Capital gains tax implications on properties transferred under family arrangements/settlements

Capital gains tax implications on properties transferred under family arrangements/settlements

What is a family settlement and how does it impact your tax liability, with respect to the properties that are involved in the settlement? We explain…

Disputes, settlements and arrangements within a family over property, have been a part of human civilisation. The war of Mahabharat happened due to a family dispute over property, which could not be resolved by a settlement or arrangement that was agreeable to all the parties. As the size of a family grows, it is inevitable that some of the branches of the family may choose to part ways. Likewise, after the death of a father, disputes may arise, over the share of each family member. To resolve such disputes, either in the present or in future, families resort to some understanding to buy peace and retain goodwill.

What are family arrangements?

Halsbury’s Law of England defines 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.

While many family disputes reach the courts, a majority of the cases are resolved, with some settlement arrived at by and between the family members. In some cases, the family members may decide to arrive at an agreement for allocation and realignment of their rights, to settle a present or anticipated dispute, without having to take legal recourse. All such cases, where family members agree to change and realign their respective rights in various assets owned by the members, either through the courts or even outside it, are called family settlement/arrangements. The family settlement or arrangement need not necessarily be entered into in writing and can be agreed upon orally.

The term ‘family’, for the purpose of family arrangement/s is to be construed in a wider sense and the existence of a common tie or relation is considered enough, to treat a particular person as the member.

The existence of legal rights or succession rights to the family property, is not necessary for the purpose of arriving at a conclusion of a person being a member. The subject matter of the family settlement, can only be either a joint property or a common property. A self-acquired property cannot be part of a family arrangement.

Does a realignment of the rights among the members, amount to a transfer under the income tax laws?

Under the provisions of the income tax laws, whenever you transfer an asset, the profits made on such transfer are taxed as capital gains, unless you are a dealer in the asset, in which case, they are taxed as business income. Section 2(47) of the Income Tax Act defines a transfer exhaustively, covering the cases of sale, exchange and even relinquishment and extinguishment of rights in an asset. As a family settlement may involve the transfer of assets among the members, by way of realignment, a question may arise as to whether such transactions are covered under the definition of transfer and subject to capital gains tax.

The Income Tax Act does not define a family settlement, or specify the consequences of realignment of the rights of family members, over various properties. As cases of family settlements and family arrangements have been litigated in courts, we can get answers from the courts’ decisions.

Various judicial pronouncements have clearly held that the transfer of assets among the members of a family, for the purpose of settling an existing or even a perceived dispute, does not amount to a transfer as contemplated under the income tax laws. Thus, none of the members, who are transferring the assets standing in their names to other members, need to pay any capital gains tax on such transfers.

Court judgements on capital gains tax on family settlements

The Bombay High Court, in the case of BA Mohota Textile Traders Pvt Ltd vs DCIT, held that that no capital gains would be attracted in case of a family settlement, as there is no transfer. Likewise, in the case of the Commissioner of Income Tax vs AL Ramanathan, 1998, the Madras High Court ruled that the realignment of interest by way of family arrangements among the family members, cannot be construed a transfer and therefore, no liability of capital gains tax should arise in such cases.

Under a family arrangement, there is a settlement of shares in the property and distribution of rights of members and therefore, it cannot be construed as transfer under the tax statutes. If there is no transfer, there is no capital gains and thus, no capital gains tax can be levied on it.

Even in cases, where a member gets some of the assets under the family arrangement, without there being any property in his name, the transaction may still qualify as a family arrangement.

As decided in the case of CGT vs D Nagrirathinam (266-ITR-342, Mad), even the value of such property received by such a recipient, cannot be treated as a gift, as the transfer is still for a consideration, i.e., to buy peace in the family and preserve the goodwill of the family. As the arrangement made is not a transfer but merely a settlement to resolve the disputes, taxes are not levied on it. It was held that neither capital gains tax, nor gift tax was leviable on such arrangements. Indian courts have consistently held that a family arrangement, merely represents the modus operandi for working out the rights in the common property of various members of the family.

In the case of Roshan Singh vs Zile Singh (AIR 1988 SC 881), the Supreme Court held that the parties to a family arrangement set up competing claims to the properties and there was an adjustment of the rights of the parties. A family arrangement is intended to put to rest, competing claims among various members of the family, to secure peace and amity