India has witnessed family settlements or arrangement since ancient times – the only difference being that evolution of time enabled individuals to formalise such arrangements in a more organised and legitimate fashion. Halsbury’s Laws of England describes 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”.[1] Family arrangements are often recorded in writing as a memorandum capturing the terms agreed amongst the family members so that there are no issues left open and it resolves all disputes and disagreements amongst the members finally – as an aide-mémoire.
Unlike ordinary contracts which require “consideration” as an essential element for their validity, family arrangements do not entail any consideration in the strictest sense. Any consideration, if at all, would be the expectation that such a settlement would help in ensuring goodwill, harmony and peace amongst the family members.[2]
Analysing Family Arrangements
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Essential Elements
The essentials of a family arrangement were laid down by the Supreme Court of India in Kale v. Director of Consolidation[3] to include the following:
(a) Bona fide settlement.—The family arrangement should be bona fide to resolve family disputes and facilitate fair and equitable allotment of properties amongst the various members of the family.
(b) Voluntary settlement.—The settlement must not be induced by fraud, coercion or undue influence.
(c) Oral or written.—The family arrangements may be oral or written. No registration is necessary for an oral agreement.
(d) Registration.—Registration of family arrangement could be necessary only if the terms of the family arrangement are reduced into writing. A distinction should be made between a document containing the terms of a family arrangement and a mere memorandum prepared after the family arrangement for the purpose of the record. In such a case the memorandum itself does not create or extinguish any rights in immovable properties and therefore, not compulsorily registrable.[4] In a recent judgment by the Delhi High Court, the Judge pronounced that if an understanding has been arrived at between the parties and it is only written down in a document after the settlement has been arrived at, the same would not require registration.[5] The memorandum of family settlement involved in the instant case was held to not partition the properties itself but only record the same as an aid of memory.
(e) Antecedent title.—The members who may be parties to the family arrangement must have some antecedent title, claim or interest 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.
(f) Fair and equitable.—Even if bona fide disputes, present or possible, which may not involve legal claims are settled by a bona fide family arrangement which is fair and equitable the family arrangement is final and binding on the parties to the settlement.
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Tax implications
A family arrangement is not treated as conveyance or a transfer, rather as a realignment of pre-existing rights. Therefore, even though properties and assets are settled among the family members, it is typically not subject to taxation under capital gains in respect of gains derived by the members who are parties to the arrangement. On the other hand, in case the properties are sold and bought among the family members, it would amount to transfer and result in capital gains tax. In Govind Kumar Khemka v. CIT,[6] the tax payer received some assets on account of a family settlement, and the court held that this should not be treated as a commercial transaction given the absence of consideration. Similarly, in CIT v. Kay Arr Enterprises[7], rearrangement of shareholding in the company to avoid possible litigation among family members was considered as a prudent arrangement and not as “transfer” of shares exigible to capital gains tax. There could be various other elements relevant to this, and therefore, cogent and specialist tax advice should be obtained for a family settlement. Other than capital gains tax, which may lead to taxation in the hands of the transferor of assets, there are also certain other provisions governing taxation of assets received in the hands of the recipient of certain assets, and there are some exemptions specifically given under the relevant provisions which require analysis.
This gets even more complicated where assets are to be transferred between companies and bodies corporate as each has its own tax implications to consider and assess. Arguably, companies are non-family members, and the existence of the corporate veil begs the question whether a company can itself ask for lifting of corporate veil and claim that the transfer from the companies would come under the purview of family arrangement,[8] and can shareholders claim they have any right to a company’s assets before liquidation[9].
Thus, while a family arrangement is prima facie tax neutral, all of these issues require intricate fact-specific analysis, and not all of this is as straightforward as one would like to see.
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Implications on Public Listed Companies
Companies listed on stock exchanges may be managed and/or owned by families desirous of entering into a family settlement. In the event that such family settlement involves transfer of shares of such listed companies, disclosures under Securities and Exchange Board India (SEBI) Regulations come into play. Specifically, Regulation 30 read with Schedule III, Part A, Paragraph A(5) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mandates disclosures to stock exchanges in case of any family settlement agreement that impacts management and control of a listed entity. Similarly, transfer of substantial shares of a listed entity, albeit pursuant to a family settlement agreement, may trigger compliances and disclosure requirements under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 as well.
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Family Arrangements Generally
From a broader perspective, family arrangements entail lesser compliance requirements than commercial arrangements; nonetheless, there is often an impetus to divide and address each aspect of existence going forward. Therefore, one not only does divide assets and largesse, but also tends to address harmonious functioning of businesses going forward, including, through non-compete, non-solicit, confidentiality and brand usage agreements. Tax benefits and absence of long drawn court battles make family arrangements one of the best mediums to plan distribution of assets. Increasingly, more families with joint ownership of assets are pursuing this modus under expert advice and guidance to cleanly structure future co-existence, and also preserve and accelerate business growth in the interests of all stakeholders, including, employees, customers, etc.
† Partner, Khaitan & Co.
†† Partner, Khaitan & Co.
††† Associate, Khaitan & Co.
[1] Halsbury’s Laws of England (5th Edn.) Vol. 91 (2012), p. 623, para 903.
[2] CIT v. A.N. Naik Associates, 2003 SCC OnLine Bom 688 : (2004) 187 CTR 162.
[3] (1976) 3 SCC 119 : AIR 1976 SC 807.
[4] Ravinder Kaur Grewal v. Manjit Kaur, (2020) 9 SCC 706 : AIR 2020 SC 3799.
[5] Himani Walia v. Hemant Walia, 2022 SCC OnLine Del 893.
[6] 2019 SCC OnLine ITAT 2922.
[7] 2007 SCC OnLine Mad 1208 : (2008) 215 CTR 244.
[8] B.A. Mohota Textiles Traders (P) Ltd. v. CIT, 2017 SCC OnLine Bom 10116.
[9] CIT v. Sea Rock Investment Ltd., 2007 SCC OnLine Kar 654 : (2009) 317 ITR 253.