‘No Cap Gain Tax on Family Asset Transfer’

Capital gains tax cannot be levied on assets divided among family members after a family settlement, according to a recent judgment by the Karnataka High Court. The issue came up before the high court after an income-tax officer raised the demand for capital gains tax on the assets divided among the members of a family. The tax demand was raised on the ground that "transfer" of assets among family members had resulted in capital gains. The high court observed that the term "transfer" does not include partition of assets among family members. Adjustment of shares and crystallisation of respective rights on properties do take place within families but they cannot be construed as transfer of assets and capital gains cannot arise without transfer of assets, the court said. 

R Nagaraja Rao, the taxpayer who moved the high court, and Neelkanth Rao owned shares in the firms owned by the family. There was a dispute between the family members over the ownership of assets, which was resolved by an arbitrator. As part of the settlement, R Nagaraja Rao resigned from the partnership firm of Kaveri Breweries and transferred his interest to Neelkantha Rao, who, in turn, transferred his shares in the other family run companies to Nagaraja Rao. 

The income-tax department claimed tax had to be paid on the capital gains arising from the transfer of the assets. The commissioner of income-tax appeals confirmed the demand, but the Income-tax Appellate Tribunal (ITAT), the second appellate body for deciding tax issues, said division of assets was a family arrangement arrived at with the help of an arbitrator and, therefore, cannot be construed as transfer of assets for the purpose of levying capital gains tax. 

Citing the judgments of the Supreme Court and high courts, the division bench of the Karnataka High Court, comprising justices N Kumar and Ravi Malimath, said: "It is well settled that partition is not a transfer… Every member has an anterior title to the property, which is the subject matter of transaction, that is, partition or a family arrangement." When there is no transfer, there is no capital gain and, consequently, no tax on capital gain, the high court said.