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Introduction: Seeding and nurturing a business with one’s entrepreneurial acumen, skills, hard work, perseverance and capital to grow it into a big fruit-bearing tree with branches spread-out, is the hallmark of a successful businessman. But equally important is ensuring that the said tree (business) continues to grow and bear fruits for the future generations to come, without there being any feuds and disputes among the different branches. A ‘Family Arrangement’ is an important and quintessential instrument, which if effectively executed, can turn out to be a gamechanger in avoiding family feuds and also in saving substantial taxes.
Meaning of Family Arrangement:
The hon’ble Supreme Court in the decision of ‘Maturi Pullaiah v. Maturi Narasimham A.I.R. 1966 S.C. 1836’, has defined the ‘family arrangement’ as,
"A family arrangement is 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.
The agreement may be implied from a long course of dealing, but it is more usual to embody or to effectuate the agreement in a deed to which the term 'family arrangement' is applied."
Essential Features of a Legally Binding Family Arrangement:
Usually, for any proposition/recital (verbal or written) to have a binding force, it should ideally be executed in the form of a binding contract or a registered agreement. Similarly, for passing on the clean title of any immovable property, its registration is usually considered essential. However, these general conceptions do not hold good in the case of a “Family Arrangement”.
The essential pre-requisites of a legally binding “family arrangement/ family settlement agreement”, have been stipulated by the hon’ble Apex Court in the landmark judgement in the case of ‘Kale v. Deputy Director of Consolidation [1976] 3 SCC 119.
The hon’ble SC had held that for a ‘family arrangement’ to have a legal binding effect on the parties to the settlement, it should be bonafide, voluntary and aimed at resolving family disputes and rival claims. It may be oral, and registration is not required even if the terms and recitals of the family arrangement are spelled out in a memorandum prepared for the purpose of record or mutation in court, after the oral family arrangement had already been effected. The members of the family arrangement should ideally have some antecedent title, claim or interest in the property or even a possible claim in the property acknowledged by the parties to the settlement. However, even if a party has no antecedent title, but the other party relinquishes its claim or title in favour of such party, and acknowledges such party to be the sole owner, then antecedent title should be assumed in such cases. Fair and equitable family arrangement, even in the absence of any legal claims, is final and binding on the parties to the settlement.
Recent Real-Life Example of Family Arrangement:
The very recent Family Settlement Agreement (FSA) entered into on 30.4.2024, by the family members of the 127 years old giant business conglomerate - ‘Godrej’, is one of the finest examples of a meticulously planned and effectively executed family arrangement, aimed at ownership realignment of the respective shareholdings of the family members in the Godrej companies, to maintain harmony and to better align ownership in acknowledgement of the differing visions of the Godrej family members.
The Godrej family run business was seeded as a lock and key manufacturing company, and had been nurtured, mushroomed and diversified today into a big and well-established giant in the consumer goods, aerospace, aviation and real-estate industry segments.
According to the FSA, the first branch of the family tree, represented by Adi Godrej and Nadir Godrej and their immediate families, will gain complete ownership over the Godrej Industries Group (GIG), which includes the five listed companies- Godrej Industries, Godrej Consumer Products, Godrej Properties, Godrej Agrovet and Astec Lifesciences, along with their respective subsidiaries and joint ventures, with Nadir Godrej as the current Chairperson. Adi Godrej's son, Pirojsha Godrej will be the executive vice chairperson of GIG and will succeed Nadir Godrej as the chairperson in August 2026.
On the other hand, the second branch of the family tree, represented by Jamshed Godrej and his sister Smita Crishna with her daughter Nyrika Holkar and their immediate families, will gain complete ownership over the Godrej Enterprises Group (GEG) of companies- including unlisted entities- Godrej & Boyce Manufacturing Company, Godrej Holdings Private Limited and Godrej Infotech Limited and all of their respective subsidiaries and joint ventures, and RKNE Enterprises, along with the prime land bank of 3000 acres in Mumbai.
The two branches/groups have held shares and Board’s representation, across the group. But now pursuant the FSA entered on 30.4.2024, both the groups will divest their respective equity interests held by them in the opposite groups’ companies, in alignment with the above-mentioned family arrangement.
Adi Godrej and Nadir Godrej will divest their respective shareholdings in the Godrej & Boyce Manufacturing Company to Jamshed Godrej and Smita Crishna. Similarly, Jamshed Godrej and Smita Crishna will divest their respective shareholdings in Godrej Consumer Products and Godrej Properties to Adi Godrej and Nadir Godrej.
Understanding Tax Implications of Family Arrangement/ Family Settlement Agreement
The tax implications of a family arrangement/family settlement agreement are explained and summarised with the help of various case laws/judicial precedents as under:
(i) Not Taxable as Capital Gain in the hands of Individuals Members: The divestment of any property, movable (say shares) or immovable (say land and building), by the individual members/parties to the family arrangement/ family settlement agreement, in favour of the other members/ parties to the said settlement, as per the terms and recitals of a bonafide, voluntary and legally binding family arrangement/family settlement agreement, and fulfilling all the mandatory conditions, as stipulated by the hon’ble Supreme Court in the case of ‘Kale v. Deputy Director of Consolidation (supra), shall not be considered as “transfer” within the definition of the expression “transfer” in section 2(47) of the Income Tax Act, and as such, in the absence of any “transfer”, no gains or profits can arise on such divestment, in the hands of the person making such divestment, which could be considered to be taxable as capital gains u/s 45 of the Income Tax Act.
It is pertinent to mention here that the general exemption from capital gains in the case of Gifts, is applicable only in the hands of blood relatives. However, in the family arrangement, it is not necessary that the parties to such arrangement should be the members of the immediate family or only the lineal ascendents and descendants/blood relatives. The parties to such arrangement can be the members of the extended family also including cousins. Thus, exemption from capital gains tax liability, will equally apply to all the members of the family arrangement, and not just lineal ascendents and descendants.
Practical Demonstration in Godrej Group FSA:
Just for academic considerations, in order to practically demonstrate the applicability of the above discussed well-settled legal position, in the above Godrej group FSA, the divesture of their respective shareholdings by Adi Godrej and Nadir Godrej in the Godrej & Boyce Manufacturing Company in favour of Jamshed Godrej and Smita Crishna, is ideally not to be considered as “transfer” within the meaning of section 2(47) of the Income Tax Act, and as such no capital gain will arise in their hands, out of such divesture, subject to the fulfilment of the above-stated mandatory conditions of a legally binding family arrangement.
Similarly, the divesture of their respective shareholdings by Jamshed Godrej and Smita Crishna in Godrej Consumer Products and Godrej Properties in favour of Adi Godrej and Nadir Godrej, is ideally not to be considered as “transfer” within the meaning of section 2(47) of the Income Tax Act, and as such no capital gain will arise in their hands, out of such divesture, subject to the fulfilment of the above-stated mandatory conditions of a legally binding family arrangement.
Further, assuming if as per the terms of the FSA, Adi Godrej and Nadir Godrej relinquish their ownership rights in some of the land holdings of the 3000 acres primary land bank in Mumbai in favour of Jamshed Godrej and Smit Crishna, then the same will also not be considered as ‘transfer’ u/s 2(47) of the Income Tax Act, and as such will not be assessable to capital gain tax.
Recent Case Laws in support of this Proposition
(a) Sujan Azad Parikh v. DCIT [2022] 145 taxmann.com 167 (Mumbai-Trib.), dated 13.7.2022, wherein it has been held that where assessee along with other family members held shares in a business concern and assessee transferred said shares under a family arrangement as per direction of CLB, no capital gain tax was liable to be paid on said transaction even if assessee paid tax on same under mistaken belief that such transaction was taxable.
(b) Gonad Kumar Khemka v. ACIT reported at (2020) 207 TTJ (Del) 393
wherein the Hon'ble Delhi Tribunal has held that,
"The authorities below did not doubt the execution of the family settlement deed and it is not the case of the authorities below that assessee and his brothers have not acted upon the family settlement deed. It is well settled law that partition or family settlement is not a transfer. We rely upon judgment of Hon'ble Karnataka High Court in the case of CIT v. R. Nagaraja Rao (supra) in which it was held as under
"Partition or family settlement is not transfer. When there is no transfer there is no capital gain and consequently no tax on capital gain is liable to be paid.”
(ii) Taxable as Capital Gain in the hands of Corporate Entities/Parties to Family Arrangement:
Unlike, in the case of individual members, the divestment of any property, movable (say shares) or immovable (say land and building), by the corporate entities/ parties to the family arrangement/ family settlement agreement, in favour of the other members/ parties to the said settlement, shall be considered as “transfer” only within the definition of the expression “transfer” in section 2(47) of the Income Tax Act, and as such, the usual capital gain taxability provisions will be applicable in the hands of such corporate parties to the family arrangement.
Practical Demonstration in Godrej Group FSA
Thus, in the above Godrej FSA, if there happens to be any divestment of any shares owned by the corporate entities say Godrej Properties or the Godrej & Boyce Manufacturing Company Ltd, in favour of any of the individual members, then such divestment will not be excluded to be considered as a transfer and the regular capital gains taxability provisions will apply.
Recent Case Law in support of this Proposition
B.A. Mohota Textile Traders (P.) Ltd. V. DCIT [2017] 82 taxmann.com 397 (Bombay)
In this case, the hon’ble Bombay High Court has held that since the assessee was a separate legal entity being incorporated as limited company, transfer of shares by assessee-company even if pursuant to a family arrangement, would amount to transfer and would be covered within meaning of section 2(47) so as to be assessable to capital gain tax.
(iii) Non-Applicability of the Fair Market Valuation/Circle Rate legislative provisions of Sections 50C/ 50CA/56(2)(x), in the hands of individual members/parties to the family arrangement
Since the divestment of any property, movable (say shares) or immovable (say land and building), by the individual members/parties to the family arrangement/ family settlement agreement, in favour of the other members/ parties to the said settlement, as per the terms and recitals of a bonafide, voluntary and legally binding family arrangement/family settlement agreement, and fulfilling all the mandatory conditions, as stipulated by the hon’ble Supreme Court in the case of ‘Kale v. Deputy Director of Consolidation (supra), are not to be considered as “transfer” within the definition of the expression “transfer” in section 2(47) of the Income Tax Act, and as such are not assessable to capital gain tax, so the fair market valuation/ circle rate valuation requirement provisions of section 50C/50CA are also not applicable on such divestments, in the hands of the individual members. Similarly, the fair market valuation/ circle rate valuation requirement provisions of section 56(2)(x), are not applicable in the hands of the recipient individual members/ parties to the family arrangement.
Practical Demonstration in Godrej Group FSA:
Just for academic considerations, in order to practically demonstrate the applicability of the above discussed well-settled legal position, in the above Godrej group FSA, the fair market valuation/circle rate valuation provisions of section 50C/50CA/56(2)(x) are not to be considered as applicable on the divesture of their respective shareholdings by Adi Godrej and Nadir Godrej in the Godrej & Boyce Manufacturing Company in favour of Jamshed Godrej and Smita Crishna, subject to the fulfilment of the above-stated mandatory conditions of a legally binding family arrangement.
Similarly, the fair market valuation/circle rate valuation provisions of section 50C/50CA/56(2)(x) are not to be considered as applicable on the divesture of their respective shareholdings by Jamshed Godrej and Smita Crishna in Godrej Consumer Products and Godrej Properties in favour of Adi Godrej and Nadir Godrej, subject to the fulfilment of the above-stated mandatory conditions of a legally binding family arrangement.
Further, assuming if as per the terms of the FSA, Adi Godrej and Nadir Godrej relinquish their ownership rights in some of the land holdings of the 3000 acres primary land bank in Mumbai in favour of Jamshed Godrej and Smit Crishna, then the taxability provisions based on the circle rate valuation of such land holdings will not be applicable in the hands of Adi Godrej and Nadir Godrej u/s 50C of the Income Tax Act, neither it will be applicable u/s 56(2)(x) of the Income Tax Act in the hands of the recipients Jamshed Godrej and Smita Crishna.
Recent Case Law in support of this Proposition
(i) Govind Kumar Khemka v. ACIT [2020] 113 taxmann.com 5 (Delhi- Trib.)
(ii) DCIT v. Paras D. Gundecha [2015] 62 taxmann.com 170 (Mumbai-Trib.)
It is pertinent to mention here that the regular Fair Market Valuation/Circle Rate legislative provisions of Sections 50C/ 50CA/56(2)(x), are applicable in the hands of Corporate Parties to the family arrangement.
(iv) Non-Taxability as Deemed Dividend u/s 2(22)(e)
It is a settled legal position that where pursuant to family settlement, the individual parties to the family arrangement receive certain amount and assets from a company in which such individuals have substantial interest, provisions of section 2(22)(e) can’t not be applied to the amount so received.
Case Law
Reliance in this regard can be placed upon the decision of the hon’ble Chennai ITAT in the case of SKM Shree Shivkumar v. ACIT [2014] 48 taxmann.com 346 (Chennai-Trib.).
Concluding Remarks: Therefore, a carefully planned and meticulously drafted family settlement agreement, just like the recent Godrej Group FSA, can go a very long way in ensuring the fair, equitable and dispute-free distribution of the family business legacy, property and succession, and simultaneously, it can also save some big-big taxes.
[For any related queries, the author Sh. Mayank Mohanka, FCA can be reached at camayank@smmohanka.com]
This Article has also been published in Taxmann with the citation [2024] 162 taxmann.com 112 (Article)
