Gift of shares by a Company valid and not taxable prior to June 1, 2010

The Mumbai Income-tax Appellate Tribunal (“Tribunal”) in a recent decision^[1] has held that transfer of shares by way of gift between corporate entities may appear strange but cannot be treated as a non-genuine transaction.

The Tribunal has held that a corporate entity can validly gift property to another corporate entity and the absence of love and affection, a general presumption in a gift transaction, should not result in the gift transaction between two corporate entities to be characterized as a “non-genuine” transaction. 

The Tribunal treated the gift as a capital receipt not chargeable to tax under the head profits and gains from business or profession.  Further, in the absence of an explicit provision in the Income-tax Act, 1961 (“the Act”) for bringing such transactions to tax during the assessment year 2008 – 09, the Tribunal held that the gift was not chargeable to tax under the head Income from other sources (“IFOS”) as well. 

While there were certain other issues that were decided by the Tribunal, in this edition of BMR Edge, we have sought to analyze the decision of the Tribunal only in respect of the question involving the validity of a gift by a corporate entity and taxability of the same prior to the introduction of the provisions under Section 56(2)(viia)^[2] of the Act.  

Facts of the Case

·          M/s British India Steam Navigation Co (“BISNCL”), a United Kingdom (“UK”) based company was the owner of shares of M/s Hill Park Limited (“HPL”) by virtue of which it enjoyed the occupational rights of three residential flats at Mumbai. 

·          BISNCL transferred the shares of HPL to its group company, M/s DP World Private Ltd (“taxpayer”) under a gift deed. 

·          The market value for stamp duty purposes was INR 69.85 million and value adopted for wealth tax return by the taxpayer was INR 227.48 million. 

·          The Revenue Authorities (“RA”) on the premise that gift cannot be logically made by one artificial juridical entity to another because the basic condition of love and affection for making gifts is absent, held that the instant transaction was for business convenience.  The RA assessed the value adopted by the taxpayer for the purposes of its wealth tax return as IFOS in the hands of taxpayer.

·          Upon appeal to the First Appellate Authority, it was held that, since the taxpayer had business relations with BISNCL (ie donor), it received a benefit or a perquisite and the income was chargeable as business income^[3] as against IFOS.  Further, the amount to be charged as business income was held to be the stamp duty value of INR 69.85 million. 

·          Aggrieved by the order of the first appellate authority, the taxpayer and the RA filed cross appeals before the Tribunal.

Contentions of the taxpayer

·          The taxpayer argued that the instant transaction is a gift of shares and consequently a capital receipt not chargeable to tax.

Contentions of the Revenue

·          The RA relying on its basic argument that gift between corporate entities is not a genuine transaction and that the transaction though colored as a gift was made for business convenience and argued that the value adopted for wealth tax return purposes should be assessed as IFOS. 

·          Alternatively, the RA contended that the taxpayer had derived benefit from the transaction and such benefit had arisen from the business connection of the donor with the taxpayer.  Consequently, it was argued that the gift should be brought to tax as business income.

Ruling of the Tribunal

·          Before analyzing the taxability of the gift transaction in the hands of the taxpayer, the Tribunal considered the validity of the gift transaction between corporate entities.

·          The Tribunal examined the provisions of Section 47(iii) of the Act which exempts transfers under a gift, will or an irrevocable trust and its applicability in case of corporate re-organizations involving transfer of shares of an Indian company without consideration. 

·          Since the term “gift” has not been defined under the Act, the Tribunal referred to the definition of the term “gift” under the Gift Tax Act, 1958 (“the GTA”) and the Transfer of Property Act, 1882 (“the TPA”). 

·          The Tribunal observed that as per the GTA, the term “gift” was defined to mean transfer of movable as well as immovable property made voluntarily and for inadequate consideration between two persons.  Further, as per Section 5 read with Section 122 of the TPA, gifts could be made by one corporate entity to another corporate entity, voluntarily and without adequate consideration.  

·          Given that the GTA was abolished with effect from October 1, 1998, the Tribunal relied on the definition of “gift” under the TPA, and upheld the validity of gifts between corporate entities.  The Tribunal observed that presence of natural love and affection to exchange gifts was not a

pre-requisite under the TPA and thus a corporate entity could make valid gifts provided it is authorized by its Articles of Association (“AoA”).   In this context, the Tribunal also referred to Section 82 of the Companies Act, 1956 (“Companies Act”) which provides that shares in a company constitute movable property transferable in the manner provided in the AoA.  Given that the donor was a foreign company and Section 82 of the Companies Act would not apply to it, the Tribunal ascertained that the donor company was permitted by the relevant law and regulations applicable to it to transfer shares by way of gift. 

·          Having upheld the validity of gift transactions amongst corporate entities, in the context of taxability of aforesaid transaction, the Tribunal held that the instant transaction resulted in a capital receipt.   

·          On the contention of the RA that the gift arose due to the business connection between the parties, the Tribunal held that no tangible material was brought on record to justify the claim.  In the absence of any specific deeming provisions treating the gift as a deemed business income, the Tribunal held that the income cannot be brought to tax as business income.

·          With respect to taxability of the gift as IFOS, the Tribunal referred to the provisions of Section 56(2)(viia) and held that the said provision was brought into effect only from June 1, 2010 and since the subject transaction was undertaken prior to this date, the income resulting from the same was not chargeable to tax as IFOS