Capital Gain in case of Family Settlement

The Madras High Court in a judgment reported as Palanikumar Pillai Vs. Palanikumar Pillai & others (1988) 1 LW 448 explained the scope of 'provision of owelty'. While referring to the Supreme Court judgment in Badri Narain Prasad Choudary & others Vs. Nil Rattan Sarkar (1978) 3 SCR 467, held to the following
effect:

"23..........A Court may also be confronted with a situation, namely, that the item of property is not capable of physical partition or is such that, if divided, it will lose its intrinsic worth, in such a case, that item is allotted to one and compensation in money value is given to the other and if such a course is not possible it is sold outright and the sale proceeds divided between the joint owners. All the aforesaid and similar other methods are adopted by Courts in making an equitable partition of the joint properties either with the consent of the parties or where such consent is not forthcoming in exercise of its own discretion.

Whatever method is adopted, it is only to implement the process of equitable partition. It would well-night be impossible for a Court to effectuate a partition on an equitable basis, if it should be held that it is under a legal obligation to divide every item of the joint property in specis. Where properties are susceptible of such division, the Court adopts it. Where it is not, it adopts one or other of the alternative methods narrated above. ............."

The Madras High Court in AL. Ramanathan's case (supra) returned a finding that an amount of Rs.8 lacs received in a family settlement to settle the disputes between the family is not subject to capital gain. It was observed as under:

"2. A perusal of the records goes to establish that dispute arose in that family and the family arrangement was arrived at in consultation with the panchayatdars and accordingly realignment of interest in several properties had resulted. The family arrangement was arrived at in order to avoid continuous friction and to maintain peace among the family members. The family arrangement is an agreement between the members of the same family intended be generally and reasonably for the benefit off the family either by compromising doubtful or disputed rights or by preserving the family property or the peace and security off the family by avoiding litigation or by saving its honour. So, the family arrangements are governed by principles which are not applicable to dealings between strangers and the family arrangement among them is for the interest of the family, for the harmonious way of living. So, such realignment of interest by way of effecting family arrangement among the family members would not amount to transfer."

In Kay Arr Enterprises case (supra), there was transfer of shares as also consideration in cash. The Court held that such rearrangement of shareholding in the Company is to avoid possible litigation among the family members and is prudent arrangement and such transfer of shares is not alienation. The Court held to the following effect:

"9. In the instant case also, the Tribunal found that the rearrangement of shareholdings in the company to avoid possible litigation among family members is a prudent arrangement which is necessary to control the company effectively by the major shareholders to produce better prospects and active supervision or otherwise there would be continuous friction and there would be no peace among the members of the family. Such a family arrangement intended 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 cannot be concluded as any other dealings between strangers, as such a family arrangement is for the interest of the family and for the harmonious way of living. Therefore, such a realignment of interest by way of effecting a family arrangement among the family members would not amount to transfer."

The Division Bench of Karnataka High Court in R.

Nagaraja Rao's case (supra) has held that partition is not a transfer and adjustment of shares, crystallization of the respective rights in the family properties cannot be construed as a transfer in the eye of law. When there is no transfer of asset, there is no capital gain and consequently there is no liability to pay tax on capital gains.