for taxing gifts received by corporates, this provision is restricted to receipt of shares of an unlisted company for no or inadequate consideration. It does not cover the receipt under consideration in the present fact pattern, being capital receipt in nature. The Tribunal relied on the Supreme Court s (SC) decision in the cases of Padmaraje R. Kadambande [2] [2] [195 ITR 877 (SC)] and Groz-Beckert Saboo Ltd. [3], in arriving at this conclusion. The provisions under the ITL for taxing unexplained cash credits are applicable only where a taxpayer either offers no explanation or its explanation is unsatisfactory as to the identity of the donors, the donor s capacity/source of payment and the genuineness of the transaction. In the facts of the present case, there was no doubt on the identity of the Donors, their capacity to make a gift or explain the source of dividends. The Tax Authority s suspicion as to the dubious nature of transaction was contrary to the facts of the case, since the transaction was backed by the resolution of the boards of directors of the corporate entities involved, affidavits for making/receipt of gifts and authorization by the respective MoA/AoA of the parties to the transaction. Furthermore, as there was no common shareholding between the Taxpayer and the Donors, provisions to tax the receipt as deemed dividend could not be invoked. With respect to computation of book profit under MAT provisions, the Tribunal relied on the SC s decision in the case of Apollo Tyres Ltd. [4], where the SC held that the Tax Authority has to accept the authenticity of the books of account of a company, prepared as per the provisions of the Companies Act, scrutinized and certified by the statutory auditors, approved by the shareholders and filed before the Registrar of Companies. The Tax Authority has limited power to make adjustments to the book profit so computed. In the case of the Taxpayer, as the gift was not credited to the P&L account, no adjustment was required while determining book profits for the purpose of MAT computation. Furthermore, as the books of account of the Taxpayer were in conformity with the provisions of the Companies Act, the amount received as gifts cannot be added to the book profits computed for the purpose of MAT. [3] [116 ITR 125] [4] [255 ITR 273 (SC)]
Comments This well-reasoned decision of the Tribunal has expounded various principles for determining whether a gift transaction is valid. The Tribunal has referred to various laws governing gift transactions between corporate entities and has accepted that, for a valid gift, natural love and affection is not a prerequisite. The Tribunal has reiterated the principles explained by the Chennai Tribunal in the case of Redington (India) Ltd., [5] and has upheld that a gift between corporate entities is a valid and legal transaction. Furthermore, the Tribunal has reiterated the principle on taxability of income that every item of receipt is not, by default, taxable in the hands of the recipient. It has to first satisfy the requirement of being in the nature of income or be covered under a specific provision to tax the receipt under the provisions of the ITL. The Tribunal also reiterated the principles laid down in the SC s decision in the case of Apollo Types (supra) that the Tax Authority has no power to make adjustments to book profits computed for the purpose of MAT if the books of account are in conformity with the provisions of the Companies Act. [5] [TS-419-ITAT-2014(CHNY)] Refer EY Tax Alert dated 18 July 2014
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